The slow dawn of the internal energy market in Europe - Explaining market liberalisation in the EU electricity sector Master thesis by Casper Andersen Master in European Studies Aalborg University 2008 The slow dawn of the internal energy market in Europe - Explaining market liberalisation in the EU electricity sector Casper Andersen Supervisor: Professor Frede Hvelplund Master Thesis - European Studies Aalborg University - October 2008 191,917 characters in total TABLE OF CONTENTS LIST OF ABBREVIATIONS......................................................................................................iv 1. INTRODUCTION....................................................................................................................1 2. METHODOLOGY...................................................................................................................6 2.1 DELIMITATION.......................................................................................................................6 2.2 CHOICE OF THEORY.............................................................................................................7 2.3 BOTTOM-UP OR TOP-DOWN APPROACH.........................................................................8 2.4 ANALYTICAL CONSIDERATIONS....................................................................................10 2.5 DEFINITION OF RELEVANT CONCEPTS.........................................................................11 2.5.1 Energy...............................................................................................................................11 2.5.2 Electricity and electricity systems.....................................................................................11 2.6 PRECONDITIONS FOR LIBERALISATION.......................................................................12 2.7 STRUCTURE OF THE THESIS.............................................................................................15 2.8 ACTOR ANALYSIS...............................................................................................................16 3. DEFINITION OF THE EU AS A POLITICAL SYSTEM....................................................19 3.1 THE SINGLE EUROPEAN ACT...........................................................................................19 3.1.1 The internal market programme........................................................................................20 3.1.2 New decision-making procedures.....................................................................................20 3.1.3 European Parliament comes out strengthened..................................................................20 3.2 THE TREATY ON THE EUROPEAN UNION.....................................................................21 3.3 THE EUROPEAN COMMISSION.........................................................................................22 3.4 THE COUNCIL OF MINISTERS...........................................................................................24 3.5 THE EUROPEAN PARLIAMENT.........................................................................................24 3.6 THE EUROPEAN COURT OF JUSTICE..............................................................................25 4.0 THEORETICAL FRAMEWORK........................................................................................27 4.1 DEFINITION OF EUROPEANIZATION..............................................................................28 4.2 EU-PRESSURE ON THE MEMBER STATES - EXPLAINING THE MECHANISMS......29 4.2.1 Positive integration - Institutional compliance.................................................................29 4.2.2 Negative integration - Changing domestic opportunity structures...................................30 4.2.3 Learning and framing domestic beliefs and expectations.................................................31 4.3 HOW MEMBER STATES RESPOND TO EU-PRESSURE - EXPLAINING THE VARIABLES.................................................................................................................................33 4.3.1 In case of institutional misfit.............................................................................................33 4.3.2 In case of changing domestic opportunity structures........................................................34 4.3.3 In case of framing domestic beliefs and expectations.......................................................36 5.0 ELECTRICITY MARKET LIBERALISATION IN CONTEXT.......................................38 5.1 THREE TRENDS IN GOVERNMENT-INDUSTRY RELATIONS.....................................38 i 5.1.1 Post World War II.............................................................................................................38 5.1.2 Energy crises in the 1970s................................................................................................39 5.1.3 Energy sectors influenced by general globalisation..........................................................40 5.2 SETTING THE SCENE: INCLUDING ENERGY IN THE INTERNAL MARKET PROGRAMME..............................................................................................................................40 5.2.1 The Commission identifies obstacles to a common energy market and a way forward...41 5.3 SUM-UP...................................................................................................................................42 6.0 EXPLAINING ELECTRICITY DIRECTIVE 96/92..........................................................44 6.0.1 The Commission as policy entrepreneur...........................................................................44 6.1 PUTTING FORWARD THE FIRST INTERNAL ENERGY MARKET DIRECTIVE PROPOSALS.................................................................................................................................45 6.1.1 The initial hearing phase on the draft electricity directive................................................46 6.1.2 Selecting the legal basis for the electricity directive.........................................................47 6.2 PUTTING FORWARD THE FIRST DIRECTIVE PROPOSAL...........................................48 6.2.1 Stepwise introduction to electricity liberalisation.............................................................50 6.2.2 Opposition from all sides..................................................................................................51 6.3 THE COMMISSION'S LEGAL STRATEGY: ENFORCING COMPETITION VIA THE EUROPEAN COURT OF JUSTICE.............................................................................................51 6.4 REVISED PROPOSALS FROM THE COMMISSION IN 1993...........................................53 6.4.1 Introducing the Single Buyer concept...............................................................................54 6.5 PROVISIONS IN THE ADOPTED DIRECTIVE..................................................................57 6.5.1 Generation.........................................................................................................................57 6.5.2 Transmission system operation.........................................................................................58 6.5.3 Distribution system operation...........................................................................................58 6.5.4 Structure/Unbundling of accounts....................................................................................59 6.5.5 Third party access.............................................................................................................59 6.5.6 Market opening.................................................................................................................60 