EU energy policy: let’s stop walking backwards

Giovanni Caccavello // 9 January 2017

In order to harmonise and liberalise the EU’s internal energy market, three consecutive legislative packages of measures were adopted between 1996 and 2009, addressing market access, transparency and regulation, consumer protection, cross-border interconnection and adequate levels of supply.

 

Whilst falling short of expectations, mainly because of policy ambiguity, strong opposition by national governments and powerful lobbying by vested interests; the results achieved by the three liberalisation packages were positive. As Stagnaro illustrates, the liberalisation of European electricity markets led, over time, to a reduction in the market share of incumbent dominant firms, the former state monopolies. There was also an increase in cross-border trade and physical power flows, and a greater degree of competition.

 

Despite its shortcomings – mainly related to the timidity of the three packages in pursuing privatisation alongside liberalisation –, the opening and integration of national electricity markets accomplished several of its initial targets.

 

One of the biggest achievements has been the development of a common electricity market for the EU. Today, when the transmission network is not constrained, a single power station sets the price for the whole European continent. For example, on Monday, January 1^st, at 4pm, the spot price for electricity was 60.96 €/MWh in France, the North of Italy, Portugal and Spain. It was only slightly lower in Belgium (59.98 €/MWh), Germany and the Netherlands (57.77 €/MWh). At the same time, when the transmission network is more congested, constraints on supply are managed efficiently by the market coupling process, a system that optimises the allocation of cross-border capacities thanks to a coordinated calculation of prices and flows between countries, covering 19 EU member states – roughly 85% of European power consumption.

 

Thus, over the last two decades, the EU energy market liberalisation process has been relatively successful and in 2015-2016 the idea of a fully-integrated internal energy market was named by the European Commission as one of its priority areas.

 

As Leautier and Crampes (http://fsr.eui.eu/liberalisation-european-electricity-markets-glass-half-full/) write, the difficulties to overcome in order to liberalise the European electricity industry remain significant, though less so than they were decades ago. From political to economic, from technical to symbolic, the barriers against a EU common electricity market have always been hard to climb since the creation of the European Coal and Steal Community (ECSC) in 1951 and the foundation of the European Atomic Energy Community (EAEC/Euratom) in 1957. Energy policy in most European countries has been characterised by a comparably very high degree of government intervention and state protectionism since the 1930s, and – despite laudable improvements since the 1980s – both of these remain salient at the present time.

 

On top of these difficulties, over the last fifteen years EU policy-makers have introduced a further threat to a liberalised and efficient energy market: ill-conceived climate-change policies.

 

In particular, since the introduction of the so-called “Energy Policy for Europe” in early 2007, environmental regulation and the expensive promotion of renewable energy sources through inefficient subsidies have led to a new wave of heavy government intervention that is reducing the scope for liberalisation, slowing the process of a fully-liberalised EU common energy market, and jeopardising European electricity markets by creating several market distortions.

 

With the appointment of the Juncker Commission in November 2014, the EC has brought forward a few key proposals to implement the EU’s 2030 Energy Strategy. The strategy’s main goals are to cut greenhouse gas emissions by 40% compared to 1990 levels over the next 14 years, to reach at least a 27% share of total renewable energy consumption; to achieve a 27% energy savings compared to the baseline scenario.
In order to meet these objectives, in 2015, the European Commission presented a proposal to reform the EU Emissions Trading System (ETS) – a cap-and-trade scheme for heavy industrial users of energy, as well as the airline sector – ostensibly to ensure the energy sector and energy intensive industries deliver the emissions reductions needed. In summer 2016, the EC brought forward proposals to accelerate the low-carbon transition in other sectors of the European economy.

 

On one hand, the most recent energy proposals are indeed more pragmatic than the 2020 Energy Strategy and seem more concerned with cutting greenhouse gas emissions more effectively.  For example, in 2015 the EC presented a proposal to reform the EU Emission Trading Scheme (ETS) and in the recent 2016 “Winter Package” the EC made some interesting steps forward in giving consumers greater control over energy choices. On the other hand, these proposals seem to reinforce the idea that Brussels wants to pursue a proper long-term industrial policy as well as an environmental policy, an idea .  This is not only at odds with the idea of a liberalised and competitive energy market – where the energy mix is determined by performance, not government fiat – but, over time, this strategy will likely imply higher costs, further market distortions, more regulations and an overall reduction in competitiveness. That is, at least, the record of industrial policy in recent history, as a recent paper from EPICENTER member the IEA shows.

 

Before embarking into expensive and inefficient climate policies, policy-makers should focus on what the three previous liberalisation directives did not achieve and why the fell short of expectations. In fact, there are two main reasons why the EU liberalisation directives failed to achieve the same positive results. The first is that Brussels gave up privatisation immediately, whilst the second pertains to the weakness of EU institutions in requesting that Member States implement meaningful liberalisation at the retail level.

 

First of all, the European Commission should consider the UK liberalisation reforms of the late 1980s and early 1990s and understand why there is a robust academic consensus (Newbury, 2006; Joskow, 2008; Stagnaro, 2015) that defines the British electricity sector reforms as the “gold standard” for comprehensive and successful liberalisation of an electricity market. More recent British experience also illustrates the pitfalls of re-regulation.

 

The British model of electricity market reforms followed consisted of six pillars: the creation of a competitive market for electricity; the breakup of monopolistic supply so each consumer could select his provider; separation of network maintenance from generation; separation of direct supply from the generation of electricity; creation of an incentive structure to set market prices in monopolistic competition, given the pre-eminence of the former state utility; and the privatisation of formerly state-owned assets.

 

The UK liberalisation model was very successful. Although Britain’s economy grew on average by 2.25% between 1990 to 2000 (a 24.75% increase in real GDP), over the same decade the amount of emission per unit of GDP dropped by nearly 30%, U.K. energy-related greenhouse gas emissions fell by 7% and electric charges for domestic consumers fell by 26% in real terms (Stagnaro, 2015).

 

Notwithstanding the fact that, over the last few years, British policymakers have retreated from liberalisation towards greater centralisation and politicisation, the 1980s and 1990s reform plan shows that the opening up of electricity markets – if properly pursued – can lead to large benefits, both in terms of reducing carbon emissions and in terms of lowering the cost of energy.

 

If EU institutions want to achieve deeper integration of national energy markets, they should ensure that the liberalisation process initiated 20 years ago is carried forward and successfully concluded. In fact, the best way to identify the optimum level of CO2 emissions; to find the most efficient ways to reduce emissions; and to determine the right level of spare capacity is a decentralised competitive market.  Regulation and state direction pale in comparison.

EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).