Communication from the Commission - Inquiry pursuant to Article 17 of Regulation (EC) No 1/2003 into the European gas and electricity sectors (Final Report) {SEC(2006) 1724}
Date: 2007-01-10
Institutions: European Commission
Subjects: electrical energy, energy policy, gas, liberalisation of the market, report, single market

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 10.1.2007 
COM(2006) 851 final 

COMMUNICATION FROM THE COMMISSION 

Inquiry pursuant to Article 17 of Regulation (EC) No 1/2003 into the European gas and 
electricity sectors (Final Report) 

{SEC(2006) 1724} 

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COMMUNICATION FROM THE COMMISSION 

Inquiry pursuant to Article 17 of Regulation (EC) No 1/2003 into the European gas and 
electricity sectors (Final Report) 

1. 

1. 

2. 

3. 

INTRODUCTION 

Well  functioning  energy  markets  that  ensure  secure  energy  supplies  at  competitive 
prices are key for achieving growth and consumer welfare in the European Union. To 
achieve  this  objective  the  EU  decided  to  open  up  Europe’s  gas  and  electricity 
markets to competition and to create a single European energy market. The process 
of market opening has significantly changed the functioning of the markets, provided 
new  market  opportunities,  led  to  the  introduction  of  new  products  and  services. 
Competition  initially  lowered  energy  prices  in  Europe  in  line  with  market 
fundamentals.  

However, while progress has been made, the objectives of market opening have not 
yet been achieved. Despite the liberalisation of the internal energy market, barriers to 
free competition remain. Significant rises in gas and electricity wholesale prices that 
cannot  be  fully  explained  by  higher  primary  fuel  costs  and  environmental 
obligations,  persistent  complaints  about  entry  barriers  and  limited  possibilities  to 
exercise customer choice led the Commission to open an inquiry into the functioning 
of  the  European  gas  and  electricity  markets  in  June  2005.  This  inquiry,  based  on 
Article 17 of Regulation (EC) No 1/20031 on the implementation of the Treaty rules 
on  competition,  aimed  at  assessing  the  prevailing  competitive  conditions  and 
establishing  the  causes  of  the  perceived  market  malfunctioning.  The  Final  Report 
(Commission  Communication)  summarises  the  results  of  the  inquiry,  which  are 
presented in more detail in the Technical Annex2 to the Final Report. 

While  the  Sector  Inquiry  was  launched  amidst  perception  that  consumers  were  not 
reaping the full benefits of liberalisation, it should be underlined from the outset that 
it was not the object of the inquiry to describe the progress made in the liberalisation 
process and the advantages resulting from it. There are many such achievements and 
customers in markets where  liberalisation has  been  successfully  introduced  are still 
among those benefiting from the widest choice of suppliers and services. They also 
pay – compared to customers in other Member States – more cost-reflective prices on 
average. The Commission remains thus convinced that there is no alternative to the 
liberalisation  process.  It  is,  therefore,  essential  to  ensure  that  existing  liberalisation 

1 

2 

Council  Regulation  (EC)  No  1/2003  of  16  December  2002  on  the  implementation  of  the  rules  on 
competition laid down in Articles 81 and 82 of the Treaty (OJ L 1 of 4.1.2003, p. 1), as amended by 
Council Regulation (EC) No 411/2004 (OJ L 68 of 6.3.2004, p. 1). 
Commission staff working paper SEC(2006) 1724. 

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4. 

5. 

Directives  are  fully  and  effectively  transposed3.  However,  more  needs  to  be  done 
before consumers can reap the full benefit. 

The Energy Sector Inquiry has focused on identifying areas where competition is not 
yet functioning well and those areas which need to be addressed the most rapidly in 
order for liberalisation to bear fruit. For the purpose of the inquiry the key areas were 
grouped  under  the  following  headings:  (1)  market  concentration/market  power,  (2) 
vertical  foreclosure  (most  prominently  inadequate  unbundling  of  network  and 
supply),  (3)  lack  of  market  integration  (including  lack  of  regulatory  oversight  for 
cross  border  issues),  (4)  lack  of  transparency,  (5)  price  formation,  (6)  downstream 
markets, (7) balancing markets, and (8) liquefied natural gas (LNG).  

The  shortcomings  identified  in  these  key  areas  call  for  urgent  action  and  priority 
should  be  given  to  four  areas:  (1)  achieving  effective  unbundling  of  network  and 
supply  activities,  (2)  removing  the  regulatory  gaps  (in  particular  for  cross  border 
issues), (3) addressing market concentration and barriers to entry, and (4) increasing 
transparency  in  market  operations.  The  Commission's  intentions  concerning 
regulatory proposals to be made in this regard are set out in its  Communication on 
"Prospects for the internal gas and electricity market"4 which is presented in parallel 
to the Final Report. 

1.1. 

The wider context 

6. 

7. 

