Communication from the Commission to the Council and the European Parliament - Prospects for the internal gas and electricity market
Date: 2007-01-10
Institutions: European Commission
Subjects: competition policy, electrical energy, gas, liberalisation of the market, report, single market

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 10.1.2007 
COM(2006) 841 final 

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND 
THE EUROPEAN PARLIAMENT 

Prospects for the internal gas and electricity market  

{SEC(2006) 1709} 
{SEC(2007) 12} 

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COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND 
THE EUROPEAN PARLIAMENT 

Prospects for the internal gas and electricity market  

1. 

EXPERIENCE TO DATE WITH THE INTERNAL ELECTRICITY AND GAS 
MARKETS 

1.1. 

Background 

A  competitive  internal  market  for  electricity  and  gas  has  been  progressively  implemented 
across  the  European  Union  since  1999-20001.  Since  then,  regular  annual  “benchmarking” 
reports  have  been  conducted  on  implementation  and  the  practical  results  of  the  Directives. 
During 2006, the Commission has continued to monitor implementation in particular through 
detailed  country  reviews  and  the  sector  inquiry.  This  monitoring  shows  that  some,  often 
uneven, progress has been achieved.  

On  the  one  hand,  during  this  time,  the  basic  concepts  of  the  internal  energy  market  have 
become  embedded  in  terms  of  the  legal  framework,  institutional  arrangements  and  the 
physical  infrastructure  such  as  IT  equipment.  However,  at  the  same  time  meaningful 
competition  does  not  exist  in  many  Member  States.  Often  customers  do  not  have  any  real 
possibility  of  opting  for  an  alternative  supplier.  Even  customers  who  have  successfully 
changed  supplier  are  often  not  satisfied  with  the  range  of  offers  they  receive.  In  summary, 
stakeholders  do  not  yet  have  a  high  degree  of  confidence  in  the  internal  market.  As  a 
consequence  of  these  shortcomings,  the  Commission  has,  throughout  2005-06,  been 
conducting an inquiry for the gas and electricity sectors under competition law. The results of 
this inquiry are published in tandem with this document2. 

1 

2 

Initially  through  Directive  96/92/EC  of  the  European  Parliament  and  of  the  Council  of  19  December 
1996  concerning  common  rules  for  the  internal  market  in  electricity  (OJ  L  27,  30.1.1997,  p.  1)  and 
Directive  98/30/EC  of  the  European  Parliament  and  of  the  Council  of  22  June  1998  concerning 
common rules for the internal market in natural gas (OJ L 204, 21.7.1998, p. 1); and subsequently via 
Directive (EC) 2003/54/EC of the European Parliament and of the Council of 26 June 2003 concerning 
common  rules  for  the  internal  market  in  electricity  and  repealing  Directive  96/92/EC  (OJ  L  176, 
15.7.2003, p. 37), Directive 2003/55/EC of the European Parliament and of the Council of 26 June 2003 
concerning common rules for the internal market in natural gas and repealing Directive 98/30/EC (OJ L 
176, 15.7.2003, p. 57), Regulation (EC) No 1228/2003 of the European Parliament and of the Council 
of 26 June 2003 on conditions for access to the network for cross-border exchanges in electricity (OJ 
L 176, 15.7.2003, p. 1), Regulation (EC) No 1775/05 of the European Parliament and of the Council of 
28  September  2005  on  conditions  for  access  to  the  natural  gas  transmission  network  (OJ  L 289, 
3.11.2005,  p.  1).  A  few  Member  States  had  already  taken  steps  towards  market  opening  before  these 
measures. 
Communication from the Commission, "Sector Enquiry under Article 17 of Regulation (EC) No 1/2003 
on he gas and electricity markets (Final Report)" - COM(2006) 851.  

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1.2. 

Positive results of competition 

Efficiency 

Liberalisation has clearly led to some efficiency improvements in energy supply and delivered 
savings to customers, particularly in the initial phase. However, recent increases in wholesale 
electricity and gas prices have, to a greater or lesser extent, fed through into the bills of end-
users and now offset some of the earlier reductions, particularly for the very largest industrial 
energy users. It would therefore appear that efficiency improvements are not being passed on 
to consumers quickly enough. It is highly questionable that gas and electricity prices are the 
result  of  a  truly  competitive  process  rather  than  being  the  direct  result  of  decision  of 
companies with market power.  

There  are  a  range  of  causes  for  higher  price  levels  including  higher  primary  fuel  costs,  the 
ongoing need for investment and the extension of environmental obligations, including the EC 
emissions trading scheme (ETS)3, as well as the development of renewable energy sources4. 
However,  a  continued  lack  of  competitive  pressure  and  high  levels  of  concentration  in 
wholesale markets has also been highlighted as well as a lack of market transparency.  

3  

4  

With  a  low  elasticity  of  demand,  the  power  sector  can  pass  on  the  opportunity  costs  of  allowances 
received  for  free  under  the  emissions  trading  scheme  to  electricity  prices.  Indeed,  empirical  and 
simulation model estimates for Germany and the Netherlands indicate that the share of CO2 costs which 
were  passed  on  to  consumers  ranges  from  60  to  100%  depending  on  market  and  technology  specific 
factors. Consequently, energy intensive industries covered by the ETS do not only face CO2 costs but 
also higher production costs due to higher electricity prices. 
See  the  Communication  from  the  Commission  of  7  December  2005,  The  support  of  electricity  from 
renewable  energy  sources  -  COM(2005)  627.  It  is  roughly  estimated  that  the  cost  of  the  renewable 
support systems as reflected in electricity prices is between 4% and 5% for e.g. Germany, Spain and the 
UK (p. 45). 

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Average5 EU-15 electricity and gas end customers prices since 1997 (at 1997 price levels) 

0
0
1
=
7
9
9
1

260

240

220

200

180

160

140

120

100

80

60

1997

1998 1999

2000

2001 2002

2003

2004 2005

2006

Electricity 

Gas

Coal

Crude oil

As shown in the graph above, the fact that retail electricity prices have, on average across all 
users,  remained  relatively  constant  in  real  terms  over  the  period,  despite  very  obvious  price 
increases in the cost of primary fuels, clearly demonstrates the effect of increasing efficiency 
in  electricity  supply.  The  electricity  price  in  particular  for  households  would  in  fact  have 
decreased  if  the  effects  of  taxation  were  excluded.  As  far  as  gas  is  concerned,  the  factors 
affecting  prices,  such  as  the  need  to  move  to  higher  cost  sources  of  supply,  for  example 
liquefied natural gas (LNG), and the continued linkage of some gas imports to the price of oil, 
would have occurred whether or not competition had been introduced. It must be recalled that 
energy  prices  cannot  be  expected  to  always  remain  low  regardless  of  external  factors.  The 
Commission  remarked  on  this  point  in  the  Communication  which  originally  proposed  the 
second  package  of  Directives6.  Competitive  and  open  markets  shall  however  bring  the  best 
prices to end users including to the energy intensive industry. 

Security of supply 

As well as improving efficiency, the internal market contributes strongly to the objectives of 
security  of  supply.  The  prospect  of  a  large  EU  market  for  electricity  and  gas  with  common 
rules is a strong incentive for new investment. In this context the latest generation adequacy 

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Weighted  average  of  large  industrial,  industrial,  commercial  and  household  prices.  Source:  Eurostat. 
The  evolution  of  prices  for  each  category  of  customers  can  be  found  in  Tables  3.7  and  3.8  of  the 
Commission  Staff  Working  Document:  EU  Energy  Policy  Data  -  SEC(2007)  12.  For  very  large 
customers, from a reference 100 in July 1997, prices have increased, in July 2006, to 121 for electricity 
and to 201 for gas. 
Communication  from  the  Commission  to  the  Council  and  the  European  Parliament  "Completing  the 
internal energy market" - COM(2001) 125, p. 8. 

