Do not dissipate too much energy with ownership unbundling
September 20th, 2007 by François Lévêque, Ecole des mines de Paris and Jean-Michel Glachant, European University InstituteOwnership unbundling is the most debated and conflicting issue of the third energy liberalisation package. This is unfortunate. Firstly, there is no fundamental reason for a controversy. Ownership unbundling has undoubtedly more advantages than drawbacks from a general economic perspective. Secondly, it is not the first priority to improve the internal electricity market. Ownership unbundling does not deserve the spotlight it has got.
CEOs and trade unions of energy companies, Member States ministers and MPs, European Commission officers and Commissioners, have engaged the mother of all battles for or against its introduction within the third energy liberalisation package. This is baffling from an economic standpoint because the matter is settled.
Let’s start with two methodological considerations. Generally speaking, vertical integration can be procompetitive. It often saves transaction costs and facilitates coordination. It can, however, also raise anticompetitive effects such as foreclosure. By denying access to an indispensable input, the vertically integrated company can eliminate or marginalise rivals from the market. When both effects occur the pluses and minuses have to be balanced on a case-by-case basis. As far as ownership unbundling between transmission systems and generation or supply activities is concerned, this balance has not to be assessed by comparing unbundling and its absence, but by comparing different forms of unbundling. In fact, EU energy law already mandates unbundling that separates accounts and management between the transmission grid and other electricity businesses. The issue is therefore whether the third package should require a more drastic type of unbundling than the one that exists today.
Our answer as economists is yes (scholars who challenge our view are welcomed to comment as well as non economists).
Why? Because there are only pluses.
In fact, the economic benefits of vertical integration, if any, are already lost. E.On or EdF are not allowed to collect information from E.On Netz or RTE, or to send management orders to their 100% owned subsidiary to improve their performances in operating or in coordinating their investments. Only portfolio synergies to smooth the stream of profits of the mother company are legally possible to exploit. Stock markets not managers or trade unions are the most efficient to arbitrate low risk regulated activities such as transmission networks and high risk activities such as competitive power generation. Ownership unbundling will allow this financial choice.
Looking at the economic pluses, they are twofold. Ownership unbundling eliminates a potential danger: the remaining incentives for incumbents to use the access to the transmission grid to limit competition from rivals. Undoubtedly, other forms of unbundling are also effective in coping with such anticompetitive behaviour. It is true, for instance, that the access to the grid in France is actually fair and non-discriminatory even though RTE is owned by EdF. A spin-off will not improve competition on the French wholesale electricity market. However, what is true today may not be tomorrow. One cannot exclude in the future a less effective French regulator, a less independent CEO of RTE, or a more intrusive chairman of EdF. Ownership unbundling nips the temptation of foreclosure in the bud and thus reduces the regulatory costs to ensure that network access levels the playing field.
Moreover, ownership unbundling would facilitate consolidation and Europeanization of transmission networks. Today, the boundaries of Transmission System Operators (hereafter, TSOs) companies are limited to national borders. In some member states like Germany, there are even regional network companies. By contrast, the grid is largely interconnected and electrons ignore borders. The optimal industry structure for electricity transmission in Europe does not correspond to 33 transmission grid companies. Cross-border alliances, mergers and acquisitions would improve the management system operating. This is especially true for interconnections for they will be managed by a single operator, not by two different parties at each end of the cross-border high voltage line (the November 2006 German black-out is a good illustration of networks pancaking drawbacks).
While ownership unbundling is a sound policy measure, it is not a panacea. It is not a magic stick that will transform the existing national championship of pumpkins into a shining procompetitive EU princess. It cannot do that because we still desperately need more effective integration of national markets, stronger cooperation among TSOs, and more European oriented mind from National Regulatory Agencies.