3 

4 

5 
6 

The introduction of competition in Europe’s gas and electricity markets is an integral 
part  of  European  energy  policy  which  is  directed  at  achieving  the  three  closely 
related  objectives  of:  a  competitive  and  efficient  energy  sector,  security  of  supply 
and  sustainability.  All  European  consumers,  i.e.  households,  commercial  users  and 
industrial  users,  heavily  depend  on  the  secure  and  reliable  provision  of  energy  at 
competitive prices. Also, the achievement of the Union’s goal of adequate protection 
of  the  environment  is  of  fundamental  importance  as  can  be  demonstrated  by  the 
commitment  to  reduce  the  emission  of  greenhouse  gases  in  implementation  of  the 
Kyoto Protocol. The Sector Inquiry therefore has to be seen against this wider policy 
context.  

European energy policy was set out in the Commission's Communication to the 2006 
Spring  European  Council5  concerning  the  renewed  Growth  and  Jobs  strategy.  That 
Communication puts the creation of an efficient and integrated energy policy at the 
heart  of  the  Commission’s  priorities.  This  goal  was  further  underlined  in  the 
Commission’s Green Paper “A European Strategy for Sustainable, Competitive and 
Secure Energy”6 which was adopted by the Commission in March 2006. 

The  Commission  is  conducting  infringement  procedures  against  a  number  of  Member  States  in  this 
respect  –  see  further  in  the  Commission's  Communication  on  the  Prospects  for  the  internal  gas  and 
electricity market, referred to below. 
Communication  from  the  Commission:  Prospects  for  the  internal  gas  and  electricity  market  - 
COM(2006) 841. 
Time to move up a gear - Annual Progress Report on Growth and Jobs, 25 January 2006. 
COM(2006) 105, 8.3.2006, SEC(2006) 317. 

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8. 

9. 

10. 

The Final Report of the Sector Inquiry is presented in parallel to the Commission's 
Strategic  EU  Energy  Review7  and 
the 
"Communication on Prospects for the internal gas and electricity market" referred to 
above  and  the  follow-up  to  the  Green  Paper.  Account  is  also  taken  of  the  work 
undertaken  within  the  High  Level  Group  on  Competitiveness,  Energy  and  the 
Environment,  which  underlined  the  need  for  better  functioning  electricity  and  gas 
markets in its first report adopted in June 2006.  

the  Energy  Package 

includes 

that 

the 

that 

these  documents 

transpires  from  all 

three  policy  objectives 
It 
“competitiveness,  security  of  supply  and  sustainability”  are  closely  interlinked  and 
complementary.  Competitive  markets  provide  the  necessary  signals  for  investment, 
which  leads  to  supply  security  in  the  most  cost  efficient  manner.  Similarly,  the 
creation of a competitive internal market will allow the Union’s energy companies to 
operate  in  a  market  of  a  larger  dimension,  which  will  improve  their  ability  to 
contribute  to  security  of  supply.  At  the  same  time,  market  forces  oblige  European 
operators  to  use  the  most  cost  effective  methods  of  production,  which  in  the 
appropriate  regulatory  environment  can  benefit  sustainability.  Consumers  will  be 
able  to  choose  between  different  providers  and  contract  schemes,  and  could  thus 
reduce  their  electricity  costs  and  adapt  their  consumption  to  market  developments. 
Competitive, cost reflective prices will help encourage energy efficiency, which can 
reduce  the  dependence  on  external  suppliers  and  which  supports  the  Union’s 
objective for sustainability and security of supply.  

The Final Report concentrates on the competition aspects of Europe’s energy policy 
and the remaining obstacles to creating a single European energy market. Quite apart 
from the fact that this aspect merits a thorough analysis in its own right, the focus is 
also  dictated  by  the  procedural  framework  (Regulation  (EC)  No  1/2003),  in  which 
the inquiry was carried out. This does not mean that e.g. security of supply goals are 
not taken into account when assessing likely pro- and anti-competitive effects in the 
context  of  applying  the  Community  competition  rules  in  individual  cases.  Indeed  a 
competitive internal market is a key instrument in delivering this objective. However 
in the context of the Sector Inquiry the main focus has been on competition. 

1.2. 

The procedure leading to the adoption of the report 

11. 

The Sector Inquiry into the European energy markets was launched on 17 June 2005. 
Initial  results  were  presented  in  the  form  of  an  Issues  Paper  published  on 
15 November 2005. Following publication of the Preliminary Report on 16 February 
2006  the  Commission  launched  a  public  consultation.  In  their  submissions 
stakeholders  welcomed  the  report,  generally  praising  its  objectivity  as  well  as  the 
wealth  of  information.  Contributions  came from  companies  operating  in  the  sector, 
both  from  incumbents  and  new  entrants,  from  national  regulators,  competition 
authorities,  consultancies,  law  firms,  energy  traders,  grid  operators,  customers, 
industry associations and national government agencies. 

12. 

The majority of the stakeholders support the findings, although there were variations 
in  the  assessment  of  the  gravity  of  the  situation  and  whether  the  situation  is 
improving or not. As regards the possible ways forward there was both support and 

7 

Communication from the Commission "An Energy Policy for Europe" - COM(2007) 1. 

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opposition  to  the  ideas  put  forward  in  the  Preliminary  Report  such  as  structural 
unbundling,  while  some  called  for  even  more  radical  remedies.  Generally  speaking 
the  vertically  integrated  incumbent  companies  were  not  in  favour  of  further 
measures,  whilst  consumers,  traders/new  entrants  and  authorities  supported  the  call 
for legislative initiatives. 

