As Europe slowly progresses toward the European Commission's nirvana of an internal energy market (IEM) much debate is heard on how best the market should be structured to achieve efficiency and effectiveness. It is certainly evident the European market is not as competitive as it should be, although on paper the individual member states can claim that they have met the minimum requirements of the wholesale competition directive. Most observers would also concur that the primary factor limiting the development of competition is the gradual creation of post-deregulation quasi-oligopolies, the so-called vertically integrated 'national champion' utility companies that have placed a growing stranglehold on their domestic markets and invested heavily in non-domestic markets.
Diluting the power of these dominant utilities may be difficult to achieve, as it is increasingly evident the Commission has no constitutional powers over the member states. Witness the minimum change of EdF and GdF's legal status by the French government to conform to the letter of the directive. In not planning to privatise more than 30% of these utilities it will not encourage increased competition in France. It is all very well increasing the number of contestable customers (as France has done under the directive, raising contestable customers from around 38% to nearer 70% of the market) but if there is no real increase in the number of supply companies there is little choice for the increased contestable base.
So what approach can be taken to achieve a more competitive marketplace? Increasingly finding favour is the notion of regional markets, the argument being that dominant domestic utilities will be less dominant in a larger geographic region. Not only, argue the proponents, does this increase competition by diluting the dominance of some utility groups it also consolidates liquidity, thereby providing better trading and price discovery.
Lending its support to this approach is APX Group, the new name for the enlarged Amsterdam Power Exchange. Following gas and power acquisitions in the UK over the past 18 months the APX Group now believes it has the core of a multi-commodity, multi-region platform. Of more interest though are its plans for the future, which centre on the coupling of the Dutch, Belgian and French power markets in a similar way to that achieved in the Nordic market. The rationale for such a coupling is clearly evident, with the two major continental gas hubs, at Belgium's Zeebrugge and the Dutch Title Transfer Facility, being part of this northwest Europe market.
Should such a northwest European gas and electricity hub evolve it would, together with the existing Nordic and soon to be launched single Iberian (MIBEL) market, form the basis of a more regionalised European market. And with Germany's EEX noting its interest in expanding and diversifying its business services, initially through power options and possibly emission contracts, the realisation of a more integrated and regionalised European energy market moves a step closer. However, would such a regionalised market achieve the levels of market liquidity and price discovery its proponents claim?
If we look at the success of the Nordic market we might be persuaded that regionalisation is the way forward. But the Nordic market's success may not necessarily be replicated elsewhere in Europe as the market is somewhat structurally different from much of the remaining EU - it was already a de facto region and most of its utilities are Scandinavian owned. By contrast the dominant domestic utilities in the remainder of Europe have invested in other non-domestic markets, which can almost be viewed as a hedge against regionalisation reducing any domestic market power.
There is no easy solution to Europe's liquidity problems, but any process that seeks to consolidate rather than fragment the market should offer more promise. In this respect the future vision of APX Group is well founded. Equally, a more regulatory-competent Commission would not be amiss in providing firmer governance on competition as an increasing number of traders become ever more sceptical of Brussels' jurisdiction on markets.
Missed opportunity
This scepticism was proved justified earlier this month when the Commission published its assessment of the first batch of national allocation plans for the EU Emission Trading Scheme (ETS). The bullish tone of the Commission preceding the assessment, that it would seek scarcity of emission allowances to push the price of allowances higher and thus incentivise greater emission compliance / reduction, proved to be little more than hot air. It quickly became apparent that the Commission would accept any allocation plan providing it conformed to the technical guidelines. In other words the Commission cannot instruct a member state to re-adjust its allocations if it is over-allocating, provided the member state is allocating allowances as laid out in the technical guidelines.
Quite simply this makes a mockery of a cap and trade system, as there will be excess allowances in the market, reducing the price of allowances and the cost of compliance. Within such a market scenario the probability of emission reductions being achieved as a result of the ETS is significantly reduced. Of greater concern though is the impact on trading. If the price of allowances is depressed the emphasis on trading is lessened as the ETS potentially becomes a one-sided sell market. But from 2008 the first mandatory phase of the ETS (coinciding with the first Kyoto compliance period) commences, at which point the ability to trade allowances to meet compliance will be critical. Yet companies that have not entered the trading market between 2005 and 2007, due perhaps to the lack of a market through depressed allowance prices, will be severely disadvantaged in not having developed the requisite trading skills.
Government and regulators may design competitive markets but these markets develop through market forces. By lacking the resolve to ensure allowance levels are properly set the Commission has arguably missed an opportunity to positively influence market forces and assist emission reduction.
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