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/ FT.com Comment & analysis / Analysis - Europe tries to fix a power failureSkip to main content, accesskey 's' Homepage, accesskey '1' Wednesday Apr 5 2006 . All times are London time. Roger Bove Edit Profile Take a Tour Log out Comment & analysis / AnalysisPrint article | Email article Main page content: Europe tries to fix a power failure By George Parker, Sarah Laitner and Thomas Catan Published: April 4 2006 19:19 | Last updated: April 4 2006 20:08 Deep in an Alpine forest a tree falls on to a power cable, plunging Italy into darkness. On the windswept Belgian coast a metre-wide carbon steel pipeline conveying gas across the North Sea operates at half its capacity, even though businesses and consumers at the other end in Britain are crying out for supplies. ADVERTISEMENT Portents of a looming energy crisis in Europe have been there for some time, had the politicians chosen to see them from the national power blackouts in Italy in September 2003 to soaring gas prices in Britain at the onset of winter last year. But it was a decision by the Kremlin in January to mark the start of Russia s presidency of the Group of Eight leading industrial nations by turning off the gas to Ukraine disrupting supplies to the European Union in the process that forced Europe s energy vulnerability to the top of the political agenda. As usual, the EU has proved itself adept at analysing the problem, most recently in an energy paper endorsed by the union s 25 heads of government at a Brussels summit last month: the question now is whether they have the political courage to do something about it. On Tuesday the European Commission, in a preliminary flexing of muscles, launched proceedings against 17 member states for not implementing existing EU energy legislation. They are accused of failing to see through an unbundling of distribution networks, such as the electric grid, from production and sales activities. The backdrop to the longer-term concerns is one of dwindling natural resources in Europe, particularly in the North Sea, which have left it heavily dependent on foreign power. By 2030 the EU will rely on imported supplies for 70 per cent of its energy needs compared with 50 per cent now. Russia will become an increasingly large supplier. Europe s external energy insecurity has been compounded by the failure of policymakers to create a genuine single market for energy, with the lower prices and greater choice that could entail from reduced production costs. Instead of pan-European energy giants competing across a market of 450m consumers, the sector is fragmented along national lines, prompting claims that big groups with large clout hinder competition. National incumbents, controlling both gas and electricity generation and distribution, are often shielded from competition. Cross-border connections are either non-existent, fragile (as in the case of Italy) or fail to respond to price signals (as with Britain s gas interconnector with the continent). Dieter Helm, an energy expert at Oxford University, produced a report for EU leaders last year warning that massive investment was needed Europe-wide to address problems thrown up by the oil price rise, threats to supplies and climate change. In an important sense there is no European integrated market yet but rather a string of national markets with bilateral connections, he wrote. The limited physical trade between countries did not matter much in the 1980s and 1990s when most member states had excess capacity and world energy prices were very low. But now it does matter, he concluded. The concentration of market power within member states is striking: EDF controls 85 per cent of the French electricity market while Electrabel, owned by the Franco-Belgian Suez, supplies a similar amount of Belgium s power market and dominates the gas sector in that country. In Germany, four groups Eon, RWE, EnBW and Sweden s Vattenfall control 70 per cent of generation and transmission. Where European companies have attempted cross-border takeovers they have often been thwarted. Spain is trying to stop Eon of Germany buying Endesa, its own national champion, while France frustrated a mooted takeover of Suez by Enel of Italy. Suez instead plans to merge with state-controlled Gaz de France in a 70bn ($86bn, 49bn) deal. How did Europe s energy market get into this state and how does it get out of it? Energy and transport are the last great frontiers of the EU s single market project areas deemed too nationally sensitive to be subject to the full liberalisation seen in the markets for goods and, to a lesser extent, services. The survival of Europe s energy behemoths lies in the hands of the Commission, which wields wide powers to break open markets. Indeed, for a while in the early 1990s, it looked as if it might use such powers against the energy sector. Peter Sutherland, the Irishman who was then competition commissioner, and Leon (now Lord) Brittan, his British successor, had already broken open national telecommunications monopolies and airline cartels, spawning world-beating private companies in the process. Energy was next on the list. But Jacques Delors, the French Commission president at the time, was not enthusiastic and member states were opposed. A colleague of Mr Delors says the Commission chief was swayed not by French lobbying but by an awareness of what was politically possible, adding: You can t attack on every front. The result has been 15 years of incomplete energy liberalisation, including an EU law covering the electricity sector in 1996 and the gas sector in 1998, which required companies to unbundle their network activities. The idea was to allow new entrants into the market but companies only had to hive off their generation and distribution activities into separate legal entities, meaning many incumbents retained control over the supply chain. According to Neelie Kroes, today s EU competition chief, the law is not working. Bundling of generation, supply, pipelines, grids and distribution seems to be at the heart of the current market failure, the Dutchwoman told an energy law conference in Brussels last month. Personally, I find full structural unbundling quite tempting. Will today s Commission, led by the Portuguese Jos Manuel Barroso, have the courage to go after such powerful vested interests? There are going to be some fights ahead: a lot of political courage will be needed but the credibility of the Commission is at stake, says