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report of the system operators is revealing. It states that, even with growth in peak demand of 
1.5-2.0% per year, providing existing and planned investments are available in due time, there 
is an ongoing surplus of generation capacity over peak demand across the EU as a whole. In 
this  respect,  new  investment  is  clearly  responding  to  the  price  signals  in  wholesale  and 
balancing  markets  where  these  are  allowed  to  function  properly.  However  problems  are 
emerging  in  Member  States  with  tightly  controlled  prices,  where  there  is  dramatic  annual 
growth in electricity demand such as Spain and Portugal. 

Competitive  markets  also  encourage  diversification  since  flexibility  to  react  to  market 
conditions  is  encouraged.  An  integrated  market  also  provides  a  more  powerful  bargaining 
position for European energy companies when sourcing energy in global markets since there 
is a larger range of options available as regards supply routes and better access to customers. 
A considerable amount of investment in a diverse range of gas import infrastructure is either 
underway or being planned. This has all been delivered as a result of the liberalisation process 
and  further  improvement  to  security  of  supply  would  result  from  a  more  competitive 
framework. 

Security  of  supply  can  no  longer  be  considered  to  be  only  a  national  issue.  The  means  of 
addressing such issues cut across national boundaries and will be beyond the powers of any 
individual country. Specifically, the development and operation of Europe’s energy networks 
must, in the future, be conducted in much more co-ordinated way, at least on a regional basis, 
if future disruptions are to be avoided. This is not the case at present and the objective of a 
coherent and secure European network is far from a reality. 

The pan-European blackout of 4 November 2006 demonstrated the vulnerability of electricity 
supply in Europe. In its advice delivered at the request of the Commission on 20 December 
2006, ERGEG concluded that lessons from the 2003 Italian blackout have not been followed 
through, and that the following was needed to keep the lights on in Europe in the future7: 

•  Adoption,  on  proposal  of  the  European  Commission,  of  legally  binding  operational 

security rules; 

•  Development by the Commission of a framework for the electricity network as part of its 

energy strategy; 

•  Improvement  of  the  co-operation  between  EU  electricity  grid  operators  which  should  be 

publicly accountable for their actions. 

Sustainability 

Competitive markets render the supply of energy as efficient as possible and eliminate undue 
monopoly  profits.  A  competitive  market  also  allows  fair  access  to  customers  for  renewable 
producers  and  an  efficient  application  of  policy  instruments  such  as  the  emission  trading 
scheme  and  energy  taxation  in  order  to  improve  pricing  of  fossil  energy8.  Transparent  and 

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ERGEG  Interim  Report  on  the  lessons  to  be  learned  from  the  large  disturbance  in  European  power 
supply  on  4  November  2006,  Ref:  E06-BAG-01-05.  ERGEG  will  produce  a  final  report  by  February 
2007. 
In order to allow to reflect the environmental aspects of electricity production in taxation, according to 
the  Energy  Taxation  Directive  (Council  Directive  2003/96/EC  of  27  October  2003  restructuring  the 

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liquid  wholesale  markets  for  energy  also  give  much  clearer  signals  in  favour  of  energy 
efficiency. 

Additionally, clear and transparent rules for labelling of electricity spur demand for electricity 
with superior sustainability characteristics.  

1.3. 

Improper implementation of the current legal framework 

It is essential that the current European legislation must be properly transposed into national 
legislation to enable the markets to operate and to ensure that they are effectively opened up 
for  all  consumers  on  1 July  2007.  The  Commission  has  therefore  launched  34  infringement 
procedures  against  20  Member  States  for  violation  and  non  transposition  of  the  existing 
Directives. Following letters of formal notice sent in April 2006 and in advance, if needed, of 
starting  procedure  before  the  European  Court  of  Justice,  on  12  December  2006,  the 
Commission  decided  to  send  26  reasoned  opinions  to  16  Member  States  including  all  the 
biggest9. 

The main deficiencies observed in transposition of the new internal market directives are the 
following: 

•  Regulated prices preventing entry from new market players  

•  Insufficient  unbundling  of  transmission  and  distribution  system  operators  which  cannot 

guarantee their independence 

•  Discriminatory third party access to the network, in particular as regards preferential access 

being granted to incumbents for historical long term contracts 

•  Insufficient competences of the regulators 

•  No  information  given  to  the  Commission  on  public  service  obligations,  especially  as 

regards regulated supply tariffs 

•  Insufficient  indication  of  the  origin  of  electricity,  which  is  essential  in  particular  for  the 

promotion of renewable energy. 

The persistent nature of these infringements, almost two years and a half after the obligation 
to  transpose  the  directives  on  1  July  2004,  clearly  demonstrates  the  insufficiencies  and 
shortcomings of the current EC legal framework arising from the directives. Energy regulators 
are  not  granted  the  necessary  powers  and  independence  enabling  them  to  ensure  that  open 
markets  that  function  in  an  efficient  and  non  discriminatory  manner  are  put  into  place.  In 
addition, the existing legal framework does not allow for a proper and efficient regulation of 
the cross border issues relating to gas and electricity network access. The preferential access 
that is granted in a persisting manner to cross border interconnectors clearly demonstrates the 
shortcoming  of  the  current  rules.  Finally,  the  legal  and  functional  unbundling  of  network 

9 

Community framework for taxation of energy products and electricity - OJ L 283, 31.10.2003 p. 51), 
Member States can exempt from taxation electricity from renewable origin. 
See 
http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/06/481&format=HTML&aged=0&la
nguage=EN&guiLanguage=en 

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operators  that  are  vertically  integrated  with  production  and  supply  activities,  which  is 
provided  for  under  the  current  directives,  does  not  succeed  in  ensuring  equal  access  to  the 
networks for all suppliers.  

1.4. 

Obstacles to competition 

Although  the  above  results  need  to  be  recognised,  it  also  has  to  be  acknowledged  that  the 
European  Union  is  still  far  from  the  objective of  a  true  internal  energy  market  where  every 
EU  consumer  has  not  only  the  legal  right  on  paper  to  choose  his  or  her  electricity  and  gas 
supplier freely between any EU company, but that this is a real, effective and easily exercised 
right. Similarly, it is equally important that new entrants are able to invest in new generation 
and gas import capacity since incumbents, if not properly unbundled, are likely to gain from a 
position of artificial shortage.  

At present, the European Union is also far from being able to guarantee to any EU company 
the  right  to  sell  electricity  and  gas  in  any  Member  State  on  equal  terms  with  the  existing 
national companies, without discrimination or disadvantage. In particular, non-discriminatory 
network access and an equally effective level of regulatory supervision in each Member State 
do not yet exist.  

In addition, the European Union has not yet adequately addressed the challenge of investing 
in  the  right  level  of  new  infrastructure  based  on  a  common  stable  European  regulatory 
framework in support of the internal market. The necessary degree of co-ordination between 
national energy networks, in terms of technical standards, balancing rules, gas quality, contact 
regimes,  and  congestion  management  mechanisms,  which  are  necessary  to  permit  cross-
border trade to work effectively, is at present largely absent. 

Both the sector inquiry and the country reviews conducted by the Commission during 2006 
have  unearthed  a  variety  of  specific  examples  which  demonstrate  the  shortcomings  of  the 
existing regulatory framework as follows: 

•  Large  and/or  vertically  integrated  companies  are  at  a  considerable  advantage  in  terms  of 
the information which they are able to use to formulate their trading strategy. By contrast, 
smaller companies find out too late about, for example, generation outages, to be able to 
adjust their positions.  

•  In  some  cases  there  remains  confusion  within  the  vertically  integrated  group  about 
responsibility  for  the  basic  functions  of  the  transmission  system  operator  (TSO),  for 
example dispatch and balancing services. 

•  TSOs  have  often,  especially  when  vertically  integrated,  failed  to  create  conditions 
conducive to liquid competitive markets – for example by maintaining localised  separate 
balancing  zones  rather  than  facilitating  the  integration  at  national  and  cross  border  level. 
This may  be a  result  of a lack of trust between TSOs that are fully  unbundled  and  those 
that are not. 

