A new wave of consolidation in the European Energy market - Is this the end game?

on energy A new wave of consolidation in the European Energy market: Is this the end game? Viewpoint on energy A new wave of consolidation in the European Energy market Is this the end game? By Hans Guenter Wolf, Olaf Remmler and Thomas Pockrandt As the result of liberalization, the European energy markets The sections that follow provide an overview of the efforts the have undergone fundamental change, and continue to do so. EU has gone through to create a common European energy The whole framework of the energy industry has changed market, and the associated regulation measures that were significantly as a result of deregulation. For example, defined by the European Commission earlier this year. The due to European Union (EU) directives and the resulting article evaluates the resulting strategies European energy national energy law amendments, new market rules – such companies have undertaken and the measures utilities need as regulation of network access, calculation of grid fees to take to maintain their competitiveness. We also provide – have been implemented for the power and gas market. The our opinion on possible scenarios of the development for the European Commission’s (EC) aim is to develop a common European energy industry regarding the effects of regulation, European market for energy where customers benefit from market structures and competition. competition-driven improvements to service and quality as well as decreasing prices. This goal was the basis for deregulation of monopolies and the opening up of markets in Convergence of European markets EU member countries. The main objective of the EU’s energy market liberalization However, different countries took different approaches to was to enhance competition in gas and electricity markets by deregulation. In reality, protectionist and prohibitive behavior creating a common European energy market. The opening continued and utilities have continued their expansion up of markets significantly changed how they functioned, strategies without experiencing substantial threats in their providing new opportunities, new products and services, home markets. These strategies involved seeking vertical and and, initially, lower energy prices. horizontal integration along the value chain and acquiring However, while progress has been made, the objectives shareholdings in foreign companies. The strategy was of liberalization have not yet been fully realized. Problems especially successful in EU countries that were ahead of include: the continued existence of barriers to free the game and who opened their markets early, such as the competition, significant rises in gas and electricity wholesale United Kingdom. Subsequently, countries outside of the prices (which cannot be explained by higher primary fuel EU, such as Hungary, the Czech Republic, and Romania costs or environmental obligations) and persistent complaints became increasingly attractive as these countries became about entry barriers and discrimination. These issues have EU member candidates due to their strong economic growth led the EC to define measures to realize the full potential of rates and an increasing potential for energy consumption. the internal gas and electricity market by January 2009. Utilities embracing this strategy include Germany’s E.ON, Germany’s RWE, France’s EDF and Central Europe’s OMV A recently published strategy paper on the future of the with shareholdings in Hungary, the Czech Republic and European energy market defined the following measures : Romania. In the next consolidation phase, a wave of mergers • Definition of new unbundling regulations: To avoid and acquisitions in the EU will follow. The industry will see the discrimination and market foreclosure, the paper market entry of companies, like Gazprom, pursuing a strategy discusses the unbundling of network ownership and the of a forward integration along the value chain. independent system operator approach. The EC has a As a consequence of this market evolution, the European clear preference for ownership unbundling because this energy market is currently dominated by a dozen market is the most effective way to ensure competition (because players. Forecasts predict a possible oligopoly of five to six network operators are not influenced by supply and companies spanning the entire European marketplace. The generation interests). It also avoids complex regulation question therefore is whether the European energy industry and administrative burdens that would be required for has entered a final consolidation phase or if this is just another the independent system operator approach. phase in a continuing lifecycle?  Viewpoint on energy • Establishment of European-wide market regulation: power generation plants to ensure security of supply To close the existing gaps between the national regulatory and to create an integrated European market. Further environments, a new single body at EU level is planned. details on these actions are expected to be published It would provide functioning European-wide regulation in the near future. and facilitate cross-border trade. The efforts to create a common European energy market, • Enforcement of strict competition: The EU will make and the associated actions taken by the EU, will determine, full use of existing regulations to pursue infringements in conjunction with other market trends, the strategies of of competition law and combat market domination. the major European utilities. Utilities within Europe need to Possible sanctions are energy release programs develop strategies to cope with both the increasing pressure (already successfully applied in Austria, France, Spain of regulation and competition and the expectations of and Germany), the prohibition of long-term gas supply capital markets and investors. Companies will evaluate their contracts and of long-term power purchase agreements. business units based on their realized return in relation to Unlike in the past, the EU will define strict requirements the capital employed. The achievable return and the value and may claim divestures, asset and contract swaps enhancement of capital employed will determine strategy for the approval of mergers and acquisitions (M&A) and decision about alternative investment strategies. Utilities in the future. undertaking this evaluation will examine each business unit under portfolio-based value creation indicators, as illustrated • Enhancement of investments: Several actions are in Figure 1.