Energy Market Reforms in Europe: Scope and Implications

by Professor Lars Bergman

Summary of a lecture held at a seminar in the Academy on March 16, 2000.

Lars Bergman, born 1945, is Professor at The Stockholm School of Economics and holds the professorship of energy and economy. He has also been a member of the SNS Conjuncture Council and the board of the The Swedish Nuclear Power Inspectorate. In 1990 he was appointed "Teacher of the year in Economics and Management in Sweden".

The implementation of EU's electricity and natural gas directives has induced a wave of of energy market reforms in Europe. The electricity market directive should have been integrated in the national legislation in February 1999, while the natural gas directive is to be implemented in August 2000.

The common feature of the two directives is that they aim to separate the infrastructure part of the industry from the potentially competitive part. Moreover, third party access to the infrastructure is secured. Thus in the electricity sector transmission and distribution is separated from generation and supply (retailing), and provisions are made to secure third party access to transmission and distribution networks.

There seems to be three key driving forces behind this process. The first is technological change that has reduced the economies of vertical integration in the energy network industries. The second is the vision of the single European market. The third is the successful examples provided by the "early movers", i.e. England and Wales, Norway and Sweden.

As natural gas still is not important in Sweden, and the natural gas market is lagging behind the electricity market, I will focus on the latter market.

The immediate implications of the electricity market reforms are that competition in generation and supply has becomes feasible, and that the incentives for structural change, horizontally and vertically, have become very significant.

The measures implemented so far have opened up for competition in the national electricity markets. In order to create a competitive European market, however, additional measures are needed. The most essential measures are:

• Cross-border tariffs that enhance rather than prevent competition. In practice this means that the tariffs should be so called non-transactions based and not include transit charges.
• Aggregate transit costs should be handled via inter-TSO compensation schemes.
• There should be schemes for allocation of the costs of building and operating new inter-connectors.

Is there a new role for government in this world of competitive and internationalized energy markets? Three potential roles can be envisaged. The first is to maintain so called Public Service Obligations, i.e. the provision of essential services to all citizens. The second is to make international agreements that make environmental policies meaningful when energy is traded across national borders. The third is to take responsibility for the security of supply.

Competitive markets have proved to be very good at determining market clearing prices when property rights are well defined, to promote efficiency in production, and to promote product and process innovation.

But competitive markets have in addition proved to be not so good at promoting equity and to allocate resources for which property rights are not well defined.

Examples of important resources and goods for which the property rights are not well defined are environmental resources, diversity of technologies and fuels (as a means for risk reduction), and security of supply.

In the context of this conference security of supply is the key issue. The new markets do not seem to put a price on that particular resource. Thus this is a field where public policies are needed, and I believe that they have a chance to be successful. But the design of security of supply policies has to be different than in the past. Exactly how different I do not know, but this is a problem on which some serious thinking seems to be worthwhile.