•  TSOs  appear  to  have  been  slow  to  act  to  increase  cross  border  capacity,  either  through 
investment  or  other  means.  This  is  often  the  result  of  inadequate  incentives  provided 
through the regulatory framework.  

•  There  is  evidence  that  both  TSOs  and  regulators  tend  to  be  over-oriented  to  short  term 
national  concerns  rather  than  pro-actively  trying  to  develop  integrated  markets.  For 

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example,  congestion  has  been  in  some  countries  shifted  to  national  borders  and  cross 
border capacity is the first to be constrained. Some regulators have been slow to agree how 
to  implement  the  basic  provisions  already  contained  in  the  legislation  –  for  example, 
market based capacity allocation. 

•  On  many  issues,  certain  regulators  are  constrained  in  their  relations  with  the  industry, 
lacking  the  appropriate  powers  and  discretion.  This  is  particularly  the  case  for  subjects 
where,  in  the  Directives,  the  regulator  is  not  responsible  ex-ante  such  as  rules  for 
functional  unbundling,  non-tariff  access  conditions,  provision  of  information  to  network 
users and gas storage. 

•  Regulators  have,  on  occasion,  been  put  in  a  position  where  their  decisions  clearly  go 
against the objective of creating a single internal market for electricity and gas, usually due 
to  direct  or  indirect  influence  from  national  governments.  The  clearest,  although  not  the 
only, example of this is inappropriate regulated supply tariffs.  

•  Concentrated national markets have tended to encourage regulators to introduce intrusive 
regulation  into  wholesale  and  balancing  markets,  for  example  price  caps,  which  are  a 
strong  disincentive  to  invest.  At  the  same  time,  capacity  mechanisms  are  wholly 
uncoordinated, leading to potential distortions. 

•  Smaller  Member  States  have  often  struggled  to  introduce  meaningful  competition  in 
isolation from their neighbours and failed to allow the creation of liquid wholesale markets 
for  electricity  and  gas.  In  these  cases,  competition  will  not  be  possible  without  a  co-
ordinated regulatory approach between neighbouring jurisdictions. 

•  Finally, in many cases, distribution system operators (DSOs) appear to be poorly prepared 

for the opening of competition to households from July 2007. 

In  addition,  the  existing  regulatory  framework  has  given  rise  to  problems  in  the  field  of 
capital movements10. First, the existence of different levels of unbundling in various Member 
States creates asymmetric situations that distort competition among market players on an EU 
scale,  and  are  difficult  to  reconcile  with  the  EC  principle  of  free  movement  of  capital. 
Moreover, this puts at a disadvantage Member States having the higher level of unbundling. 
Secondly,  in  some  cases  where  cross-border  entry  has  taken  place  by  means  of  a  producer 
from  a  Member  State  taking  over  or  merging  with  a  company  in  another  Member  State, 
national  energy  regulators  have  intervened  arguing  that  an  authorisation  procedure  was 
necessary  to  guarantee  public  security  and  general  interest  objectives,  in  a  way  that  is  not 
justified under the free movement of capital principle11. 

As  a  result  of  these  widespread  shortcomings,  incumbent  electricity  and  gas  companies 
largely  maintain  their  dominant  positions  on  "their"  national  markets.  This  has  led  many 
Member States to retain tight control on the electricity and gas prices charged to end-users. 
Unfortunately  this  is  often  a  serious  constraint  on  competition.  Although  the  Commission 
recognises  that  dominance  requires  regulatory  action,  and  consumers  might  need  protection 
from  price  manipulation,  these  generalised  price  caps  are  preventing  the  internal  energy 

10 
11 

Under Article 56 EC Treaty.  
There  is  no  equivalent  to  the  "EU  passport"  in  financial  services  in  the  energy  sectors.  Each  MS 
regulator grants authorisations (e.g. the authorisation procedures for new power stations in Article 6 of 
the Electricity Directive 2003/54/EC). 

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market  from  functioning.  They  are  also  preventing  price  signals  demonstrating  where  new 
capacity is needed, and therefore, by discouraging investment, damage security of supply and 
will  lead  to  future  supply  crunches.  The  EU  cannot  allow  such  a  situation  to  develop.  An 
attempt to address problems in the wholesale market, indirectly, through controls on the retail 
market usually leads to foreclosure of both. This is not in the long term interests of customers. 

End user price controls amount to public service obligations which, if discriminatory, are not 
compatible  with  Article  3  of  the  Directives  which  imposes  PSOs  in  order  to  ensure  equal 
access  to  customers  for  all  companies.  Secondly,  if  compensation  payments  are  involved, 
these must comply with state aid rules. Thirdly, competition law may be relevant with respect 
to price discrimination and restrictions on re-sale. As indicated above, the Commission has 
already launched a number of infringements relating to regulated tariffs. It will continue 
to ensure that all such obligations comply with Community law.  

The  Commission  noted  these  ongoing  problems  with  the  electricity  and  gas  market  in  its 
report issued at the end of 200512. At the time, it was considered too early to draw definitive 
legislative conclusions. However, the Commission did commit itself to a number of actions. 
These have been delivered as follows: 

(1) 

(2) 

(3) 

(4) 

The  Commission  has  undertaken  detailed  country  reviews,  interviewing  market 
participants in each Member State, including smaller companies and new entrants13.  

Based  on  the  advice  of  the  European  Regulators  Group  for  Electricity  and  Gas 
(ERGEG),  the  guidelines  on  congestion  management  for  cross  border  electricity 
exchanges were adopted on 9 November and entered into force on 1 December 200614.  

ERGEG  has  launched  the  regional  initiatives  and  is  working  towards  removing 
barriers to market integration in the following areas: transparency, access to capacity, 
and the development of gas hubs. 

The Commission has completed the sector inquiry15. A number of investigations have 
been launched against companies in the electricity and gas sectors. 

The Commission has also pursued infringements to redress identified problems in the field of 
capital movements. 

The Commission now intends to take action to address the remaining issues in the following 
areas: 

•  Ensuring non-discriminatory access to well developed networks, 

•  Improving regulation of network access at national and EU level, 

•  Reducing the scope for unfair competition, 

12 
13 

14 
15 

COM(2005) 568. 
See  accompanying  document:  Commission  Staff  Working  Document,  Implementation  report  on 
electricity and gas EU regulatory framework: country reviews - SEC(2006) 1709. 
Decision 2006/770/EC. 
See the Communication from the Commission, "Sector Enquiry under Article 17 of Regulation (EC) No 
1/2003 on the gas and electricity markets (Final Report)" - COM(2006) 851. 

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•  Providing a clear framework for investment, 

•  Resolving issues relating to households and smaller commercial customers. 

Section 2 includes a summary of the Commission’s intentions. The legislation introduced in 
2003,  if  implemented  correctly,  contains  many  of  the  key  requirements  for  developing  a 
competitive European market such as full market opening, the introduction of regulated third 
party  access  and  the  obligation  to  create  a  regulatory  authority.  Some  strengthening  of  the 
existing provisions is, however, necessary. The Commission will propose these during 2007 
following a comprehensive impact assessment, including the evidence of the sector inquiry. 

2. 

KEY OUTSTANDING ISSUES 

2.1. 

Ensuring non-discriminatory access to networks through unbundling 

Legal unbundling of TSOs has already led to an improvement in third party access (TPA) to 
networks. Basic principles of non-discrimination have been established and, for the most part, 
tariff structures have been developed which encourage the development of competition. Cross 
subsidies  have  been  progressively  removed.  This  process  is  still  ongoing  for  distribution 
system operators, for which legal separation is not a requirement until July 2007. 

Although progress has been made since 2004, the evidence reported in Section 1 from both 
the  country  reviews  and  the  sector  inquiry  indicates  that  legal  and  functional  unbundling  as 
currently  required  by  the  legislation  is  not  sufficient  to  ensure  that  a  real  competitive 
European market for electricity and gas can develop.  

