A STUDY ON THE DEREGULATION OF THE ELECTRICITY SECTOR AND THE IMPLICATIONS FOR THE PORTUGUESE MARKET

UNIVERSIDADE TÉCNICA DE LISBOA INSTITUTO SUPERIOR TÉCNICO A STUDY ON THE DEREGULATION OF THE ELECTRICITY SECTOR AND THE IMPLICATIONS FOR THE PORTUGUESE MARKET MARTA ISABEL DA COSTA PAIVA PINTO (Licenciado em Engenharia e Gestão Industrial) Dissertação para obtenção do Grau de Mestre em Engenharia e Gestão de Tecnologia Orientador Doutor RUI MIGUEL LOUREIRO NOBRE BAPTISTA Constituição do Júri Doutor MANUEL FREDERICO TOJAL DE VALSASSINA HEITOR Doutor JOSÉ MANUEL AMADO DA SILVA Doutor PEDRO FILIPE TEIXEIRA DA CONCEIÇÃO Doutor RUI MIGUEL LOUREIRO NOBRE BAPTISTA Janeiro 2001

Abstract The European Directive for the electricity market was introduced in 1996, after several years of internal debates, defining the rules of the game for the different players in this market: generation, transmission, distribution and electricity supply. The objective of the European Union (EU) is to establish the internal energy market, which should cover the electricity industry, as well as the natural gas industry. It is well accepted that all the European countries are now facing new opportunities in this context which must be used as a way to develop their own industry and economic competitiveness. It is not just a matter of electricity price but much more: it is a change in the market structure; a change in the way companies operate in the market and develop their business models; a change in the technology used by energy companies and energy users. It is also a challenge for new economic activities related with this sector that will emerge in order to support and complement all the changes that start to appear. To evaluate the implications of the electricity deregulation process in Portugal it was decided to make an international benchmarking study picking some reference examples and examining different ways in which the EU Electricity Directive is being implemented. The countries chosen were the United Kingdom, Spain, Germany and France. With the case studies analysis it was possible to evaluate potential relations between deregulation policies and the correspondent impacts on market structure and innovation, developing a framework that was used for the analysis of the Portuguese electricity market. From the case studies analysis it was concluded that it is not possible to establish a standard pattern for the deregulation process among European countries: the EU Electricity Directive gives the possibility to each country chose its own way. In Portugal, the electricity sector it is just starting to open the door to the European context and hence it is possible to create distinct possible scenarios with different impacts. The future of the sector is dependent on the time, the political decisions and the dynamics of the sector in the other European countries, especially Spain, which represents the main competitor for the Portuguese electric companies. Keywords: EU Policy, reestructuring, privatization, deregulation, competition, vertical disintegration, market structure, business designs, technology. Page 2

Resumo A Directiva Europeia para o Sector Eléctrico entrou em vigor em 1996, depois de vários anos de debates internos, definindo as regras do jogo para os vários intervenientes do mercado: geração, transmissão, distribuição e fornecimento de electricidade. Com esta Directiva a Comissão Europeia pretende desenvolver um mercado interno de electridade, que deverá incluir além do sector eléctrico o mercado interno do gás natural. Os países da União Europeia estão, neste contexto, perante novas oportunidades que deverão ser utilizadas como forma de desenvolvimento do sector eléctrico e da sua própria competitividade. Não é apenas uma questão de redução dos preços de venda da electricidade para os consumidores domésticos e industriais: trata-se de uma mudança na estrutura do mercado; uma alteração na forma como as empresas se posicionam no mercado e desenvolvem os seus modelos de negócio; uma mudança nas tecnologias utilizadas para a produção e utilização de electricidade. Trata-se também de um desafio para o desenvolvimento de novas actividades económicas relacionadas com o sector eléctrico que irão emergir como forma de complemento e suporte a todas estas mudanças. Para avaliar as implicações da desregulamentação do sector eléctrico em Portugal foi decidido proceder a um estudo internacional, através da análise de exemplos que foram examinados nas várias vertentes de implementação da Directiva Comunitária. Os países seleccionados foram: o Reino Unido, a Espanha, a Alemanha e a França. Com estes quatro casos de estudo foi possível avaliar potenciais relações existentes entre as diferentes políticas de liberalização e os correspondentes impactos ao nível da estrutura de mercado e inovação, desenvolvendo um modelo que foi utilizado para a análise do mercado português de electricidade. Com a análise dos casos de estudo foi concluido que não é possível estabelecer um padrão para o processo de desregulamentação no contexto europeu: a Comissão Europeia dá a cada país a possibilidade de utilizar uma política individual para a aplicação dos vários requisitos da Directiva Comunitária. Em Portugal o sector eléctrico está ainda numa fase inicial de reestruturação e privatização, sendo desta forma possível criar distintos cenários com diferentes impactos. O futuro deste sector depende do tempo que ainda é necessário para se fazerem notar quaisquer tipo de impactos, depende também de decisões políticas e da dinâmica que o sector poderá vir a desenvolver nos Page 3

