Energy pricing: Fixed rate or free-market?

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As electricity and gas markets slowly open up to competition, EU countries with fixed pricing policies are coming under growing pressure to let market forces decide prices. But opponents point to the potentially high social consequences of the measure.

By liberalising energy markets, EU countries have started to introduce policies aimed at encouraging new operators to enter the market and compete to offer gas and electricity to customers at the best price.

However, these markets remain far from perfect, because the liberalisation process is still incomplete. Moreover, pricing remains a highly sensitive issue, as it affects both households (which need energy for heating and cooking) and industrial consumers (which rely on affordable electricity and gas to keep their businesses going).

At the same time, climate change policy is crawling to the top of the EU agenda, making 'decarbonisation' of the energy sector a top political priority. Low-carbon technologies, however, come at a higher price than conventional fuels such as coal or gas. 

Moreover, as energy consumers also happen to be citizens and voters, the issue of energy pricing is making a comeback at the forefront of the political stage.

In many EU countries, the state retains control over electricity and gas prices charged to end-users. In most cases, these policies were decided upon to shield households and industries from violent price swings and keep energy affordable.

But with liberalisation, regulated prices and market prices still co-exist in many countries, creating confusion for customers and uncertainty for businesses wishing to break into national energy markets.

In a communication dated 10 January 2007, the European Commission states that price controls "may be needed to protect consumers in certain specific circumstances, for instance in the transition period towards effective competition" on the liberalised gas and electricity markets. However, it adds that they "must be balanced so as not to prevent market opening, create discriminations among EU energy suppliers, reinforce distortions of competition or restrict resale".

17 EU countries are currently applying regulated tariffs for electricity and nine are doing the same for gas, according to a survey by the European Group of Energy Regulators (ERGEG), published in June 2007. Depending on the countries, fixed prices may cover such things as:

  • Transport and distribution cost (power lines or pipes);
  • Taxes and levies (VAT and others), and; 
  • Supply costs (generation, marketing, customer management, etc.)

The regulated tariff does not necessarily apply to all customers. It may only cover households and small businesses, for example, leaving large industrial customers to buy their energy on the open market (for example, gas in the Netherlands and electricity in Denmark).

However, according to the ERGEG study, where both systems co-exist, 80% of end-users chose the regulated price, making genuine competition on retail markets an elusive objective for now.

Regulated tariffs: 'Not reflecting real costs, blocking competition'

According to ERGEG, price setting is "one of the factors which hinder equal access of all suppliers to customers". "New entrants who do not have power generation capacities or long term contracts buy energy on wholesale markets," ERGEG points out. As a consequence, "wholesale price levels must be lower" than the regulated price if they are to compete on the open market.

However, market players are often unable to make competitive offers. In France, Spain, and to a lesser extent Italy, "the regulated tariffs are […] set at a level so low compared with market prices that they fully prevent market opening," according to the Commission (EURACTIV 14/12/06).

In the EU executive's view, electricity and gas prices in those countries "do not reflect costs," leading to "under-investment" in new supply capacity. Moreover, it says artificially low tariffs "impede real competition," effectively blocking new suppliers' access to the market.

EFET, the European Federation of Energy Traders, is unambiguous: "The regulated tariffs cannot anticipate volatile wholesale prices" and therefore tend to "eradicate the only natural link between the wholesale and retail markets". In short, they act as a price distortion mechanism.

French tariffs in the line of fire

In France, the controversy has centred on the TaRTAM (Tarif Réglementé Transitoire d'Ajustement du Marché), a scheme allowing companies that opted for a market-based electricity tariff to switch back to the regulated tariff for a period of two years. 

TaRTAM was introduced because some companies were experiencing price rises of up to 70% above the regulated tariff upon moving to the free-market price. 

This is the main argument of those defending regulated tariffs – that they act as a cushion against wild price swings when energy markets are affected by external factors, such as political instability in oil-producing regions.

The French authorities have also pointed out that the price of electricity is naturally low in France because the costs of investment, notably in nuclear power stations, have already been covered. The low French tariff thus only reflects good policy decisions made decades ago, it is argued. "[Regulated] tariffs are not a distortion [of competition]. They only reflect the controlled costs of the French electrical production capacity," said French Industry Minister François Loos in 2006. Moreover, capped prices are not incompatible with EU liberalisation directives, Loos remarked.

Long-term supply contracts under scrutiny

Against this background, the long-term contracts passed between industrial consumers of electricity and large utility groups have increasingly attracted the attention of the European Commission. 