2. 

13. 

THE FINDINGS  

The main findings of the Sector Inquiry can be grouped – as indicated above – under 
eight  headings.  Whilst  there  are  some  obvious  differences  between  the  gas  and 
electricity  sectors,  the  many  similarities  and  inter-relationships  between  the  sectors 
plead for a common presentation.  

2.1.  Market concentration 

14. 

15. 

16. 

17. 

At  the  wholesale  level,  gas  and  electricity  markets  remain  national  in  scope,  and 
generally  maintain  the  high  level  of  concentration  of  the  pre-liberalisation  period. 
This gives scope for exercising market power.  

Wholesale gas trade has been slow to develop, and the incumbents remain dominant 
on  their  traditional  markets,  by  largely  controlling  up-stream  gas  imports  and/or 
domestic  gas  production.  Incumbents  trade  only  a  small  proportion  of  their  gas  on 
gas  exchanges  (“hubs”).  With  little  new  entry  in  retail  markets,  customer  choice  is 
limited  and  competitive  pressure  constrained.  The  overall  picture  for  potential  new 
entrants  is  one  of  dependency  on  vertically  integrated  incumbents  for  services 
throughout the supply chain. 

Although  electricity  trading  is  more  developed,  sales  on  wholesale  electricity 
markets  generally  reflect  the  significant  level  of  concentration  in  generation. 
Analysis of trading on power exchanges shows that, in a number of them, generators 
have scope to exercise market power by raising prices, a concern also expressed by 
many  customers.  Analysis  of  trading  positions  on  forward  markets,  which  overall 
shows  less  concentration,  demonstrates  that  the  electricity  markets  depend  on  few 
suppliers  with  long  positions  (i.e.  generate  more  than  they  resell).  Analysis  of 
generation  portfolios  also  shows  that  the  main  generators  have  the  ability  to 
withdraw capacity to raise prices.  

In the context of the inquiry, a study has been conducted on concentration levels in 
the  electricity  sector8.  An  analysis  of  concentration  on  an  hourly  basis  shows  that 
even  during  off-peak  hours  markets  remain  highly  concentrated  and 
that 
concentration levels, even in the less concentrated markets, reach significant levels at 
peak  hours.  The  analysis  based  on  measurements  of  the  structure  of  the  market  in 
every hour also reveals that, in certain markets, long-term contracts and, to a lesser 
extent,  the  reserve  requirements  can  reinforce  concentration  levels.  Further,  the 
analysis shows that the existing level of interconnection capacity is not sufficient to 
significantly reduce concentration. 

8 

This issue is presented as a separate chapter in the Technical Annex to the Final Report. 

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2.2. 

Vertical foreclosure 

18. 

19. 

20. 

The  current  level  of  unbundling  of  network  and  supply  interests  has  negative 
repercussions  on  market  functioning  and  on  incentives  to  invest  in  networks.  This 
constitutes a major obstacle to new entry and also threatens security of supply.  

New entrants often lack effective access to networks (in gas, also to storage and to 
liquefied  natural  gas  terminals)  despite  the  existing  unbundling  provisions.  The 
operators of the network/infrastructure are suspected of favouring their own affiliates 
(discrimination). Vertical integration also leads to a situation where operational and 
investment  decisions  are  not  taken  in  the  interest  of  network/infrastructure 
operations,  but  on  the  basis  of  the  supply  interests  of  the  integrated  company 
(including grid connection for competing power plants). This is highly damaging to 
security of supply.  

Another form of vertical foreclosure was found to exist by way of the integration of 
generation/imports and supply interests within the same group. This form of vertical 
integration reduces the incentives for incumbents to trade on wholesale markets and 
leads to sub-optimal levels of liquidity in these markets. In particular, the prevalence 
of long-term supply contracts between gas producers and incumbent importers makes 
it  very  difficult  for  new  entrants  to  access  gas  on  the  upstream  markets.  Similarly, 
electricity  generation  assets  are  in  the  hand  of  a  few  incumbent  suppliers  or  are 
indirectly controlled by them on the basis of long-term power purchase agreements 
(PPAs)  giving  the  incumbents  control  over  the  essential  inputs  into  the  wholesale 
markets.  Low  levels  of  liquidity  are  an  entry  barrier  to  both  gas  and  electricity 
markets. 

2.3.  Market integration 

21. 

22. 

Cross-border  sales  do  not  currently  impose  any  significant  competitive  constraint. 
Incumbents  rarely  enter  other  national  markets  as  competitors.  Insufficient  or 
unavailable  cross-border  capacity  and  different  market  designs  hamper  market 
integration.  

For gas, available capacity on cross-border import pipelines is limited. New entrants 
are  unable  to  secure  transit  capacity  on  key  routes  and  entry  capacity  into  new 
markets.  Very  often,  the  primary  capacity  on  transit  pipelines  is  controlled  by 
incumbents  based  on  pre-liberalisation  legacy  contracts  which  are  not  subjected  to 
normal third party access rules. Incumbents have little incentive to expand capacity 
to  serve  the  needs  of  new  entrants.  This  is  reinforced  by  ineffective  congestion 
management  mechanisms,  which  make  it  difficult  to  secure  even  small  volumes  of 
short-term,  interruptible  capacity  on  the  secondary  market.  In  many  cases,  new 
entrants have not even been able to obtain a sufficient amount of capacity when there 
have  been  expansions  of  transit  pipeline  capacity.  Expansions  have  generally  been 
tailored to the needs of the incumbents' own supply businesses. 