outros países europeus, com especial destaque para Espanha que corresponde ao principal concorrente das empresas eléctricas portuguesas. Palavras-chave: Políticas Comunitárias, reestruturação, privatização, desregulamentação, competição, desintegração vertical, estrutura de mercado, tecnologia, modelos de negócio. Page 4

Acknowledgments I want to present my first acknowledgments to my father, my mother and my brother, who gave me all their support during this last year. They were very important for me during this process, giving me confidence and strength in the most difficult moments. Second, my thanks to all my friends, who were always so concerned with the dissertation and its evolution. My special thanks to my good friend Rosana with the very important advices and to my special friend Carlos with all the patience he had with me. To Rui Baptista my thanks for the time he spent with me that was fundamental for the evolution of the work and for me to be able to finish the work on time. To Manuel Heitor, my thanks for the confidence he had in me, allowing me to develop a dissertation on a subject that was always my preference. To Eng. Vasco Coucello from EDP Group and Eng. João Santana from ERSE, many thanks for the information they gave me. Without the support of these two institutions I m sure some parts of this work would not have been be possible to do. To finish my special thanks to Mercer Management Consulting, who gave me the opportunity to spend so much time on the dissertation and that always looked at it with so much respect. I hope I can use it in the future and compensate all the support I received from José Taboada, Catalina Parra, Javier Gomes de Olea, Rafel Asencio and all my colleagues. Page 5

Table of Contents Abstract... 2 Resumo... 3 Acknowledgments... 5 Table of Contents... 6 Index of Figures... 8 Index of Tables... 10 CHAPTER I INTRODUCTION... 11 I.1. Market Deregulation in European Union... 11 I.2. Electricity Market Deregulation in European Union... 13 I.2.1. Market Structure contrasts... 14 I.2.2. Energy Mix contrasts... 14 I.2.3. Regulatory Reforms contrasts... 15 I.3. The Internal Electricity Market Directive... 16 I.3.1. The change from the monopoly to the competitive market... 16 I.3.2. The new market structure under the EU Electricity Directive... 17 I.4. Energy Market Outlook... 22 I.4.1. Electricity consumption evolution worldwide... 22 I.4.2. Electricity generation mix evolution worldwide... 22 I.4.3. Electricity sector in Western Europe... 23 CHAPTER II - CASE STUDIES ANALYSIS... 25 II.1. Introduction and Methodology... 25 II.2. Electricity Sector in United Kingdom... 28 II.2.1. Market Structure Evolution... 28 II.2.2. Major Impacts... 38 II.3. Electricity Sector in Spain... 50 II.3.1. Market Structure evolution... 51 II.3.2. Major Impacts... 58 II.4. Electricity Sector in Germany... 77 II.4.1. Market Structure Evolution... 77 II.4.2. Major Impacts... 80 II.5. Electricity Sector in France... 87 II.5.1. Market Structure Evolution... 87 II.5.2. Major Impacts... 90 II.6. Conclusions... 95 CHAPTER III FRAMEWORK FOR CASE STUDIES ANALYSIS... 96 III.1. Introduction... 96 III.2. Market Liberalization Framework... 97 III.2.1. Context... 97 III.2.2. Indicators for market competition stages... 98 III.2.3. Indicators for market non-competitive stages... 99 III.2.4. Framework for market deregulation policies...101 III.2.5. Analysis...103 III.3. Innovation Impacts Framework... 105 III.3.1. Context...105 III.3.2. Market Structure Innovation...106 Page 6

