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Ronne, Anita --- "How do other countries carry out energy regulation?" [2004] NZYbkNZJur 5; (2004) 7 Yearbook of New Zealand Jurisprudence 57

Last Updated: 12 April 2015

How Do Other Countries Carry Out
Energy Regulation?

Anita Ronne^*

I. INTRODUCTION

We take energy for granted. Fuel shortages and power cuts are rare, but during one-and-a-half months in August and September 2003, we witnessed a series of 'worst ever' blackouts that left millions of people in the dark. To adapt the words of Leonard Cohen, 'First we take Manhattan, then we take London, then Copenhagen and then Rome.' This reminds us how dependent society is on reliable and secure energy supplies and how power failures are inflicting widespread damage on local economies. We have already seen many theories abound as to why the electrical systems collapsed; mismanagement, ageing electric systems, lack of unified standards for reliability, and computer hackers. The exact reasons have still not been determined and energy officials are saying that the systems are designed for this not to happen. Consequently, it is natural to ask the question: so how did it happen? However, no full explanations are provided yet. 'The answer is blowing in the wind.'

There is no doubt about the great benefits of interconnection and integration, but these recent experiences do highlight they have drawbacks as well. As interconnections become more comprehensive, the more interdependent the supply areas and markets become, and the bigger the effects if there is a blackout. The worldwide trend of liberalization of energy markets has led to speculation about the possible effects of liberalization, and has led to connected moves in the direction of re-regulation and restructuring. Some observations can be made about these trends in Denmark and Europe generally in order to provide a comparative perspective on the New Zealand experience.

II. THE EUROPEAN UNION

In many respects, Denmark has several characteristics in common with New Zealand. It is a small country of islands and easy access to the sea. It has a small population, and a primarily temperate climate.' It has sound

Faculty of Law, University of Copenhagen, Denmark.

Denmark's area is 43,096 km² including 405 islands. Its population is 5,368,354 and

population density is 125 per km². Average temperature: January 4.9^°C, July 18.5°C,

democratic traditions, a high standard of living with no big gaps between rich and poor, and a high awareness of environmental issues. However, with respect to electricity, there is a big difference; New Zealand is isolated and does not have electricity interconnections and trade with other countries, and no foreign competitors for the domestic electricity industry. Denmark, on the other hand, is part of a big common market —the European Union.

A clear and decisive target in Europe has been the creation of an internal market and free trade across national borders. This objective is to be seen within the framework of Europe's growing import dependence on energy.² Energy is considered a normal good but with the special characteristic that purchases have to be transported through networks that are regarded as natural monopolies.

Growing from six Member States in 1952 to 15 by 1995, the European Union today embraces more than 370 million people, from the Arctic Circle to Portugal, from Ireland to Crete. The 15 member countries are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Portugal, Spain, Sweden, the Netherlands and the United Kingdom. In May 2004, the EU will be enlarged by the addition of ten new member states: Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia. Three more states have applied for EU membership: Bulgaria, Romania, and Turkey. One must note also that the EU has entered into special agreements with countries that belong to the so-called European Economic Area: Iceland, Lichtenstein, and Norway — the consequences of which are that most Community law and principles apply to them as well.

EU law and the following sections on the internal energy market therefore have implications for between 25 and 30 countries. It is a condition for applicants to harmonize their national energy legislation and to implement and meet the requirements of EU legislation and principles. This is also the case with respect to some non-member countries such as Norway.

Sunshine average per year: 1,710 hours. Precipitation (average per year): 768 mm. Danish Energy Authority, Energy in Denmark, 2001.

2. An overall strategy to strengthen the security of supply can be found in the Green
   Paper Towards a European Strategy for the Security of Energy Supply, COM (2000) 769 and Final Report on the Green Paper Towards a European Strategy for the Security of Energy Supply COM(2002) 321. A great deal of information on the European Union is available at <www.europa.eu.int>. See also Martha M. Roggenkamp, Anita Ronne, Catherine Redgwell, lngo del Guayo, eds., Energy Law in Europe: National, EU and International Law and Institutions (Oxford: Oxford University Press, 2001).

III. THE INTERNAL ENERGY MARKET

In order to combat the energy crisis of the 1970s, public control and state-owned energy monopolies became the norm for countries in Europe. Only a decade later, the European Commission launched a number of initiatives in order to break up these monopolies and to develop a common market without frontiers — the so-called internal energy market. However, the different member states expressed a lot of resistance and opposition to the new ideas. It took, in fact, almost another decade before things had matured so much that the first two Directives on the establishment of a common market for electricity and gas could be adopted by the European Parliament.

