COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT Recent progress with building the internal electricity market

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT Recent progress with building the internal electricity market

I. Introduction

In Lisbon the European Council asked to speed up liberalisation in the electricity and gas sectors, with the aim of achieving a fully operational internal market in these areas. The European Council will assess progress achieved in this field in Stockholm in March 2001 on the basis of a report and proposals from the Commission.

Full opening of energy markets is a key factor in Europe's competitiveness. Electricity is the most important energy source in the European Union; the electricity industry is one of the biggest sectors of the economy in Europe, with production of some 2500 terawatt-hours [1] per year and annual turnover totalling around EUR 150 billion. The gradual introduction of competition in this sector has already produced a significant decrease in electricity prices over the last two years.

[1] Or 2500 billion kilowatt-hours.

At the same time, as a precondition for full liberalisation, it is necessary to maintain and raise standards of public service and to take into account the implications in terms of jobs in the industry.

As requested in Lisbon, the Commission will make proposals in the light of the results emerging from the Florence process to define specific measures to ensure smoother operation of the internal market. This Communication gives a brief analysis of the state of play and examines, notably on the basis of the latest results of the Florence process, the action to be taken by operators and the regulatory authorities, under the supervision of the Commission, to make the internal electricity market work smoothly.

II. State of play of the opening-up of electricity markets

All Member States, except Luxembourg [2], have now adopted national legislation implementing the provisions of the Directive concerning common rules for the internal market in electricity (Directive 96/92/EC). However, some Member States (France and Belgium) have yet to adopt the secondary legislation (implementing decrees) needed in order to apply the laws. The Commission will continue to ensure that the national implementations are compatible with the different provisions of the directive.

[2] According to the information available, Luxembourg will adopt the implementing law on 23./24. May 2000.

The Directive sets minimum targets for the opening of the market which correspond to 30% of the consumption in 2000 and 35% in 2003. This opens up the possibility for the biggest consumers to choose their suppliers freely. Many Member States are going beyond these requirements laid down by the Directive. As a result, implementation of the Directive has opened up two thirds of the consumer market for electricity in the EU (Annex I).

Also, where the Directive left Member States the choice between comparable mechanisms, most States have opted for the approach likely to create the most positive effects in terms of the functioning of the market. For instance, regulated third-party access, the authorisation procedure for new generating capacity, full legal unbundling of operation of the network from production/distribution and putting in place independent regulatory authorities are the options most Member States have chosen. These systems are the most appropriate to avoid discrimination against new market entrants.

As a result, one of the most visible effects, lower electricity prices, is becoming a reality (Annex II). Statistics on electricity price trends in the European Union from 1996 until 1999 show that prices have fallen by around 6% [3] on average and by up to 20% in some cases. All electricity consumers - households, small businesses and industry - are benefiting from this trend, which gained strength significantly in 1999.

[3] Simple arithmetical average. Source: Eurostat.

Cross-border trading, another key aspect of liberalisation, is also progressing: the total volume of trade in electricity is equivalent to around 8% of total electricity production in the Community.

These developments are encouraging, even compared with developments in other parts of the world such as the USA. The European Union is the region furthest ahead with turning the separate national sectors dominated by monopolies into an integrated regional market in electricity.

However, the final objective of a fully integrated market has not yet been achieved. Indeed, all market participants recognise that two issues must be re-examined in order to create a real internal market:

- Unbundling of operation of the network from production/distribution

Market access, in particular of new entrants, is only possible when access to the network is granted on the basis of fair and non-discriminatory rules. Experience shows that it is very much easier to achieve this goal when operation of the transmission and distribution systems (in practice, often by incumbent, vertically integrated companies) is unbundled from the other interests of the industry, in particular production and distribution/trading.

Member States must ensure that the commercial interests of the parent company are materially fully separate from the grid operation activities.

- Regulated third-party access

Experience so far has confirmed that the system of regulated third-party access on the basis of published prices is the method of access to the network most appropriate to avoid any discrimination. This system not only prevents discrimination, but also allows companies to plan their electricity purchases, knowing the tariffs in advance. By contrast, in the negotiated access system, the obligation to renegotiate prices and conditions of access each time the contract comes to an end places a burden on companies. Member States should therefore examine what measures are required to ensure that all third-party access is regulated in a transparent manner to exclude discrimination of any kind.

