A cosy system that spells disaster for Europe's key industries

The largest energy users in Europe have much to complain about, and one of the most articulate of these is Philippe Varin, CEO of Corus. He highlights three areas of market failure — ‘the inability to provide predictability, to guarantee availability and to offer competitive prices’. From any perspective that is a fundamental failure. For industries for which energy, and especially electricity, is a significant part of their production, it is little short of disastrous.

In the last year, electricity price volatility has increased fourfold. Unable to predict future prices, investment decisions have had to be put on hold, and, he says, ‘that is unacceptable’.

Additionally, last winter Corus came very close to cutting steel production in the UK because of threatened shortages of supply of gas, and this risk will almost certainly return this coming winter. ‘You cannot run a business properly when you can be short of gas supplies at short notice.’

Most damaging of all, high electricity prices have made the European steel industry less competitive. ‘In the last two years it has been a pretty awful picture — worse in the UK than in mainland Europe. In the UK we undertook a restructuring programme over the last three years, saving £120m per year, but these savings have been completely offset by increases in electricity prices. Our competitors in emerging countries like Russia and Brazil haven’t faced such excessive price rises. In terms of competitiveness we are back to square one.

‘These problems cannot be addressed by the member states alone. Creating competitive energy markets, a fully functioning internal market and securing energy supplies requires an EU role’, he says. And, he points out, after the debacle of the constitution, what an opportunity this would be to show that the EU is worth something to its citizens.

So what is he expecting the EU to do? ‘The first thing is that the competition rules have to be enforced. Neelie Kroes, the Dutch competition commissioner, is obviously determined to crack down on anti-competitive behaviour, and that is a good sign, but we have a long way to go. We are so far from having a competitive market in most EU member states, with real choice for consumers. In Germany we have a choice of RWE and E.ON; in the Netherlands there are only three suppliers. Competition in this situation is theoretical, not actual, and cannot deliver the benefits of lower prices that true competition brings.’

The second thing he wants is for the single market to be enforced. ‘Today, we are half pregnant: we proclaim a single market but the reality is not the case — there is just too little physical interconnection for electricity and gas between countries. A connection capacity of 10% of national consumption would be sufficient, but we are far from that. You can have a single market in law but without the pipes and wires it cannot function. There is presently a €10/MWh price difference for electricity between the Netherlands and Germany — why? Because the interconnection between them is small, and is controlled by the electricity providers.’

His third point is that the real unbundling of the networks from the producers has not been made in most EU states: ‘it is cosmetic. If you look behind the scenes these businesses have the same shareholders; there are long-term contracts between the network and supplier which in practice prevents newcomers entering the market. There is theoretical unbundling, but 90% of capacity has been booked in long-term contracts, and of the remaining 10% no one knows what is going on because there is no transparency. For a new provider of energy to enter the market in this situation is very difficult’, he says.

‘Unbundling of distribution and supply businesses has to happen in all the member states, along with increased transparency and capacity in the interconnections between the electricity grids and gas distribution systems of member states. This will facilitate new providers to enter the market to provide competition.’

He is convinced that Brussels has to make this happen and that it will require a wider remit for the Commission in energy matters.

‘It is not a matter of flicking a switch — this will take some years to put right’, he says. For industries like steel this presents real problems. There is a market price for steel that is set globally: steel companies in the EU cannot raise their prices to take on board higher energy costs, and so are forced to restructure instead. This is difficult, not their first choice, ‘but if necessary we know how to do it’, he says.

If industries like steel have to restructure to maintain their competitiveness, then the EU must provide them with the confidence that it, in turn, is going to deliver on its reforms. For Philippe Varin, this would mean the EU setting a target for trans-border electricity capacity at 10% of national consumption in four years time — ‘simple statements that give confidence’.

He also has concerns that there is too little generating capacity in some member states and that there is too much short-termism in the energy sector. In general he believes electricity producers have no incentive to build new capacity — ‘why would they do so when they enjoy a comfortable position with few competitors, high prices, and substantial profits?’, he asks.

There are, of course, also security-of-supply issues relating to the availability of gas. In his view this is essentially a foreign policy challenge rather than a commercial one: with 90% of production controlled by nationalised companies, security of supply has to be managed as part of the totality of relations between countries. The EU provides the weight that no single country, even Germany or the UK, can bring to international relations.

So, the challenge for the EU is considerable — enforcing the competition rules, making a reality of the single market, ensuring there are sufficient energy connections between states, and developing and maintaining appropriate foreign policies to secure supply for the long term.

But there is something else just as significant that he wants to talk about — the handling of CO2 emissions. Here his criticisms are just as stinging as his assessment of the failures of the market place.

‘We are not on the right track. The present system gives a fantastic windfall profit to electricity producers whilst reducing the competitiveness of the rest of the EU’s industry. Something is terribly wrong. There is no question that everyone now recognises that climate change is an issue, and industry has no problem with that. But the current EU Emission Trading Scheme with allocations made by country and by plant within each country does not work’, he says.

The steel industry competes in a global industry where 90% of new capacity in steel making is coming from countries that are outside the Kyoto agreement. ‘We think it is unfair to penalise the EU steel industry. What is the point — to make an example? It just creates pressure to relocate manufacturing outside the EU — actually raising emissions because of additional transport costs. And whether you are good or bad, there is nothing in the Scheme that gives incentives to make the ‘good’ better or make the ‘bad’ improve. Nothing! It is not an effective system.

‘Each country has taken decisions on allocations without any consideration of the performance of the plants themselves. And because allocations are by plants within nation states a company cannot choose between capacity in the Netherlands, France or the UK. The system is not promoting good practice and neither does it promote a global perspective. The crash in carbon prices is just another indicator of this fiasco.’

So what should be done instead? He concedes that phase 1 (2005-2007) is already running and phase 2 (2008-2012) is already agreed. ‘The big question facing all of us, industry and government, is: what do we do beyond 2012? Whatever we do, it must dovetail at some point with a global system and we have to take that into account from the start’, he says. He is not even sure that the cap-and-trade scheme will survive: ‘it is not approved by many countries and I do not think our track record is very positive either’, he says.

He does not claim to have answers and is sure that Brussels does not have answers at present, but he wants industry to sit around the table with government and think about how a future scheme will one day go global, and how it will employ industry benchmarks to ensure that Europe’s most CO2-emission-efficient steelworks are not penalised along with the least efficient. The steel industry will be ready to share ideas on this later in the year when their thinking is more developed.

Both the market failure that Philippe Varin describes and the failings of the Emissions Trading Scheme must be put right. Serious dialogue between industry and government, perhaps in the form of a high-level working group, will be essential if the reforms are to be effective.