As members of SESSA forum, we listed in 2005 a set of 20 priority and secondary actions to make progress towards a competitive and integrated EU market. Ownership unbundling only belongs to the second category. Improving the management of interconnections and balancing services, reinforcing regional cooperation of TSOs and planning their joint investments, making national regulators working and thinking pan-European, and setting a market surveillance committee come first. We will not repeat the whole list and what we said in 2005 to argue it in a talk in Brussels and in a MIT working paper, both entitled “Electricity Internal Market in the EU: What to do next?”. We would just like to add today that unbundling will only act as a catalyst for the improvement of the EU internal market within the golden triangle of: markets integration, networks co-operation and Europeanization of national regulation. Outside this golden triangle unbundling will only shine as a lonely star like a Queen chairing a parliamentary political system.
François Lévêque and Jean-Michel Glachant
P.S. For the sake of fairness please note that Jean-Michel Glachant chaired yesterday the European Commission conference presenting to the public the draft of the Energy Third Package, through the persons of Commissioners A. Piebalgs and N. Kroes as well as by the ERGEG Chairman Sir J. Mogg. In fact, transparency in blog is as important as transparency in management of cross-borders interconnections…
September 20th, 2007 at 3:36 pm
As usual, Jean-Michel and François hit the nail on the head. Independent network ownership gives up no vertical relationships that may not turn pernicious, while at the same time promoting the integration of the whole European network.
But there is another, perhaps stronger, benefit in ownership unbundling–the collective action of the new arms-length parties: the network owners and major network users. Those economists who witnessed the greatest ownership unbundling of all–the Congressionally-mandated, Securities and Exchange Commission-managed, 1935 breakup of the US utility holding companies–could see the powerful effect creating independent, sophisticated, and well-funded actors who often-enough had adverse interests. It led directly to the creation of an independent interstate gas network in the US; the country’s most competitive and efficient.
The absence of adverseness has been the bane of the other US energy networks–electricity transmission and oil pipelines. When it comes to the pursuit of efficient, flexible and competitive networks that are owned by powerful and longstanding vertically integrated firms, regulators too often bring a knife to a gunfight. No so with the collective action of the independent network users that ownership unbundling creates.
Those economists who saw that grand ownership unbundling (JR Commons, MG Glaeser, E Troxel and JC Bonbright, among others–all long dead) would argue, as would I, that ownership unbundling belongs in the first category of actions to make progress toward competitive, secure, flexible and integrated EU energy markets.
Jeff D. Makholm
September 20th, 2007 at 7:24 pm
Thank you François and Jean-Michel for your interesting paper.
As it appears within the document and in the categoy of the blog, it is only dedicated to electricity and all arguments are built on that sector. It could have been more apparent in the document that for gas the balance between pluses and minuses is from far not the same.
I remind that the economy and operation of the gas sector, particularly in continel Europe, is completely different than electricity one. For example, the production actors have a totally different positionning and therefore the assets repartition of the “integrated” gas groups has nothing to do with those acting in electricity.
In addition, in gas operation with a daily balancing of networks, a TSO has no influence on production priority and therefore no influence on the competitivity and margin of such or such stakeholder.
Gas industry can’t be seen only as a financial field. Stocks markets are generally said to be the most efficient to arbitrate; unfortunately they are also sometimes sheeplike, and blind until the market breakdown would arrive ; it can be dangerous to let them, at the end, the only entities in a position to arbitrate risks.
One of the argument of the paper for ownership unbundling is to eliminate a potential danger and your paper anticipate that, perhaps, one day, the regulator could be less effective or the chairman of EDF more intrusive …. It reminds me the Spielberg’s movie “Minority report” : people are arrested before they commit the crime the police anticipate they will commit . Very effective indeed. More seriously, that kind of argument are not constructive , it is more or less a lazy argument who avoids to think to true industrial questions.
Finally, I am not convinced that ownership unbundling would participate to consolidation and Europeanization of the transmission networks. If the result is that the MS are owners of the networks, as it is already in a significant proportion of the country who have choosen to unbundle, it would be not in favour of that process except to give the opportunity to the largest current network operator in Europe to buy a patchwork of network pieces.
