G LOBAL U TILITIES C ENTER D ÜSSELDORF GERMANY Will Ownership Unbundling deliver? Executive Summary!@#
Ernst & Young s New Study on EU Energy Market Restructuring Ernst and Young is about to release a new report on the impact of unbundling on European utilities. It examines the implications for different markets and the strategic options which companies now face. Below is a summary of the report s contents and conclusions. For a copy of the full report please get in touch with Helmut Edelmann on helmut.edelmann@de.ey.com or call your usual Ernst & Young contact. Unbundling Study 2007: Executive Summary Introduction European countries may acknowledge the value of cooperation, but they tend to resist conformity. The utilities sector is a perfect example of this tension: there s a massive diversity from country to country in terms of openness, competition, regulation, and ownership across the industry. The challenge on the European Union s (EU) hands is creating a level playing field for competition in the face of such diversity. If they cannot find a way to do this, the stated aim of the European Commission (EC) to open up Europe s gas and electricity markets to competition and to create a single European energy market, 1 could very well be in jeopardy. There are clearly two camps with clearly opposing views, one on either side of the EU s new proposals to deliver a single European energy market. Those in favor which tend to be the countries around the edge of Europe have largely fulfilled ownership unbundling and many, with the exception of the UK, have an industry which is still driven by state-owned utilities. The other camp the opponents if you like encompasses the countries in the middle of the European continent, where the markets tend to be dominated by vertically integrated transmission companies, in many cases privately-owned. The countries in favor and their utilities are likely to be seen as the winners at the end of this process. Depending on who you talk to, the proposed unbundling reforms may or may not solve the problems of conflict of interest. Opinion among EU Member States remains divided, with France and Germany strongly resistant, whilst Spain, Sweden, and the UK are in favor. What is clear is that unbundling would certainly have serious consequences for the ownership, structure, and management of the present vertically integrated utilities (VIUs), and for the utilities sector as a whole. 1 Sector Inquiry 10 January 2007 2
Impacts on Companies So what has been the impact of the EC s various competition enhancing mechanisms on utilities management so far? Where liberalization has been fully implemented, it has often been followed by reconsolidation as the remaining large vertically integrated industries purchase the smaller companies in the liberalized markets. There has also been a tendency for gas and electricity companies to merge or to be acquired. This has resulted in a complex structure to the industry in Europe with a disparate population of companies of different sizes, functions, and geographical scope (as shown in the figure below). REGULATED NON-REGULATED Regulated wires/pipes (regulated transmission & distribution with some non-regulated activities) Regulated integrated (regulated generation, wires & supply with some non-regulated activities) Integrated transmission & distribution (generation & supply non-regulated) Integrated distribution (generation & supply non-regulated) Non-regulated business Integrated electricity and gas players National Grid EnBW, E.ON, RWE Iberdrola, Essent, Nuon Centrica Electricity players Red Electrica, Terna EDP, PPC, UESR EDF, Verbund, Vattenfall Endesa, Enel, CEZ, Fortum Atel, Suez 2, Statkraft Gas players SNAM Rete Gas GDF ENI The EC s proposed third round of legislation will affect all these organizations differently. Specialist grid companies such as National Grid (NG) in the UK are likely to be interested in acquiring transmission assets or possibly in Independent System Operator (ISO) management contracts. The nature of the market for the competitive businesses will also change; ownership unbundling would bring non-discriminatory access to the grid for competing generation companies, with the result that sales, margins, and service standards will be challenged by new entrants. For VIUs involved in the transmission business, ownership unbundling presents three critical decisions: 1) Should they dispose of the network? 