The problems  reported are not universal  and it  would be wrong to devalue the considerable 
efforts  that  have  been  made.  However  the  issues  regularly  brought  to  the  Commission’s 
attention constitute a major source of actual and potential distortion.  

Inherently, legal unbundling does not suppress the conflict of interest that stems from vertical 
integration,  with  the  risk  that  networks  are  seen  as  strategic  assets  serving  the  commercial 
interest of the  integrated entity, not the  overall interest of network customers. The evidence 
collected  within  both  the  sectoral  enquiry16  and  the  country  reviews  show  that  this  leads  in 
some cases to the following problems. 

First, non discriminatory access to information cannot be guaranteed. The information barriers 
put  in  place  under  the  current  unbundling  rules  cannot  guarantee  that  TSOs  do  not  release 
market sensitive information to the generation or supply business of the integrated company.  

Secondly, the current unbundling rules do not remove the incentives for discrimination with 
respect  to  third  party  access.  Incumbents  owning  the  networks  may  therefore  use  network 
assets to make entry of competitors more difficult. Discriminatory access conditions include 
connection  of  new  power  plants  for  new  entrants,  unequal  access  to  network  capacity 
(hoarding), maintenance of artificially small balancing zones, or not making available unused 
capacities. 

16  

Technical  Annex  to  the  Communication  from  the  Commission,  "Sector  Enquiry  under  Art  17  of 
Regulation (EC) No 1/2003 on the gas and electricity markets (Final Report)" - SEC(2006) 1724, from 
paragraphs 144 (gas) and 474 (electricity). 

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Thirdly, investment incentives are distorted. The vertically integrated network operators have 
no incentive to develop the network in the overall interest of the market with the consequence 
of  facilitating  new  entry  at  generation  or  supply  levels.  There  is  considerable  evidence  that 
investment  decisions  of  vertically  integrated  companies  are  biased  to  the  needs  of  supply 
affiliates17. Such companies seem particularly disinclined to increase, for example, gas import 
capacity in an open process which has, in some cases, led to security of supply problems. The 
same applies, in some cases, to the availability of connection capacity for new generation. 

The Commission has examined the unbundling issue closely and concluded that only strong 
unbundling provisions would be able to provide the right incentives for system operators to 
operate and develop the network in the interest of all users.  

It  is  therefore  considering  two  main  avenues  for  further  TSO  unbundling  measures,  with  a 
view to making formal proposals: 

•  fully (ownership) unbundled TSOs: the TSO would both own the transmission assets and 
operate  the  network.  It  would  be  independently  owned,  i.e.  supply/generation  companies 
could  no  longer  hold  a  significant  stake  in  the  TSOs.  Many  argue  that  the  difficult 
problems  described  above  will  only  be  solved  once  such  full  ownership  unbundling  is 
applied  to  TSOs.  This  would  indeed  have  a  number  of  advantages  as  follows.  Non 
discriminatory third party access to networks would be guaranteed and perceived as such, 
thereby  encouraging  investment  in  generation  and  gas  import  infrastructure.  TSOs  could 
also  more  easily  exchange  potentially  market  sensitive 
increasing 
effectiveness. Moreover, it would allow clear incentives to be provided to increase internal 
EU  infrastructure  capacity  since  investment  decisions  would  no  longer  be  distorted  by 
supply  interests.  Additionally,  it  would  facilitate  cross  border  mergers  of  transmission 
companies  which  would  allow  for  more  effective  management  of  cross  border  issues. 
Finally,  there  clearly  is  a  balance  between  the  level  of  unbundling  and  the  level  of 
regulatory supervision. Full ownership unbundling would reduce the need for increasingly 
burdensome regulation as the regulatory oversight could be less detailed to ensure that no 
discrimination  takes  place.  The  relatively  heavy  supervision  aiming  at  guaranteeing  the 
independence  of  the  vertically  integrated  TSOs  could  be  substantially  alleviated.  In 
addition,  considering  the  lower  regulatory  burden  that  would  result,  it  could  certainly  be 
implemented more easily and faster. 

information 

•  separate system operators without ownership unbundling: This solution would require 
separation of system operation from ownership of the assets. Supply/generation companies 
could  no  longer  hold  a  significant  stake  in  the  independent  system  operator  (ISO). 
However,  the  transmission  assets  themselves  could  remain  within  a  vertically  integrated 
group. The system operator would be solely responsible for operation and dispatch, being 
the  primary  interface  with  network  users,  and  would  exercise  control  over  network 
maintenance and development decisions. System operators would require sufficient funds 
and  personnel  not  employed  at  the  same  time  by  a  vertically  integrated  group.  The  ISO 
model would require detailed regulation and permanent regulatory monitoring. 

17 

See  the  national  sections  on  network  operator  and  unbundling  in  the  Commission  Staff  Working 
Document,  Implementation  report  on  electricity  and  gas EU  regulatory  framework:  country  reviews  - 
SEC(2006)  1709;  and  the  Technical  Annex  to  the  Communication  from  the  Commission,  "Sector 
Enquiry  under  Article  17  of  Regulation  (EC)  No  1/2003  on  the  gas  and  electricity  markets  (Final 
Report)" - SEC(2006) 1724, especially from paragraphs 157 (gas) and 487 (electricity). 

EN 

11 

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Economic  evidence  shows  that  ownership  unbundling is the most effective means to ensure 
choice  for  energy  users  and  encourage  investment.  This  is  because  separate  network 
companies  are  not  influenced  by  overlapping  supply/generation  interests  as  regards 
investment  decisions. 
  It  also  avoids  overly  detailed  and  complex  regulation  and 
disproportionate administrative burdens.  

The independent system operator approach would improve the status quo but would require 
more detailed, prescriptive and costly regulation and would be less effective in addressing the 
disincentives  to  invest  in  networks.  In  its  reply  to  the  Commission's  Green  Paper,  ERGEG 
also indicated that its preferred approach was ownership unbundling18. 

The Commission will examine both options closely with respect both to the electricity and gas 
networks taking account of the individual characteristics of each sector. The objective in both 
cases  will  be  to  ensure  fair  network  access  for  all  companies  and  ensure  that  sufficient 
incentives  are  in  place  for  TSOs  to  provide  adequate  capacity,  notably  through  new 
infrastructure.  

The unbundling solution chosen must be applicable to all operators and to all national markets 
in order to avoid inconsistencies between the national dimension of regulatory competences 
and the EU dimension of a single energy market19. It should be noted that a justifying element 
for any restrictive effect of the proposed options to the right of establishment and the freedom 
of capital movements could be found in imperative reasons of general interest (e.g. security of 
supply). Since ownership unbundling has already been introduced in 11 Member States, the 
Commission will further evaluate their experience in comparison with that of Member States 
having  introduced  legal  unbundling.  There  is  a  relation  between  unbundling  and  regulation. 
Markets in which there is less than ownership unbundling require more detailed, complex and 
prescriptive  regulation.  In  such  circumstances,  national  regulators  need  in  particular  more 
intrusive  and  burdensome  powers  to  prevent  discrimination.  However,  disincentives  to 
adequately  invest  in  networks  without  ownership  unbundling  can  not  in  any  event  be  fully 
addressed by regulators. 

2.2. 

Improve regulation of network access at national and EU level  

2.2.1.  Enhancing the role of national regulators 

The  2003  electricity  and  gas  Directives  introduced  a  requirement  for  Member  States  to 
establish regulators with specific competences. However, in many cases, experience suggests 
that the effectiveness of regulators is frequently constrained through a lack of independence 
from  government  and  sufficient  powers  and  discretion.  For  example,  the  country  reviews 
reveal that there are many issues for which regulators do not have discretionary and effective, 
ex-ante  powers,  such  as  establishing  rules  for  functional  unbundling  or  non-tariff  access 
conditions. In other cases regulatory duties are split between the specific regulatory authority 
and  the  ministry,  or  the  competition  authority.  The  country  reviews  confirm  that  where 
insufficient powers are given to national regulators, this leads to inconsistent decision making 
and inadequate compliance. This is confirmed by a separate consultant's report on regulatory 
competences,  which  concludes  that:  "there  remain  insufficiencies  in  respect  of  the  scope  of 

18  

19  

Council of European Energy  Regulators (CEER) response to the Energy Green Paper of 11 July 2006 
(C06-SEM-18-03). 
Under Article 26(1) of  the  electricity  Directive 2003/54/EC,  small  isolated systems  may  be granted  a 
derogation from unbundling rules. 

