Electricity demand in parts of Europe is on the rise.
The European Union (EU), unlike the United States, enters 2004 with neither a constitution nor a European regulatory agency to oversee the EU's "single market" goals in energy. The EU, however, faces many cross-border issues affecting trade in electricity and natural gas, just as the United States does. While the member countries of the EU have become more energy efficient, new investment in all segments of electric infrastructure still is needed. To fund this investment in the most efficient manner, a legal and institutional regulatory framework for the entire region must be established.
The EU has taken the position that the "liberalization" (or introduction of competition to monopoly) will be limited to certain segments of the energy process. Thus, competition is the selected method for the generation of electricity, the exploration and marketing of natural gas, and the marketing of both to the end consumer, whether residential, commercial, or industrial.
Energy statistics show significant investment opportunities as a result of the EU's push for competition. The most recently available figures from the Paris-based International Energy Agency, indicate that Western Europe consumes about 2.5 billion kWh, or 18.2 percent, of global electricity demand. In comparison, North America consumes about 30 percent, and Eastern Europe and the former Soviet Union consume 10 percent of global electricity.
The EU imports about 50 percent of its energy needs and is projected to import more than 70 percent by the year 2030. Energy consumption is expected to continue at the recent rate of 1 to 2 percent per year among current EU member states. The accession countries of Central and Eastern Europe are expected to consume at a higher rate as they experience economic growth in the 5 to 6 percent range.
The electric capacity situation at this time varies greatly within the EU, with some countries (France, Germany, the United Kingdom, and Italy) in a current oversupply situation, and others (Sweden and Norway) facing undersupply. A deficiency in transmission infrastructure does not make it possible to completely export from regions that are short of power to those with an oversupply of generation capacity, so more investment in both generating and transmission capacity is warranted.
The , published by the International Energy Agency (IEA), reports that the European Union will need almost 650 GW of new generating capacity (to meet new demand and to replace 330 GW of retired facilities) over the next 30 years. The investment needed is on the order of $525 billion. In addition, the EU member countries will invest approximately $120 billion in new transmission facilities during the same period. The distribution sector also will need to be built out and refurbished, at an estimated cost by IEA in excess of $413 billion. The IEA's report recognizes the important role of regulation. The IEA assumes that regulation will be adequate. It says: "Government, while providing a stable regulatory framework that allows investors to be rewarded, will need to monitor developments in investment to ensure that adequate infrastructure is built."
Proposed New Rules: Incentives For Transmission Infrastructure
The EU has recognized that the current situation in transmission is one of inadequate transfer capability leading to the inability to fully integrate markets. At a recent Barcelona Summit, EU member states pledged to increase interconnection to at least 10 percent of the installed generation capacity by 2005.
The transmission component, whether high voltage for electricity or high pressure for natural gas, and the local distribution component continue to be treated as monopoly services under state regulation. However, as is the case with U.S. policy, competitive production needs non-discriminatory and fairly priced access to its markets. Transmission service must be both adequate and offered at just and reasonable rates. To create a system large enough to provide this level of "adequate" service, the role of the regulator is crucial.
The European Commission, recognizing the size of the investment problem, sent a communication to its association of national electric and gas regulators, the Council of European Energy Regulators (CEER), requesting it "put forward guidelines on how to regulate and financially reward the construction of infrastructure." In response, the CEER issued in March 2003 a white paper, "Principles on Regulatory Control and Financial Reward for Infrastructure." The CEER determined to first advance a set of principles and follow up later with more detailed guidelines for the electricity and gas energy sectors.
In the United States there are no government-established and agreed-upon principles of regulation. However, the regulation of public utility rates in the United States is relatively fixed by a series of U.S. Supreme Court rulings based on the application of the U.S. Constitution's Fifth Amendment takings clause and the Fourteenth Amendment's due process clause, which provide the underpinnings for the "just and reasonable" standard adopted by regulators and now enforced by U.S. courts.
While the introduction by the CEER of a set of principles is not the same as a new law, it is an important step in the creation of an investment climate needed to attract capital at reasonable rates. Perhaps a future EU constitution will provide the opportunity to provide the legal framework and higher level of investor assurance provided by the U.S. Constitution, when applied to utility rate setting.
The CEER opens its document with a single statement of principle: "The full liberalisation of the market is the dominant prerequisite for the efficient use of existing infrastructure and the development of new infrastructure. In these circumstances, a key focus should be on the ability of signals emerging from trade to highlight the need for new investment."
The document presents eight principles around which future guidelines should be based. The principles cover the role of government, the need for independence of the network, and the duties of regulators (see sidebar, p. 45).
A Single Standard Market: Can Europe Succeed Where the U.S. Failed?
