Drinking beer might help understand energy long term contracts!
May 18th, 2008 by Jean-Michel Glachant, European University InstituteToday’s European electricity markets are still wrapped up with long-term vertical contracts and liberalization has not changed much this traditional sales pattern. Due to their ambiguous effects on competition and welfare in the long run, long term contracts are a key issue of competition law enforcement and we cannot but notice that economic theory remains far from providing precise guidance to competition authorities.
However, despite wide concerns over the ability of de-integrated markets to ensure an optimal allocation of risks, the Commission has constantly voiced strong concerns over their anti-competitive effects. Perceived legal uncertainty is strong at the moment in the market place mainly for two reasons and we will argue that it is largely overstated.
First is the lack of Commission decisions on long term vertical contracts (LTC, hereafter) in electricity since liberalization. Cases in electricity prior to the opening up of markets are interesting but characterized by a clear lack of methodology leading to inconsistencies and decisions based on fairly weak grounds (e.g. security of supply) which are unlikely to be accepted today, at least on the same terms. The legal uncertainty created by the lack of precedents has been amplified by the split between the current state of Commission thinking and its past decisional practice where long durations (15-20 years) had repeatedly been accepted.
Second, the long-term trend of EC competition policy modernization has strongly increased legal uncertainty. In the old system, legal certainty came from the possibility to notify LTC ex ante to the Commission in order to get clearance in case the agreement was not covered by an exemption regulation. Nowadays, firms and their legal counsels must define the relevant market and self-assess their agreements as well as potential efficiencies pursuant to Art 81(3). Modernization also aimed at implementing a ‘more economic’ approach based on long-term consumer welfare, which meant gradually shifting from a legal ‘form-based’ analysis of contracts to a more ‘effect-based’ approach where the real economic effects of competitive behaviors should be more important than the drafting of contracts. Last, there is a continuum between Art 81 and 82 EC (which tackles abuse of a dominant position) as LTC might be analyzed under the latter when the firm is dominant and while the Commission has started modernization more than ten years ago, the reform of Art 82 EC is still lagging behind.
The Commission stated in the explanatory memorandum attached to the Third Energy Package that it will soon provide guidance on downstream LTC. There is no doubt that such guidelines will be mainly based on past and recent case law and are unlikely to deviate from Commision’s present course of action. For the first time in 2007, a comprehensive methodology for better analyzing LTC in energy has been sketched out in the Distrigas case where the Commission had concerns about liquidity problems on the Belgian wholesale gas market due to the portfolio of LTC concluded by the firm with industrial customers. Distrigas and the recent related decisions (e.g. Synergen, Gas Natural/Endesa, Repsol or E.ON Ruhrgas) demonstrate that a clear analytical framework has emerged. The Commission will now focus on interactions among several key elements, and importantly in the following order: market characteristics, competitive position of contracting parties, the share of the customer’s demand tied, duration, the overall share of the market covered by contracts containing such ties and efficiencies. As a result, a sort of structured rule of reason has emerged. Beyond the reasoning applied, this is the stability within each step of the methodology across decisions that is even more striking, striking enough to wonder whether such stability is really the outcome of a more economic approach.
This is not our opinion. Most analytical devices and remedies which have been integrated in recent decisions in energy are not new to EC competition policy and can be traced back to key decisions in the long process of modernization of vertical restraints analysis. One of the main innovations of recent decisions in energy is the use of the cumulative market doctrine and the taking into account of patterns of consumption. The cumulative effect doctrine is a way to analyze if an agreement, which taken isolated would not fall within the scope of Art 81 EC, nevertheless has an appreciable effect on competition when assessed in its legal and economic context, especially when it is part of a network of parallel agreements concluded by one or several dominant suppliers. In Distrigas, this is primarily the cumulative effect of the network of contracts concluded by the firm which grounds the infringement of Art 82 EC. Historically, the doctrine of cumulative effect on foreclosure has been a cornerstone of the modernization of vertical restraint analysis and has been regularly endorsed by Community Courts. The reasoning applied today in Energy had in fact been slowly devised in famous series of cases in the beer and ice cream sectors. It was first treated in the Art 81 EC cases Brasserie de Haecht (1967), Delimitis (1991) and more recently Langnese-Iglo (1995), Schöller (1995), Neste (2000) or Van den Burgh Foods (2003). This is a well-established tool of competition analysis which will be used in future energy proceedings and help firms analyze themselves the potential anti-competitive effects of their portfolios of LTC.
Facing traditional competition issues in a completely new and fast-evolving market setting, the Commission thus tends to apply methodologies and remedies similar to those used in other sectors. As a result, we think that the (not so) new methodology which we depicted above is likely to be here to stay and that competition law enforcement to the energy sector is becoming similar to any other sector. Competition policy toward long-term vertical contracts in electricity therefore becomes more predictable and firms benefit from more robust guidance to make their portfolio of contracts comply with EC competition rules.
However, a contradiction is worth emphasizing. One rationale of the more economic approach in EC competition policy is to better capture industry specifics and as such, there is no reason to believe that energy at this stage of the liberalization process must be analyzed as the beer or ice-cream sectors, except if energy truly converged with these industries which is not the picture we find in the Sector Enquiry. True, applying some analytical devices such as the cumulative effect doctrine does bring some relevant insights for competition enforcement in energy. However, we think that the application of the methodology applied in recent decisions also expresses a path dependency in competition law enforcement and the difficulties the Commission currently faces in energy. When we argue that legal certainty has recently been upgraded in electricity, this does not come from a new methodology able to capture real economic effects with a high level of consistency but from a methodology which the Commission knows and can apply. Antitrust authorities cannot rely on well established economic foundations when enforcing competition law in electricity whereas industrial organization theory is usually more mature and thus helpful in other sectors. In the face of the difficult policy trade-offs brought up by LTC in energy, it may thus be tempting to disregard sector specifics and use well-known methodologies from other sectors, and this is what is happening: drink beer and eat ice-cream to see the end of legal uncertainty for long-term contracts in the EU electricity markets!
Jean-Michel Glachant and Adrien de Hauteclocque
This blog has been written out of ‘Legal Uncertainty and Competition Policy in Deregulated Network Industries: The Case of Long-term Vertical Contracts in the EU Electricity Markets’