The European Parliament recently voted on the so-called “Third Energy Package” following a first reading of the proposed Directives relating to electricity and natural gas on 18 June and 9 July respectively. By an overwhelming majority, the Parliament rejected the independent system operator (ISO) compromise and their proposed amendment to the draft Directive provided for full ownership unbundling as the only option available.

In relation to gas, the Parliament rejected the ISO but endorsed an Independent Transmission System Operator (ITO) model, which would allow gas supply companies to retain ownership of the pipelines but transfer management of the system to an independent body.

The European Commission's orginal proposals on unbundling were heavily influenced by the results of DG Comp Sectoral Inquiry, which found a worrying level of market concentration, poor integration between markets and barriers to entry for new entrants caused by vertical foreclosure. The report concluded that full ownership unbundling would be the most effective model in helping to address the deficiencies highlighted.

Several European countries resisted the full ownership unbundling model advocated by the Commission and the Parliament. The most notable opponents include France and Germany, whose markets are dominated by powerful vertically-integrated incumbent energy companies. Facing the possibility of a veto, the Commission attempted a compromise model as an alternative choice to full ownership unbundling- the Independent System Operator, which would allow assets to be retained by the energy companies but transfer operation of the network to an entirely independent company. The ISO would also have the power to make investment decisions in relation to the network. This is designed to ensure that the networks will be operated independently rather than working in favour of the vertically integrated energy companies and creating barriers to entry by third parties.

Even this compromise has met opposition. France and Germany have raised concerns regarding the powers that the independent companies would have in relation to the development and maintenance of the network. They have tabled a proposed “third option”- the ITO, which would allow the assets to stay where they are but would transfer the management to an independent body, whose membership would include a trustee appointed by the regulatory authority but whose role would be to act in the interests of the owner company in relation to preserving the value of the assets.

Whether there would be any appreciable difference in practice between the ISO and ITO options remains to be seen but, curiously, as noted above, the Parliament has supported this “third option” in relation to gas while rejecting the ISO model. In relation to electricity however the Parliament remains firm in their convictions, having rejected anything short of full ownership unbundling. It would seem in that regard, the Parliament’s current position is irreconcilable to that of France and Germany.

The draft Directives will now go to the European Council for a first reading. It seems unlikely that the Council will support the Parliament’s stance in relation to electricity given the powerful opposition that full ownership unbundling faces. Germany and France could exercise their veto should the Council chose to back the parliament’s proposed amendments - both countries claim that full ownership unbundling is contrary to their national Constitutions and they are unlikely to accept full ownership unbundling, even if the majority of the Council do. The real questions are: will the ISO model be the one that is supported or will the new ITO model be accepted in its place? And will either of these models be sufficient to address the continuing problem of vertical foreclosure?

Lesley Gray is a solicitor in the Energy and Utilties Group at leading UK law firm Shepherd and Wedderburn.

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