III.3.3. Company Business Design Innovation...111 III.3.4. Technological Innovation...117 III.3.5. Framework for Innovation Impacts...119 III.3.6. Analysis...121 III.4. Concluding remarks... 123 III.4.1. Liberalization policies global indicator versus Innovation impact global indicator...124 III.4.2. Detailed liberalization policies indicators versus Innovation impact global indicator...124 III.4.3. Liberalization policies global indicator versus detailed Innovation impact indicators...127 III.4.4. The influence of country specific factors...129 CHAPTER IV PORTUGUESE ELECTRICITY MARKET... 133 IV.1. Electricity market structure evolution... 133 IV.1.1. Generation...135 IV.1.2. Market mechanisms...135 IV.1.3. Supply...135 IV.1.4. Transmission and distribution networks...136 IV.1.5. Regulation...136 IV.2. Changes already present in the market... 137 IV.2.1. Electricity prices...137 IV.2.2. Energy Mix evolution...141 IV.2.3. Energy Balance evolution...142 IV.2.4. EDP s strategies...143 IV.2.5. Eligible consumers...146 IV.2.6. New entrants in the market...146 IV.3. Scenarios for electricity deregulation in Portugal... 147 IV.3.1. Introduction...147 IV.3.2. Particularities of the Portuguese electricity sector...148 IV.3.3. The most important drivers...150 IV.3.4. Global scenarios for the electricity market in Portugal...154 IV.4. Concluding remarks... 161 CHAPTER V CONCLUSIONS... 163 Bibliography... 169 Glossary... 173 Page 7

Index of Figures Figure 1. Electricity Market Value Chain...17 Figure 2. World Energy Mix Evolution...23 Figure 3. Electricity Generation Mix in Western Europe...24 Figure 4. Methodology...27 Figure 5. Electricity market evolution in UK...28 Figure 6. Electricity generation split by companies, in UK...38 Figure 7. Electricity supply split for big industrial customers...39 Figure 8. Electricity supply split for medium and small industrial customers...39 Figure 9. Energy mix evolution in UK...43 Figure 10. Electricity prices evolution for domestic and industrial consumers, in UK...45 Figure 11. World electricity prices comparison, for industrial and domestic consumers...46 Figure 12. Electricity balance evolution, in UK...47 Figure 13. Electricity market evolution in Spain...50 Figure 14. Spanish electricity system...53 Figure 15. Electricity generation and distribution markets split by companies...58 Figure 16. Horizontal concentration in electric sector...59 Figure 17. Endesa Group...62 Figure 18. Diversification strategy adopted by Endesa Group and Iberdrola Group...64 Figure 19. Electricity tariffs evolution, in Spain...66 Figure 20. Electricity prices evolution, in Spain...67 Figure 21. Web pages Spanish utilities...69 Figure 22. Electricity mix evolution, in Spain...70 Figure 23. Mix of production by fuel type, in Spain...71 Figure 24. Additional CCGT capacity in Spain...72 Figure 25. Electricity balance evolution, in Spain...75 Figure 26. Efficiency comparisons in the electricity market...76 Figure 27. Electricity market shares in Germany...78 Figure 28. Top 10 electricity generation companies in Western Europe...81 Figure 29. Web page from a german utility...83 Figure 30. Electricity mix in Germany...85 Figure 31. Electricity balance evolution, in Germany...86 Figure 32. Electricity market shares in France...87 Figure 33. Electricity generation mix in France...91 Figure 34. Electricity balance evolution, in France...92 Figure 35. Electricity export/production evolution, in France...92 Figure 36. High-level indicators, for market deregulation policies... 103 Figure 37. Indicators for UK, Spain, Germany and France... 104 Figure 38. New pressures for the electric utilities... 105 Page 8

