EU Energy Policy Blog

My interest lies in how security of supply is interpreted and dealt with in the political process, for it is a highly political concept and policies that affect security of supply are deeply intertwined with politics.

The concept of security of supply (hereafter, SoS) has many interpretations. It can be seen in economic and technical terms, such as uninterrupted flow of energy, with ‘interruptions’ being either technical or non-market forces. However, in the political process it has other meanings. One may be the continuous flow of energy at ‘low’ or politically acceptable prices. Another may be obtaining energy without endangering other policy aims, such as protecting the environment, restricting usage, investing public monies heavily or allowing the emergence of a small number of dominant international companies. Which definition is used is crucial for analysing the ‘problem’ of SoS and possible solutions. Here, I merely point out that for many actors in the policy process, the second and third definitions of SoS are the most relevant policy objectives, although specialists in the energy field may well find them far too broad.

Indeed, energy supply enjoys (or suffers from) multiple policy objectives, which vary according to actors in the policy process. Key aims in Europe at the national and/or EU levels can be roughly grouped into four different headings. One is creating a competitive market, through policies such as ending legal monopolies, reduction of market power and reducing cross-subsidies. This has been pursued at both EU and national levels since the 1990s, involving many policies. Thus for instance, EU and national legislation has ended legal monopolies throughout the energy industries and created re-regulatory rules to ensure that competition is ‘fair and effective’, especially that suppliers cannot cross-subsidise different activities which would distort competition. A second objective (although often denied or pursued implicitly) is developing powerful European firms, be these ‘national champions’ or ‘Euro-champions’; French support for EDF offers an excellent example, but other countries have similar objectives. Ensuring low energy prices represents a third policy objective, as government seek to ensure economic growth and also protect living standards, as well as enjoying political popularity. However, the best means of achieving these is debated: supporters of competition claim that liberalisation will lead to prices falling while those supporting the development of national/European champions argue that only large firms can undertake long-term investment that will produce low costs and hence prices. Protecting the environment represents a further policy objective, one that has become increasingly politically important. A further policy aim by fiscally-constrained governments is to avoid higher public expenditure and if possible, increase revenues from energy taxation. Finally, lying behind much government policy is the desire to gain popularity and shift blame for difficult choices.

Several policy options for achieving SoS seem relevant, especially as defined in a broader sense by politicians (whether any or all of these possibilities will actually aid SoS is another matter). One is increasing non-oil generation through new sources of energy such as solar and wind power, nuclear power or ‘old-fashioned’ coal. Another is lowering demand via higher efficiency and conservation and/or through reducing activities and goods that use energy. A third option is better coordination of demand and supply in Europe, which involves better transmission infrastructure. Finally, Europe may seek increased political and/or economic influence over 3rd countries that have energy reserves.

However, each of these options has both advantages and suffers from difficulties, notably of running counter to some of the diverse policy objectives that are currently pursued in energy. Thus for instance, new sources of energy conflict with other objectives, notably protecting the environment, avoiding higher public spending or ensuring political popularity. Alternative methods of supply such as tidal barrages or windfarms may be deemed ‘unsightly’ while nuclear power remains fiercely opposed by many environmental groups on both environmental and economic grounds. Indeed, what constitutes ‘cleaner’ energy sources remains highly debated. Conservation of energy may well require public financial support that run counter to liberalisation and the reduction of cross-subsidies and raise serious competition concerns, and/or need very high oil prices to be economically viable. Moreover, achieving no risk of supply interruptions is likely to mean higher prices due to the need to have spare capacity and/or damage to the environment. Reducing demand through lower usage may run counter to economic growth and/or be unpopular. Coordination of demand and supply may run counter to policies of liberalization, and/or may meet difficulties of rivalries among competing champion firms. Achieving greater influence over third nations such as Russia may require much greater EU political coordination and again run up against competition among European suppliers.