23. 

In  electricity,  integration  is  hampered  by  insufficient  interconnector  capacity  and  a 
lack  of  adequate  incentives  to  invest  in  additional  capacity  to  eliminate  long-
established  bottlenecks.  In  addition,  on  certain  borders,  long-term  pre-liberalisation 
capacity  reservations  still  exist  despite  the  ruling  of  the  European  Court  of  Justice 
that  such  reservations  are  not  compatible  with  EC  law,  unless  they  were  notified 

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under  Directive  96/92/EC.  Improving  access  to  existing  interconnectors  requires 
better methods of congestion management. However, better use of capacity is often 
not in the interest of vertically integrated network operators. 

2.4. 

Transparency 

24. 

25. 

26. 

There is a lack of reliable and timely information on the markets. 

Network  users  require  more  transparency  going  beyond  the  current  minimum 
requirements  set  by  EU  legislation.  Of  particular  importance  is  data  relating  to 
network  availability,  especially  for  electricity  interconnections  and  gas  transit 
pipelines. Data on the operation of generation capacity and gas storage also needs to 
be  more  widely  available.  For  electricity,  in  particular,  it  was  noted  that  rules  on 
proper market conduct and supervision differ significantly between Member States, 
as there is little harmonisation at EU level of the transparency requirements.  

To  ensure  a  level  playing  field,  all  market  participants  require  information  to  be 
made  available  on  an  equal  footing  and  in  a  timely  manner.  At  present  there  is  an 
information  asymmetry  between  the  vertically  integrated  incumbents  and  their 
competitors.  Improved  transparency  would  minimise  risks  for  new  market  players 
and  so  reduce  entry  barriers  and  improve  trust  in  the  wholesale  markets  and 
confidence in price signals. Obviously it needs to be ensured that no collusion takes 
place  on  the  basis  of  the  published  information  and,  although  commercial 
confidentiality  is  important,  this  should  not  be  allowed  to  undermine  effective 
transparency by being given too wide an interpretation. 

2.5. 

Price formation 

27. 

28. 

29. 

30. 

More effective and transparent price formation is needed in order to deliver the full 
advantages  of  market  opening  to  consumers.  Many  users  have  limited  trust  in  the 
price  formation  mechanisms,  while  regulated  supply  tariffs  below  market  prices 
discourage new entry.  

Gas import contracts use price indices that are linked to oil derivatives (e.g. light fuel 
or  heavy  fuel)  and  prices  have,  therefore,  closely  followed  developments  in  oil 
markets. This linkage results in wholesale prices that fail to react to changes in the 
supply and demand for gas, which is damaging to security of supply. No clear trend 
towards more market based pricing mechanisms can be observed in long-term import 
contracts. Ensuring liquidity is crucial to improving confidence in price formation on 
gas hubs, which will allow for a relaxation of the linkage to oil.  

Electricity  price  formation  is  complex.  Increases  in  the  price  of  primary  fuels  have 
certainly  played  a  role  in  recent  electricity  price  developments,  especially  in 
marginal plants. However this does not appear to fully explain the recent price rises. 
Similarly, the effect of the EU CO2 emissions trading scheme on electricity prices is 
not yet entirely clear.  

In  several  Member  States,  regulated  tariffs  have  generated  adverse  effects  for  the 
development  of  competitive  markets,  since  they  have  been  set  at  very  low  levels 
compared to market prices and cover a large part of the market, thereby effectively 
leading  to  re-regulation.  Similarly,  in  several  Member  States,  special  measures  to 

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reduce  electricity  bills  for  energy  intensive  industries  have  been  considered.  Such 
schemes must be compatible with antitrust and State aid rules. 

2.6. 

Downstream markets 

31. 

32. 

33. 

34. 

Competition  at  the  retail  level  is  often  limited.  The  duration  of  retail  contracts  for 
industrial customers and local distribution companies can have a substantial impact 
on the opportunities for alternative suppliers to successfully enter the market.  

The cumulative effect of long contract durations, contracts with indefinite duration, 
contracts with tacit renewal clauses and long termination periods can be substantial. 
The  analysis  shows  that  the  degree  to  which  the  industrial  customers  are  tied  to 
incumbent  suppliers  on  a  long-term  basis  differs  significantly  between  Member 
States. 

Customers demand more competitive offers from non-incumbent suppliers and regret 
the  absence  of  pan-European  supply  offers.  The  number  of  competitive  offers  that 
customers receive is particularly unsatisfactory in some Member States characterised 
by a high level of concentration. 

For gas, restrictions on how customers can dispose of their gas, in combination with 
restrictive  practices  by  suppliers  regarding  delivery  points,  limit  competition  and 
prevent  the  achievement  of  efficiencies  by  these  customers.  In  electricity,  certain 
standard contracts contain restrictions, which may also raise competition concerns. 

