Jacques Percebois, Professeur, Universitè Montpellier I
Directeur du CREDEN - Centre de Recherche en Economie et Droit de l'Énergie

Scarcity of energy resources is not the main problem today: fossil fuels reserves will be abandoned well before being exhausted. The problem is about the rational and economic uses of these resources with a view to avoiding irreversible damage to our environment as a result of global warming. Three objectives are considered as global priorities in the European Union, although their respective importance can vary among countries. The three targets are common but the weight given to each of them is not the same in each European country: it is the reason why it is difficult to implement a common energy policy in Europe.

• The search for competitive energy; confidence in the market mechanisms is the rule, but the energy access cost must reflect the positive and negative externalities and the role of the Government should be limited to creating the conditions for such an approach through CO2 emission trading, green or white certificates etc.
• The search for supply security, in order to give the priority to national resources and to favour the diversification of imported energy sources.
• The fight against global warming aiming to implement joint and cooperative policies with other countries, in the hope of preserving a threatened environment considered as a “common public good”.

The search of an acceptable compromise between these three targets constitutes a major challenge for Europe today. The common objective is both to reduce the energy intensity of GDP by 20% to the year 2020, and to satisfy primary energy consumption with renewable sources up to 20% at the same time. Promoting energies without greenhouse gases currently involves favouring wind, photovoltaic and thermal solar energies as well as nuclear energy. Promoting renewable energies requires both research funding and financial incentives. It should be recalled that all energies have at a certain point in time been helped by Governments. We may mention the very high national coal subsidy, the tax benefits given to the petroleum industry in order to encourage exploration as well as military and civil nuclear research subsidies. Today there are three instruments enabling to promote wind and photovoltaic energies: the very profitable feed-in tariffs, “green certificates” programs in which electricity providers have to acquire a minimum amount of green electricity produced by operators holding a certificate and Government biddings to develop such facilities. Most countries have opted for feed-in tariffs in the European Union, i.e. guaranteed purchase prices for green electricity over a long period (10 – 15 years). The purchase price is higher than the traditional electricity price based on electricity generation marginal cost. It is an incentive policy but it has two drawbacks: uncertainty about the quantity of green electricity to be produced and heterogeneous profits for green electricity producers with a rent for the most efficient ones. Every producer will obtain the same guaranteed price but generation costs are different from one generator to another. This rent, paid by the end-user is costly for the society.
The potential for energy savings is considerable. It depends on promoting technologies, and favouring new behaviours. Two sectors are particularly concerned because of the potential energy savings they represent, plus the fact that they largely relate to individual behaviours: the transport and housing sectors.

Concerning electricity generation the main debate is about the optimal mix of fuels to be used. Coal, oil-fuel and natural gas are polluting sources; hydraulic capacity is limited inside Europe and nuclear is a questionable solution for many countries. The trend favouring natural gas has to be limited because of political risks: the gas war between Russia and Ukraine or Bielorussia has induced European countries to focus more on supply security. The comeback of coal represents a major threat for the environment. Some people believe that technological progress could solve this issue as coal could be employed for more diversified uses in the future. “Clean coal” techniques for producing electricity as well as the development of “CO2 storage” technologies should promote the use of coal. Increasing productivity in coal-fired plant enables to reduce the amount of CO2 emitted per kWh. Nuclear power satisfies only 7% of the world primary energy, 15% in the European Union and 38% in France (about 80% of the French electricity generation). A lot of European countries have decided to not build new nuclear power reactors. Nuclear energy is an unpopular type of energy for two main reasons: firstly due to its military origin and to the accidents which have occurred in the past (as in Chernobyl) and secondly due to the management of nuclear wastes whose lifetime can exceed thousands of years. However nuclear energy has many advantages. The “border station” cost per nuclear kWh is more competitive when oil and gas prices are high; nuclear has the advantage relative to coal and oil or gas of not generating any CO2 emissions and this advantage is considered as a significant asset today. It is the reason why, for the European Commission, the nuclear option is to be considered seriously at the present time.

The search for a competitive energy is also a priority but the implementation of a “single market” for electricity and gas seems not to be able to cut energy prices; for the European consumer competition is not able to lead to lower prices. For some people “the gas and electricity liberalization leads to higher prices to favour competition while competition is not able to lead to lower prices” . Since July the 1st all the European consumers can choose their gas and electricity supplier. It is the consequence of a very long evolution which has progressively cut the legal monopolies in charge of electricity and gas production and distribution. These monopolies (often public ones) were generally installed just after the Second World War to favour the economic reconstruction of the European countries. The Treaty signed in Rome in 1957 had planned liberalization for all commodities, energy included. The European Directives, adopted in 1996 for electricity and in 1998 for natural gas, have implemented two complementary measures:

• the progressive eligibility of energy end-users, industrial users at the beginning and everybody, households included, today;
• third party access to the transmission and distribution gas and electricity networks; these networks are considered as “essential facilities” Thus open access is the rule and each supplier may use such networks when it pays a fee fixed by a Regulatory Commission.
• The goal of market opening for the network industries is not to juxtapose 27 competitive markets but to create a single gas and electricity market. This implies a convergence of gas and electricity prices for all European consumers. This convergence obviously implies the removal of bottlenecks that still subsist in electricity interconnections between the Union countries. Unbundling of electricity generation, transmission and distribution activities, currently legal and probably in the form of ownership unbundling in the near future, is required by the European Commission and the same evolution is observed with natural gas.