Not only do policy makers face trade offs among different policy aims, but powers over energy policies are now highly dispersed among many different actors with diverse and incompatible interests, time horizons and attitudes towards risk and uncertainty concerning SoS. Within European nations, sectoral economic energy regulators have key powers over matters such as interconnection and price caps, especially in regulated parts of the sector such as infrastructure access. General competition authorities have powers over mergers and acquisitions, which have been so central to the re-structuring of energy supply. Both sets of regulators generally pursue policies of promoting competition, and are hostile to decisions that may increase SoS through creating greater spare capacity that avoids sudden power shortages but may in fact create barriers to entry and hence competition. Equally, they are skeptical about the possible benefits of creating dominant positions through the development of large firms that supporters of such firms claim could offer greater influence over third nations with energy or more integration of supply and demand, or the ability to finance new investment in generation. They are particularly concerned about vertically-integrated firms that could abuse their position in transmission to gain unfair competitive advantages in other market segments open to competition. They are usually opposed to subsidies, especially cross-subsidies, even if these are for worthy aims such as aiding conservation or the development of ‘cleaner’ energy sources and may focus on achieving competition and prices based on costs. Usually economic regulators have few duties to protect the environment.

However, environmental regulatory agencies have powers and duties over environmental protection. Conversely, they usually do not have duties to ensure SoS or competition. For their part, the courts are increasingly involved in energy as policy making and regulation become subject to judicial challenges. In Europe, their ability to balance different policy aims such as SoS or conservation is limited, and often they are concern is to ensure that legal rules and especially procedures have been followed. They can be used to attack policies such as creating new energy sources through the planning process.

Companies are crucial to SoS. But companies are diverse and have conflicting interests and views. Incumbent firms may wish to protect their domestic markets and also to expand abroad. They often argue that SoS requires a high degree of certainty over regulation and profitability to encourage long-term investment, an aim that conflicts with a competitive market. Equally, they may argue that achieving SoS through matching supply and demand is helped by being vertically-integrated, so that generation, transmission and distribution are matched, including by long-term contracts. But, the economic regulators are suspicious of such arguments. For their part, new entrants fear that SoS arguments will be used to limit their entry – e.g., by levies for renewables or additional capacity that penalize them or the creation of very large national or European champions. Firms also differ in terms of public ownership. Privately-owned firms are designed to maximize profits (although even publicly-owned firms can be under government pressure to ensure high profits) and especially in ‘liberal market’ economies, short-term profitability can be crucial to shareholders. Hence they may find uncertain and/or very long-term investment difficult; equally, policies that reduced their profits such as energy conservation are unlikely to be compatible with the aim of maximizing shareholder value.

Users too are highly diverse. Some companies are heavy energy users and exposed to international competition and their main concern is price; for others, energy is less of a cost and hence continued supply is more important. Domestic users also vary: although higher energy prices are almost always unpopular, some are also concerned about the environment while others cannot afford higher prices even if these are needed to reduced demand or pay for investment and conservation.

Governments retain key powers over energy and SoS. Sometimes they are owners of suppliers and hence concerned to protect their value and indeed their industrial alliances. More generally, they are highly subject to lobbying by large companies, notably suppliers. They also often have short-term aims such as re-election and hence are very sensitive to pressures to reduce energy prices, rather than pursuing long-term conservation or investment policies. Their capacity to finance investment or conservation measures are limited given fiscal constraints. But governments are also divided entities, with different ministries having diverse aims- eg the energy/industry ministry, the finance ministry (for whom higher energy prices may provide helpful increased revenues through taxes ) and the environment ministry.

Not only have European policy makers pursued many aims, which may be potentially incompatible, but regulatory powers have been greatly dispersed between the national and EU levels. The European Commission seeks to increase its role, which may be resisted by national governments. The EU has pursued liberalization and anti- state aid policies, which conflict with possible subsidies and/or allowing the creation of large energy firms that can cross-subsidise certain activities or enjoy greater certainty thanks to vertical integration. National governments can be harmed??? of increased EU power in energy.

Thus SoS in Europe faces dispersion of powers and responsibilities among several actors with different interests, strategies and time horizons. Choices over SoS involve balancing different objectives and accepting trade offs. Moreover, whatever policies are chosen will require coordination (either through competitive markets or through public policies) of inter-dependent actors. The current dispersion of powers makes such coordination and choice of trade-offs difficult to achieve.

Mark Thatcher, London School of Economics

This entry was posted on Thursday, July 10th, 2008 at 4:17 pm and is filed under Energy Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.