6.5.7 Public Service Obligations................................................................................................61 6.5.8 Transition..........................................................................................................................61 6.6 The applied mechanisms of change.........................................................................................61 6.6.1 Mechanism of institutional compliance............................................................................61 6.6.2 Mechanism of changing domestic opportunity structures................................................62 6.6.3 Mechanism of learning and framing domestic beliefs and expectations..........................63 6.7 MEMBER STATE POSITIONS ON THE DIRECTIVE........................................................64 6.7.1 Germany............................................................................................................................64 6.7.1.1 German government...................................................................................................64 6.7.1.2 German industry........................................................................................................66 ii 6.7.1.3 German socio-economic actors.................................................................................67 6.7.2 France................................................................................................................................68 6.7.2.1 French government....................................................................................................68 6.7.2.2 French industry..........................................................................................................69 6.7.2.3 French socio-economic actors.......................................................................................70 6.7.3 The UK..............................................................................................................................71 6.7.3.1 UK government..............................................................................................................71 6.7.3.2 UK industry....................................................................................................................71 6.7.4 EU-level interest groups....................................................................................................72 6.8 Variables affecting the domestic response to EU-induced reforms.........................................74 6.8.1 Institutional fitness............................................................................................................74 6.8.2 The impact of the Commission's legal strategy on member states' preferences...............75 6.8.3 Changing domestic opportunity structures.......................................................................78 6.8.4 Framing domestic beliefs and expectations......................................................................80 7. CONCLUSION.......................................................................................................................82 BIBLIOGRAPHY.......................................................................................................................86 FIGURES Figure 1: The relationship between the EU and its member states: Bottom-up and Top-down........10 Figure 2: Unbundling and the perception of natural monopoly before and after liberalisation........15 Figure 3: Actors and patterns of influence and pressure....................................................................17 Figure 4: The co-decision procedure used for the electricity directive..............................................26 Figure 5: Two steps determine the impact of EU-reform..................................................................34 Figure 6: Two steps determine the national outcome of EU-reform.................................................36 TABLES Table 1: The Commission's treaty-based powers against member states and industrial actors.........23 Table 2: two points of analysis in Europeanization theory................................................................27 Table 3: The Commission's dual strategy..........................................................................................56 iii LIST OF ABBREVIATIONS DSO Distribution System Operator EC European Community ECJ European Court of Justice ECSC European Coal and Steel Community EDF Electricité de France EEC European Economic Community EP European Parliament EU European Union Euratom European Nuclear Energy Community GW Giga Watt IEM Internal Energy Market IMP Internal Market Programme ISO Independent System Operator kV Kilo Volt MEP Member of the European Union nTPA Negotiated Third Party Access OU Ownership Unbundling PSO Public Service Obligations rTPA Regulated Third Partly Access SEA Single European Act TEU Treaty on European Union TPA Third Party Access TSO Transmission System Operator QMV Qualified Majority Voting iv Introduction 1. INTRODUCTION In the last couple of years, energy policy has skyrocketed to centre stage on the European political agenda. At a landmark summit in March 2007, the EU's heads of state for the very first time agreed on a coherent and much inclusive set of goals for the future EU energy policies and at the same time made clear the close overlapping of interests between climate concerns, security of energy supply and a proper functioning of the internal energy market to secure European competitiveness through affordable energy.1 What makes it groundbreaking is the fact that EU's leaders were able to agree on these ambitions in light of the fact that energy matters have been largely underdeveloped during the first 50 years of EC and EU cooperation. The European Union as we know it today is the offspring of the political epilogue that succeeded the ending of the Second World War. In order to guard against a repetition of the two world wars in the same century, the European leaders at the time began the process of establishing cooperation across national borders to ensure lasting peace in Europe. Already in 1946, Winston Churchill put forward his vision for a "United States of Europe" and in 1949, the Council of Europe was established as the first pan-European institution. The year after, the French foreign minister Robert Schuman held a speech in which he recommended a community for the integration of the European coal and steel production. The aim was to create a common administration of the two basic prerequisites for modern warfare. Schuman's speech in 1950 became the starting point for the European Coal and Steel Community (ECSC), which included six founding member states, namely France, Germany, Italy, Belgium, Luxembourg and the Netherlands.2 However, following attempts to create further integration in the form of a common European defence and an early political union were rejected. These failures led the European leaders to focus instead on economic integration, which led to the development and later adoption of the Rome Treaty in 1957. The treaty established the European Economic Community (EEC), while the European Nuclear Energy Community (Euratom) was established the same day. The result of this was the foundation of the modern EU in three crucial treaties. Two of these three dealwith European harmonisation of energy matters within coal and nuclear power. Nevertheless, neither the ECSC nor Euratom succeeded in creating any spill-over to energy matters outside their initial 1 Presidency conclusions - Brussels European Council 8/9 March 2007 2 Urwin 1995: 44 1 Introduction purpose of handling coal and nuclear energy issues. One important explanation for the lack of a more comprehensive