Figure 39. Energy industry radar screen... 108 Figure 40. Customer oriented strategy... 112 Figure 41. Channel options for electricity supply companies... 115 Figure 42. ENRON trading capabilities evolution... 116 Figure 43. Metering and billing activities developed by electric utilities... 118 Figure 44. High-level Innovation Impacts... 121 Figure 45. Innovation Impacts indicators for UK,Spain, Germany and France... 122 Figure 46. Global indicators... 124 Figure 47. Market competition indicators versus innovation impact global indicator... 124 Figure 48. Market non-competition indicators versus innovation impact global indicator... 125 Figure 49. Upstream and wholesale indicators versus innovation impact global indicator... 126 Figure 50. Downstream & customer beneficts indicators versus innovation impact global indicator. 126 Figure 51. Market deregulation global indicator versus market structure innovation indicators... 127 Figure 52. Market deregulation global indicator versus business design innovation indicators... 127 Figure 53. Market deregulation global indicator versu technology innovation indicators... 127 Figure 54. Portuguese electricity system... 134 Figure 55. Electricity prices evolution in Portugal (constant prices)... 137 Figure 56. Electricity prices evolution in Portugal (current prices)... 138 Figure 57. Electricity prices evolution, for Portuguese domestic consumers... 139 Figure 58. Electricity prices variation for households... 139 Figure 59. Electricity prices evolution, for Portuguese industrial consumers... 140 Figure 60. Electricity prices variation for industry... 140 Figure 61. Electricity generation mix evolution, in Portugal... 141 Figure 62. Electricity balance evolution, in Portugal... 142 Figure 63. Electricity imports/consumption evolution, in Portugal... 142 Figure 64. Electricity companies in EDP Group... 143 Figure 65. Portuguese and Spanish electricity systems comparison... 148 Figure 67. Potential changes for electricity generation market... 151 Figure 68. Potential changes for market mechanisms... 152 Figure 69. Potential changes for competition in electricity supply market... 153 Figure 70. Scenarios for Portuguese electricity market evolution... 154 Figure 71. Most conservative scenario... 155 Figure 72. Innovation impacts for the most conservative scenario... 156 Figure 73. Most radical scenario... 157 Figure 74. Innovation indicators for the most radical scenario... 158 Figure 75. Intermedium scenario... 159 Figure 76. Innovation indicators for the intermedium scenario... 160 Figure 77. Potential innovation impacts in the Portuguese electricity system... 161 Page 9

Index of Tables Table 1. EU Directive...12 Table 2. Companies in the electricity supply market, by share of sites...40 Table 3. Companies in the electricity supply market, by output supplied...40 Table 4. Mergers&Acquisitions in the electricity market...42 Table 5. New CCGT generation units in UK...44 Table 6. Level of opening in the UK electricity market...47 Table 7. Electricity generation expansion with new CCGT, in the Spanish market...65 Table 8. Eligible consumers in Spain, per level of consumption (Gwh/year)...68 Table 9. International exchanges of electricity, in Spain (1998, GWh)...75 Table 10. Indicators for market deregulation policies... 101 Table 11. Market deregulation policies evaluation, for each case study... 102 Table 12. Indicators for innovation impacts... 119 Table 13. Innovation impacts evaluation, for each case study... 120 Table 14. Eligible consumers in Portugal... 146 Page 10

CHAPTER I INTRODUCTION I.1. Market Deregulation in European Union Regulatory reforms have become a major priority of economic policies throughout the world in the last two decades. However it is a very complex matter and these are progressive reforms that can not be done overnight. It started in the late seventies in the United States and then the wave came to Europe and the rest of the world. This new trend toward deregulation is the reverse of the trend that was developed in the thirty years after World War II, which was called for more regulation, nationalization and more state control of the economy (European Commission, 1999). Market deregulation is related with national particularities and even if there are some generic principles, there certainly are no standard patterns among sectors or among countries. Each sector and each country has their own way to conduct regulatory reforms because regulation is not only a matter of economic theory and it is linked to political institutions, to sociology and to history. The concept of public utility is different when we compare the United States and European countries (European Commission, 1998). - The public utility doctrine emerged in the United States in the 19 th century from conflicts between producers and users/customers, in sectors where there was a tendency to concentrate economic power, like railway transportation and electricity distribution. The doctrine of public utilities says that when there is first necessity (i.e. a goal that is very useful to the public) and there is a natural monopoly, there is a public interest for public intervention, especially to control tariffs and investments. In the US the public utility appeared as a branch of the anti-trust legislation; - In Europe, especially in France, Service Public relates to an activity which the state decides to conduct by itself, where its duty is to intervene strongly in order to correct deficiencies of private initiatives. In this context, there are different kinds of public services: the defense, diplomacy and justice, at the heart of the state s mandate; the social services such as public education and public health and the industrial or economic public services like energy, transportation, post and telecommunications. Page 11