In conclusion, it should be underlined that the opening of the market provided for in the laws implementing the Directive is not enough to create a true single market in practice. In particular, the ultimate objective is a truly integrated market, not juxtaposition of fifteen more or less liberalised markets.

III. Measures and mechanisms to facilitate the functioning of the market

Non-discriminatory cross-border transmission pricing and an effective congestion management system are two essentials to give a decisive boost to developing a European energy market. The objective is quickly to achieve a simple, objective, transparent, non-discriminatory trading system reflecting costs in order to create a real internal energy market instead of fifteen liberalised but still overfragmented markets.

The so called "Florence process" was set up to facilitate this. It brings together in a forum representatives of the Commission, of the national administrations, of the Council of European Regulators and of the Association of European Transmission System Operators (ETSO). Producers, consumers and operators on the market, together with the European Parliament are also represented.

The aim of the forum is to prepare and facilitate decisions or proposals of a technical nature, for example on cross-border transmission pricing and congestion management, in an informal forum bringing together all stakeholders. The advantage of these technical measures is that they can be applied rapidly by the regulatory authorities in the Member States without waiting for a new directive.

1. Cross-border transmission pricing

The nature of electricity makes it particularly difficult to develop a pricing system which is transparent, objective and non-discriminatory and at the same time reflects costs. The physical flows of electricity do not coincide with the contractual relationship between the seller and the buyer: if a generator in northern Europe sells electricity to a consumer in southern Europe this does not mean that the electrons produced by the generator will in fact flow from north to south.

However, even if not clearly attributable to individual economic transactions, trade in electricity gives rise to physical flows between transmission systems. In some cases, electricity produced in country A will transit through the transmission system in country B on its way to the consumer in country C. It is therefore necessary to provide for compensation of the costs to the transmission system operators bearing such transit flows. This compensation must be charged to the operators of the systems from which the flows originate.

At its meeting in March 2000 the Florence process reached agreement between participants, in principle, on a provisional cross-border pricing mechanism, which marks a major step forward. This mechanism for compensation payments between system operators should apply initially for one year and come into force on 1 October 2000. On this date all existing national import and export charges will be withdrawn.

This system consists of the following components:

- Determination of the total costs incurred by all transmission system operators (TSO) attributable to cross-border flows of electricity (based on the volume of the physical flows measured over a given period): these total costs determine the "compensation fund" - the total available for compensation between TSOs for transit flows of electricity.

- Determination of the contributions to be made by each national TSO to the compensation fund, based on the outgoing physical flows minus the incoming physical flows (measured in the past): any operator which physically exports more electricity than it imports must contribute to the fund.

- Determination of the compensation to be received by each TSO, based on the transit flows (measured in the past).

From the contributions and compensation determined for each TSO, the list of net contributors and net beneficiaries is compiled.

The level of the cross-border transmission costs for which the compensation payments between system operators will be made will be determined, for a one-year trial period, from the provisional figures available from the Association of European Transmission System Operators (ETSO).

This provisional figure will have to be reassessed; the level of total compensation will determine the level of the real charges for cross-border trading. Exact calculation of this total is therefore extremely important for the development of trade in electricity. To this end, the Commission and national regulators will ensure that a method of calculating transit costs which fully reflects costs will be developed.

The methodology that will be used by each TSO to show the contributions made and compensation received under their national pricing system should, at least in the short term, be left to a certain extent to subsidiarity. Each operator will, therefore, determine the method best suited to its particular circumstances. This method will be subject to the approval of the national regulatory authority. However, the national methodologies will be forwarded to the Commission for approval prior to implementation. The Commission will verify that the potentially different approaches at Member State level lead to no distortion of the internal market.

Work must continue in order to produce a more fully developed system for sharing the costs between generators and consumers. The objective is to have the system in place by around October 2001. There is general agreement between all parties concerned that the ratio between generation [4] and consumer [5] charges needs to be harmonised to achieve a long-term stable solution of the cross-border pricing issue. The main reason for harmonising the relative level of the generation charges is the need to create a level playing field for all generators in terms of access to the European market using the network. On the basis of a proposal from the national regulators, the Commission will evaluate the progress made and, if necessary, make specific proposals by the end of 2000 in order to ensure timely implementation of a Community-wide approach.

