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Liberalization of energy markets

The electricity market with free competition, as we know it today, is still very young and under development. Three decades ago, the European electricity sector was a monopoly. Vertically integrated companies were responsible for generation, transmission and supply of electricity. In the absence of competition, these companies were able to determine electricity prices. Since those companies also hold the grid infrastructure, market access of new players was impossible.

In 1996 the European Union started to gradually open the market for competition – to liberalize the energy market just like it did before with several other sectors. The aim was and is to create one single integrated internal European electricity market across all EU member states to reduce overall grid costs and benefit from synergies in the security of supply.

A key step in this process was and is the unbundling of the European power sector with the aim to split up the generation, transmission, distribution and delivery activities. As a result of the unbundling process, the vertically integrated companies can no longer both generate, trade and supply electricity while managing the transmission and distribution networks.
This unbundling didn’t happen overnight. In the first energy package in 1996, only accounting unbundling was required. It demanded the vertically integrated companies to split up the bookkeeping according to the different activities. This was clearly not sufficient enough to create a competitive market.
In the second directive, introduced in 2003, legal unbundling was demanded. It meant that a single company was allowed to operate in only one of the activities of the electricity value chain: either production, transmission, distribution or supply. It also demanded that by 2007 all European customers should have the ability to choose their supplier. But because the different companies still could be part of the same holding, the owners of those companies still had quite some market power.
In the third energy package, which came into force in September 2009, the next step towards free competition was made by introducing ownership unbundling. This package is followed by the Energy Union Winter Package in 2016/17, which strives to achieve a fully-integrated, further decarbonized electricity market and ensures security of supply through solidarity and cooperation between EU member states.

The current situation

In an ideal situation, both the production and supply are fully competitive activities. It means that none of the companies in the generation activities can influence electricity prices on the wholesale market by using their market power. This should eventually lead to lower prices for the consumer. Also in the retail market, where the suppliers sell electricity contracts to the end-user, free competition is in the benefit of the consumer. Households now have the choice to pick the supplier that offers them the best tariff and service.

In reality, a perfect competition seldom exists. Especially in industries with large capital investments and large infrastructure, the activities are typically in the hands of a few large companies. For the energy economy, national regulating institutions monitor abuse of market power and quantize the level of free competition with the so-called concentration ratio CR3. An analysis by ACER, the Agency for the Cooperation of Energy Regulators in Europe, revealed that the level of market concentration in Italy is still very high, with Enel being the main supplier with a market share of more than 80% in household’s electricity supply.

Infrastructure as a limiting factor

The infrastructure of the grid creates a natural monopoly. It would be almost impossible to build a second grid, since the construction of such a large infrastructure would require a high level of investment and extensive permits.

In order to ensure a reliable operation of the grid and to avoid market power abuse, not only the ownership is unbundled. In addition, the natural monopoly is regulated by an independent regulator. It monitors, for example, the access tariffs that the TSOs and DSOs charge to producers, who wish to connect their plant to the electricity grid.

In Italy the transmission system operator (TSO) is Terna. Whereas the transmission network is operated by only one company, the distribution grid is split up in several geographical areas. The most important example of the overall 135 Italian distribution system operators (DSO) is Enel Distributione S.p.A, which covers over 80% of the Italian electricity demand. The most important local operators are A2A, ACEA, IRIDE, DEVAL and HERA. The national regulator for both electricity and gas markets in Italy is AEGGSI (Autorità per l’energia elettrica, gas e il Sistema idrico). They guarantee transparency and competitiveness of the energy market, defend consumers’ interests and advice authorities on energy issues.