This doctrine of Service Public has emerged in Europe after the World War II, leading to nationalization most of these different sectors. But what made things change in Europe? In the late seventies an economic policy revolution was born in Anglo-Saxon countries, in the United States first, then in the United Kingdom, mainly caused by excess inflation and a feeling of public service inefficiency. There was a rise in the public opinion against excessive welfare state, too much taxation, too much inflation and too much intervention of the state in the economy. So, the general trend of economic policy was a decisive factor to develop the deregulatory policies in Europe that some years later were reinforced by the Maastricht Treaty (1992). The US experience in deregulation, that started in 1978 with the deregulation of airline transportation, the new legislation for development of independent power production in the energy electricity sector and the disruption of AT&T in 1982, were not seen as major events in Europe. But their economic consequences were felt very rapidly and forced European firms to adopt new market strategies. The United Kingdom was the first country to implement deregulation policies and these ones were much more relevant to the European countries with the common pattern in public services of nationalization and national monopolies. Deregulation and privatization in the UK started in 1983 with the British Airways and it was followed in 1984 by British Gas, in 1986 by British Telecom and the water authorities, in 1989 by electricity, in 1992 by rail transportation and in 1994 by the post office. From 1986 to 1999 several directives were adopted by European Council of Ministers under the pressure of the European Commission. Some countries were reluctant to accept this but, with the majority rule they were compelled to do it. In the table above are listed some of the EU directive dates that were implemented in all the member countries (European Commission, 2000): Table 1. EU Directives SECTOR EU DIRECTIVE DATE Telecommunications 1987 Airline 1990 Railway 1991 Electricity 1996 Gas 1998 Source: European Commission (DGE XXII) Page 12

I.2. Electricity Market Deregulation in European Union After several years of internal debates, the European Directive for the electricity sector was introduced in 1996. As it was already mentioned, the drive towards liberalization of energy markets in the European Union forms part of a global process of deregulation. The objective in the EU is to establish the internal energy market, which should cover the electricity industry, as well as the natural gas industry. According with the European Commission (1998), there are three basic reasons for the energy liberalization in European Union: - From a political point of view we can say that energy liberalization in general, and in particular of the electricity industry, is not something new. In countries such as the United States, United Kingdom, Norway, Argentina, Chile, Australia, Japan and New Zealand, processes are taking place or have already taken place which aim at liberalizing electricity and/or natural gas markets and opening them up to more competition. The general aims of such developments are to improve efficiency, to create a more competitive energy-producing industry, to ensure security of supply and to attract new investors; - The second reason for energy liberalization is economic. If the European Union has such an important role to play in global trade, this means that European companies will be competing against other manufacturers or service-providers, which operate on the basis of different economic factors and inputs. For instance, the electricity bought in Germany in 1998 for was approximately 33% more expensive than in the United States and 50% more expensive than in Australia. In the present context, more and more business is being conducted on a global scale and European industries have to face fierce competition from the economies of East Asia, Central Europe and North America; - The third reason for energy liberalization in Europe is legal in nature. The EC Treaty defines the internal market as an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of the Treaty. In this context, it is necessary to consider also the electricity as a good with free exchange within the EU countries. Page 13

To analyze electricity deregulation in the European Union it is very important to understand and accept the particularities of this sector, when compared with others, as well as the deep contrasts among the European countries concerning the industrial organization and regulation of the electricity sector. I.2.1. Market Structure contrasts In Europe there are countries with national monopolies and public-owned establishments like France with EdF or Italy with ENEL. Smaller countries such as Portugal, Greece or Ireland also have national monopolies and public-owned establishments. On the other extreme, there are totally liberalized countries like United Kingdom that with the 1989 reform vertically disintegrated the national monopoly (CEGB) into production and transmission and also has separated the distribution and supply activities of the regional monopolies (RECs). In between those two extremes there is the mixed case, such as the Central European model of organization which is based on federalism, decentralized organization, where distribution is held by municipalities and local authorities, while transmission and generation are held by industrial companies, without any national monopoly. In this case capital is mixed, both public and private. As we can see, each European country has its own way of organizing and regulating electricity market, and this is much unlike the United States, where there is a strong unification, with many kinds of utilities, but still the same pattern in the country as a whole (European Commission, 1999). I.2.2. Energy Mix contrasts The primary source of energy to generate electricity is very contrasted in Europe (European Commission, 1999). There are countries that are dominated by coal like Germany and United Kingdom. There are countries, as Netherlands, in which electricity generation is dominated by natural gas. Spain and Italy are dominated by fuel and oil while Norway, Sweden and Switzerland are dominated by hydropower. In the case of France the nuclear power dominates, representing 75% of total electricity generation, and also Belgium, with 60% of its electricity being produced by nuclear plants. Page 14