[4] Known as G (or "Generation") charges in the terminology used by operators.

[5] Known as L (or "Load") charges.

2. Congestion management

Considerable progress has been achieved. As requested by the Council and in line with the conclusions of the last Florence Forum, ETSO has presented the results of its work on the following specific issues:

- available transfer capacity: ETSO will define the available interconnector capacity on a regular basis and will publish this data from spring 2000 on;

- information exchange between TSOs to ensure system security: an appropriate mechanism has been developed and is operational;

- new interconnector capacity: agreement has been reached to analyse existing bottlenecks in terms of interconnectors between systems. The Community has a key role in this respect to ensure that operation of the market is not hampered by physical constraints. To this end, it is necessary to prepare, after consultation of the Member States, a plan for interconnectors of European interest. Often the construction of new interconnector capacity poses no problem in terms of financing or profitability (the market is there) but is a question of striking a balance between local reservations about new infrastructure and the general interest;

- mechanisms to allocate available transfer capacity: allocation mechanisms based on non-discriminatory auctioning have been developed for specific congested lines, notably France-Spain and Germany-Denmark. The objective is to adopt common guidelines in this area, in the light of the experience gained.

IV. Complementary action

Smooth functioning of the internal electricity market will depend on solving a number of highly technical issues. However, these solutions must be complemented by more general measures to support smooth operation of the market.

1. Public service levels

Steps must be taken to ensure that the level of service within the electricity industry is not impaired by the liberalisation process. This principle is clearly in line with the spirit and letter of the Directive, which provides for measures to guarantee compliance with the essential rules for public service on a competitive market. These rules normally ensure that all citizens are entitled to electricity supplies at fair prices, sometimes provide special protection for the most vulnerable (the elderly and disabled) and protect the environment and security of supply. Experience so far shows that the quality of public services is unimpaired by the introduction of competition provided administrations or regulators impose specific conditions, for example for the issuing or retaining of a licence to sell electricity.

The Commission will submit a communication describing the measures taken by the Member States to protect consumers, with a view to the Stockholm European Council in March 2001. The information available will also be used for a benchmarking exercise to promote best practice. In conjunction with the Member States and other relevant parties, the Commission could make proposals for the policy guidelines to be followed to develop the public service.

Like the measures to reinforce the universal service in the telecommunications sector, the objective is to ensure the highest possible standards of public service throughout the Community.

2. Effects of liberalisation on employment

The process of opening the markets must take into account employment prospects in the industry. A comprehensive assessment must cover not only the restructuring or even job losses in the sector itself but also the positive effects on the economy and employment as a whole as a result of greater competitiveness and lower costs, particularly in energy-intensive industries.

The Commission has launched a study focusing, in particular, on experience in the countries furthest ahead with liberalisation. The results, expected by the summer, will make it possible to present an analysis of the principal trends and of the measures to be taken on quality.

3. Benchmarking

The Member States have opened up their electricity market further than required by the Directive. However, experience has shown that the degree of liberalisation provided for in the legislation is not necessarily matched by actual developments on the market. Therefore, the Commission, with the support of EUROSTAT, will develop indicators to assess the degree of true competition on the national markets as well as on the Community market as a whole. Also, a study will be launched in the next few weeks on the pricing systems applied by Member States for network access. The results will be available in time for the Stockholm European Council.

The aim is to obtain a complete picture of how the markets work and to spotlight best practice in the Community.

4. Imports/exports

In principle the trade agreements give non-EU countries the right to sell electricity in the European Union; some are already seeking to make use of it. Two items seem to be of particular importance in this respect:

- reciprocal access to markets;

- compliance with environmental standards.

One way forward would be to conclude regional or bilateral agreements, or a common interpretative declaration, as currently under preparation between Switzerland and the EU. Such agreements would be concluded between the EU and these countries to secure mutual market access on the basis of reciprocity and compliance with equivalent environmental standards. The Commission will propose a negotiating mandate in the next few months.

5. Technical assistance for applicant countries

The Commission has established an action plan to give all applicant countries the technical assistance they need in the transition to a competitive energy market. The applicant countries must align their legislation on the relevant EU directives. To assist them, the action plan puts the accent on the real needs for assistance on regulatory issues, drafting legislation, operation of the market and transmission system, establishment of national regulatory authorities, etc. Tailor-made action is being organised to smooth the transition process.

