Ken Silverstein EnergyBiz Insider Editor-in-Chief

Liberalization within Europe, or the separation of transmission, distribution and generation assets, is leading to convergence there. Because consumers could have more choices, the prospect of shrinking market share at home means that many domestic utilities are looking beyond their borders. That possibility also means that some governments may try to protect their utilities, which they consider national jewels.

"The run up to the 2007 full-market opening in Europe will continue to feed consolidation momentum in the EU," says Manfred Wiegand, Global Utilities Leader at PricewaterhouseCoopers (PwC). "Around the globe, increased competition is driving companies to turn to mergers and acquisitions activities to deliver growth."

Power deals in Europe accounted for 58 percent of all targets and 44 percent of all bidders in the total worldwide power deals market in 2005, says PwC. The industry had a banner year in 2005 in part because of record natural gas and power prices. That has permitted those utilities with solid financials to expand beyond their traditional territories.

Looking ahead, European utilities want to acquire key assets so as to avoid volatile wholesale markets as well as cut their dependence on foreign suppliers. PwC says that the courtship of Russia and Europe presents some intriguing possibilities. Western Europe gets about 25 percent of its natural gas from Russia. That interdependency combined with the need for investment point to a strong likelihood of key players striking deals.

The European Union (EU) is working hard to open up national economies to foreign competition within the utility sector. Regulators assert that the $60 billion utility market there is rife with inefficiencies and that open markets would accrue to the benefit of commercial, industrial and residential customers. About 40 percent of the 47 million electricity and gas customers in the United Kingdom, for example, are now served by alternative providers.

The EU market is bustling. Germany's E.ON has made a $35 billion bid for Spain's Endesa. That move might scuttle Endesa's plans to merge with France's Suez. To complicate the matter, Gaz de France and Suez, both of which are based in Paris, have announced their intent to merge. That combination would create the world's second largest utility. The first would remain Électricité de France, another French company. Suez now owns all of Belgium-based Electrabel.

Economic Nationalism

French Prime Minister Dominique de Villepin says that the deal between Gaz de France and Suez has been in the works for months and that the two utilities are already working on projects to build two natural gas plants. Both boards have already given preliminary approval to the merger while French lawmakers are considering legislation to facilitate this combination.

"The board of directors continues to consider that, given ... their commitment to developing electricity-natural gas convergence ... combining the two groups would create the greatest value for all shareholders," Suez says, in a prepared statement. The French government, which owns 80 percent of Gaz de France, would own about 35 percent of the proposed company.

Enel, which is forbidden by law from selling more than half of Italy's electricity, must expand outside the country to increase sales. Despite the move by the French companies to unite, Enel says it is still looking to acquire Suez. Beyond that, it says it is looking at Eastern Europe. Meantime, Électricité de France says that it has no plans to get left behind and is also seeking international partners.

French, German and Spanish nationals would all like access to foreign markets, although they are perceived as taking steps to protect their own enterprises. Spain, for example, would give its primary regulator there the right to veto any merger. The French have even stronger sentiments, coining the phrase "economic patriotism." The EU Commission is intent on opening markets: In the case of Spain, it is threatening legal action if it would prevent the E.ON and Endesa merger.

Some EU regulators and analysts fear the wave of merger activity is not designed to achieve economies of scale but to protect national markets. Ulrik Stridbaek, the policy advisor on electricity markets for the Paris-based International Energy Agency, said in an interview with Reuters that recent developments in some countries smack of nationalism. "Intervention due to 'strategic importance' seems outdated and at odds with the development of an internal energy market."

EU commissioners are able to penalize members in an effort to enforce compliance with the rules governing liberalization. But such powers may not motivate national governing bodies to carry out the policies to open up their energy markets. Altogether, the amount of electricity flowing among the European countries hovers around 11 percent of all consumption -- up only slightly in the last five years when liberalization there first began.

The race to open the EU market by 2007 has set off a wave of mergers on the continent. The trend, however, has run headfirst into economic nationalism, or the pride that countries have in their prized utility assets. If liberalization is to succeed, the EU Commission must break down those barriers and enable new market entrants the opportunity to provide better services and superior prices. The mergers will likely continue. But, it is uncertain if the driving factor will be competitive pressures or nationalistic tendencies.

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