EN 

12 

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activities, available powers and regulators’ ability to exercise independent regulation" and that 
this  "causes  residual  problems  of  regulatory  asymmetry  and  in  some  cases  prevents  the 
appropriate development of competition"20. 

The  Commission  has,  therefore,  come  to  the  conclusion  that  energy  regulators  need  to  be 
strengthened at national level and have the required level of discretion to take decisions on all 
relevant  issues.  The  Commission  considers  that  regulators  need  strong  ex-ante  powers  over 
the following areas: i) all aspects of third party access to networks, ii) access to gas storage, 
iii)  balancing  mechanisms,  iv)  market  surveillance  of  e.g.  power  exchanges,  v)  compliance 
with functional and account unbundling for distribution system operators, vi) all cross border 
issues,  vii)  consumer  protection  including  any  end-user  price  controls  viii)  information 
gathering, 
intends  to  propose  a 
strengthening of the Directives on this basis.  

ix)  sanctions  for  non-compliance.  It  therefore 

It is also essential to ensure that decisions at national level do not have an adverse effect on 
the  aspects  most  critical  for  market  entry  and  the  evolution  towards  an  EC  internal  market, 
respectively  for  gas  and  electricity.  To  this  effect,  certain  individual  national  regulatory 
decisions,  in  particular  as  regards  cross  border  issues  and  the  effective  development  of 
competition, should be notified to the Commission. This structure is already used in relation 
to  exemptions  for  third  party  access  for  new  infrastructure  (under  Article  22  of  the  Gas 
Directive 2003/55/EC and Article 7 of the Electricity Regulation (EC) No 1228/2003) and in 
the  electronic  communication  sector  since  200321.  The  Commission  will  examine 
appropriate  criteria  under  which  other  such  decisions  would  require  notification  and 
Commission oversight22. 

2.2.2.  Co-ordination of regulators at EU level 

The  creation  of  an  integrated  EU  transmission  network23  implies  modifications  to  the 
regulatory  framework.  Removing  inconsistencies  in  investment  decisions  and  network 
operation has financial implications, including the allocation of costs and risk associated with 
increasing  capacity.  In  addition,  ongoing  problems  exist  in  relation  to  inconsistencies  at 
national  level  between,  for  example,  tariff  structures,  capacity  allocation  rules,  balancing 
arrangements  and  trading  timetables  and  security  of  supply  measures.  The  result  of  these 
differences  in  market  design  is  market  segmentation  with  even  some  national  markets 
remaining  split  into  different  local  “tariff”  or  “balancing”  areas,  which  act  against  the 
development of the internal market. This segmentation of the European market increases the 
effect of the dominance of a small number of suppliers and is damaging to security of supply.  

20 

21 

22 

23 

"Study of the Powers and Competencies of Energy and Transport Regulators" Europe Economics and 
TIS, October 2006". 
Directive 2002/21/EC of the European Parliament and of the Council of 7 March 2002 on a common 
regulatory framework for electronic communications networks and services (Framework Directive) (OJ 
L 108, 24.4.2002, p. 33, Article 7). 
The Commission considers that such supervisory powers would be necessary over the following areas: 
i)  exemptions  from  TPA  for  new  infrastructure,  ii)  regulation  of  end-user  prices,  iii)  all  decisions 
relating  to  cross  border  issues,  including  the  detailed  implementation  of  guidelines,  and  iv)  market 
dominance issues, particularly regarding the absence of adequate liquidity, including decisions relating 
to the treatment of existing transmission contracts. 
See 2.4 below. 

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Regulators  are  already  seeking  to  resolve  such  issues  through  ERGEG  and,  explicitly,  the 
regional  initiatives  for  electricity  and  gas24.  There  are  encouraging  signs  that  significant 
improvements  will  be  delivered  in  this  way.  However,  progress  is  dependent  on  all  the 
involved regulators agreeing on improvements, and having the necessary powers and duties. 
A  greater  impetus  is  therefore  required,  including  more  detailed  EU  co-ordination requiring 
increased  resources.  This  will  be  underlined  in  the  Commission  report  on  experience  with 
Regulation  (EC)  No  1228/2003  which  will  include  a  concrete  list  of  actions25.  Three  main 
configurations  might  be  considered,  embodying  the  necessary  delegations  of  powers  in 
compliance  with  the  EC  Treaty,  which  would  require  amendments  to  the  legislative 
framework, in particular as regards the second and third options. 

•  Gradually  evolving  the  current  approach:  reinforcing  collaboration  between  national 
regulators  by  notably  requiring  Member  States  to  give  national  regulators  a  Community 
objective,  and  introducing  a  mechanism  whereby  the  Commission  could  review  some 
decisions of national regulators which affect the internal energy market26. 

•   A European network of independent regulators (“ERGEG+”): Under this mechanism, 
the role of ERGEG will be formalised, and it would be given the task to structure binding 
decisions  for  regulators  and  relevant  market  players,  such  as  network  operators,  power 
exchanges  or  generators,  on  certain  precisely  defined  technical  issues  and  mechanisms 
relating  to  cross  border  issues.    It  would  need  the  appropriate  involvement  of  the 
Commission,  where  necessary,  to  ensure  that  due  account  was  taken  of  the  Community  
interest. 

•  A new, single body at Community level would be set up. It would in particular be granted 
the  responsibility  for  adopting  individual  decisions  for  the  EU  electricity  and  gas  market 
related  to  regulatory  and  technical  issues  relevant  to  making  cross  border  trade  work  in 
practice27.  

Of the three options, the Commission considers that the first, gradually developing the current 
approach,  would  not  be  sufficient,  notably  because  progress  would  continue  to  be  based  on 
voluntary  agreement  between  27  national  regulators  which  often  have  different  interests. 
Thus, the minimum approach likely to make rapid and effective progress in harmonising the 
technical issues necessary to make cross-border trade work effectively would be the ERGEG+ 
approach. 

24 

25 

26  

27 

ERGEG launched the Electricity Regional Initiative (ERI) on 27 February 2006, followed by the Gas 
Regional Initiative (GRI) on 25 April 2006. 
To  be  published  early  2007:  it  identifies  seven  areas  where  greater  regulatory  co-ordination  is 
potentially  needed,  only  some  of  which  are  fully  covered  in  the  Regulation:  a)  security  rules,  b)  grid 
connection  rules,  c)  rules  for  trading  electricity,  d)  transparency,  e)  balancing  and  settlement,  reserve 
power, f) data exchange, g) locational signals and investment incentives. 
As indicated above, this is based on the approach already used  in the electronic communication sector 
and in relation to exemptions for third party access for new gas and electricity infrastructure. 
Under the Draft Interinstitutional Agreement on the operating framework for the European regulatory 
agencies  [COM(2005)  59],  such  a  body  may  in  particular  be  entrusted  with  the  task  of  applying 
Community standards to specific cases, which includes the power to adopt individual decisions which 
are legally binding on third parties (Article 4). 

EN 

14 

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Given the importance of investment projects to bring gas to Europe’s borders, ERGEG would 
also be expected to play an important role in the dialogue with Europe’s international energy 
partners.  This  would  enable  a  strong  promotion  of  international  co-operation  at  regulatory 
level.  Collaboration  with  South  East  Europe,  Euro-Mediterranean  and  the  International 
Energy Regulation Network should all be continued and new avenues with Russia and others, 
such as e.g. an EU-US dialogue, could be explored. 

2.3. 