Georges LIENS
PS : just a small addition concerning the comment of JD. Makholm
I am not sure that “one size fit all” and the competitivity of the US gas market and of some other markets is firstly correlated to a significant domestic production and not only with the structuration of the industry.
September 21st, 2007 at 12:26 pm
I fully agree with Jean-Michel and Francois on the main benefit of ownership unbundgling but, precisely because of that, I fail to understand their policy conclusion, set very forcefully at the beginning of their note. It seems to me (and I side with Jeff Makholm on that) that there is a very strong case for making ownership unbundling an absolute priority, especially in the European gas industry. That there are other valuable policy measures to be taken (and the 3rd package includes some of them) does not diminish the importance of this one. If your policy conclusion was consistent with your economic analysis, your paper would be entitled “Two Thumbs Up for Ownership Unbundling” .
October 2nd, 2007 at 11:12 am
Always fun when reading Jean Michel’s and Francois’ contribution as you can hear them talk. I agree with Pierre Noel on the (wrong?) impression of the title and I agree also with George Liens on the role of natural gas.
Although all the economic arguments on full ownership unbundling may be there, there is a risk that the debate will take more energy than we will gain. In the heated Dutch debate over the last 3 years about full network ownership unbundling there was almost a full stand-still on discussing any other policy issue in energy. But more importantly, I would fear that the rational discussion on the industry structure will be bypassed by the emotional discussion on ownerships. We generally do not trust private ownership to run our networks (as we probably do not give full trust to our regulators and their regulatory system; as a former one I am speaking from experience). And, in addition, we would distrust foreign state-owned companies even more…..
Yes, a golden triangle (market integration, network cooperation and europeanisation of regulations) requires a balance. And this balance-seeking should govern the discussion, including to take a closer look at ISO-type of arrangements.
Yes the discussion and the arguments tend to focus on electricity and although in theory there is no reason to treat gas differently, the EU-reality is there. As we will not have (anymore, like f.i. the US) an EU-only gas supply system, we will have to organise our supplies more and more on the basis of long-haul pipeline-based infrastructures. Large new ones will have to be build and filled requiring a complicated coordination mechanism throughout the whole value-chain in order to manage and share the huge risks involved. It is very unclear if and how the exemptions to the unbundling proposals and to the new infrastructures will give the appropriate answers. We would need more creativity in the discussion and try to manage the right balance on the “Madrid-Moscow axis” seeking an effective EU market design in harmony with a reliable supply security system.
Come on Jean-Michel and Francois, and others, let’s think the golden power triangle and let’s think gas, showing our DGTREN & DGCOMP-friends with their Florence and Madrid-gangs some ideas on how to secure competitive EU markets with reliable external supply security.
October 2nd, 2007 at 7:09 pm
So as everthing is for the best 1° how do you explain that energy prices have grown up with the liberalisation of the market?
2° how do you explain that you professors in French universities are paid by the French State and that you receive research grants on pulic funds? I think it would be better that the market proves istelf its superiority without a State intervention?
3° You pretend you are independant scholars, but you are not since you receive funds from the European Commission and from electric firms members of the electric oligopoly.
3° You make a confusion between a very competitive market (perfect competition) and oligopolies. Olgopolies are not competitive and are not good for the consumers. As would say the economists they are not pareto-optimal
October 21st, 2007 at 10:24 am
It appears that you have replied nothing.
May 8th, 2008 at 5:15 pm
“Moreover, ownership unbundling would facilitate consolidation and Europeanization of transmission networks.”
Completely false. In many jurisdictions States Transmission and Distribution are deemed to be ‘public services’ and must be owned by public entities. Step forward, France!
So how do you see consolidation happening in that scenario? France merges with Belgium???
What is important to consolidate is not the ownership of the wires, just the operation (access control, dispatching, information flows).
Who owns the wires is irrelevant for competition -unfortunately- you seem to exhibit the same biases as the Commission on this issue.
June 4th, 2008 at 8:57 am
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