2.7. 

Balancing markets 

35. 

36. 

37. 

Currently,  balancing  markets  often  favour  incumbents  and  create  obstacles  for 
newcomers.  The  size  of  the  current  balancing  zones  is  too  small,  which  leads  to 
increased costs and protects the market power of incumbents. 

For gas, the small size of current balancing zones increases the complexity and costs 
of shipping gas within Europe. Costs are increased by highly complex and divergent 
rules  in  each  zone,  and  by  the  obligation  to  reserve  capacity  at  each  border  point. 
These  problems  are  exacerbated  by  the  time  dimension:  the  shorter  the  balancing 
period,  the  higher  the  risk  of  imbalance  for  the  supplier.  All  these  aspects  create 
major obstacles for new suppliers to enter the market, which the vertically integrated 
incumbents have little incentive to remove. Furthermore, balancing charges, clearing 
costs  and  penalty  charges  are  not  transparent  and  often  contain  unjustified  penalty 
charges,  favouring  incumbents.  Effective  unbundling  is  necessary  to  create  a  level 
playing field in the balancing markets and to reduce barriers to entry.  

In  electricity,  the  markets  on  which  transmission  system  operators  have  to  acquire 
balancing and reserve energy are highly concentrated, which gives generators scope 
for  exercising  market  power.  This  can  result  in  entry  barriers  for  new  suppliers 
facing  a  high  risk  of  high  imbalance  prices  and/or  high  network  charges  (to  the 
extent that balancing costs are included in the costs of the network). Concentration in 
balancing  markets  could  be  reduced  if  the  geographical  size  of  control  areas  was 
enlarged. Harmonization of balancing market regimes would be an important step to 
increase the size of control areas, improve market integration and simplify trade. In 
some  Member  States  the  structural  relation  between  TSOs  and  their  affiliated 

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generation  provides  an  incentive  for  the  TSO  to  buy  excessive  reserve  capacity 
and/or to pay high prices, thereby favouring their affiliated generation arm. Results 
indicate  that  the  amount  of  capacity  reserves  bought  differs  substantially  between 
TSOs.  

2.8. 

LNG markets 

38. 

39. 

3. 

40. 

LNG supplies widen Europe’s upstream supplier base and are therefore important for 
both  security  of  supply  and  competition  between  upstream  suppliers.  The  potential 
for LNG  supplies  to favour less  concentrated  downstream  markets  still  needs  to  be 
realised.  

Traditionally  LNG  has  been  imported  by  national  incumbents  who  also  own  LNG 
terminals, and this situation has prevented LNG imports from increasing downstream 
competition.  Recent  trends,  however,  point  to  more  capacity  going  to  new  entrants 
and  to  producers  themselves.  This  is  likely  to  have  a  positive  impact  on  fostering 
downstream competition unless such effects are frustrated by anticompetitive rules or 
behaviour. Strong investment in LNG terminals has taken place and is scheduled to 
take place in the coming years. Investments in some LNG terminals have benefited 
from exemptions from third party access obligations under a test applied by national 
regulators  with  Commission  supervision.  This  test  seeks  to  achieve  a  balance 
between  ex ante  incentives  to  invest  and  competition  once  the  investment  has  been 
made. While experience is largely positive, improvements are possible.  

REMEDIES 

In order to address the malfunctioning of the market identified in the Sector Inquiry 
and  to  significantly  improve  the  scope  of  competition,  it  is  essential  to  apply  both 
competition and regulatory-based remedies. Competition law enforcement can make 
a  significant  contribution,  but  cannot  by  itself  open  markets  and  resolve  all  the 
shortcomings identified by the Sector Inquiry: a number of regulatory measures are, 
therefore, also needed. 

3.1. 

Competition law enforcement 

41. 

Full  and  combined  use  of  the  Commission’s  powers  under  antitrust  rules  (Articles 
81,  82  and  86  EC),  merger  (Regulation  (EC)  No  139/2004)9  and  State  aid  control 
(Articles  87  and  88  EC)  is  needed  to  maximise  the  impact  of  the  Commission’s 
enforcement  action.  The  Commission  is  forcefully  pursuing  infringements  of 
Community  competition  law  (antitrust)  in  the  sector  wherever  the  Community 
interest so requires, in close cooperation with National Competition Authorities.  

3.1.1.  Market Concentration  

42. 

Market concentration has been identified as a major concern for the success of 
the  liberalisation  process.  The  market  power  of  pre-liberalisation  monopolies  has 
not yet been eroded. This makes the Community's action under the merger regulation 
essential  so  as  to  ensure  that  the  competitive  structure  in  relevant  markets  (which 

9 

Council Regulation (EC) No 139/2004 of 20 January 2005. 

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43. 

44. 

currently are at most national in scope) does not further deteriorate. In recent merger 
cases remedies such as divestitures, contract and/or gas release have been applied. In 
addition,  the  impact  of  long-term  upstream  contracts  on  downstream  concentration 
has emerged as a major theme. 

