Why this horse-trade in Europe means that gas costs more than it should

NO-ONE expected the path to liberalisation of Europe’s energy markets to be smooth but, as politicians, officials and energy companies horse-trade about how best to proceed with the Third Energy Package, many European consumers continue to pay more for their gas than they need to.  Yes, it’s as simple as that.

They’re paying more because would-be suppliers from a range of global sources are either locked out of large parts of Continental European markets or find the prospect of battling for capacity and accessing customers just too difficult — not to mention commercially risky — in a world where incumbents dominate transmission networks and do few favours to competitors.

So long as a broader range of suppliers are locked out or opt out, Continental European gas markets will lack the gas-to-gas competition that tends to be the prerequisite for producing the most competitive prices.  

Instead we remain with the status quo, which means that gas prices tend to be indexed to oil, often creating arbitrary additional revenues to incumbents at the expense of consumers. Benefitting in this way, incumbents will continue to sign oil-indexed long-term contracts, locking Europe into a non-competitive gas market.

There’s a link here to the climate change agenda as well.  Once the costs of the Emissions Trading Scheme are added to our current unnecessarily high prices on the Continent, European industry risks becoming globally uncompetitive.

Now that’s not an argument against the ETS, which we support; it’s an argument for liberalisation, which will lower gas-prices, create more demand for gas and offset demand for higher carbon fuels such as coal and oil.

Let me welcome, though, the heroic efforts that are being made by some of the key players.  When the current slate of commissioners were appointed a few years ago, I don’t think that many people expected Energy Commissioner Andris Piebalgs and Competition Commissioner Neelie Kroes to unite so solidly behind the liberalisation agenda.  

Many also underestimated the determination they would show in holding out for pure solutions to unblocking the sclerosis in the Continental European gas market, resisting compromises that quite simply will not do the job.

There has been a lot of good work carried out in the parliament as well.  We at BG Group have found members of the European parliament’s industry committee to be extremely keen to hear the arguments — and in particular arguments that counter the dire warnings emerging from the incumbent companies that dominate the market.

Among the points we have been focussing on in our discussions is, of course, ownership unbundling.  In our view, it is hard to see how Continental Europe’s gas markets can be truly open until transmission systems and pipeline capacity rights are separated from supply companies.

I accept that obliging companies to divest parts of their businesses may seem like a drastic requirement but, without such divestment, it may prove impossible to arrive at the optimal outcome: a network open to a large number of players and capacity used as efficiently as possible.

And let’s be clear: ownership unbundling is by no means a death knell to large European incumbents.  The revenues from the transmission element of their businesses might be regular and investment low risk; but they are also effectively capped by the regulatory regime in which they operate.

In the UK, Centrica demerged from its transmission arm in 1997 but 11 years on it remains one of the six main gas and power suppliers in the UK, continuing to thrive in a market which has welcomed E.On, RWE, EdF, GdF and Iberdrola.

Another argument deployed is that we need large European companies that can stand toe-to-toe with Gazprom and pack the clout to prevent them exploiting their dominance of gas supply into the Continent.  There are two arguments to counter that line: first, large incumbents do not become minnows overnight by shedding their transmission arms; and, second, a competitive, integrated market would incentivise suppliers to bring in diverse sources of gas.  This could actually diminish Russia’s ability to leverage its bilateral gas relationships in Europe.

Nor is it true that transmission companies will be unable or unwilling to invest in new capacity.  In a properly functioning market with transparency around access to customers, capacity and supply, there will be no barriers to investment.  Regulated and unbundled transmission system operators will have every incentive to invest in additional capacity, as they will make their money by earning a regulated return on their asset base.  

National Grid Gas in the UK, which was investing £130m during the year its transmission activities were separated from supply (1997-8), spent £590m in main network capex in 2006-7 and the figures for 2007-8 and 2008-9 are forecast to be £720m and £450m respectively.  

Despite the support for ownership unbundling from some members of the European parliament’s industry committee, if the European Council feels it can’t press on with the measure in its present form, then we are likely to be in the kind of compromise territory that Commissioner Piebalgs has worked so hard to avoid.

It is hard to see how a compromise can deliver the open market and the benefits of greater supply source diversity that it would bring.  The tragedy is that it is consumers in particular who’ll suffer, paying more for their gas than they need to.

It’s time that member states set aside the interests of their national monopolies and put consumers before companies.

 Mark Carne is Executive Vice President — Europe & Central Asia, BG Group.