January 2007

Energy Sector Inquiry: hardly

smooth Kroesing
The gas and electricity sectors have been under the • high market concentration
European Commission’s spotlight for the last year and
• lack of transparency, including in relation to price
a half, in the context of the competition Energy Sector
formulation, and
Inquiry, the creation of a new Energy Policy for Europe,
and controversy about jurisdiction over merger control • possible market-sharing collusion between incumbent
decisions. Two Directorates-General have been working operators.
together (DG-COMP and DG-Energy and Transport (TREN))
The Commission also identifies additional problems relating to
investigating the energy market, issuing preliminary findings
long-term downstream contracts, balancing and LNG supplies.
in February 2006 and holding public meetings to hear from
interested parties. Their overall aim is to achieve the goals
of the EU’s Lisbon Agenda: creating more growth and jobs Remedies
and a more competitive European industry globally. Key to The primary remedies that the Commission intends to put
this in the energy sector has been allowing cross-border in place include:
deals to replace national champions with pan-European
champions and removing national barriers and controls. • greater use of its competition enforcement powers in
individual cases, namely
On 10 January 2007, the Commission unveiled its long- – increased merger control
awaited final competition report in the Sector Inquiry and
its Energy Policy setting out the perceived problems in – more Articles 81 and 82 investigations
the sector and suggested remedies. (This briefing focuses – investigations under the state aid rules
primarily on the competition report; however a number of
the issues covered in the report are also dealt with in the • changing the regulatory framework, in particular, in
Commission’s Energy Policy document, such as internal relation to
market and security of supply issues.) – unbundling

– removing regulatory gaps

Commission’s findings
– addressing market concentration and barriers to
The Commission confirms some of the problems identified
entry and
in its preliminary findings, including:
– increasing transparency.
• vertical integration (primarily inadequate unbundling)
The Commission’s Final Report is disappointing in terms of
• lack of market integration (principally lack of regulatory
concrete proposals. Where its intentions are clear, it needs
control of cross-border issues)
the Council and Parliament to support any regulatory
change and for antitrust cases to produce infringement
 Commission Communication, Inquiry pursuant to Article 17 of decisions for progress to be made. Below we offer some
Regulation 1/2003 into the European gas and electricity sectors details of the main problems identified by the Commission,
(Final Report), 10 January 2007.
 Commission Communication to the European Council and the along with the possible solutions.
European Parliament: An Energy Policy for Europe, 10 January 2007.
Some issues in-depth level responsible for adopting decisions in relation to the
European energy sector.
Vertical foreclosure
Vertical foreclosure is a key concern of the Commission. It
Where unbundling does not become a legal requirement
takes a range of forms. A major concern is discrimination,
(and ISOs are established), it is likely that national
the Commission having received complaints that vertically
regulators will be given more intrusive and burdensome
integrated incumbents favour their own affiliates with
powers in an attempt to prevent discrimination by
regard to both operational and investment decisions.
vertically integrated companies.