Energy  release  programmes  (i.e.  electricity  Virtual  Power  Plant  auctions  and  gas 
release  programmes)  are  a  means  to  develop  market  liquidity  and  increase  entry 
opportunities. They constitute suitable remedies to competition concerns not only in 
the merger area but also under antitrust rules. In order to be fully effective they must 
be well-designed and large scale. Substantial experience has been gathered with such 
programmes  by  competition  and  regulatory  authorities  at  national  level  (e.g.  in 
Spain,  France,  Austria,  Germany)  and  by  the  European  Commission  (in  merger 
cases)  allowing  the  authorities  to  avoid  pitfalls  and  ensure  their  effectiveness.  For 
gas,  such  release  programmes  have  the  additional  advantage  that  they  are  likely  to 
increase hub liquidity which supports the introduction of price signals not biased by 
the gas-oil-price link.  

In  certain  circumstances  applicable  antitrust  law  also  permits  the  application  of 
farther  reaching  structural  measures  as  a  remedy  to  infringements  of  competition 
rules.  This is  the  case  where  behavioural remedies would be  less effective to  bring 
the infringement to an end, where there is a substantial risk of a lasting or repeated 
infringement  that  derives  from  the  very  structure  of  the  undertaking,  or  where 
behavioural remedies would be more burdensome10. 

3.1.2.  Vertical foreclosure 

45. 

46. 

47. 

Wherever  competition  infringements  are  facilitated  by  vertical  integration  between 
supply and generation and infrastructure businesses and insufficient unbundling, the 
full force of the Commission’s powers to prevent future abuse needs to be applied. 

The  Sector  Inquiry  has  also  confirmed  the  vertical  tying  of  markets  by  long-term 
downstream  contracts  as  a  priority  for  review  of  case  situations  under  competition 
law and for providing guidance where required. When such contracts, concluded by 
dominant firms, foreclose the market, Article 81 or 82 EC may be infringed unless 
there  are  countervailing  efficiencies  benefiting  consumers11.  Similarly,  power 
purchase agreements in the electricity sector can have foreclosure effects. 

Furthermore,  the  concentration  of  gas  import  contracts  in  the  hand  of  a  few 
incumbents  is  one  of  the  main  reasons  why  competition  at  the  subsequent  level  of 
trade  does  not  take  off.  Whilst  this  does  not  as  such  put  into  question  existing  and 
future  upstream  contracts,  it  requires  attention  with  respect  to  their  effects  for  the 
downstream markets. 

10 
11 

See Article 7(1) and recital 12 of Regulation (EC) No 1/2003. 
In the analysis of long-term contracts, sunk investments, if any have been made by the parties, are taken 
into account - see Commission Guidelines on the application of Article 81(3) of the Treaty (OJ C 101, 
27.4.2004, p. 97, paragraph 44). 

EN 

10 

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3.1.3.  Market integration  

48. 

49. 

50. 

Foreclosure  can  also  arise  at  other  levels  of  the  value  chain,  most  prominently  as 
regards  access  to  infrastructure  (transmission  and  distribution  networks  and/or 
storage  facilities),  particularly  in  cases  where  cross-border  access  is  concerned, 
thereby preventing market integration. Such access can be blocked through long-term 
transmission  contracts  and  through  the  associated risk of capacity hoarding. Action 
in this field should include an analysis of the competition effects of pre-liberalisation 
long-term contracts and the compatibility of such contracts with competition rules. 

Additionally, lack of investment and delayed investments by transmission companies 
with vertically integrated supply companies are other serious sources of concern. It is 
recalled  that  one  National  Competition  Authority  has  found  that  a  vertically 
integrated  network  operator  deliberately  stopped  an  investment  project  in  order  to 
benefit its supply branch by depriving competitors of access to more capacity12.  

Market  partitioning  remains  one  of  the  most  serious  obstacles  to  market 
integration.  The  fight  against  collusion  between  incumbents  remains  a  priority  of 
antitrust  enforcement  action,  reflecting  the  overall  priority  of  the  Commission  to 
fight attempts by undertakings to coordinate rather than to compete. 

3.2. 

Structural issues and pro-competitive regulatory environment 

51. 

52. 

The  findings  of  the  Sector  Inquiry  will  enable  the  Commission  to  focus  its 
enforcement action on the most serious concerns identified in the report. They also 
make it easier for the Commission to identify efficient remedies that can effectively 
resolve the competition problems identified in individual cases. 

However,  key 
issues  relating  to  market  structure  and  the  regulatory 
environment  will  have  to  be  addressed  in  parallel,  in  order  to  remedy  the 
malfunctioning of the markets that has been demonstrated by the inquiry.  

The Sector Inquiry has identified the following main fundamental deficiencies in the 
competitive structure of current electricity and gas markets: 

– 

– 

– 

Structural  conflicts  of  interest:  a  systemic  conflict  of  interest  caused  by 
insufficient unbundling of networks from the competitive parts of the sector; 

in  the  regulatory  environment:  a  persistent  regulatory  gap 
Gaps 
particularly for cross border issues. The regulatory systems in place have loose 
ends, which do not meet; 

A chronic lack of liquidity, both in electricity and gas wholesale markets: the 
lifeblood for our markets is lacking and the market power of pre-liberalisation 
monopolies persists; 

– 

A general lack of transparency in market operations in the sector. 