In the recent past, before liberalization, the price of kWh was generally fixed by the Government and this regulated tariff was calculated by the incumbent in charge of production and distribution of electricity. The customer had to pay a fixed premium each year and a bill proportional to the quantity of kWh consumed, but the price of this kWh was relatively stable over time. Now the price of the kWh is partly linked to the price observed on the electricity spot market. In fact only 50% of the price paid by the household is now variable, 50% of this price being stable because it corresponds to the fee paid for access to the transmission and distribution networks. Such a fee remains fixed by the Regulatory Commission. The variable part of the bill (50% in this example) is now dependent on the conditions observed on the electricity market in Europe. The economic logic requires that the market price has to be, at each hour, equal to the variable cost of the kWh produced by the marginal power station necessary to balance demand and supply for electricity .During a large part of the year this marginal power station is a coal or natural gas power station. The price of natural gas is dependent on the oil price because natural gas is largely imported and long term contracts include escalation clauses between oil products prices and gas prices. High price for oil means high price for natural gas and indirectly high price for electricity. Electricity liberalization is not directly responsible for this situation…Price volatility on the spot market is a direct consequence of such evolution but derivatives markets are available today and hedging is possible.

The energy liberalization was, at the beginning, implemented in a context of low prices for oil, gas and coal. Today the price of oil is high. It is the reason why the market-price of electricity is much higher than the former regulated price of kWh, even in countries as France where the part of nuclear in the electricity generation is high. In the past regulated tariffs were fixed according to the cost of nuclear energy because nuclear power stations were generally the “marginal power plant” in France . Today with the European single market and large interconnections nuclear power stations are no longer the “marginal power plant”, except for some hours when electricity demand is low. Thus the price of the European kWh is largely dependent on the cost of gas turbine power stations, generally a German power station. If nuclear generation was higher in Europe, in Germany particularly, nuclear power stations could be the “marginal supplier” during a large part of the year. But, because of a lack of investments in the nuclear industry, gas and coal power stations become the “marginal supplier” on the market . Consequently the price of electricity is now largely dependent on the price of oil…The market price of kWh paid by an end-user who has opted for eligibility is ,since the beginning of 2004, higher than the regulated price and eligible customers who have invoked eligibility in the past sometimes regret their decision today. Possibility of reverting to former regulated tariffs being refused by the regulator, these customers consider that liberalization is a failure. As electricity cannot be stored its price is far more volatile compared with other types of energy (gas in particular). Sometimes It is also due to the market power (capacity withdrawal) of some operators on the spot and the role of the regulator is to punish such behaviours.
Liberalization may also lead to adverse effects such as a lack of investments in the energy sector. With a public monopoly system the main priority is to prevent energy failure. Overcapacity is often observed and such a strategy may be costly for the end-user who has to pay for not necessary investments. In a deregulated market system, private firms seek under rather than overcapacity. With under-capacity the spot price will be higher and profits higher too. This behaviour makes risks of energy failure more likely i.e . a risk of black-out.
A new risk for operators (particularly for incumbents) is also observed today with deregulation in the energy sector. Market opening for network industries is often associated with an at least partial opening of the capital of gas and electricity utilities. When a company’s capital is floating hostile takeover bids are possible and it is easy for foreign operators to control company strategy. Hence the theory that it is necessary to achieve a “critical size” to be sheltered from hostile takeovers may explain the concentration observed on the European energy market (to be too big to be eaten). Such operators’ concentration may tomorrow result in questionable competition on the electricity and gas spot markets…

At the beginning the European Union was created around energy targets (CECA about coal and Euratom about nuclear). Today implementing a single market for energy is an ambitious objective but we may keep in mind external considerations, such as the price of oil, and national considerations, such as “patriotic” industrial strategies. Confidence in the market’s mechanisms is an official and common priority but in the same time Governments may adopt protectionist or even “patriotic” approaches to help national energy firms. The wish for a cooperative strategy concerning environmental issues is everywhere mentioned but State preferences are not always compatible because energy constraints are not the same everywhere and because the energy balance structures are very different from one country to another. The role of the European Commission is today to give incentives to develop common networks for gas and for electricity in Europe and to impose common rules concerning the open access to these networks. It is also to publish a Code of Good Behaviour for both the European operators and the foreign ones.