Member Article

The European Commission's January report on the energy sector competition made uncomfortable reading for the European Union's Council of Energy Ministers, who were presented with it in February and considered its proposals at the EU summit in March.

The clear message from the Commission is gas and electricity is too expensive. It proposes a number of solutions, ranging from a substantial strengthening of the powers of national regulators to changes in the method for allocating interconnector capacity. However, it is the Commission's views on unbundling and vertically integrated energy companies that have caused the biggest controversy.

The Commission rejects as inadequate the independent system operator model, under which networks would be placed in the hands of separate system operators without full ownership bundling. Instead, it favours full ownership unbundling, under which transmission system operators, in whom neither supply nor generation companies could hold a significant stake, would own and operate the networks.

But will the law stop the Commission in its tracks? The possibility of legal challenges to ownership unbundling is not an area that has been considered in any depth, although the Commission does appear conscious that any action it proposes must satisfy the EU principle of "proportionality".

The first legal obstacle to be negotiated involves property laws in individual member states. The German Government has suggested that forced property unbundling might breach the country's constitutional property rights, with a major Germany energy company further signalling that it would amount to an "expropriation" of shareholders' assets.

There is nothing in principle to prevent "expropriation", provided the principles of legality and proportionality are respected. The European Convention on Human Rights provides for the protection of property. Under it , an interface with a property right must be authorised by law (which any unbundling measures would be) and must demonstrate a reasonable degree of proportionality between the means selected and the ends sought.

Were ownership unbundling to be challenged on this basis, the case would ultimately come down to an assessment of "proportionality" and whether the Commission has sufficiently robust arguments to justify its case.

A potentially more significant legal obstacle involves Article 295 of the EC Treaty. This provides that the treaty shall in no way prejudice the rules in member states governing the system of property ownership. Article 295 is unlikely to prevent ownership unbundling outright, but it may prevent the forced privatisation of state-owned electricity assets which full ownership unbundling would involve in certain member states. To that extent, attempts by the Commission to promote ownership unbundling in other member states (where electricity assets are already in private hands) could well be viewed as discriminatory and unlawful because they would lead to an uneven playing field for competing public and private sector operators.

All that said, the greatest hurdle facing the Commission is ensuring sufficient consensus among member states to take forward its suggestions. Ownership unbundling faces one obvious impediment - France. Francois Loos, the country's energy minister, has proposed a model based on the French system of "regulated unbundling", where large energy companies are left in tact but prices for access to energy grids are set by an independent regulator.

The other obvious objector is Germany, which has adopted a more conciliatory stance, no doubt motivated in part by the fact Germany currently holds the EU's six-month presidency. Micheal Glos, Germany's economics minister, considers the first step should be to ensure that the Acceleration Directives are fully implemented. Second, an independent operator could take over management of the distribution networks of integrated energy companies. Only if that fails to ensure competition should ownership unbundling be considered.

Unsurprisingly, France and Germany joined forces to block the ownership unbundling proposal at the last summit, although the wording of the summit's conclusions were surprisingly robust. They spoke of the need to have 'effective separation of supply and production activities from network operations".

The Commission has taken the summit's conclusions as giving it the approval necessary to bring forward legislation later this year. Competition Commissioner Neelie Kroes, as recently as last month, was still (publicly at least) pushing for full ownership unbundling. However, it is likely that the draft legislative package will be softer, providing for the adoption of the independent system operator model. This model may in turn prove to be an interim step for more radical proposals in the future.

Sebastian McMichael is a solicitor specialising in competition law and regulation with commercial law firm Shepherd and Wedderburn LLP. Email: [email protected]