Reducing the scope for unfair competition 

As  repeatedly  identified  in  Commission  monitoring  reports,  and  as  further  explored  in  the 
sector  inquiry,  many  national  markets  are  characterised  by  high  levels  of  concentration  and 
consequent concerns about wholesale market manipulation. Both gas and electricity markets 
are susceptible to concentration due to the existence of pre-liberalisation monopolies and their 
natural characteristics.  

In particular, electricity is a product with low elasticity of demand, so that even with relatively 
high prices, customers do not reduce their consumption very significantly. This, the effects of 
congestion and the need for continual balance of supply and demand, increase the scope for 
market  dominance.  For  gas,  competition  difficulties  also  have  their  roots  in  the  structure  of 
the gas industry outside the EU as well as national production in Member States. 

These  problems  are  made  worse  due  to  the  national  scope  of  markets  and  the  lack  of 
integration. The improvements discussed in Sections 2.1 and 2.2 above would provide strong 
impetus to market integration and reduce such problems. 

In addition, over time and provided there is fair access to networks, new investment by non-
incumbents  will  also  contribute  to  eroding  concentration.  This  would  be  particularly 
encouraged if incumbents or TSOs were to publish a list of suitable electricity generation or 
gas storage sites, and adopt mechanisms for releasing such sites to new investors. In the short 
term, market participants have identified a range of other possible measures that would also 
assist the process of moving to more competitive and contestable electricity and gas markets 
and which relate to: a) transparency, b) contract structures and c) gas storage.  

2.3.1.  Transparency 

The problem of concentration is made worse where dominant companies are not required to 
reveal information to other market participants. For example, wholesale price movements are 
often caused by variations in production or the use of import capacity by the largest electricity 
and gas companies. If smaller market participants are unable to track the underlying causes of 
changes  in  market  price,  they  will  be  at  a  disadvantage.  A  higher  degree  of  transparency 
would also allow for improved market surveillance. ERGEG has already proposed guidelines 
on transparency and advised the Commission that these should be made legally binding.  

The  Commission  intends  therefore  to  introduce  binding  guidelines  for  transparency 
through  either  new  legislation  or  by  modifying  the  existing  electricity  Regulation  (EC) 
No  1228/2003.  It  also  intends  to  improve  the  transparency  requirements  for  gas  using 
Regulation (EC) No 1775/2005. In both cases the advice of ERGEG will be the starting 
point. 

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15 

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2.3.2.  Long term gas transmission and downstream contracts 

The  Commission  has  repeatedly  acknowledged  the  role  of  long-term  contracts  between 
external  producers  (i.e.  upstream)  and  companies  supplying  customers  in  the  European 
Union28. These long-term contracts reflect the need for upfront investments to be undertaken 
and have an important role to play as regards access to cost-effective energy inputs. However, 
such  agreements  are  often  extended  downstream  and  serve  to  foreclose  the  downstream 
market via priority transmission contracts and disproportionately long term supply contracts 
with  either  local  suppliers  or  directly  with  final  customers.  This  often  results  in  market 
foreclosure within the European Union. 

The gas Regulation already imposes strict use-it-or-lose-it conditions regarding transmission 
contracts. This includes contracts which were concluded under Directive 91/296/EEC on the 
transit  of  natural  gas  through  grids.  These  requirements,  when  combined  with  additional 
investment  in  gas  networks,  may  help  overcome  the  current  blockages  to  meaningful 
competition. Further development of use-it-or-lose-it guidelines would also help competition 
develop  more  rapidly.  The  Commission  will  strictly  monitor  compliance  with  the 
requirements  of  Regulation  (EC)  No  1775/2005.  It  will  further  develop  the  guidelines 
under  the  Regulation.  It  also  considers  that  any  regulatory  decisions  relating  to  such 
contracts  should  be  subject  to  Commission  scrutiny  under  the  arrangements  discussed 
in Section 2.2.1.  

2.3.3.  Access to gas storage facilities 

A  second  factor  affecting  competition  in  the  gas  sector  is  the  limited  availability  of  storage 
which  is  often  in  the  hands  of  the  incumbent  companies.  Although  storage  is  not  a  natural 
monopoly,  facilities  in  certain  locations  may  have  a  large  impact  on  the  functioning  of  the 
internal market. Voluntary guidelines for good practice for storage system operators (GPSSO) 
were  agreed  in  2004  but  the  findings  of  the  ERGEG  final  2006  report  on  monitoring  the 
implementation  of  the  guidelines29  showed  a  rather  disappointing  picture  in  terms  of 
compliance.  Similarly  the  sector  inquiry  highlighted  a  number  of  problems  in  this  respect. 
The  Commission  therefore  intends  to  examine  measures  which  would  best  balance  the 
need for effective access with maintaining incentives for new storage developments. This 
may need a specific regulatory framework requiring the following: a) legal unbundling, 
b)  the  adoption  of  binding  guidelines  following  further  advice  from  ERGEG,  and  c) 
increased powers of regulatory agencies over gas storage on an individual facility basis. 

2.4. 

Co-ordination between transmission system operators 

Gas and electricity needs to be able to flow freely across the European Union in accordance 
with compatible technical rules. This is essential not only to ensure a competitive market but 
also to guarantee security of supply. In order to achieve this, it is essential that TSOs make 
sufficient  transmission  capacity  available  to  meet  demand  and  integrate  national  markets 
without jeopardising the quality of supply. The network in the Member States was designed to 
fit  the  needs  of  many  partitioned  national  markets  not  those  of  a  single  European  one. 

28 

29 

See for example, consideration 25 of Directive 2003/55/EC or consideration 8 and 11 in combination 
with Articles 5 and 6 of Directive 2004/67/EC. 
Available 
http://www.ergeg.org/portal/page/portal/ERGEG_HOME/ERGEG_DOCS/ERGEG_DOCUMENTS_N
EW/GAS_FOCUS_GROUP 

at 

EN 

16 

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Increased  investment  in  the  network  with  a  pan  European  objective  is  therefore  strongly 
needed. It requires joint planning of system development and the allocation of the costs and 
risks of increasing cross-border interconnection. Furthermore,  as well as the construction of 
important  new  interconnections,  there  are  many  other  ways  in  which  TSOs  could  increase 
capacity. Replacement of major transformers for instance, installation of phase-shifters or, for 
gas, additional compression equipment, could also yield important additional capacity. Other 
enhancement  could  come  simply  from  more  regular  information  exchange  between  TSOs, 
operational techniques such as re-dispatch, improvement in congestion management practices 
such as the wider use of co-ordinated market coupling at the day ahead stage, as well as intra-
day  allocation.  All  such  measures  require  a  very  high  level  of  co-operation  and  a  clear 
regulatory framework.  

Similarly,  in  order  to  function  effectively  at  cross-border  level  in  a  secure  way,  TSOs  also 
need  to  have  agreed  detailed  inter-TSO  operational  standards.  This  requires  a  high  level  of 
technical  co-operation  between  TSOs  including  detailed  exchange  of  information,  both  in 
terms of long term network planning and on a real-time operational basis. From the point of 
view  of  network  users,  these  interoperability  issues  should  be  visible  to  the  least  possible 
extent.  

The experience of the Commission suggests that it is doubtful whether this can be achieved in 
the current framework where both TSOs and regulators are inclined or even obliged to follow 
a national focus. This is a key theme of the country reviews for several Member States.  

An  enhanced  level  of  TSO  co-ordination  would  require  a  new  legislative  framework  at  EC 
level.  Existing  associations  of  TSOs  would  be  granted  an  institutional  role  with  formal 
obligations  and  objectives  being  added  to  their  role30  (“ETSO+\GTE+  solution”31).  For 
example the TSO group may be required by the Commission or the regulators, in particular in 
view of ensuring security of supply, to report on European grid operation and investment as 
well  as  the  development  of  technical  standards  for  network  security  discussed  above. 
ETSO+\GTE+  could  be  granted  the  task  of  adopting  recommendations  on  precisely  defined 
technical  issues,  such  as  standards  and  operational  rules.  It  could  also,  in  particular,  be 
responsible  for  monitoring  the  developments  of  networks  so  as  to  improve  the  transmission 
capacities  between  Member  States.    ETSO+\GTE+  would  also  be  responsible  for  reviewing 
progress  with  infrastructure  investments,  for  example  on  a  rolling  two year  basis  as  well  as 
interacting with local populations affected by such investments. 