6. Electricity from renewable sources of energy

In 1997 the Commission submitted the White Paper on renewable energy sources which stressed the fundamental role which they play in security of supply and protection of the environment. The White Paper suggested an indicative objective of doubling the share of renewable energy resources in the energy balance of the European Union to 12% in 2010. Increasing use of electricity generated from renewable energy sources will make a major contribution to attaining this objective and meeting the commitments entered into by the European Union in Kyoto on reducing greenhouse gases. To meet the target of 12%, for example, it was considered necessary for the electricity sector to make a contribution by raising the share of renewable energy sources in total electricity consumption to 22.1%.

Therefore, a critical mass must be fostered on the market to make electricity generated from renewable sources of energy competitive enough to fit into the internal energy market.

The Commission has submitted a proposal for a directive with this aim for the Council meeting on 30 May 2000.

V. CONCLUSIONS

Certain progress has been made with implementation of the electricity market, both in terms of the degree to which it has been opened up and in the form of falling prices for industrial and domestic consumers.

However, if the Community is to reap the full benefits of a competitive, dynamic market, any further liberalisation needs to be both quantitative and qualitative in nature. It should lead to a situation where, in due course, all consumers have the right to choose their supplier.

In order to secure this right, fair access to the network must be guaranteed, through transparent and objective rules and non-discriminatory tariffs. At the same time standards of public service must be kept high and raised and the effects on employment and the environment must be taken into account.

The existing directive lays down the basic principles concerning the conditions, procedures and rate of liberalisation. However, complementary measures are essential, notably on the cross-border aspects and congestion management, before a real single electricity market can come into operation.

The Florence process was established to meet this need. Based on concertation between the players, it marks an original approach from the institutional and governance points of view. The Commission has involved the Member States and all the leading players in this process, while preserving each party's respective powers. In this way, the Florence process offers incontestable advantages in terms of efficiency and speed, bearing in mind the nature of the issues concerned.

For example, the March 2000 meeting of the Forum made tangible progress on cross-border pricing and market transparency. The Commission, in close collaboration with the national regulators, will ensure that the preliminary pricing mechanism scheduled in October 2000 meets the declared objectives, i.e. reflects costs, is objective and transparent and is non-discriminatory. This transitional system will lay the foundation for putting in place a stable, harmonised system.

The Commission is overseeing this work.

The latest results of the Florence process, notably on the principles for cross-border pricing, will be taken into account or adapted in the amendments to the Directive on the internal market in electricity which the Commission will submit in its communication for the Stockholm European Council. On the same occasion the Commission could make further proposals on the internal market in electricity, particularly for a significant and faster increase in the number of customers eligible, for greater unbundling of the operational and accounting sides and regulated third-party access.

Finally, as regards congestion and the lack of major interconnectors, the Commission plans to propose a mechanism for concertation between stakeholders with a view to defining a European plan for the major interconnector infrastructure still missing.

Annex 1 (Opening of the market by Member State)

Annex 2 (Price trends)

ANNEX 1

OPENING OF THE MARKET BY MEMBER STATE

>TABLE>

Note: When this table was drawn up Luxembourg had not yet implemented the Directive.

ANNEX 2

PRICE TRENDS 1996 - 1999 (current prices)

Excluding tax (Source: Eurostat)

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N.B: Aspects to be taken into account when interpreting this table:

- 1996 was chosen as the basis year to show developments as from the adoption of the Directive, the point in time the anticipation of liberalisation was likely to start being effective.

- Belgium, Greece and Ireland had an additional period, respectively of one year, of two years and of one year, for the transposition of the Directive. A priori, that should have delayed the impact on the prices.

- certain countries (e.g. the United Kingdom) had already started the liberalisation of their markets before the adoption of the Directive. Thus, the potential for price reductions has already been realised partly before 1996.

- in theory, the creation of an internal market will have as a result an alignment of the prices in Member States. Thus, there will be a differentiated tendency with regard to price reductions in certain Member States, dependent on the price level prevailing prior to the adoption of the Directive.

- certain Member States have immediately opened up their markets completely and, additionally, have set up electricity market places organised similar to stock exchanges. In the majority of these Member States the most important price reductions can be seen.