The 'third energy package' provides companies in the EU with three options for separating electricity production from supply provision.
1. Ownership unbundling
Companies that control both energy generation and transmission are obliged to sell part of their assets. Investors are able to retain their participation in the dismantled groups via a system of 'share-splitting', whereby two new shares are offered for each existing share.
2. Independent System Operator (ISO)
Companies involved in energy production and supply are allowed to retain their network assets, but lose control over how they are managed. Crucially, commercial and investment decisions are left to an independent company (ISO) designated by national governments, with the prior approval of the European Commission to ensure a sufficient level of independence.
3. Indepenent Transmission Operator (ITO)
Like the ISO option, the ITO model allows integrated companies to retain ownership of their gas and electricity grids. However, they will have to give up daily management of the grids to an independent transmission operator.
Crucially, companies remain in control of commercial and investment decisions, but will have to set up a framework to ensure the independent operation of the transmission network.
A special commodity
Unlike gas, electricity cannot be stored, at least not in large quantities and not over long periods, given the present state of technology. Electricity must therefore be made available at short notice and in response to sudden changes in demand.
Greater electricity market liberalisation, particularly if it is characterised by a higher number of smaller electricity producers feeding into a large and complex Europe-wide grid, would require significant restructuring of the exisiting electricity transmission infrastructure.
In the long term, grids would need to be highly stable, yet also adaptable and responsive to power input from a wide variety of small and large electricity generators, including households. National transmission system operators (TSOs) play a key role in this process, as they are responsible for managing and overseeing the flow of high volumes of electricity through grids.
Nevertheless, at present, Europe's grids remain largely centralised, and are set up to distribute electricity generated by large coal, nuclear and gas power plants. The EU's energy market is also plagued by under-investment in cross-border power transmission capacity and a lack of coordination between TSOs, which also manage power flows between member states, according to a Commission impact assessment.
Fair access and investments
Proponents of liberalisation argue that in a market where power generation and supply is controlled by a few large firms, there is little incentive to invest in and expand network capacity, since this would pave the way for more competition and bring prices (and thus profits) down.
But not all experts agree that liberalisation would lead to network upgrades, and have instead raised concerns about potential grid instability and even under-investment as a result of a lack of stewardship by the established players.
Opponents and proponents of liberalisation do agree, however, that getting TSOs to cooperate better while stimulating greater investment in networks requires the right regulatory framework.
The third legislative package gives more power to national regulators and creates a new European Agency for the Cooperation of Energy Regulators (ACER) to ensure that market players act fairly at both national and European level.
The package also creates a European Network for Transmission System Operators (ENTSO) for both gas and electricity. Both measures are designed to give firms and financiers greater certainty when planning network upgrades, and to prevent the kind of market abuse and cartel-like behaviour that has been documented in Germany, for example (EURACTIV 5/11/07).
But a number of regulatory experts - as well as the EU's two main energy regulatory bodies, the Council of European Energy Regulators (CEER) and the European Regulators Group for Electricity and Gas (ERGEG) - argue that the powers of the new bodies, in particular those of ACER, are too limited and are pushing for its mandate to be strengthened (EURACTIV 25/01/08).
Even if the correct regulatory conditions can be created, power transmission technologies and standards must be such that the quality of power flows is ensured.
While power disruptions or temporary fluctuations in the quality and strength of electricity voltage flows can be a nuisance in households, they can spell disaster for hospitals and other facilities that rely on sensitive equipment.
"An undervoltage as short as ¼ of a cycle (about four milliseconds) is often sufficient to confuse sensitive electronic devices, potentially putting patients' lives at risk," according to Leonardo Energy, an initiative of the European Copper Institute (ECI).
In addition to safety concerns, poor power quality, notably through sudden voltage decreases or 'dips', costs the EU an estimated €150 billion annually, according to Leonardo Energy, which says that EU standards on power quality are outdated given the current state of technologies.
But tightening the EU's current power or voltage quality standard EN50160, as established by the European Committee for Electrotechnical Standardisation (CENELEC), is a sensitive issue, as this would require costly upgrades at virtually all points of the electricity supply chain. The standard is currently under review, but details of the process are being kept tightly under wraps, with no clear timeline available.
Traders waiting in the wings
Efforts in Brussels to create a functioning European electricity market are thus complicated not only by political concerns, but also by complex technical and financial issues that affect the entire scope of the EU's electricity infrastructure.
Traders, meanwhile, are pleased that the liberalisation process is moving forward given the enormous potential of wholesale electricity trading within a pan-European power exchange.
Such wholesale trading, which takes place either through actual physical trading in power or through trading of financial instruments (futures, derivatives, etc.) "is critical in a liberalised market, and is one of the key drivers of liberalisation. It is where liberalisation impacts utilities first," says Eurelectric, which represents the EU's electricity industry in Brussels.
Since 2005, trading volumes in the EU have stabilised following a significant decline in the wake of the 2001 Enron scandal in the US, which rattled the confidence of many market participants in energy trading.
Despite the market's recovery, energy traders worry that a stalled liberalisation process and continued price controls, such as France's regulated energy tariffs and renewable feed-in tariffs, could undermine progress.
The climate link
The drive to integrate and liberalise the EU's energy sector is inextricably linked with the bloc's wider climate change agenda, notably commitments to achieve a 20% decrease in CO2 emissions by 2020, coupled with a 20% increase in renewable energy use during the same period.
The Commission hopes that efforts to boost renewables and a high carbon price under the EU's emissions trading scheme in particular could act as drivers for the creation of a well-functioning pan-EU electricity and gas market.
It thus came as no surprise that negotiations were heated throughout 2008 and into 2009, as EU member states had to simultaneously hammer out complicated and sensitive new laws concerning not only the energy sector, but the overall framework of EU efforts to address climate change.