2) If so, how should this be done? 3) When is the right time to do it? 2 Only very little gas activities in Belgium Essentially, there are two unbundling options: either create two or more separate companies by splitting the shares, or dispose of the transmission asset to a third party. In the case of disposal, there will be a choice over how much cash to retain in the company, and how much to distribute to shareholders. The generating supply remainder of the VIU can use this cash for new investment. Management is likely to prefer this option. The next choice is how quickly to dispose of the network. There are different forces that might cause management to accelerate or delay disposal. Early disposal gives the company first mover advantages in the acquisition of new assets elsewhere. It is also likely that grids will depreciate as more become available and as their strategic value disappears, so early disposal may be advisable. There are also some disadvantages, but in the case of obligatory ownership unbundling these disadvantages will materialize in any case. The advantages of early disposal may therefore prevail. 3
In the case of an ISO, the choice is in two stages. The first choice is whether to adopt the ISO model or to go for full ownership unbundling. Assuming that disposal is the preferred option for ownership unbundling, similar considerations will govern the choice. Disposal will simplify the business, reduce regulator involvement, give first mover advantages, and relieve the company of a depreciating asset. The ISO model will diversify the business and reduce risk, but introduce contractual and regulatory complexity. From an accounting and financial communication perspective, it should also be noted that the ISO model will generate complex questions. Even if the VIU still legally owns the network, will it still be possible to consolidate the assets (under IFRS or US GAAP for example) since the VIU will actually have no control over them? The ISO model option could have tremendous impacts on the balance sheet and profit and loss of the VIUs. European Strategy Unbundling and the release of cash for acquisitions, combined with possible resistance from competition authorities to increased presence in domestic markets, may strengthen the existing trends towards globalization. A radical change in unbundling requirements will have different impacts across Europe, depending on the existing market practice. Companies will need to develop different strategies to manage that change: those who react quickly and effectively will gain advantage. The harmonization of legal requirements across networks in Europe will simplify business models for pan-european utilities. However, sharper regulatory monitoring of unbundling requirements means companies will need to audit their current unbundling status rigorously. Compliance risk A third round of EU regulation with deeper unbundling, tighter regulation, and more challenging criteria for cross-border cooperation will increase pressures to comply and to demonstrate compliance. Even for ownership unbundling, the fulfilment of legal requirements has to be monitored by regulatory authorities. The EC therefore intends to introduce binding guidelines for transparency, and to convert the European Regulators Group for Electricity and Gas (ERGEG) to a body with statutory authority, known as ERGEG+. ERGEG has prepared draft guidelines, but it has no legal authority. There are also country-specific guidelines for example, Germany s state regulatory authorities and federal states have common guidelines to implement informational unbundling in respect of the new energy law. To minimize compliance risk, it would be wise for utilities to be able to demonstrate that they fulfil the current unbundling requirements in each European market. This might best be done via a neutral, external auditor. Such a body could bring a useful new perspective to bear on internal discussions around how to fulfill the compliance requirements. It is also likely that the assessment of an external auditor would be more credible with third parties. By engaging a neutral, external institution, the utility would demonstrate full openness and its commitment to compliance with the current unbundling legislation. An external body can achieve easier implementation from its knowledge and insight of practice and benchmarks all over Europe; it can also adopt a neutral position regarding internal conflicts. An external assessment will also minimize personal risks for the people responsible for implementing an unbundling compliance program, since they would not be forced into possible conflict with their co-workers. 4