Another important concern is ownership unbundling. The

Commission has identified full unbundling as the most
Market concentration: stricter merger control
effective means of opening up the market and attracting
conditions; and energy release programmes
the investment that is required. To date, full unbundling has
The Commission is keen to promote energy release
been successfully implemented in 11 Member States, but
schemes such as virtual power plant auctions and gas
there has been strong political resistance in others. As an
release programmes, contract swaps and refinery and
alternative, an independent system operator (ISO) would
pipeline divestitures to relieve the chronic lack of liquidity
improve the current scenario, but this would require more
in the market and encourage new entrants. It believes
detailed and costly regulation, and would not encourage
these schemes are suitable for both mergers and anti-trust
investment.
cases but they come with some caveats. The Commission
recognises that the schemes must be well designed and
Vertical foreclosure issues also arise through a lack of
on a large scale to be effective and must be combined with
effective access for new entrants, (pre-liberalisation) long-
a release of network capacity to have any impact on the
term contracts, and the need to ensure security of supply.
competitiveness of the market. (A recent example is the
Commission’s conditions in the GDF/Suez merger. See also
Cross-border sales ‘Freeing Energy’, Competition Law Insight, June 2006, by
The Commission wants to see a more ‘European’ market Denton Wilde Sapte solicitors Rebecca Owen-Howes and
for energy. It still analyses the sector in terms of national Caroline Thomas, which discusses such requirements in the
markets, however, because cross-border sales are virtually recent E.ON/MOL case.)
non-existent. There are a number of reasons for this,
including insufficient cross-border capacity, difficulty in
Downstream markets: long-term contracts
securing transit, insufficient congestion management,
The Commission has found that the cumulative effect of
and reluctance of incumbents to increase capacity (which
long-term contracts, contracts with indefinite duration,
would allow access for new entrants). In addition, the
contracts with tacit renewal clauses and long termination
Commission discovered that in certain Member States
periods are harming retail competition severely.
pre-liberalisation capacity reservations are still in operation
despite the ECJ having found these to be incompatible with
The Commission’s concern about long-term contracts
Community law.
follows on from the decision last year of the German
Federal Cartel Office which found that E.ON’s supply
The Commission has made it clear that the minimum
contracts with distributors violated EC competition law.
approach necessary to enhance cross-border trade through
The FCO ruled that contracts longer than four years
harmonisation of standards would be to create a European
which cover 50 per cent of that company’s annual gas
Network of Independent Regulators (ERGEG+) which
requirements, or two-year contracts which cover 80 per
would impose binding decisions on specific issues such as
cent of requirements, will be prohibited.
cross-border capacity. However, the Commission has not
ruled out the creation of a new, single body at Community

The Commission has also found that gas and electricity
supply contracts may contain other restrictions on usage
that could restrict competition, for example, restrictions on
how customers can dispose of their gas.
Increased enforcement: more cartel prosecutions and
investigations of abuse of dominance
The Commission is currently conducting two
investigations for possible breach of the competition rules
following raids of gas and electricity companies across
Europe in May and December 2006. Allegations include
market-sharing, withholding capacity and exclusion
of potential competitors from wholesale markets and
possible abuses in balancing markets.
Following sector inquiry reports, further investigations
– including dawn raids – are likely and the Commission has
made it clear that it will scrutinise contracts concluded by
dominant energy companies closely.
Next steps
Competition Commissioner Neelie Kroes commented
that her Final Report is “not the end of the story, but
more the beginning of a new one”. If the Commission
has the necessary support from Member States, further
liberalisation measures can be expected. The Commission
is currently conducting an in-depth impact assessment,
following which it will bring detailed formal proposals to the
Council and the Parliament later in 2007. Its intentions at
this stage are set out in its Internal Market Communication
and include:
• Amending the Gas and Electricity Directives, for
example, to include the introduction of exemptions for
new pipelines affecting more than two Member States
• Publishing a report in early 2007 on cross-border
exchanges in electricity, which is expected to identify
areas where further action is required, such as rules for
trading, transparency and balancing
• Improving transparency requirements through new
legislation or modifying the relevant existing regulations
for electricity and for gas
• Developing an Energy Customer’s Charter to cover
consumer protection and energy poverty including
improving the level of information available to help
customers choose their supplier
Developments relating to competition policy include:
• More investigations in the sector addressing individual
anti-competitive practices
• Results of the investigations under Articles 81 and
82 commenced in May 2006 of energy companies in
Belgium, Germany, Italy, France, Hungary and Austria
and in December 2006 of electricity companies in
Germany – outcome expected in 2008
• Possible ECJ proceedings brought by the Commission
against Member States for failure to comply with their
obligations under the gas and electricity directives, for
example in relation to business separation.
• Pricing study: the EC has commissioned a study to
identify whether rising fuel prices are caused by general
increases or substantial mark-ups by large players.
For further information, please contact one of the following:
Michael Brothwood, Consultant
T +44 (0)20 7246 7465
michael.brothwood@dentonwildesapte.com
Jonathan Tatten, Partner
T +44 (0)20 7246 7527
jonathan.tatten@dentonwildesapte.com
Charles Wood, Partner
T +44 (0)20 7246 7663
charles.wood@dentonwildesapte.com

Commission Communication to the European Council and the



European Parliament: Prospects for the Internal Gas and Electricity

Market, 10 January 2007.
 ©2007 Denton Wilde Sapte LLP, unless otherwise indicated. All
information correct as at time of printing. Consistent with our policy
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