energy policy not appearing from the ECSC and Euratom has to do with the fact that Germany and France each had their own favourite sector to nurture. Early on, France had put much effort into building up its own nuclear industry, while Germany focused more on coal- fired electricity. On top of that, Britain emerged as oil producer in the 70s and hence EC members pursued national programmes and priorities based on their individual preferences, which made energy unfit for cooperation within the EC.3 Incidentally, I was based in Brussels as part of an internship at the Confederation of Danish Industries’ Brussels office, when the Commission published its comprehensive energy package in January 2007. I personally witnessed the intense atmosphere and excitement surrounding the publishing of the Commission’s proposals. From many sides, I was told that this kind of interest from policy makers, interest representatives, the media, analysts, and many other actors was unprecedented, and that it was a clear testimony to the importance of energy policy on the European agenda. Some even believed that spearheading the road for Europe to become the low-carbon region of the world by use of renewable energy sources, energy efficient technologies and properly liberalised energy markets to facilitate it would become the future reason for the entire EU cooperation. And thereby replace what had to date been the reason for the European cooperation, namely preventing war between European states. This notion which was the main reason for the first 50 years of cooperation (1957-2007) and now to be succeeded by a united European fight for energy supplies with reduced dependency on imported fossil energy sources climate change holds a strong symbolic value. The obvious importance of energy policy in European societies is the reason why I have chosen European energy policy as the overall theme of my master thesis. However, the size and magnitude of European energy policy makes it necessary to focus on particular policy areas. Energy policy has too many perspectives to find a possible way of analysing the whole subject. It covers international relations and security politics, economic and social politics and environment politics, not to mention the continuous enhancing climate change dimension. Due to my internship in Brussels and the fact that I still work for the organisation in Denmark, I have chosen to examine, in more detail, the Commission’s long-lasting attempts to liberalise the energy markets in the member states. This 3 Matlary 1997: 17 2 Introduction entails a replacement of the divided national markets by an integrated European market based on general internal market principles and competition rules. By applying this perspective, the thesis will be able to integrate, in the best possible way, issues such as competitiveness of businesses, internal market principles, and a good understanding of how the energy sectors in Europe are organised and function. Because of strong member state preferences for keeping the energy sectors under close national control, the Commission did not take action towards forming an internal market for energy until the last part of the 1980s. This was despite strong presence of energy policy in the original three treaties of the European Community. The turning point was the formulation of the Internal Market Programme, which aimed at creating one single market within the member state area for a range of sectors. Although energy was not initially included in the programme, the Commission chose to include the sector as it was deemed instrumental if the programme was to be successful. The electricity and gas sectors were two specific areas of energy selected as particularly important to reform. With the Internal Market Programme followed also a new political paradigm which supported liberalisation of markets with competing actors to replace state monopolies. Introducing competition in the sectors by means of liberalisation was vested in three key principles and put forward in directive proposals by the Commission in 1991. First, third party access (TPA) to the grids should allow more electricity providers to deliver power to end-users instead of being forcefully bound to a single supplier. Secondly, a non-discriminatory procedure replaced exclusive rights for the construction of new power stations and lines. Thirdly, the concept of unbundling was introduced as a means to separate the monopoly company's control over both production and transmission of the electricity. This was done in order to prevent discriminatory actions against third party actors and to prevent inter-company subsidies which would also hamper fair competition. Liberalising the energy markets in Europe by means of the above principles has been a very difficult road for the Commission to pass. Opposition from sectoral actors and member state governments were as a starting point very fierce. The national utilities feared the new competitive market, and member state governments reacted negatively to the new ideas as it was believed to be too much in conflict with existing regulation of the sector. Nevertheless, a compromise on a directive to liberalise the electricity and gas sectors was reached in the Council in respectively 1996 3 Introduction and 1998 after years of negotiations. In light of the above, it is interesting to examine the apparent success of the Commission and its supporters in presenting an adopted directive against such heavy opposition among member state governments and key sectoral players. Based on the developments described above, the research question of this thesis is as follows: Why was directive 96/92 on common rules for the single market in electricity adopted despite initial opposition from a majority of member state governments and key actors in the national electricity sectors? The research question is relevant to try and answer for a number of reasons. Above all, the composition of the research question will shed some light on the apparent political struggle for powers and ideas, i.e. the way the single market in electricity should progress and the direction of it. The struggle lay in the negotiations between the European Commission as driver of the internal market programme and the member states in the Council of Ministers is something that is vital to analyse in order to answer the research question satisfactorily. Moreover, the national energy companies played a big part in the political developments due to their traditionally strong role as a public service function and strong ties to the state. Liberalisation, as presented all along by the Commission in the different versions of the draft directive, would mean a radical overhaul of the entire sector, including not least the often monopolistic position of these companies. So their voice in the political discussions cannot be ignored. Lastly, the European business community as well as major users of electricity played a role in supporting whatever means that would provide them reductions in their electricity bills. Secondly, directive 96/92 is relevant despite the fact that it as been rendered obsolete and replaced by a second directive and soon a third in late 2008 or early 2009. It begs the question of why the attempts to decide on satisfactory rules for the electricity markets have been going on for almost 20 years and counting. This long time-stretch is unprecedented for single market policy development across any policy area. It is also relevant because the directive introduced many of the key concepts still debated in stricter shapes and forms today and the negotiation process then still form the basis for today's heated negotiations. All in all, the first directive started the still unfinished 4