Anyone familiar with the various interpretations and the applications of the federal law by state and federal regulators in the United States will marvel at the attempt to harmonize the regulatory regimes of 15 countries in this manner. The absence of an EU constitution at this point in time is less likely a hindrance to the establishment of a single market in electricity (and one in natural gas) than is the absence of a single central regulator. Consider for a moment how the electric transmission rules might look in the United States without the benefit of FERC regulation. Speaking at the 2003 annual meeting of the U.S. Energy Bar Association, one of the French energy regulators, Commissioner Jacques-Andre Troesch, indicated that the task of the current regulators is to harmonize national regulations across borders in areas of tariffs, renewable energy, taxation, public service obligation and integration of stakeholders. He further said the creation of a single European regulator is hindered by differences between national markets that are too wide, cooperation requirements among the existing national regulators, the necessity of establishing a European-wide committee, and the difficult option of a single regulator.
In recognition of the need for more coordination of European regulatory policy, on Nov. 11, 2003, the European Commission announced the establishment of the "European Regulator Group for Electricity and Gas" as an official advisory body to the commission. The group is to advise and assist in consolidating the internal energy market. Members of the group will be the heads of the respective regulatory agencies in the European Commission member countries. This mechanism may prove both cumbersome and ineffective, but the ability of the CEER to come together and agree on the CEER's eight principles gives hope that the new group may be able to establish some guidelines based on these principles.
To complicate matters even more, the EU's single market for electricity soon will be expanded to include neighboring states in central and Eastern Europe. The EU also has looked ahead at steps to integrate with the more distant but larger market of Russia. Finally, on Dec. 9, 2003, the EU also signed a memorandum of understanding to integrate the energy markets of Southeast Europe by 2005. All of the skills used to date in the EU to create a single market in Western Europe will be called upon to extend that market to this diverse and recently troubled part of Europe.
The successful creation of a single market for electricity and another for natural gas among economically developed states of the EU is a formidable task. Lacking a central regulator and operating on treaties and agreements rather than a single constitution, the member states of the EU have managed to create a single vision and cohesive energy policy. This policy has at its core the belief that competitive markets are more efficient than central planning and monopoly. The EU has determined that markets should be allowed to develop where feasible. The EU also has accepted that the functions of transmission and distribution are better provided by regulated monopoly. Finally, the EU has shown that it can advance its objectives, slowly, through the use of forums and summits that bring together the many stakeholders.
Whether there are any lessons here for the United States is debatable. The United States lacks a single cohesive view of the benefits of competition either at wholesale or at retail. This was the core problem in failed attempts last year to pass a comprehensive energy bill. At a minimum, the EU has chosen competition over monopoly, and collaboration over division. It also has looked to extend its market to create an even larger energy market, ensuring greater benefit to its member states and ultimately to its citizens.
European Union Adopts Directives Supporting a Competitive Market
- Following input from the electricity forum, the European Parliament and the Council of the EU on June 26, 2003, adopted a new electricity directive (2003/54/EC) and a new regulation (12/28/2003) effective July 2004. The new directive repeals the 1996 requirements and moves to create common rules for an internal market as well as new conditions for access to the network for cross-border exchanges of electricity. However, the EU has established a stringent set of requirements beyond those possible by the U.S. Federal Energy Regulatory Commission (FERC), short of additional legislation. The new electricity directive requires:
- 1. Unbundling
Further unbundling through a new requirement that transmission and distribution system operators be independent of generation in "legal form, organization, and decision-making."
- 2. Retail Access
All non-residential consumers must have access to competition by July 1, 2004, and full retail access must be in place by July 1, 2007. The United Kingdom and Germany opened access to all consumers earlier, but the new requirements are the minimum standard for all member states and are enforceable by the basic treaties governing the EU member state relations.
- 3. Open Access
Such access to the transmission and distribution grids is now mandatory and regulated. The old practice, where it remained, of negotiated and private tariffs will be superceded by a system of published and regulated access tariffs to electric transmission and distribution systems.
- 4. Independent Regulators
Each member state must establish independent regulatory agencies charged with enforcement of competition by the development of access charges and methodologies. Independence is defined in terms of the electric industry. It is not clear whether this precludes agencies from being within various cabinet ministries.
- 5. New Generation Capacity
The new directive calls for "authorization" procedures rather than "tendering" procedures. In this case it appears that the EU wants to create a system where a potential builder of new generation capacity faces a set of clear rules for how to apply for authorization to build a facility and put it at market risk. Tendering, or bidding to fulfill a specific supply contract, is allowed if the government feels that there is insufficient generation coming on line in the open market process. To ensure transparency, the tendering process can be done by a fully independent transmission system operator or in its absence by the regulator directly.
Commissioner Troesch of the French regulatory agency reported at the December 2003 annual meeting of the U.S. Energy Bar Association in Washington, D.C., that the main legal provisions of the new directives also include review clauses, consumer protection, energy labeling, and the establishment of a European regulators group. Troesch explained that the "review clause" provisions require that special reports be made by the European Commission to measure the benefits of liberalization. These reports are due before Jan. 1, 2005, and should refer to issues such as the ability of the competitive markets to fulfill public service obligations within the member states.