An inquiry into the energy sector, presented on 10 January 2007, found that electricity suppliers often have difficulty breaking into some national markets because industrial consumers tend to buy their electricity on a long-term, exclusive basis from their incumbent operator (see pages 287-298 of the 'Report on the Energy Sector Inquiry'). 

Supporters of long-term supply contracts argue that they fulfil a useful role. For large industrial consumers, they offer more predictable prices than the open electricity market. In turn, long-term contracts reduce uncertainty for energy firms, allowing them to plan ahead and propose set tariffs for their clients.

But, according to the Commission, long-term contracts essentially hamper competition and prevent necessary price signals from being passed on to consumers. When gas or electricity prices rise, consumers should be encouraged to reduce their consumption, the argument goes.

A number of antitrust investigations have been launched in this context. In July 2007, the Commission launched a formal antitrust investigation against French group EDF and Electrabel, the Belgian branch of Suez-GDF, for alleged market-rigging (EURACTIV 30/07/07). The investigation, which is still ongoing, focuses on the introduction of long-term exclusive purchase obligations in supply contracts to industrial consumers of electricity. The Commission considers such practices to be an abuse of their dominant market position, as they make it difficult for new suppliers to enter the electricity market and makes clients less likely to switch supplier.

Similarly, a long-term supply contract between EDF and Exeltium, a consortium of large industrial electricity consumers in France, also raised concerns at the European Commission. Formal antitrust proceedings were launched in 2007 and dropped a year later after a number of changes were introduced to the framework contract.

The EU executive applies the same thinking to the gas sector, arguing that long-term sales contracts between European energy firms and foreign suppliers of natural gas act as a barrier to new market entrants, who have to buy their gas at more volatile market prices.

A possible 'blueprint' deal was reached last year, when Belgium's Distrigas agreed to limit its long-term gas supply contracts. The Commission told energy firms they can avoid future antitrust cases by following Distrigas's example (EURACTIV 12/10/07).

Social tariffs to tackle fuel poverty

However, even the most ardent supporters of liberalisation recognise that competition should be matched by measures to protect consumers. 

In the UK, all the major energy utilities, including British Gas, E.ON and EDF Energy, have introduced social tariffs to protect households from fuel poverty. A Winter Fuel Allowance scheme was also introduced by the government for the most vulnerable sectors of the British population, such as the elderly. But these have been criticised for failing to keep up with rising energy bills.

Moreover, clients who were not on the social scheme were sometimes offered better deals when closing contracts over the Internet. Ofgem, the UK energy regulator, intervened and issued guidelines requiring energy companies to offer a social tariff which must equal the supplier's cheapest deal. The tariff applies to customers who spend more than a tenth of their income on energy.

Boosting consumer rights and information

With households still nervous about changing electricity supplier, the European Commission has decided to focus another dimension of its policies on encouraging competition in the retail electricity sector.

In February 2009, it announced the launch of an investigation into the "malfunctioning" EU electricity market, following the publication of a survey which revealed that the energy sector was "underperforming" for consumers (EURACTIV 3/02/09). The probe will focus on "unfair" conditions for electricity consumers regarding billing, comparability of offers and unreasonable commercial practices, after the Commission found that "less than two thirds of consumers are satisfied with their energy supplier". 

The report reveals that consumers are extremely unlikely to switch gas or electricity supplier, with just seven and eight percent respectively indicating their willingness to do so. "Facilitating switching in key retail sectors should be a policy priority," the EU executive said.

Europeans spend an average of 5.7% of their household budgets on energy, according to Commission figures, with electricity accounting for the largest part of this expenditure. Customers are particularly annoyed about recent price hikes for gas and electricity, with 60% reporting increases compared with 3-4% who reported decreases. 

Moreover, Europeans have a "limited" awareness of their rights, according to the Commission. To improve consumer information, the EU executive has launched a number of initiatives:

  • A European Energy Consumer Checklist, which will compile information in an online database about local and regional energy markets (EURACTIV 8/05/08).
  • A Citizens' Energy Forum to debate consumer protection issues. The forum will include energy regulators, competition as well as industry and consumer associations at European and national levels.
  • A European Charter on the Rights of Energy Consumers, which compiles existing rights in a single non-binding text (EURACTIV 06/07/07).

The rights of energy consumers are outlined in the EU's 2003 directives on electricity and gas liberalisation (see EURACTIV LinksDossier).

