EU Court upholds primary importance of internal energy market

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In its first ruling on mandatory unbundling, the European Court of Justice has deemed this principle so vital to the internal market that it supersedes fundamental freedoms enshrined in the EU Treaties, such as free movement of capital. It is a victory of public interest over pure economics. The ruling in the case of the Netherlands vs. three energy companies comes on the eve of fresh EU guidance intended to better align the state interventions by member state governments. (Photo EU Court of Justice by Bjorn Giesenbauer)

It’s been 17 years that the EU has been trying to complete its internal energy market. Seventeen years and three legislative packages later however, the bloc will probably still miss its 2014 deadline to complete the work. So energy ministers admitted at an informal meeting in Vilnius, Lithuania, in September. But if implementation has wavered, the rationale has not: the purpose of the internal energy market is to promote competition, enhance security of supply and enable decarbonisation, all to the ultimate benefit of consumers.

One crucial foundation of the liberalisation process is the idea of unbundling, or separating out network management from energy generation or supply activities. The EU’s third and last legislative package from 2009 introduced mandatory “ownership unbundling” for transmission system operators (TSOs – owners of high-voltage networks). But it did not do so for distribution system operators (DSOs – owners of low-voltage or “last mile” networks), maintaining instead requirements for a weaker “legal and functional unbundling”. There were several reasons for this, including that “the scope for discrimination as regards third-party access [to networks] and investment… is less significant at distribution level”.

On 22 October, the European Court of Justice clearly came down in favour of the Dutch government

The purpose of unbundling is to promote an open and transparent market, non-discriminatory access to networks and a level playing field. The idea is to combat cross-subsidisation between generation/supply and networks, including exchange of strategic information, to ensure both undistorted competition in electricity and gas markets (i.e. competitive prices for consumers) and sufficient investment in networks.

Dutch ambition

With these objectives in mind, the Netherlands decided to go beyond the specific EU requirements at distribution level. In a nutshell, from 2006 the Dutch government decided to forbid: 1) private investors from owning or acquiring shares in DSOs in the Netherlands (the “privatisation prohibition”); 2) shared ownership of DSOs and producers, suppliers or traders of electricity and gas (the “group prohibition”); and 3) engagement by DSOs in activities unrelated to the network (i.e. energy sales, financing of or debt guarantees for other activities). This effectively amounts to full ownership unbundling for DSOs and a legal requirement for them to be 100% state-owned.

This was sufficient to drive three vertically integrated energy companies in the Netherlands – Essent, Eneco and Delta – to court. They argued that the legislation was incompatible with the free movement of capital as enshrined in the EU Treaties. On 11 March 2009, the Court of The Hague dismissed the companies’ claims. But on 22 June 2010, the Regional Court of Appeal overturned that judgement. The Dutch government subsequently brought an appeal to the Netherlands’ Supreme Court, which decided to turn it over to the European Court of Justice (ECJ).

Vindication

On 22 October, the ECJ clearly came down in favour of the Dutch government. How did the Court decide? First, it ruled that the privatisation prohibition falls within the scope of article 345 of the Lisbon Treaty, which leaves member states free to establish rules on public ownership. This does not mean however, that these rules are exempt from the EU Treaties’ fundamental rules on for example free movement of capital (article 63), the Court continued. It concluded that the privatisation prohibition is a restriction on the free movement of capital; as are the group prohibition and prohibition on non-network activities.

 The Court recognised that adequate investment in distribution networks is designed to ensure security of supply, another “overriding reason in the public interest”

All three laws must therefore be justified through the objectives that underpin them to be legal. “Are [these objectives]… purely economic interests, or can they also be regarded as interests of a non-economic nature, in the sense that in certain circumstances, as overriding reasons in the public interest, they may constitute a justification for a restriction on the free movement of capital?” asked the Court. The answer was yes.

“The objectives which underlie… property ownership may be taken into consideration as overriding reasons in the public interest to justify the restriction on the free movement of capital,” the Court declared. Similarly for the other two prohibitions: “The objectives… may… justify restrictions on the free movement of capital.” Like the Dutch laws, the EU Treaties pursue undistorted competition in the interest of consumers and case law dictates that consumer protection constitutes an “overriding reason in the public interest”. The Court also recognised that adequate investment in distribution networks is designed to ensure security of supply, another “overriding reason in the public interest”.

As per standard practice in a referral like this, it is now up to the Netherlands’ Supreme Court to make a final decision in the dispute. It will do so in the knowledge that the objectives pursued by the Dutch laws justify restrictions on fundamental freedoms. What it will have to confirm is that “the restrictions at issue [are] appropriate to the objectives pursued”.

Consequences

Assuming that the ECJ judgement is upheld, Eneco Holding and Delta will see their DSO activities split out of them. Essent is the only one of the three that was already split, in July 2009, into Enexis Holding (DSO) and Essent (producer). Essent was subsequently bought by RWE. Eneco and Delta have identified DSO subsidiaries – Stedin Netbeheer and Delta Netwerkbedrijf respectively – but have yet to fully unbundle.

They are reportedly not keen to do so, fearing lost turnover and cashflow. These companies are under pressure in other areas already, from managing an ageing nuclear power station (Delta) to difficulties in making gas plants commercially viable with the ever greater influx of renewables. They also argue that their future weaker selves may be more susceptible to foreign takeovers. Some of the newly created DSOs in contrast, such as Liander (part of Alliander, spun out of Nuon), would reportedly be interested in re-engaging in non-network activities. But if the ECJ judgement is upheld, this will remain a thing of the past.

If the Court is prepared to underline the importance of unbundling so clearly for distribution, how does Gazprom stand a chance arguing over the same rules for transmission in the case of South Stream?

For the rest of Europe, the Dutch case is a signal that the ECJ will uphold the EU’s efforts to create an internal market for energy as something very clearly in the interests of the public. It will back ownership unbundling, even for distribution, over fundamental freedoms such as the free movement of capital. It will let individual member states go beyond the prescriptions in EU law to build transparent, fully competitive electricity and gas markets, and to secure adequate investment in networks. It recognises that public interest is ultimate objective here.

A final thought: if the Court is prepared to underline the importance of unbundling so clearly for distribution, how does Gazprom stand a chance arguing over the same rules for transmission?

Commission comes with “state intervention package” for the internal market

On 5 November, the European Commission issued detailed “guidance” for member states “on state intervention in the electricity market”. This guidance covers: 

  • best practice for renewables support scheme design – from feed-in tariffs to green certificate schemes
  • guidance on making more use of renewables cooperation mechanisms – how member states can work together to meet their renewables targets (e.g. through statistical transfer or joint projects)
  • a case for capacity markets – what might justify them and how they could be designed
  • demand side response measures – how to ensure the wider uptake in Europe of solutions like demand response 

See here for more information. We will return to these issues in more detail later.

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