I.2.3. Regulatory Reforms contrasts Some countries have been very much in advance of the EU Directive in terms of reforms. The first European country to adopt the deregulation reforms was the United Kingdom that was followed by countries in Scandinavia and also Germany and Spain. Before this trend of deregulation it was the EdF/French model which was the rule in Europe. But there are still some countries that are very conservative, especially France whose moves to comply with the Electricity Directive are very slight (European Commission, 1999). Page 15

I.3. The Internal Electricity Market Directive Until the 90 s, the european electricity generation was dominated by monopoly companies, and in some countries by fully integrated companies, managing the electricity chain from the electricity production to customer service and supply. Although each country adoped its own market structure, the state owned companies had in general a big control of the electricity chain and in some situations were the only ones supplying electricity to the final consumers. During the last two/three decades it became increasingly clear that it was possible to allow competition to develop in this industry, like in any other, and still maintain essential and basic public policy and service objectives. Some countries, like the United Kingdom and much of Scandinavian countries, made this change some years ago. But for most of EU countries and for the EU as a whole, 19 February 1999 marks the date that competition became the norm for electricity trade and production across the EU (European Commission, 1999). I.3.1. The change from the monopoly to the competitive market One of the main reasons to explain the existance of monopoly companies is due to the presence of economies of scale along the entire range of the demand (European Commission, 1998). In such a circunstance, it is optimal to allow the production of a good to be met by only one firm while it could, on the other hand, exclude from the marketplace some alternative production technologies. But when we consider a single electricity european market this argument loses credibility as in that situation the demand curve that each national utility will face is not the local demand but the agregation of the demands from the different countries. As a result, national companies that used to operate under a monopolistic scheme as the cheapest solution can be considered to be in a competitive environment in the unified market, since european demand size clearly overtakes the supply capacity of any producer. Another reason to explain the introduction of competition in the electricity market was the technological development that provided opportunities for the new entrants on the electricity market generation (European Commission, 1998). New technologies, like gas turbines, provided the opportunity to decentralise the power production without any significant losses compared to the centralised system and to invest in less capitalintensive technologies. Page 16

I.3.2. The new market structure under the EU Electricity Directive The electricity Directive sets out basic rules, which the Member States have to incorporate in their legislation. In accordance with the subsidiary principle, Member States are given a large margin of choice, as long as the different choices lead to equivalent economic results. The Directive does not impose a single rigid new market structure, but sets out the minimum conditions under which competition can be developed. The main issue in the new market structure is to open the generation and retail of electricity to new competitors while maintaining the infrastructure (transmission and distribution wires) management as a monopoly business, being regulated by independent entities and allowing the use of it by all other market players (European Commission, 1998). Figure 1. Electricity Market Value Chain Electricity Traditional Chain Generation Transmission Distribution Retail / Supply National and/or regional monopolies, with integration of the value chain New Electricity Chain, under the EU Directive Generation Transmission Distribution Retail / Supply Open to competition since Feb. 1999 National and/or regional monopolies being regulated Gradually open to competition Page 17

