European energy: united or fragmented?

Conventional wisdom suggests that the market’s trading requirements could be satisfied by just three trading hubs, located in the UK, Scandinavia and mainland Europe, as these hubs would correlate with the three main inter-linked transmission grids in Europe.

The central driving force of the European Union is a united states of Europe, a consolidated market infrastructure derived from shared policies. This consolidated approach to government extends to the EU markets in gas and electricity, which is being both catalysed and facilitated by the recent directives on electricity (February 1999) and gas (August 2000) competition. But these directives, which the EU now wants to merge in recognition of the growing convergence between gas and electricity, are having polar impacts on the market.

Through increased competition – over 60 per cent in electricity and around 40 per cent in gas – utilities are looking to mergers and acquisitions to maintain economies of scale as prices, and as a consequence, margins fall. The result is the gradual creation of super-utilities with RWE, E.ON, Electricité de France and Endesa (if its acquisition of Iberdrola is approved by regulators) leading the way. But competition is also having an impact on trading, which has undergone significant change in the past decade. Increased market competition has lead to increased price and market risk, focusing attention on new trading opportunities, which are being facilitated by the new technology of the Internet.

While the number of gas and electricity utilities are falling the number of trading platforms is increasing, with consolidation at one end of the market and fragmentation at the other. Before the recent restructuring of the European gas and electricity markets the entire European energy market was served by just one exchange – London’s International Petroleum Exchange. Now, as the first year of the new millennium draws to a close the European energy market has seven ‘energy exchanges’. And by the end of next year this number could more than double. Not surprisingly all these new platforms are Internet-based.

The short-term view is of a market rapidly fragmenting with new e-commerce platforms – trading, brokering and procurement. But while the ‘service’ side of the market fragments the underlying utility market continues to consolidate. At some juncture the proliferation of platforms will lose its economic value and consolidation will take hold, suggesting a medium-term view of exchange consolidation, but how far will this consolidation go, and which platforms will be successful? Two scenarios can be considered when addressing this question. The first concerns the value of exporting US-developed platforms into the European market, and the second, the value of developing platforms specifically for the European energy market.

If we accept the view that the energy market will eventually be served by a small number of global platforms then there is a strong case for US platforms being dominant in Europe as the genesis of e-trading has been in the US. But we also have to accept that there has been no historical precedent of technology being successfully exported to other markets. Nord Pool, for example, was unable to re-create its successful Scandinavian power platform in California. This argument suggests that a global market platform can only be successful if it is conceived and developed as a global platform. This implies that the IntercontinentalExchange, which has been conceived as a global platform, will be successful in Europe. But other US-developed platforms seeking to export into Europe, such as Houston Street Exchange which recently entered the German market, will not.

The alternative of importing non-European platforms is to develop new platforms specifically for the European market. This approach is behind the fragmentation endemic in the market, as each EU member country believes it can host the best exchange for both its domestic market and for the EU. At the current rate of development Europe will be served by five UK-based exchanges, two in Germany, and one each in Scandinavia, France, Austria, Netherlands and Poland with the prospects of at least one other in Spain. In addition to these the European market will be served by up to four US-based platforms seeking to provide global trading solutions. Clearly the European market cannot support all of these platforms.

This train of thought leads us to discuss market saturation. How many platforms will be sufficient for the trading requirements of the European energy market? The fragmentation of exchange platforms is unlikely to continue beyond the end of 2001. By this time the dynamics of consolidation will have started to impact on the underlying utility sector, creating an imbalance between utilities and service platforms. At this juncture the exchange platforms will consolidate, but as to the final European structure there are many possibilities.

Conventional wisdom suggests that the market’s trading requirements could be satisfied by just three trading hubs, located in the UK, Scandinavia and mainland Europe, as these hubs would correlate with the three main inter-linked transmission grids in Europe. As all hubs would be Internet based they would be linked electronically, affording pan-European trading. It would also be feasible to have a series of exchange spokes – niche regional exchange platforms – feeding into the hubs. But which existing, and proposed, exchange platforms would form the hubs? The final outcome of the European energy trading structure is far from certain. What is certain is that the market will consolidate and converge with the Internet facilitating the multi-vertical trading platforms for the evolving market. It is also fairly certain that the successful trading platforms will originate and be developed for the European market. With the possible exception of IntercontinentalExchange it is unlikely that US-developed platforms will replicate their success in Europe.