To create a single internal market for electricity, the European Commission issued a directive on Dec. 19, 1996, requiring implementation by the member states by February 1999. A directive is binding as to the results achieved on each member, but national authorities can choose their own form or methods to meet the results. Under the European Commission laws, a directive is the secondary level of law after a regulation, and it carries more authority than a decision, recommendation, and opinion.
The electricity directive called for significant changes in the way electricity was treated in the member countries and for unbundling of generation from network and supply activities. The directive also adopted the objectives of transparent pricing and non-discriminatory access and service on the part of the transmission operators. It did not, however, call for changes in ownership or privatization in the case of government ownership of assets.
The directive did call for competition in generation through a combination of free market entry through an authorization process and tendering of competitive bids for new capacity requirements in generation. The directive also addressed the issue of retail access by initially offering electricity suppliers a choice of a single-buyer model, negotiated third-party access, or mandatory market openings for large customers. The unbund-ling was to be functional with an independent transmission system operator, at least in terms of management. Most member countries introduced the concept of regulated access rather than negotiate and establish national regulatory agencies to handle this task.
As the member countries moved ahead with implementation, it became apparent that certain provisions were not working as intended, and additional measures would be required. The commission established a forum to discuss the issues and barriers to the establishment of the single market for electricity envisioned by the directive. The first commission Electricity Regulatory Forum, held in Italy in 1998, addressed cross-border trade, including lack of interconnection in critical locations. Nine additional meetings have been held since that time. A parallel program-the European Gas Regulatory Forum-has addressed similar issues in natural gas.-B.T.
European Regulatory Agencies
Almost all the member states of the EU have electricity regulatory agencies. These national regulatory agencies are members of the Council of European Energy Regulators (CEER). Only Germany is currently missing from this list, as it is in the process of establishing an independent regulator. The structure of the new European regulatory agencies varies from the single person Ofgem regulatory office in the United Kingdom to the 10-member Spanish commission.
The United Kingdom was the first of the EU member states to establish an independent regulatory office through its creation in the 1980s of separate gas and electric regulatory agencies Ofer and Ofgas.
In the 1980s Ofer, under the initial direction of Professor Stephen Littlechild, and Ofgas, under the chartered accountant Sir James McKinnon, provided a stellar example of independence and objectivity to the new European energy regulatory scene, as well as the commensurate controversy. British regulation followed the pattern established in Professor Littlechild's earlier white paper, which introduced the primacy of the price cap rate-setting regime into European regulation.
As the EU expands membership, the newly created regulatory agencies of Central and Eastern Europe also will join CEER. At this time, all of the countries of the former communist block except Serbia and Montenegro have established regulatory agencies and created an affinity organization, the Energy Regulators Regional Association (ERRA.) The secretariat has been established in Budapest with the active assistance of the U.S. National Association of Regulatory Utility Commissioners (NARUC) under funding from the U.S. Agency for International Development. In most cases, the structure of these agencies has been the U.S. multi-member commission model, with some variation in the number of members appointed.
Russia has both a Federal Energy Commission and regional commissions. These regional regulators also have established a trade association similar to the NARUC model. Clearly the U.S. regulatory model has been a major export success in Europe. -B.T.
The following agencies are currently members of CEER: Austria Belgium Denmark Finland France Great Britain Greece Ireland Italy Netherlands Norway Portugal Spain Sweden
Principles of Regulatory Control
Public authorities should endeavor to encourage sufficient investment in gas and electricity network infrastructure in order to implement the internal energy market, facilitate efficient competition, and safeguard security of supply. Public authorities need to maintain oversight of infrastructure decisions in order to promote both security of supply and network efficiency.
Transmission system operators must manage their networks in a way that ensures the efficient use of infrastructure.
Public authorities should establish transparent, non-discriminatory and standardized options for the development of infrastructure, and aim as far as possible to minimize regulatory risks.
Public authorities should enforce a minimum procedure for the publication of the transmission system operators' infrastructure plans.
Transmission system operators must be effectively unbundled to ensure that there is no conflict of interest when making investment decisions and to ensure there are sufficient incentives to provide non-discriminatory third-party access. Unbundling of network ownership is the preferred route to follow.
Public authorities should establish, in advance and in a transparent manner, which regulatory regime is to be applied for both national and cross-border investments. That regulatory regime should include a clear description of its applicability, the relevant criteria for the financial reward for new infrastructure investment, and should describe the relevant criteria applicable to third-party access to the new infrastructure.
Merchant infrastructures have to be decided on a case-by-case basis and should continue to be subject to an ex-ante regulatory control for each individual case. Where the merchant status is granted on a time-limited basis, the ongoing regulatory status should be properly reappraised at the end of this period.
Public authorities should guarantee that procedures applicable to granting required licenses for new investments in gas and electricity network infrastructure are non-discriminatory and efficient.
Swifter, more expeditious administrative authorization procedures are required for infrastructure development, particularly those for interconnection infrastructure.-B.T.
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