Will Ownership Unbundling Deliver a Single European Market? The impact of ownership unbundling is limited. Ownership unbundling is just one of the steps necessary to improve competition and ultimately establish a single European energy market. To achieve the full effect, we need the right mix of unbundling, regulation, and cooperation between transmission companies, as well as harmonized implementation of the EU Directives, clear criteria for independence, common rules for privately-owned and state-owned utilities, and common rules for monitoring unbundling requirements. Topics Covered in the Full Unbundling Study Ernst & Young s new study on the impact of energy market restructuring explores the issues and forces at work, and aims to support your thinking about how to handle the impact of change on your business. We investigate: The development of unbundling and its current status in Europe The role of unbundling within utilities and in the wider context of energy policy How the EC proposes to use unbundling to achieve a better integrated, more competitive European energy market How utilities can manage these changes to their advantage. We would welcome contributions to further debate about the issues discussed here. Please contact Helmut Edelmann at: Ernst & Young, Global Utilities Center, Graf-Adolf-Platz 15, 40213 Düsseldorf, Germany. Tel: +49 211 9352 11476. helmut.edelmann@de.ey.com Alternatively, you can obtain copies of the study from your normal Ernst & Young contact (see next page). 5
Ernst & Young Contacts GLOBAL Ben van Gils Global Utilities Leader Global Utilities Center, Düsseldorf, Germany Direct tel: +49 211 9352 21557 ben.van.gils@nl.ey.com AUSTRIA Elfriede Baumann Vienna, Austria Direct tel: +43 1 211 70 1141 elfriede.baumann@at.ey.com Heidemarie Kretschmer Vienna, Austria Direct tel: +43 1 211 70 1180 heidemarie.kretschmer@at.ey.com BALTICS Jonas Akelis Vilnius, Lithuania Direct tel: +370 5 2742 200 jonas.akelis@lt.ey.com BELGIUM Vincent Etienne Brussels, Belgium Direct tel: +32 2 774 9554 vincent.etienne@be.ey.com CZECH REPUBLIC Josef Pivonka Prague, Czech Republic Direct tel: +420 225 335 603 josef.pivonka@cz.ey.com Ludek Jirecek Prague, Czech Republic Direct tel: +420 225 335 480 ludek.jirecek@cz.ey.com GERMANY Gerd Lützeler Düsseldorf, Germany Direct tel: +49 211 9352 18614 gerd.luetzeler@de.ey.com Dr. Helmut Edelmann Global Utilities Center Düsseldorf, Germany Direct tel: +49 211 9352 11476 helmut.edelmann@de.ey.com GREECE, ROMANIA, BULGARIA, TURKEY Vassilios Kaminaris Athens, Greece Direct tel: +30 210 2886235 vassilios.kaminaris@gr.ey.com Yolanda Sánchez Martín Athens, Greece Direct tel: +30 210 2886454 yolanda.sanchez-martin@gr.ey.com HUNGARY Istvan Havas Budapest, Hungary Direct tel: +36 1 451 8701 istvan.havas@hu.ey.com Zoltan Tremmel Budapest, Hungary Direct tel: +36 1 451 8138 zoltan.tremmel@hu.ey.com ITALY Dr. Massimo Delli Paoli Rome, Italy Direct tel: +39 0667 535 752 massimo.delli-paoli@it.ey.com NETHERLANDS Klaas-Jan Schoppink The Hague, Netherlands Direct tel: +31 70 328 6782 klaas-jan.schoppink@nl.ey.com NORDICS John Avaldsnes Stavanger, Norway Direct tel: +47 517 06 740 john.avaldsnes@no.ey.com Kim Richter Stavanger, Norway Direct tel: +47 982 06 674 kim.richter@no.ey.com POLAND Piotr Piela Warsaw, Poland Direct tel: +48 22 557 75 80 piotr.piela@pl.ey.com Jaroslaw Wajer Warsaw, Poland Direct tel: +48 22 557 71 63 jaroslaw.wajer@pl.ey.com SPAIN Juan María Román Gonçalves Bilbao, Spain Direct tel: +34 944 356495 juanmaria.romangoncalves@es.ey.com David España Martín Bilbao, Spain Direct tel: +34 944 243777 david.espanamartin@es.ey.com SWITZERLAND Alessandro Miolo Zurich, Switzerland Direct tel: + 41 58 286 46 54 alessandro.miolo@ch.ey.com Thomas Lüthi Zurich, Switzerland Direct tel: + 41 58 286 30 41 thomas.luethi@ch.ey.com RUSSIA Dmitry Lobachev Moscow, Russia Direct tel: +7 495 228 3677 dmitry.lobachev@ru.ey.com Vladimir Merkushev Moscow, Russia Direct tel: +7 495 755 9881 vladimir.merkushev@ru.ey.com UK Jon Hughes London, UK Direct tel: +44 7899 064320 jhughes4@uk.ey.com Bill Easton London, UK Direct tel: +44 20 7951 5463 beaston@uk.ey.com FRANCE Isabelle Triquéra Paris, France Direct tel: +33 1 46 93 84 87 isabelle.triquera@fr.ey.com Ing. Diego Massari Rome, Italy Direct tel: +39 0667 535 653 diego.massari@it.ey.com 6
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