EU Energy Commissioner Andris Piebalgs is confident that liberalisation will eventually pay off for consumers. "We know that markets bring the best prices and the best service," he said in an interview with EURACTIV in January 2007. "In the end, only prices freely determined by the market can ensure the best price for customers and give the right signal for the huge investments needed to ensure our security of supply," the commissioner said.

In a hearing before the French Senate in April 2008, Neelie Kroes, the EU's competition commissioner, said regulated tariffs and consortiums such as Exeltium represented unfair competition for energy firms operating on the free market. She said, however, that regulated tariffs are acceptable for households and small and medium-sized enterprises (SMEs). But she said these were less acceptable for big companies.

In a separate hearingPiebalgs said electricity prices needed to reflect the actual costs of running existing power stations, but should also include planning for future energy investments, which are expected to soar in the future due to the transition to a low-carbon energy system. National tariff schemes that respect these two conditions are acceptable, he said, but the ones currently applicable to French industry do not seem to respect this rule. 

Piebalgs also pointed out that EDF was taking full advantage of market opening in Germany and the United Kingdom, but prices in France were too low to allow new competitors to enter the French market.

But EU consumer groups say liberalisation has so far failed to deliver. According to European consumer organisation BEUC, the "current liberalisation is largely a missed opportunity" for households, due to frequent complaints such as difficulties in switching suppliers, incorrect billing, difficulties in contacting operators with questions or complaints, overpriced 'help-lines' and aggressive door-to-door selling.

Energy-intensive sectors such as steelcement and chemicals saw their electricity bills increase by up to 60% after the initial round of liberalisation in 2004, according to UFC-Que Choisir, a French consumer group. The group warns that a repeat of the phenomenon is "highly probable" in the household sector, particularly in the event of a spike in imported gas prices.

The European Commission admitted to the shortcoming when it presented its 2009 Consumer Market Scoreboard. EU Consumer Affairs Commissioner Meglena Kuneva said she will make the electricity retail market "the target sector for investigation in 2009" (EURACTIV 3/02/09).

Under a public service contract signed with the French government, power utility Electricité de France (EDF) agreed to keep its tariffs below inflation until the end of 2010. EDF is 87% state-owned and Europe's largest utility by market capitalisation. According to EDF, the switchover to full liberalisation needs to be softened with a transition period. "We should make regulated tariffs compatible with market opening, by making clear this is only a transition," EDF boss Pierre Gadonneix said on 13 December 2006 (EURACTIV 14/12/06).

The European electricity sector, represented in Brussels by Eurelectric, says competitive electricity markets simply "cannot co-exist with regulated prices." In a paper dated November 2006, Eurelectric says consumer prices are closely linked to wholesale prices as they are "part of the same value chain". The wholesale market, it says, "creates the reference price that sends the appropriate signal to all the market players".

But imposing set tariffs will break that link, Eurelectic says. "This means that […] changes in fundamentals will not be properly reflected in the price," ultimately affecting the whole chain. "This conflict can lead to various failures and distortions in the electricity market, and ultimately to the collapse of the liberalisation process," Eurelectric warns.

EFET, the European Federation of Energy Traders, expressed concerns about "tendencies to revert to market intervention and centralised planning" in the power sector, saying it was "reminiscent of the pre-liberalisation era". According to EFET, "the plan of several EU member states to strengthen or re-introduce regulated tariffs for the price of electricity" charged to households or industrial consumers are delaying or distorting the process of establishing reliable wholesale price signals in the relevant countries.

"Well-functioning wholesale markets in electricity and gas, founded on harmonised and open access to monopoly transmission infrastructure, are fundamental building blocks for the overall internal energy market. If they are allowed to function properly, they can not only facilitate competition and choice, but also help maintain supply security, achieve environmental objectives and increase EU competitiveness in a global context."

  • July 2004: Industrial market opens up to competition.
  • 10 Jan. 2007: Commission issues progress report on the internal energy market and final results of a competition enquiry, which confirmed "serious problems" in the liberalised energy markets (EURACTIV 11/01/07).
  • July 2007: Household market opens up to competition.
  • 19 Sept. 2007: Commission presents 'third liberalisation package' (EURACTIV 20/09/07).
  • 10 Oct. 2008: EU energy ministers clinch deal on 'third liberalisation package' (EURACTIV 13/10/08).
  • 2 Feb. 2009: Commission announces probe into retail electricity market (EURACTIV 3/02/09).

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