Efforts  should  also  be  made  to  have  a  gradual  evolution  towards  regional  system 
operators:  Cross  border  system  operators  would  be  set  up.  These  would  be  independently 
owned and would require additional unbundling as discussed above.  

2.5. 

Providing  a  clear  framework  for  investment  in  generation  plant  /  gas  import 
and transmission infrastructure 

Initial concerns relating to the incentives for building of new plant and gas infrastructure in a 
competitive framework were prompted by experiences with the introduction of competition in 
other parts of the world. However it was quickly apparent that these were the result of some, 

30  

31 

This could take the form of a consultative group to be established by the Commission or of a voluntary 
agreement under co-regulation. 
ETSO,  the  European  Transmission  System  Operators,  and  GTE,  Gas  Transmission  Europe,  are  the 
associations of the European electricity and gas network operators. 

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17 

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now  obvious,  design  faults  in  the  trading  arrangements  as  well  as  possible  market 
manipulation  by  certain  market  participants.  The  2003  Directives  contained  safeguards  to 
avoid such problems and the gas and electricity Directives on security of supply have further 
strengthened this aspect32. As we have seen from the development of competitive frameworks 
at national level, moreover, increased regulatory certainty at EU level will act as a significant 
magnet  to  further  investment  and  help  deliver  security  of  supply.  Creating  a  stable  and 
attractive environment for investment must be a priority of future action at EU level. In this 
regard, improvements to the regulatory framework are also necessary to ensure coherence and 
deliver regulatory certainty, which requires further change as described in Section 2.2.  

Beyond this, it should be emphasised that, in the energy sector as in other sectors, creating a 
framework  necessary  to  increase  investment  in  R&D  and  innovation  should  be  a  priority  at 
EU and Member States levels. Trends in RTD investments in the energy sector will be closely 
followed.  

2.5.1. 

Investments in electricity generation and infrastructure 

Considerable  investment  is  needed  to  replace  Europe’s  aging  power  plants  and  this  is  now 
coming  forward  on  a  competitive  basis  in  response  to  current  price  levels.  Problems  which 
have  arisen  in  certain  Member  States  are  –  if  not  associated  with  inadequate  unbundling  –  
largely  the  result  of  inappropriate  controls  over  prices  at  either  the  wholesale  or  retail  level 
and in those Member States which lack a liquid and reliable wholesale market. It is important 
to stress that the Directives give any company the right to invest in an electricity generation or 
gas import project. Although many projects are being developed by the large incumbents, this 
is not always the case.  

Potential  investors  do,  however,  need  up  to  date  information  on  short  and  medium  term 
developments in the market. The creation of the Office of the Energy Observatory , in charge 
of  the  collection  and  monitoring  of  the  essential  data  in  the  energy  sectors,  will  be  an 
important complementary measure to facilitate efficient new investments. Taking into account 
the electricity Directive on security of supply, the Commission will also establish a working 
group to monitor the investments needed in electricity generation and examine the investment 
framework  to  have  sufficient  capacities  being  created  in  Member  States.  There  are  several 
other  policies  that  also  serve  to  influence  investment  in  electricity  generation;  for  example, 
allocation  of  emission  certificates  or  the  effect  of  specific  incentives  to,  for  example, 
renewable generation. These wider issues cannot always be addressed in the framework of the 
Directives.  However  they  will  be  pursued  by  the  Commission  in  other  energy  policy  areas 
discussed in the Strategic Energy Review Action Plan. 

The  development  of  an  effective  electricity  infrastructure  is  also  supported  at  EC  level  in 
particular through the TEN-E Guidelines33. 

32 

33  

Council Directive 2004/67/EC of 26 April 2004 concerning measures to safeguard security of natural 
gas supply (OJ L 127, 29.4.2004, p. 92) and Directive 2005/89/EC of the European Parliament and of 
the  Council  of  18  January  2006  concerning  measures  to  safeguard  security  of  electricity  supply  and 
infrastructure investment (OJ L 33, 4.2.2006, p. 22). 
See the Communication from the Commission, "Priority Interconnection Plan" - COM(2006) 846. 

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2.5.2. 

Investments in gas import infrastructure 

Market signals have also brought forward a range of investment projects for bringing gas to 
the European market. The use of the exemption process under Article 22 of the gas Directive 
has been instrumental in some cases. In some cases an enhanced Community framework via 
involving ERGEG may be necessary, especially where many Member States are affected. As 
well  as  maintaining  the  existing  Commission  powers  over  such  exemptions,  the 
Commission also intends, to modify the gas Directive in order to provide a Community 
framework  under  the  mechanisms  discussed  in  Section  2.2.2  for  exemption  of  new 
pipelines  affecting  more  than  two  Member  States.  It  will  also  consider  producing  new 
guidelines for all exemptions which will give greater certainty to potential investors.  

2.6. 

Issues relating to households and smaller commercial customers  

From  2007  all  electricity  and  gas  customers  will  have  the  right  to  switch  supplier  from  the 
historical incumbent. There are a range of outstanding issues that need to be resolved in order 
for this final phase to be successfully realised. Country reviews suggest that there are several 
Member States where the preparation for full market opening in 2007 is not well advanced, 
while the sector inquiry has also confirmed significant obstacles at the distribution level. 

2.6.1.  DSO Unbundling 

Full  market  opening  requires  distribution  companies  to  ensure  fair  access  to  networks,  a 
workable  procedure  for  switching  and  confidentiality  in  data  handling.  However  the 
Commission’s country reviews and the sector inquiry reveal that this is often not yet the case. 
The  are  many  concerns  about  the  incidence  of  cross  subsidies,  discrimination  in  the  way 
information  is  handled  as  well  as  problems  with  switching  procedures  and  load  profiling, 
including the interaction with balancing rules.  

Many of these difficulties can be traced back to insufficient unbundling of network companies 
from supply businesses. Under the existing Directives, DSOs above the threshold of 100.000 
customers have the same unbundling regime as TSOs. Several Member States have failed to 
ensure  implementation  of  functional  unbundling  despite  the  fact  that  is  was  required  from 
2004. Legal unbundling of DSOs is required from July 2007. The Commission will continue 
actively to pursue Member States with insufficient rules for DSOs. 

Moreover,  some  market  participants  argue  that  the  existing  Directives  do  not  provide 
sufficient enforcement at Member State level. ERGEG has already set out a recommendation 
on  best  practice  for  supplier  switching  and  this  needs  to  be  enforced.  The  Commission 
therefore  intends  to  strengthen  the  powers  of  regulators  to  enforce  functional 
unbundling. 

Furthermore, DSOs with fewer than 100 000 customers are currently excluded from the basic 
unbundling  requirements  in  the  current  gas  and  electricity  Directives.  This  makes  it  rather 
unlikely,  without  very  strong  regulation,  that  other  potential  users  will  get  fair  access  to 
networks. The Commission will re-examine the suitability of the 100 000 threshold. 

2.6.2.  The Household Market Segment: Consumer Protection and Energy Poverty 

Experience  to  date  has  demonstrated  that  wholesale  energy  prices  exhibit  considerable 
volatility.  This  raises  the  question  of  whether  and  how  end-user  customers,  including 

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vulnerable  customers,  should  be  exposed  to  such  fluctuations.  The  gas  and  electricity 
Directives  require  safeguards  to  be  put  in  place  in  order  to  protect  consumers  as  well  as 
includes the concept of universal service for electricity. Finally, the annexes of the Directives 
require that consumers also have to be given rights to transparent contract structures, a dispute 
settlement mechanism, the right to switch free of charge and protection from mis-selling.  