I.3.2.1. Electricity Generation As mencioned by the European Commission (1999) generation is one of the main components in the cost of electricity 1. In February 1999, the Directive introduced full competition across the EU for all new generating capacity. Under this new context, any producer is able to build a new power plant and generate electricity anywhere in the EU, either on the basis of an authorization system or a tendering procedure. At the same time the Directive imposes a maximum 50% of market share for a single company in each european member state. Under an authorization procedure any company may build and operate a new generation plant, provided that it complies with the planning and energy supply criteria for authorization specified in the Member State in question. Alternatively, under a tendering procedure, whenever there is a necessity for new generation capacity on the basis of regular long-term planning forecasts, an independent body will draw up an inventory for new means of production and the requisite capacity will be allocated by a tendering procedure. Until the present moment almost all Member States have opted for for the authorization procedure for the construction of new generation capacity. According with the IFIEC Europe (confederation of federations from 12 of Member States, with 64 active members) all the EU countries opted for the authorization procedure, except Portugal where the puclic system is using the tendering procedure. I.3.2.2. Electricity Retail/Supply In order to create a competitive market that works in practice, a sufficient number of consumers has to be free to purchase electricity from the supplier of their choice. On the other hand, liberalization has to take place progressively as the change to competition requires major reestructuring, new trading systems and mechanisms to be put in place and time for companies to adapt to the new competitive environment. According with the EU Directive the freedom to choose the electricity supplier will be achieved in a step by step approach that started in 1999 with the very large consumers. By 2003 the market has to be liberalized for all medium-sized consumers, representing at least 33% of each national market. Page 18

While the Directive obliges Member States to liberalize only large industrial consumers during the first stage, most Member States are moving faster and will either open their markets completely, or at least move a step further than the Directive requires. In fact in 19 February 1999, when the Electricity Directive was put in place, almost two thirds of all European consumers were able to choose their electricity supplier freely. I.3.2.3. Access to Electricity Wires To enable the transport of electricity from producers to eligible customers the EU Directive requires the owners and operators of the electricity networks, the transmission and distribution system operators, to provide other with access of their lines. In most countries there are one transmission system operator and several distribution system operators. The Directive provides three alternative methods of achieving this: regulated third party access, negociated third party access or the single buyer model. In fact, all Member States have opted for regulated or negociated third party access (TPA), except Portugal and Italy, that use the single buyer and the regulated third party access for both transmission and distribution system in the case of Portugal and only for the transmission system in the case of Italy. Under the negociated third party access each user of the network negociates the terms of access with the system operator. With the regulated third party access the tariffs are fixed and published by the relevant authorities, and applied to all users of the network. Regulated TPA is the option that most Member States have chosen: only Greece and Germany have opted for the negociated TPA. Access to the transport wires can only be refused when there is not enough capacity to transport the electricity or when transport would make it impossible to carry out public services obligations. There are two distinct entities related with the electricity wires s management: - The transmission system operator (TSO) is the entity responsible for running the high voltage transmission grid, the one to which big electricity producers deliver their production. Imports and exports of electricity also flow via the transmission grid. The 1 According with some statistical data around two thirds of the final cost of electricity is associated with generation, around 4% due to transmission, roughly 25% can be attributed to distribution and between 1% to 7% to supply charges depending on the customer type. Page 19

distribution companies tap from this grid via sub-stations and transformers that lower the voltage level to distribution levels; - Distribution system operators are the entities responsible for running the medium and low voltage distribution lines. Distribution lines are the ones that provide the final consumers (households and business) with electricity. I.3.2.4. Unbundling In Europe the transmission network was largely owned by vertically integrated electricity companies that generate, transport, distribute and sell electricity. These companies own the transmission network infrastructure which, under the new rules, must offer on equal terms to its own company and to its competitors. However, there is in reality a clear risk that such companies will be temped to discriminate in favour of their own group companies when granting access to the network. To prevent this discrimination, the Directive requires Member States to take three basic measures: - Ensuring management unbundling of the transmission system operator; - Ensuring accounting separation of transmission and distribution activities from other parts of the company; - Ensuring that appropriate mechanisms are set up to prevent confidential information being passed by the transmission system operator to other parts of the company. An alternative to the accounting and management unbundling approach of the Directive is to legally separate the transmission system operator from the vertically integrated company. This means that it becomes a separate company, and operates entirely independently from other electricity companies. This approach is the most effective in ensuring that discrimination does not take place and it is the one most used by the Member States. Only Denmark (part East), Germany, France, United Kingdom (Scotland and Northen Ireland) and Austria still have the TSO vertically integrated with electricity companies. Page 20