The main objective of these two Directives — Common Rules for the Internal Market in Electricity (96/92/EEC) and Common Rules for the Internal Market in Natural Gas (98/30/EEC)³ — was to increase competition with the view of obtaining the benefits of cheaper energy prices. A primary means of attaining this objective was to divide the energy sector in two separate parts, firstly that of production and trade where competition could be introduced, and, secondly, the monopoly sectors (networks and gas storage) that needed to be regulated.

The first principal step of the liberalization process was to obtain transparency. This implied the creation of an open market for all players and clear ways of getting access to the customers. Secondly, it was important to ensure that no parties were favoured or had special privileges. As a result, the defined monopolies — transmission and distribution — needed to be separated from each other and from other activities. This was called unbundling. It could impose different levels of requirements; unbundling of accounts, of management, or of ownership. Finally, fair and equal access to networks had to be guaranteed for all players in order to introduce competition.

IV. THE MARKET DIRECTIVES

EU adopted its Market Directive for electricity in 1996, and, two years later, a Directive for natural gas. It was the result of many hard negotia

3 Directive 98/30/EC of the European Parliament and of the Council of 22 June 1998

Concerning Common Rules for the Internal Market in Natural Gas, 03 L204, 21/07/1998, p 0001-0012. Directive 96/92/EC of the European Parliament and of the Council of 19 Dec 1996 Concerning Common Rules for the Internal Market in Electricity, 03 L 027, 30/01/1997, p 0020-0029.

tions between the member countries. The provisions of the Gas Directive are modelled on those of the Electricity Directive. As already indicated, the prime purpose was and is to develop common and harmonized rules that will support free competition and trade across national borders. Article 3 of the Directive sets out the general rules for the organization of the sector. It provides that member states must ensure that electricity undertakings are operated in accordance with the principles of the Directive, with a view to achieving a competitive market in electricity.

The Directive requires the member states to implement legislation that ensures a clear separation between monopoly activities and commercial activities. A means to this end is to include an obligation to unbundle the different functions previously performed by vertically-integrated energy companies, and to separate accounts in order to hinder cross-subsidization and to increase transparency. Moreover, the owner of the infrastructure must give access to third parties, and finally customers must be able to choose their supplier. The introduction of competition is, however, based on a gradual opening of the market and member states are at liberty to impose on distribution companies an obligation to supply customers located in a given area.

To accelerate the opening of the energy market, new Market Directives were adopted on 1 August 2003.⁴ These Directives for electricity and gas must be implemented in national legislation by 1 July 2004. The overarching objective of the new initiatives is to ensure efficient competition and thereby cheaper prices, to provide a real level playing field and to increase the standards of service for customers. The new Directives imply qualitative as well as quantitative measures to create a more efficient open energy market. The electricity market must be totally open by July 2007 — for wholesale customers by July 2004, and for everybody else by July 2007.

To ensure a better functioning of the market, a higher level of unbundling is also required. The new obligation includes a legal unbundling that implies that vertically integrated companies need to establish a separate company for each activity in contradiction to the present requirement of account unbundling. Moreover, member states must ensure that trans

4 Directive 2003/54/EC of the European Parliament and of the Council of 26 June 2003

Concerning Common Rules for the Internal Market in Electricity and Repealing Directive 96/92/EC, OJ LI76, 15/07/2003, p 0037-0056. Directive 2003/55/EC of the European Parliament and of the Council of 26 June 2003 Concerning Common Rules for the Internal Market in Natural Gas and Repealing Directive 98/30/EC, OJ L176, 15/07/2003, p 0057.

mission is carried out via an independent system operator. The new Directives, furthermore, require regulated access to the networks, in contrast with the old ones which included the possibility of negotiated access. Regulated access is cost-based and based on the principle of publication of tariffs, whereas negotiated access does not ensure equal conditions for third parties, because only main commercial conditions are published. Member states are obliged to take appropriate measures to protect final customers, and in particular vulnerable customers.

The new Directives also require each member state to appoint an independent regulator to regulate the monopoly parts of the industry and to ensure non-discriminatory access to the network. The regulator has to be independent from the industry — not necessarily from the political and administrative institutions. One of the lessons learned in Europe has been that deregulation or restructuring in fact requires effective control and a very active regulator.

The Directive recognizes that member states may impose public service obligations on the industry. These may relate to security, regularity, quality and prices of supplies, and environmental protection like efficiency and climate protection. Such obligations must be clearly defined, transparent, non-discriminatory and verifiable. As a method of carrying out these public service obligations, the member states can implement long-term planning. Also, it must be ensured that household customers enjoy universal service and a right to be supplied with electricity at reasonable prices. There are still possibilities for derogations and exceptions — the background being the risk that there may be no interest in implementing new projects. To make such projects more commercially viable it is possible to refuse third party access to new networks.