a Barroso aide. Mr Barroso, who leads perhaps the most liberally inclined EU executive ever assembled in Brussels, sees energy liberalisation as a rare cause capable of uniting Europe s free-marketeers and EU integrationists, who view a common energy strategy as a step towards closer union. Mr Barroso believes he has the tools to do the job. Yesterday s legal suits provide early evidence. But the biggest tests are yet to come. First, the Commission is expected to use its competition powers to tackle protectionism in the energy market, which it believes to be most blatant in the case of Spain s attempt to block a 29bn bid by Eon of Germany for Endesa. Then Ms Kroes, as part of a review of the sector, will attempt to live up to her own slogan I m no pussycat by acting against big energy incumbents that she sees as blocking prospective entrants. This year Andris Piebalgs, the Latvian energy commissioner, will also review the existing EU energy directives to see whether they are working. He says he believes legal unbundling by energy giants of their different operations can still be made to work, if properly policed. Finally, there is what Mr Sutherland calls the nuclear option , which would involve the Commission invoking a little-used power in order to open the market by decree a tactic used with devastating effect against the telecoms sector in the late 1980s. Nothing is ruled out, says a Commission official. Mr Barroso knows that in spite of the Commission s legal powers, the EU executive needs political cover. He says Angela Merkel, Germany s chancellor, has been fantastic in her support , offering crucial backing when it comes to taking on French interests. And Britain, Italy, the Netherlands, the Nordic countries and many new member states in the east are making liberal noises. But he admits that, while Ms Merkel may support Eon s bid for Endesa, powerful forces in Germany s energy market will fight all the way if Brussels tries to challenge their dominance in their home market. Ms Merkel met German companies on Monday to discuss energy strategy. Others, such as Spain, talk a good game on free markets until their national champions are threatened. Moreover, even if the Commission succeeds in its goals, broad practical obstacles remain to efforts to form a pan-European energy market. One of the most important is infrastructure. Cross-border electricity links are often fragile and building new ones is expensive. They also invariably run into environmental opposition. Existing links were built on an ad-hoc basis and there remain few incentives to set up more when long-term prices difficult are to forecast. There is the added inconvenience that building links to neighbouring countries allows competitors into protected national markets. The European Commission wants imports to be capable of providing 10 per cent of countries consumption and insists that big pan-European energy companies will have the incentive to build them but this target remains a distant dream. Ciara Ryan, a partner at Deloitte energy markets, says: Sometimes there is not enough of a long-term price signal or regulatory certainty for companies to make a long-life investment in an electricity interconnector and ensure that there is a sufficient return on their investment. As well as lacking sufficient interconnection physically from one country to the next, the existing capacity that is there is often not being used in an efficient way. Links from the Netherlands to Belgium and Germany to France are particularly congested at the moment, she adds. Further structural problems exist. Each of the 25 national markets has different codes for using its energy grids and infrastructure. Countries are reluctant to set up a European regulator to overcome this with the power to police grid access. In addition, the market suffers from a lack of transparency, which makes it difficult to know how much is available for spot purchase rather than being tied-up in long-term contracts. As the UK s experience this winter showed, there are fears that continental companies are sitting on gas rather than selling in Britain, even when dwindling North Sea gas reserves and domestic supply disruptions drove prices in the UK up to record levels. The assumption was that the market would deliver, particularly when prices in the UK were many times higher than in continental Europe. But commercial logic did not apply and the interconnector often ran at half capacity. Mr Barroso knows that for all the armoury at his disposal, he has to win the political argument that the market is the answer to Europe s energy problems. Many national politicians still believe that security of supply is simply too important to be left to foreign-owned energy conglomerates and an imperfect market. Jos Lu s Rodriguez Zapatero, Spain s prime minister, summed up the gut suspicion last month when he explained his attempts to keep Endesa in Spanish hands. This has not got to do with countries that are more or less open, or with protectionism or not, he said. This has got to do with security with energy security. SYMPTOMS OF A DYSFUNCTIONAL MARKET PROTECTIONISM France: Accused of trying to block a takeover of Suez, the Franco-Belgian utility, by Enel of Italy. It is merging Gaz de France with Suez instead. Spain: Changing the law to frustrate a bid by Eon of Germany for Endesa, claiming energy is a strategic sector that should be protected. ENERGY ISLANDS Baltic states: No interconnection capacity with the rest of the EU. Heavily dependent on Russia. Spain/Portugal: Madrid accuses Paris of protecting its home market by refusing to increase capacity between France and Spain, leaving the Iberian peninsula isolated. WEAK LINKS Britain: Gas interconnector with the continent running well below capacity in spite of soaring UK gas prices. Regulator says Britain paid 1bn more for its gas than it needed to this winter because suppliers such as Gaz de France failed to ship. Italy: Relies on imported electricity and was plunged into darkness in September 2003 when Alpine trees broke power lines from Switzerland. DOMINANT COMPANIES Germany: Eon Ruhrgas and RWE. France: EDF and Gaz de France. HIGHLY DEPENDENT ON RUSSIA Poland: Wants a Nato-style approach to European energy security, protecting it against Moscow. Furious at being bypassed in Germany s plan to import Siberian gas through a Baltic Sea pipeline. Hungary: Badly hit when Russia turned off gas supplies to Ukraine. 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