Ken Silverstein EnergyBiz Insider Editor-in-Chief

The formal process of deregulating Europe's energy markets began six years ago. Under the plan, commercial and industrial customers have been able to choose their electric and gas suppliers since July 2004 while residential ones plan to select their provider by July 2007. And while the EU will probably hit its deadlines, officials in charge of ensuring that the competition is fair say that a single market among its 25 members will not be fully functional a year from now.

"There was real concern about the development of wholesale gas and electricity markets, not to mention high prices and limited choice for consumers," says Neelie Kroes, the EU's competition commissioner, in a briefing in Brussels on the progress of "liberalization" in the EU. "I am afraid I have to paint a rather gloomy picture."

Besides the concentration of economic power among too few participants, Kroes goes on to say that newcomers have difficulty entering markets because of an inadequate infrastructure to move power and gas between countries and because many of the more lucrative deals are currently locked up in long-term contracts. And, finally, while the EU has an enforcement mechanism to bring about compliance, it's still tough to dislodge national interests when it comes to protecting their own energy markets.

Essentially, the liberalization plans have consisted of two-parts: The first has tried to create a level playing field by granting third party access to network infrastructure while the second has required monopolies to functionally separate their transmission, distribution and generation assets. That latter phase has been problematic, limiting consumer choices.

In May 1999, Great Britain became the first European country to allow both its electric and gas consumers a choice of supplier. Between 1996 and 1998, gas markets opened across the country with the unbundling of British Gas' assets. The electricity sector followed in 1999. According to utility officials there, the benefits of competition have shown themselves through lower prices and an array of new offerings.

But, throughout most of the continent, the pace of change is varied. Great Britain leads the charge with Denmark and Sweden right behind. Meantime, France and Germany have complied but are waiting to see how deregulation fares before they totally open their markets. Those types of sentiments prompted the European Commission to send formal warnings to 18 of the 25 members in October 2004. Since then, however, eight of those members in violation have complied with the new rules.

National Interests

But EU regulators are fighting a pervasive attitude -- one that wants to protect national interests while at the same time take advantage of increased opportunities abroad. For example, critics say that it is still difficult for outsiders to invest in France and Germany's energy sector, even though the two have been bidding on foreign interests. Germany's E.ON just made an all-cash bid for Spain's Endesa in the biggest power deal ever.

Indeed, European utilities have spent at least $50 billion buying up other power-related businesses around the continent. Germany's RWE and E.ON, for example, are now quite active in the United Kingdom and Central Europe while France's Electricite de France is a major player in Italy -- even though that enterprise still controls 86 percent of the French market. Meanwhile, Sweden's Vattenfall has taken a position in Germany.

But deregulation cannot work if incumbent utilities exercise market power and are permitted to deny alternative power suppliers access to their power grids and natural gas pipelines. EU commissioners are able to penalize members in an effort to enforce compliance. 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.

So far, Great Britain and Italy have been the most progressive when it comes to exercising regulatory authority. Italy's energy regulatory body, for instance, suggested that its native Enel be forced to divest of its power generators, or lease capacity, so that newcomers can gain access to markets there. As a result, Enel now controls just 40 percent of the generating capacity in Italy, compared to what had been 80 percent.

"Because the market is not completely functioning, we have had such a price increase," says EU Energy Commissioner Andris Piebalgs, at a press conference. "It's not a goal per se to sue member states in court. It is a necessary step if there is a failure. It's not enough to legislate. The member states must apply the rules that they have made for themselves. The commission will use all the means at its disposal to insist on this." Earlier estimates say a failure to open energy markets throughout the continent would cost $15 billion a year in lost opportunities and excessive inefficiencies.

To compound the situation, the EU 25 imports a quarter of its natural gas from Russia. Meantime, the group maintains close energy ties to Algeria and is opening links to Libya and Nigeria. To get fuel supplies from those nations, more gas pipelines are necessary -- lines that would have to run through either the Middle East and Central Asia to get on to the mainland. The prognosis: The EU Commission says that about 70 percent of its energy will come from foreign sources by 2020.

Despite the apparent risks, the EU says that more supplies and more supply routes are essential. Liberalization has increased the number of competitors and led to price reductions in those countries that are furthest along, it says.

The economies of Europe and the rest of the world are expected to expand and will therefore need added power and gas supplies. Accomplishing this requires massive investments -- billions in Europe alone. Investors must be persuaded that markets are open and that national interests don't impede their abilities to win market share. The EU is following through on its promise to liberalize markets throughout the continent. But, market dominance along with a choppy infrastructure threatens progress.

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