Even when a common market is developed, there is still a need for two types of regulation. First of all, control is needed with respect to access, including approval of tariffs. Not least important is access to recourse. This kind of regulation is to be performed by an independent sector regulator. The other type of regulation which the public authorities need to address is regulation in order to ensure that the sector fulfils certain objectives related to energy security. These objectives include issues as environmental protection, quality of supply, and energy conservation.

A. The Electricity Market

The EU Directives must be implemented in national legislation, and this implementation does in fact show a rather varied picture, especially with respect to the opening of the market.⁵ This is illustrated by Table 1.

Table 1: Market Opening for Electricity in the EU

Germany is said to have a 100 per cent market opening. However, it is claimed by many member states, with the support of the EU Commission, that the German market opening is an opening in theory and not in practice, as access conditions are very complicated and therefore non-transparent. In this connection, it should be noted that there is no sector regulator in Germany. Responsibility for energy regulation is vested in the general competition authorities. With respect to trade across national borders, a country like Germany is very important. All roads may lead to Rome, but for energy infrastructure all networks need to pass through Germany. Consequently, it is absolutely crucial for the development of the European market, whether north, south, east, or west, that access to the German infrastructure is assured.

5 Commission Staff Working Paper, Second Benchmarking Report on the Implementation of the Internal Electricity and Gas Market, 2/10/2002, SEC (2002) 1038.

The new member states — the central and eastern European countries —have not been quite so aggressive in their market opening. This is illustrated by Table 2. The obvious reason for this is that in terms of introducing competition this is a much younger region. In addition it is an area in transformation which in fact applies to all sectors of society.

Table 2: Market Opening for Electricity in Countries Joining the EU

B. The Natural Gas Market

The natural gas market is not open to the same degree as the electricity market. This is mainly due to the fact that liberalization was initiated two years later than for electricity. Table 3 demonstrates this state of affairs.

Table 3: Market Opening for Natural Gas in the EU

With respect to the new member states, the picture shows the same tendency, as Table 4 demonstrates. As far as countries like Latvia, Czech Republic, and Hungary are concerned, the market opening has not started at all.

Table 4: Market Opening for Natural Gas in Countries Joining the EU

V. STRUCTURE OF THE INDUSTRY — IS IT POSSIBLE
TO CONTROL THE GIANTS?

Europe has moved from monopolies that were primarily owned by the state and vested with exclusive rights. In fact this development may be seen not only within the energy sector but also in telecommunications, railways, postal services, and to some extent airways. It has been a distinct objective to leave the scenario of state monopoly and find a pathway towards more efficient industries. At the same time there has been a trend of privatizing the industry. However, ownership as such does not necessarily have anything to do with liberalization of the market. In principle, there exists no problem in having state-owned utilities, as long as the regulation is efficiently applied.

Liberalisation has — at least in Europe — enabled a comprehensive restructuring process. Mergers and takeovers are the daily headlines. This takes place partly within sectors but also between the gas and electricity sectors. Moreover, national companies have moved internationally and bought foreign companies to become stronger and to get a bigger share of the market. In this connection Germany and France are dominant, and it should be emphasized that these two countries represent about 50 per cent of the European economy. On the other hand, it is interesting to note that the French GDF and EDF maintain a monopoly position in their home market, and that Germany is accused of having established a market that is not transparent.

It is relevant to think about future development scenarios, and ask whether we are creating new monopolies; but now international monopolies that replace national monopolies. If so, how are we to control these giants?

VI. THE SWINGING PENDULUM

Looking back, it is interesting to note that during the period up to the energy crisis of 1974 and 1979 the energy sector was more or less left to the market with no public intervention. The political change (and therefore the regulatory change) since then is reflected two political statements from Denmark. The first is from 1979:

The Danish energy system has up till now ... been market-based ... predictions about a future shortage in oil have led to a desire for an overarching public control of important parts of the energy sector.

The second is from 2003, about 25 years later:

The market is the most efficient point of departure for management of security of supply ...⁶

The change of policy is profound and the philosophy is the opposite — the focus is now on the market. Although both quotations come from Denmark, I feel confident that equivalent statements can be found in the recent history of almost all other countries. It is indeed a case of a swinging pendulum. The challenge must be to ensure that through appropriate regulation, countries are not faced with the same problems as those of the seventies!

No doubt there is something special about energy, and the electric transmission grid is quite possibly the most vital piece of infrastructure that exists. But with Darryl Jenkins, director of the Aviation Institute of George Washington University, it may be stated that 'The plus of a network is that everything is connected. The minus of a network is that everything is connected.' The final concluding remark must therefore be that electricity is the modern world's bloodstream, but it is like with oxygen — we do not notice it till it is no longer there.

6 See Energy Policy Statement 1979, by the Ministry of Trade, March 1979, Annex on

"Assessment of the energy security of the Danish energy system to 1995", p 3; and Energy Policy Statement 2003, by the Minister for Economic and Business Affairs, May 2003.