Long-term Contract Regulation in EU Electricity Markets
Loyola de Palacio Series on European Energy Policy
In the old era, European electricity markets were characterized by legal monopolies, geographic demarcation, vertical integration and cooperation both on the supply and demand sides. From the early 1990s onwards, the European Union has pursued a top-down reform process leading to the gradual implementation of a competitive market design within Member States. The new competition model of decentralized markets prescribed electricity generation to be vertically de-integrated as much as possible from retailing and not committed in long-term (supply) contracts with retailers or large consumers in order to allow entry and development of effective competition on wholesale and retail markets. In practice however, long-term contracts remain a pervasive feature of most European electricity markets despite the progress of liberalization which has not succeeded in much changing the traditional sales patterns. The current refining and harmonization of European market designs may be pointless if incumbents continue to use these contracts as devices to control markets. These contracts, indeed, frequently create anti- competitive effects when competition is imperfect and these effects are likely to be worsened in a slowly liberalizing market context where an oligopoly of super-dominant suppliers has been in place for decades. However, there is also growing acceptance that their positive impact on operations and investment makes them desirable as long as effective competition on wholesale and retail markets has not developed. Indeed, the main advantage of long-term contracting for individual firms is to hedge price and quantity risks in their input and output markets and therefore facilitate investment, operation and entry.