EU Energy Policy Blog

The Third Energy Package has been agreed. From the publication of the proposals by the Commission, in September 2007, discussions have been dominated by the issue of (ownership) unbundling. Following heavy pressure from some Member States, notably Germany and France, a ‘Third Way’ of unbundling was accepted as another unbundling option. The discussions have taken away attention from other issues and the quality of the Package has suffered as a result. But has it been worth it?

As an alternative to full ownership unbundling the proposals by the Commission contained the option of an Independent System Operator (ISO) as derogation. In the ISO option a body designated by the Member State and outside of the vertically integrated undertaking takes over the transmission system operator (TSO) responsibilities. This option enables the vertically integrated undertaking to keep the transmission assets on its balance sheet. In response to the proposals by the Commission, a number of Member States, notably Germany and France, proposed an alternative that became known as ‘the Third Way’. This variant is now included (with some changes and additional provisions) in the Third Package as the option of the Independent Transmission Operator (ITO). Within the ITO option the TSO remains within the integrated company and the transmission assets remain on its balance sheet. Additional regulatory conditions are imposed to guarantee the independence of the ITO from the vertically integrated undertaking.

Discussions within the EU institutions on the Green Paper and the Third Package were dominated by the issue of unbundling. Already, the publication of the proposed package by the Commission (September 2007) left limited time for agreement with the elections of the Parliament coming up in early June 2009. The first reading in Parliament, the adoption of the common position in Council and the final legislative tripartite negotiations between the EU institutions were rushed. Many other important issues were neglected because there was the bigger issue of unbundling to discuss in the limited time available. The quality of the Third Package suffered as a result. If anything, an opportunity lost for all involved.

But at least the proponents of the ‘Third Way’ got what they asked for, an alternative to full ownership unbundling where the transmission assets and the TSO can remain within the vertically integrated undertaking? True, but sometimes you should be careful what you wish for, in case you may actually get it. It is at least doubtful whether the ITO option is as attractive as it once may have been perceived. In short, it involves having capital tied up in assets over which one has no control, with a return much lower than in the remaining part of the company, and getting exposed to a heavy regulatory burden on the entire undertaking.

Vertically integrated companies will be faced under the ITO option with transmission assets on their balance sheet which are to be regarded as a financial asset only. Many additional regulatory provisions specific to ITOs in the Gas Directive ensure that the integrated company will have no control over these assets and provide for a huge regulatory burden. In fact, the entire vertically integrated undertaking will be subject to severe regulatory scrutiny, as regulators will want to make sure that, for example, no shipper-confidential information will be transferred from the ITO to the remaining part of the undertaking, and that cost are allocated properly between the ITO and the non-regulated part of the business. Also, joint services, e.g. a joint legal service, will not be allowed.

Still it could be argued that the very significant value of the transmission assets, even without the right to exercise control, contributes significantly to the financial value of the integrated company. However, the amount of money tied up in the regulated transmission assets represents a totally different risk/reward ratio than applicable in the remaining part of the integrated company. In many cases, the level of regulated return on the transmission assets will be far below the level of return on the supply or production activities within the undertaking. In other words, if the company could use the money tied up in the regulated assets for their other activities they could achieve a much higher return. Assuming that the integrated company is not opportunity-constrained, holding on to these financial assets, with their much different risk/reward ratio and without any control on these assets therefore ultimately detracts from shareholder value.

Companies such as Shell and ExxonMobil, who due to their global presence have undergone liberalisation processes elsewhere in the world, have recognised this phenomenon before most of the European players. Indeed, Shell and ExxonMobil have withdrawn completely from the regulated transmission business within the EU, a withdrawal which was finalised by the sale of the BEB and EMGTG assets to Gasunie last year. As a result, they now have their hands free to promote the further liberalisation and open access of the networks without having any conflict of interest in this regard.

For many integrated companies in Europe this probably sets an example worth following. However, in the interim the financial crisis emerged, making access to capital much more expensive. Would this be a good time to sell transmission assets on a large scale? The financial climate may detract many from divesting now, forcing some vertically integrated companies to opt for the ITO. On the other hand, the inquiries by the EU Directorate General for Competition into several integrated companies will continue and may lead such companies to commit to full ownership unbundling of their networks anyway.

It seems inevitable that further cases of ownership unbundling will emerge over the next few years. This will undoubtedly also lead to further consolidation and the emergence of cross-border TSOs. Those companies that have already taken the step towards ownership unbundling are natural actors in this process and lead the way. Their first-mover advantage allows them to concentrate on development of the market rather than the inward focus of having to transform themselves into an ITO.

The benefits for the market are obvious. Regional, ownership unbundled transmission/ infrastructure companies have a natural incentive to maximise the offering of capacity to the market, as this is the sole mechanism through which they achieve their revenues. They will be happy to invest to meet market demand. With their large scale and regional approach they can pass through the benefits of synergies and eliminate unnecessary interfaces. Finally, as they do not have any potential conflict of interest with supply or production interests, regulation can be lighter, decreasing the regulatory and administrative burden and increasing efficiency even further.

Time will tell, but it seems that the ITO option has its greatest potential for those companies that can not afford to sell their transmission networks under the current economic conditions or that are opportunity constrained and have no suitable investment potential. In any event, the conclusion must be that, whereas full ownership unbundling has not been directly achieved through the Third Package, it would appear that the scene has been set for a market structure that will move gradually but inevitably into the direction originally envisaged in the Commission proposals. So was it worth it? For you to judge.

W.P. Groenendijk

NB The author is currently Manager European Affairs with Gasunie but his contribution is written à titre personnel.

This entry was posted on Sunday, May 17th, 2009 at 7:00 pm and is filed under Electricity, Energy Policy, Gas. 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.