12 

The Italian Competition Authority has recently taken action against the delaying tactics of an incumbent 
operator to expand an important import pipeline. 

EN 

11 

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Options  for  regulatory  action  at  EC  level  are  discussed  by  the  Commission  in  its 
Communication  on  “Prospects  for  the  internal  gas  and  electricity  market”.  The 
findings of the Sector Inquiry and the resulting deficiencies identified below support 
and  confirm 
that 
Communication.  

the  analysis  brought 

the  Commission 

forward  by 

in 

3.2.1.  Unbundling 

53. 

54. 

55. 

56. 

The  Sector  Inquiry  confirms  the  finding  that  it  is  essential  to  resolve  the  systemic 
conflict  of  interest  inherent  in  the  vertical  integration  of  supply  and  network 
activities,  which  has  resulted  in  a  lack  of  investment  in  infrastructure  and  in 
discrimination.  It  is  crucial  to  ensure  that  network  owners  and/or  operators  do  not 
have incentives that are distorted by supply interests of affiliates. This is particularly 
important at a time when Europe needs very large investments to ensure security of 
supply and to create integrated and competitive markets. 

To  achieve  this,  it  will  be  necessary  to  decisively  reinforce  the  current  inadequate 
level of unbundling. This would, in turn, also facilitate cooperation among network 
operators.  

Economic  evidence  shows  that  full  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. 

Furthermore, the public consultation has not revealed any significant synergy effects 
linked  to  vertical  integration.  Indeed,  where  ownership  unbundling  has  been 
implemented, experience shows that both the network business and the (production 
and) supply business continue to thrive after separation. 

3.2.2.  The regulatory environment 

57. 

Whilst ownership unbundling would substantially contribute to reducing problems of 
market power and lack of liquidity, it is clear that also other measures will be needed. 
As the  Sector Inquiry  confirms, Europe needs a substantial strengthening of the 
powers  of  regulators  and  enhanced  European  coordination.  This  goes  in  hand 
with the findings presented by the Commission in its Communication on “Prospects 
for  the  internal  gas  and  electricity  market”.  Only  a  strengthened  regulatory 
framework  can  provide  the  transparent,  stable  and  non-discriminatory  framework 
that  the  sector  needs  for  competition  to  develop  and  for  future  investments  to  be 
made. 

58. 

The main ingredients of such a strengthened framework should be: 

- 

- 

enhanced powers for independent national energy regulators,  

reinforced coordination between national energy regulators,  

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- 

- 

reinforced cooperation between Transmission System Operators (TSO), and  

substantially enhanced consistency of regulation in cross-border issues. 

59. 

Reinforced coordination between national energy regulators, with a stronger role for 
Community oversight to ensure the Internal Market interests, particularly as regards 
cross-border  issues  and  areas  most  critical  for  market  entry,  will  be  necessary  to 
overcome  the  current  regulatory  cross-border  gap  which  cannot  be  remedied  by 
application of competition rules alone. Options for regulatory measures are discussed 
in the Communication on “Prospects for the internal gas and electricity market”. 

3.2.3.  Chronic lack of liquidity 

60. 

61. 

62. 

Reinforced  unbundling  rules  and  an  improved  regulatory  environment  for  cross 
border  issues  in  particular  should,  in  the  medium  term,  substantially  reduce  the 
problems of market power and lack of liquidity in a sustained manner, by bringing 
additional supplies to concentrated national markets. However, there remain serious 
concerns  in  the  short  term,  as  regards  the  lack  of  sufficient  liquidity  and 
sustained  market  power  in  wholesale  markets,  which  is  leading  to  higher  prices  in 
retail markets just as full liberalisation is to be implemented on 1 July 2007. 

As  already  indicated,  competition  law  enforcement  will  be  an  important  tool  to 
address any anti-competitive conduct concerning this issue. However, more may be 
needed. As the levels of concentration in gas and electricity markets have remained 
high,  often  reflecting  pre-liberalisation  monopolies,  national  energy  regulators 
should  analyse  conditions  in  their  respective  markets  in  co-operation  with 
competition authorities and make appropriate proposals. Measures taken in the past 
by  a  number  of  Member  States  include  release  programmes  (i.e.  electricity  Virtual 
Power Plant auctions and gas release programmes).  

It  is  also  recalled  that  certain  Member  States  have  introduced  under  national  law 
ceilings on ownership of electricity generation and control over long-term upstream 
gas  contracts  (imports  and  national  production),  as  an  effective  measure  to  rapidly 
reduce market power. For electricity, such measures could imply either divesture or 
asset  swaps  of  power  plants  on  a  European  scale.  For  gas,  it  could  mean  contract 
release, contract swaps and/or divesture of domestic production, as have been applied 
in recent merger cases. Widening of small TSO areas and introducing more open and 
flexible  tendering  procedures  for  balancing  energy  could  reduce  the  current  high 
levels  of  concentration  in  balancing  markets  and  remove  obstacles  to  entry,  with  a 
positive knock-on effect in wholesale markets. 

63. 

Furthermore,  the  Sector  Inquiry  has  highlighted  the  importance  of  enhancing  the 
scope for entry through investment in new generation and gas import infrastructure 
as  well  as  strict  application  of  use-it-or-lose-it  provisions  for  infrastructure  and 
suitable generation sites.  