Without energy, people cannot live in today’s economic and social environment. Electricity is 
essential  to  citizens’  daily  life.  It  also  often  impacts  on  the  availability  of  many  essential 
services.  Households  with  lower  income  spend  proportionally  more  on  energy  than 
households with higher income. Also, households in rural areas spend proportionally more on 
energy than those in urban areas. For the large majority of EU citizens, access to electricity 
supply services is satisfactory. This is evidenced by recent data coming from a Eurobarometer 
poll  and  a  consumer  satisfaction  study34.  The  average  score  of  consumer  satisfaction  at  EU 
level is 7.6 (on a scale from 1 to 10)35.  

The  Commission  considers  that  the  highest  possible  standards  of  public  service  must  exist 
across the EU. The changes taking place in the European energy market must fully protect the 
citizens’ rights to be supplied with enough electricity to meet their basic needs at reasonable, 
easily and clearly comparable and transparent prices. Special measures may also be taken to 
ensure  the  protection  of  the  most  vulnerable  citizens,  particularly  in  terms  of  fuel  poverty. 
Finally, the gas and electricity Directives provide for protection from unfair selling practices 
and  the  citizens’  right  to  have  the  necessary  information  to  choose  and  possibly  switch 
supplier.  

These  provisions  must  be  implemented  at  national  level  with  transparency  and  without 
discrimination.  They  must  not  impede  the  opening-up  of  the  energy  internal  market  to  the 
benefit  of  all  consumers  in  2007.  Well  targeted  universal  and  public  service  obligations 
(USOs  and  PSOs),  including  proportionate  price  regulation,  must  remain  an  integral  part  of 
the market opening process. Energy consumption is relatively inelastic. Consumers will often 
react  to  price  fluctuations  through  investment  in  new  equipment  that  will  help  reduce 
consumption.  Many  Member  States  have,  however,  retained  more  general  controls  on  retail 
supply tariffs. Although price controls prevent suitable price signals being given to customers 
about future costs, targeted price regulations may be needed to protect consumers in certain 
specific  circumstances,  for  instance  in  the  transition  period  towards  effective  competition. 
They must be balanced so as not to prevent market opening, create discriminations among EU 
energy suppliers, reinforce distortions of competition or restrict resale. 

Liberalisation  may  be  accompanied  by  aggressive  and  misleading  marketing  and  selling 
strategies  used  by  energy  companies  to  pressurize  consumers  to  switch.  The  Unfair 

34 

35 

2006 eurobarometer survey on consumer satisfaction on services of general interest (EU-25) and on 
IPSOS Consumer Satisfaction Survey 2006, to be published. 
Access to electricity is difficult for 4% of consumers. Almost all European citizens who have access to 
electricity effectively use it. Out of 72% of European consumers who have access to piped gas, 74% use 
it. Between 2004 and 2006, the affordability of electricity has remained relatively constant, except for 
Greece and Italy (upward trend) and for Malta (sharp decrease). 66% of European citizens say that 
prices of electricity services are affordable while for 16 % of them prices are not affordable and 15 % 
consider prices as excessive. Only a few consumers have lodged a complaint related to the provision of 
electricity and gas (6% for electricity and 5% for gas). On average, 62 % of EU consumers feel that 
their interests are well-protected. In some big countries (Germany, Italy and Spain) this share is lower 
than 50%. 

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Commercial  Practices  Directive  puts  in  place  a  robust  framework  for  addressing  these 
issues36.  

A  clear  picture  of  the  national  measures  that  Member  States  have  taken  to  transpose  the 
energy Directives with regard to consumer rules is not available. Existing data suggests that 
Member  States  have  made  rather  limited  use  of  targeted  PSOs  to  address  vulnerable 
customers. Indeed only half the Member States have even attempted to define this group and 
only  five  have  any  form  of  social  tariffs.  There  are  also  substantial  differences  in  terms  of 
compensation  for  supply  interruptions  –  only  8  Member  States  have  refund  systems  -  and 
codes of conduct for transparency of prices and contract conditions. 

The  Commission  will  therefore  assess  the  national  legislation  in  this  field,  its  impact  on 
operators as well as on households. In particular through the infringement procedures, it will 
provide guidance as to compliance of national measures with Community law. 

The Commission will also keep under constant review the retail markets to assess the effects 
of  liberalisation  on  households,  in  view  of  increasing  consumers’  confidence  in  the  energy 
market and limiting the risk of market manipulation. 

Finally, the Commission will launch a major information and awareness raising campaign in 
the run up to full market opening in July 2007, and intends to develop an Energy Customers' 
Charter to (i) tackle fuel poverty, (ii) improve the minimum level of information available to 
citizens to help them choose between suppliers and supply options (iii) reduce red tape when 
customers  change  supplier  and  (iv)  protect  customers  from  unfair  selling  practices  in 
compliance with the relevant EC directives. 

2.6.3.  Frequency of meter reading 

Some wholesale market issues can be traced back to an insufficient elasticity of demand. For 
example  wholesale  price  volatility  is  partly  caused  by  the  fact  that  smaller  customers  are 
insulated from wholesale price movements over the short term making wholesale prices more 
volatile.  Even  where  prices  are  totally  free  of  controls,  infrequent  measurement  of 
consumption prevents any kind of demand response from certain customers. 

The extended use of smart metering would enhance competition and other policy goals such 
as energy efficiency and security of supply, encouraging innovation in the provision of energy 
services. Smart meters are also good for consumers giving them more frequent readings and 
the  opportunity  to  modify  their  consumption  patterns.  Directive  2006/32/EC  on  energy  end 
use efficiency and energy services already provides for Member States to use smart metering 
to  achieve  energy  efficiency  targets.  The  Commission  will  examine  whether  further 
specific action is required in this area. 

36 

Directive 2005/29/EC of the European Parliament and of the Council of 11 May 2005 concerning unfair 
business-to-consumer  commercial  practices  in  the  internal  market  and  amending  Council  Directive 
84/450/EEC,  Directives  97/7/EC,  98/27/EC  and  2002/65/EC  of  the  European  Parliament  and  of  the 
Council  and  Regulation  (EC)  No  2006/2004  of  the  European  Parliament  and  of  the  Council  (‘Unfair 
Commercial Practices Directive’) (OJ L 149, 11.6.2005, p. 22), applicable as from 12 December 2007. 

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3 

CONCLUSIONS AND NEXT STEPS 

The  discussion  above  sets  out  the  main  Commission  conclusions  from  the  experience 
gathered  over  the  last  seven  years  in  putting  into  effect  a  competitive  European  market  for 
electricity and gas. This initiative has been a qualified success. While there are some positive 
results, the outcome of the sector inquiry and the country reviews have given the Commission 
a  substantial  insight  into  the  current  state  of  the  liberalisation  process,  which  has  shown, 
despite significant shortcomings, some progress and considerable further potential benefits. 

A  competitive  integrated  market  remains,  in  the  view  of  the  Commission,  the  only  way  to 
deliver a secure and sustainable energy future for Europe, based on a coherent electricity and 
gas  market  consisting  of  500  million  consumers,  all  operating  according  to  the  same 
competition and regulatory framework.  

The Commission believes that it is now time to consider its options for encouraging a further 
breakthrough which will be the final step towards fully functioning electricity and gas markets 
at European level, as presented in the Sections 2.1-2.6 above. 

The  Commission  has  already  initiated  an  impact  assessment  procedure  to  identify  the  most 
suitable methods for implementing these intentions in practice. It will conclude this exercise 
later  in  2007.  A  further  Communication  including  detailed  formal  proposals  to  the  Council 
and the European Parliament will be produced. 

The  Commission  calls  on  the  Council  and  European  Parliament  to  confirm  that  the  key 
objectives to be pursued in completing the internal energy market are those identified by the 
Commission  and  to  endorse  the  Commission's  intention  to  table  further  measures  to  ensure 
that they are achieved. 

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