Grid locked

Where have the Dutch power merchants gone? Weero Koster reveals all

In the Dutch electricity sector, legal developments are fast and far-reaching. The liberalisation process initiated by the 1996 EU Electricity Directive has come to its final stage. In July, the household segment lost its captive status.

To achieve complete liberalisation of the Dutch power markets, the Dutch parliament hastily adopted the Intervention and Implementation (I&I) Act (June 2004). Initially intended as an intervention device to halt the privatisation drive set out in conjunction with the first stages of liberalisation in 2002, the I&I Act was revamped to implement the Second EU Electricity Directive (2003).

Along with it came a new Dutch policy to unbundle Dutch power distribution grids legally and “up to shareholder level”, coupled with a planned re-evaluation of the possibility of privatisation in 2007. But will these rules create the liquid, efficient and complete Dutch marketplace for power, which is much needed to encourage responsible rather than the indulgent use of power?

Liberalisation has resulted in a demand for privatisation. Dutch utilities are in almost all cases organised as a group of companies, comprising distribution, transmission, supply and trading activities. The shares in these companies are held by local Dutch governments.
These governments have difficulty exercising the degree of effective control over the utilities commensurate with their public function and are wary of the financial risks associated with the liberalised market. At the same time, market entry for new players is difficult as a greenfield operation, leading to demand for shares in the incumbent market utilities.

The link between unbundling and privatisation
The Dutch, though, link privatisation to the unbundling of grids. The discussion on this political linkage started three years ago, when the Dutch Socialist Party filed a motion in parliament which posed stringent conditions on privatisation of electricity grids.

By law, the privatisation of utilities is subject to consent by the Minister of Economic Affairs. Clear language on the criteria to be applied by the minister is not written in the law, however. The Dutch have struggled with this dilemma for years, to the point of detracting from other important elements of market structure.
Finally, in March, the minister published his new policy on the privatisation of energy companies and the management and ownership of the electricity grids. His compromise solution appears to enjoy broad political support. It entails that, as per 1 January 2007, Dutch grid companies will have to be separated entirely from the other group companies, assets and activities – a major deviation from the present situation.

Complete legal unbundling
Under the new policies, the grid company cannot form a part of one group together with production and supply companies. The company designated as the grid manager in accordance with the 1998 Electricity Act (revised by the I&I act) will have to have ownership of the grids (both legal and economic) and will be positioned directly under the public shareholders. The grid company cannot have any ties with the other group companies and must be fully separated up to the shareholder level. Existing group structures will thus have to be changed. In the coming months, the Dutch Ministry of Economic Affairs will draft an action plan on the implementation of the separation.

Privatisation and restructuring
Production, trading and supply activities and assets may be privatised, but only after they have been fully separated from the grids. A decision on privatisation of the grids themselves will not be taken before 1 January 2007.

Even before the privatisation of such assets or of grid companies, however, shareholders may – or may have to – restructure or recapitalise both the grid units and the production, supply and trading companies. Most groups will have their central financial and cash management functions at group holding level, and existing loan covenants will not permit a demerger of a substantial part of the group assets. In that context, the companies may be replacing equity by debt or seeking to divest. Purportedly, a number of institutional investors and banks have shown an interest in such recapitalisation.
However, no material changes (such as a creation of additional security interests) may be put in place until the new policies are on the statute books. That will probably be by the end of this year.

Views on the future
The Dutch government expects that the Dutch energy companies will be taken over by foreign international enterprises which compete in the European market. Given such a process of internationalisation and concentration, the Dutch government is of the opinion that the Dutch market will benefit from truly independent Dutch grids.

The Dutch government acknowledges the importance of sufficient interconnection in order to create one European market with a level playing field. Current cable initiatives to the UK and Norway are generally supported, and the Dutch authorities are in the process of negotiating a memorandum of understanding on interconnectivity rules and procedures with the relevant Belgian and German entities.

Liquid, efficient markets
These initiatives to relieve constraints to entry and expand the geographic market area, together with the unbundling of grids, are likely to benefit the development of a functioning power marketplace. The degree of unbundling is remarkable, however, as it goes far beyond what is required internationally and does not consider alternatives, such as the creation of financial transmission rights to the use of the transmission grid.

It is also doubtful whether they will prove to be enough, because they address some issues related to the supply side of the market and consumer protection, but do not recognise that in these markets the demand side and trading arrangements deserve more attention from the legislature.

More metering and trading
In the transition that the Dutch power market is now going through, the demand side of the market cannot respond to price incentives for the simple reason that most customers do not have hourly metering. This makes demand more unresponsive and inelastic than it needs to be, yielding a great deal of market power to the incumbent suppliers. For that reason, it would have seemed more appropriate to first establish a functioning wholesale market and arrange the infrastructure for retail hourly billing and metering, and only then liberalise the household segment of the market.

Additionally, because power cannot be stored and requires real time coordination between production and transmission systems, the market itself, and thus trading arrangements, need legal attention. Currently, the Dutch power exchange APX and the clearing institute Endex are laudable private initiatives, but remain largely unregulated. General securities laws apply to a very limited extent and APX trades only a day ahead, not in futures. The much larger over-the-counter market is governed only by contract law and is not facilitated by screen trading, such as on the German EEX.

Indulgent use of power?
What is needed is hourly metering and detailed trading arrangements for forward contracts, facilitated by supporting legislation. Without it, the emergence of a liquid, efficient and complete power marketplace will be difficult, and without such a marketplace some players may be enticed into an indulgent rather than a responsible use of power.

Weero Koster is head of Norton Rose’s Amsterdam energy practice