3.2.4.  Lack of transparency in market operations 

64. 

There  is  general  recognition  that  access  to  market  information  should  be  further 
enhanced. All relevant market information should be published on a rolling basis in a 
timely manner. Any exceptions should be very strictly limited to what is required to 

EN 

13 

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reduce  the  risk  of  collusion.  Guidelines  as  well  as  monitoring  and  eventually 
adaptation of existing regulation should serve to further enhance transparency in the 
gas and electricity sector. Intended proposals are outlined in the Communication on 
“Prospects for the internal gas and electricity market”. 

3.2.5.  Other important issues 

65. 

66. 

67. 

68. 

69. 

70. 

In  addition  to  these  four  fundamental  areas,  other  issues  of  pro-competitive  market 
environment need consideration. On these issues, specific suggestions for regulatory 
action at EC level are made by the Commission in its Communication on “Prospects 
for the internal gas and electricity market”. 

Regulated retail tariffs can have highly distortive effects and in certain cases pre-
empt  the  creation  of  liberalised  markets.  It  is  of  crucial  importance  to  assess  the 
impact of remaining regulated supply tariffs on the development of competition, and 
remove distortions13. 

In  order  to  achieve  that  access  to  new  infrastructure  is  not  unduly  restricted,  the 
Commission should continue to ensure that exemptions from access provisions are 
not  detrimental  to  the  development  of  competition.  It  is  important  that  projects 
continue  to  be  scrutinized  on  a  case  by  case  basis  with  strict  application  of 
competition  principles  striking  a  proper  balance  between  incentives  for  ex ante 
investment  and  ex post  competition,  and  that  the  exemption  procedures  are 
streamlined.  

In order to achieve a single European network from the perspective of the network 
user,  there  is  a  need  for  appropriate  harmonisation  of  market  design,  especially 
regarding  methods  having  an  effect  on  cross  border  trade.  Action  is  needed, 
wherever  current  capacity  is  insufficient,  to  develop  interconnector  capacity  as  a 
necessary  condition  for  the  development  of  competition  and  the  integration  of 
markets.  These  aims  can  only  be  achieved  through  increased  cooperation  between 
national  regulators  inducing  increased  cooperation  among  TSOs  across  national 
borders within a well-defined procedural framework. 

In order to put more gas transmission capacity on the market, it will be important 
to clarify the legal position of pre-liberalisation long-term gas transmission contracts 
under the Second Gas Directive14, which are already now subject to strict use-it-or-
lose-it rules and to the rules of competition law.  

Further  changes  are  needed  regarding 
limited 
interconnector  capacity.  For  electricity,  implicit  day-ahead  auctions  or  equivalent 
measures should be promoted as much as possible to ensure that interconnectors are 

the  method  for  allocating 

13 

14 

For the household market segment, there is a need to strike the right balance between competition and 
universal public service obligations. 
Directive 2003/55/EC of 26 June 2003 concerning common rules for the internal market in natural gas 
(OJ L 176, 15.7.2003, p. 57). Replaces the First Gas Directive. 

EN 

14 

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71. 

72. 

4. 

73. 

used  to  their  maximum  extent.  TSOs  should  also  have  incentives  to  maximise  the 
amount of cross border capacity made available to the market15. 

In  order  to  provide  sufficient  guarantees  for  effective  access,  third  party  access  for 
gas storage should be reviewed so as to strike the right balance between the need for 
effective access and maintaining incentives for new storage developments.  

A  monitoring  system  for  trading  on  wholesale  markets  (e.g.  power  exchanges) 
would  increase  market  participants’  confidence  in  the  market  and  limit  the  risk  of 
market  manipulation.  Regulators  should  be  empowered  to  collect  and  exchange 
relevant  information  in  this  respect.  They  should  have  the  power  to  make 
recommendations  for  enforcement  action  or  have  the  power  to  carry  out  such 
enforcement action themselves.  

CONCLUSION 

The  Sector  Inquiry  has  identified  a  number  of  serious  shortcomings  which  prevent 
European  energy  users  and  consumers  from  reaping  the  full  benefit  of  the 
liberalisation process. The findings support the conclusions of the Communication on 
“Prospects for the internal gas and electricity market”, which has been carried out by 
the  Commission  in  the  follow  up  to  the  Green  Paper  and  in  the  course  of  the 
preparation of the Strategic EU Energy Review. These initiatives bring forward the 
Commission's intentions as to proposals for regulatory reform, aiming at an Internal 
Market for energy that contributes to sustainability, competitiveness and security of 
supply.  In  addition,  and  in  parallel,  the  Final  Report  also  draws  conclusions  with 
regard to enforcement action under EC competition law. Both these documents aim 
at identifying and remedying obstacles to creating a single European energy market, 
in which consumers fully benefit from the opening of markets to competition. 

15 

E.g. Scarce capacity that is kept in reserves by some TSOs for emergency situations may be offered to 
the  market  as  interruptible  capacity,  and  can  be  bought  back  when  required,  using  for  instance  cross 
border congestion rents. 

EN 

15 

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