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EU Energy Sector Inquiry Should Be Welcomed

Originally published on Energy Post.
By Diego Zuluaga

Capacity problems can best be tackled by letting prices fluctuate and making energy providers responsible for intermittent supply. To the extent that support schemes are used, they should be technology-neutral and driven by market forces to ensure efficiency, argues Diego Zuluaga, Deputy Director of the Epicenter (European Policy Information Center), a coalition of six free-market think tanks in Europe. For this reason, writes Zuluaga, the sector inquiry announced by the EU’s competition watchdog on 29 April, should be welcomed. 

Of all the functions performed by the EU, competition policy is arguably the most important, and where it potentially stands to do the most good. Unfortunately, in recent times, many of the Commission’s attempts at trust-busting have been misguided. Last month EU competition authorities issued formal charges against Google, and subsequently we found out that it may be widening its probe into the digital economy to encompass e-commerce, on-demand streaming services, ride- and lodging-sharing apps and communications services like Skype. This, despite the outstanding level of innovation and dynamism in the sector, and with earlier rulings having been shown to be unnecessary at best and damaging at worst.

Still, every once in a while the Commission sets its sights on genuinely harmful and anti-competitive practices, as was the case on 29 April when Margrethe Vestager, head of the EU’s competition watchdog, announced a sector inquiry into public subsidies to energy utilities. The announcement followed the presentation in February of the EU’s Energy Union strategy, which seeks to promote the integration of European energy markets, and the introduction in 2014 of new rules on state aid outlining the conditions for public support in the energy sector to be compatible with the Single Market.

It would make much more sense to remove both the implicit subsidy to fossil-fuel consumption and the direct support to cleaner energy

It is important to note that European governments and the EU itself heavily intervene in energy markets by subsidising consumption, implicitly or explicitly. A 2014 report for the European Commission estimated the total cost of interventions at national and EU level at €120 billion, and this figure excludes transport subsidies. Sometimes these interventions seek to address the ‘negative externalities’ (e.g. pollution, climate change) caused by the use of certain forms of energy. Other times, they run directly counter to governments’ stated environmental goals by subsidising (e.g. through VAT exemptions) the consumption of fossil fuels. As my colleague Philip Booth has argued, it would make much more sense to remove both the implicit subsidy to fossil-fuel consumption and the direct support to cleaner energy – which would save taxpayers’ money and have similar effects to the current schizophrenic arrangements.

Market failure

At any rate, the investigation announced last week is limited to governments’ use of capacity mechanisms, which aim to ensure adequate supply of electricity at peak times. Such mechanisms, which are in operation or under consideration in many EU countries – including the UK, Germany and France – take many forms. They can be:

  • subsidies for the construction of new power plants
  • payments to maintain idle capacity that can be tapped when demand outstrips regular supply
  • forward contracts that give the holder a right to receive a premium on top of the prevailing market price
  • auctions for a given volume of capacity above peak-load demand
  • obligations for providers to meet a pre-determined ‘security margin’ on top of expected maximum demand

They may also include demand-side mechanisms, in the form of financial incentives for consumers to use less energy at peak times; the installation of smart meters to show users when it is most efficient to limit consumption; and energy storage, especially from renewable sources which are intermittent (sometimes the wind doesn’t blow and the sun doesn’t shine) and therefore less efficient.

In countless ways, government policy has distorted European energy markets and raised the cost of providing electricity

At first sight, the need for such state support might appear to be evidence of so-called market failure: market forces cannot bring about sufficient supply to customers at all times and in all circumstances, and so governments must step in to give electricity providers incentives to make sure there is surplus capacity for when regular supplies are strained.

Yet, on closer inspection, it quickly becomes apparent that the heavy hand of the state lies at the heart of the problem. Hefty renewables subsidies (as in Spain and Italy) have encouraged the growth of intermittent energy sources like wind and solar energy. Strict emissions targets and air quality regulations have made some (especially coal-fired) thermal plants unviable, leading to their retirement without adequate replacement. And the phase-out of nuclear plants in Germany poses a challenge to its electricity production (20 per cent of which came from nuclear energy before the 2011 Fukushima disaster). In countless ways, government policy has distorted European energy markets and raised the cost of providing electricity in exceptional circumstances. And so the need for capacity mechanisms arises. State intervention begets more state intervention.

Barrier to integration

But EU state aid rules limit such measures strictly to the purpose of emergency supply, and strict conditions must be met for them to be acceptable. They cannot unduly distort energy markets, and they must tackle the problem in the most economically efficient way. Mechanisms that would constitute a barrier to cross-border energy trade, or undermine competition in the sector, should also be avoided.

Such considerations are critical because Member States may use capacity mechanisms to favour certain providers at the expense of others, and even to shield domestic energy producers from competition from the rest of the EU. Capacity schemes may also hinder competition by artificially sustaining less efficient providers. Crucially, they could form a barrier to market integration in the energy sector, hampering efficiency and increasing costs for consumers.

Could it be that France’s capacity scheme is an attempt to shield French nuclear power stations from competition?

France, for instance, operates a capacity scheme in the form of obligations for providers to meet a predefined volume target. But could France’s peak capacity needs be better met through other means? Given Spain’s plentiful surplus capacity – largely from renewables, a hangover from its pre-crisis subsidy binge – it might be that greater interconnections across the Pyrenees could increase the efficiency of energy markets on both sides, liberating resources for other uses and delivering lower costs. Could it be that France’s capacity scheme is preventing such efficiency-improving integration? Indeed, might the scheme be a deliberate attempt to shield French nuclear power stations from competition?

Such questions will concern Commission technicians as they pursue their investigation over the course of 2015 and 2016. The sector inquiry is an opportunity to tackle energy protectionism in Member States and remove barriers to pan-EU trade that make electricity more expensive and endanger security of supply. Of course, state aid considerations are one among many factors driving EU energy policy (environmental targets being another notable one), so it is likely that Member States will be given more leeway than the rules imply, and that some existing support will be ‘grandfathered into’ the new guidelines. But the Commission’s impulse to question the reasoning behind state intervention into national energy markets should be welcomed.

As Carlo Stagnaro convincingly argues in a recent EPICENTER briefing, capacity problems can best be tackled by letting prices fluctuate and making energy providers responsible for intermittent supply. To the extent that support schemes are used, they should be technology-neutral and driven by market forces to ensure efficiency. Finally, efforts to boost security of supply and reduce emissions must be accompanied by greater liberalisation, which is painfully lacking in many energy markets across the EU.

Open markets and free trade must be at the heart of any attempt to integrate European energy markets. That is the kind of competition policy the EU needs.

Editor’s Note: Diego Zuluaga is Deputy Director of EPICENTER (the European Policy Center), an initiative of six leading free-market think tanks from across the European Union: Civismo (Spain), the Institut Economique Molinari (France), the Institute of Economic Affairs (UK), Istituto Bruno Leoni (Italy), the Lithuanian Free Market Institute and Timbro (Sweden).

Reprinted with permission.

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