The energy year just ending will be rightly remembered as an oil year, not just for the record high crude oil and products prices but also for the strong influence exercised by the oil market throughout the entire energy complex. At a time when governments and regulators are striving for increased market deregulation and competition it is becoming apparent that these deregulating markets will always default back to oil. Gas prices closely followed those of oil, which in turn provided direction for electricity and coal prices. In short, oil has been a proxy market for the entire energy complex, regardless of whether it is deregulated or not.

For those who believed 2004 would be the year when the energy market finally shook off the Enron shackles and moved forward purposefully into a bright new era then, unfortunately, they will be disappointed. But in truth there were few optimists twelve months ago. The same hopes and promises for a bright new era the previous year had not been realised so why should this year be any different? And indeed are there any grounds for optimism in the year to come?

From a European power trading perspective the year has been poor. Hopes that market liquidity would improve with greater market confidence and participation were quashed. Indeed far from improving, market liquidity in the electricity sector has regressed, but we should not be too surprised. With further mergers and acquisitions through the year the number of physical participants has reduced and the level of vertical integration has increased. Such a market structure is less conducive to trading as the supply and generation businesses within the vertically integrated operation can be mutually offset.

It is difficult to see what, if any, benefit the second EU directive on competition has had. Although the directive mandated for full competition in gas and electricity markets at the wholesale level from July it has led to few competition improvements, particularly with respect to Europe’s gas markets. Arguably the only change, from a trading perspective, from last year is with regard to new trading platforms and the route to market, with a greater volume of trade transacted electronically compared to the previous year. On trading platforms, Italy finally introduced its power exchange in April (although it will not open to all market participants until 2005) and London’s International Petroleum Exchange introduced new UK electricity futures contract in September. Amsterdam’s APX Group integrated its acquired businesses – UK Power Exchange and APX (UK) – into a ‘new’ UKPX with ‘new’ forwards contracts replacing the futures, while France’s Powernext added futures contracts to its spot contracts.

November marked the end of the incumbent European Commission’s five-year term and if the July mandate was meant to signal the realisation of its five-year plan for an internal European energy market then regrettably these objectives have not been realised. Since the first electricity directive in February 1999 there has been palpably little real progress when measured against the directive objectives. In Europe’s two main energy markets, Germany has yet to introduce a regulator (delayed until next year) and France has yet to privatise its state-owned gas and electricity behemoths. The resilience to change in both these markets was notable, with disagreements between the German economy and environment ministries delaying the energy regulator, while a series of union strikes in France directed at the government privatisation plans for EdF and GdF led to strong concessions from the government. Elsewhere in Europe the planned single Iberian market (MIBEL) was also delayed for the second time, now until June 2005, as the Portuguese and Spanish governments failed to reach agreement before the planned market openings in the spring and then autumn.

For the new EU energy commissioner the challenges are obvious but the route to be taken less so. The apparent disregard for directives, and the inability of the previous Commission to enforce them, may suggest further progress toward an internal market is severely limited and that current market competition may be as good as it gets. The planned EU benchmarking report in 2005 may well confirm this view.

Further challenges for the new Commission will be presented by emission reduction. The timetable for approving and harmonising national allocation plans ahead of the 1 January start date of the EU Emission Trading Scheme (ETS) slipped badly during 2004 and the expected value of the first phase of the scheme (from 2005-07) has consequently receded. For the Commission, its internal energy market and ETS were planned as role models for other economies, but while Europe is arguably more advanced than other geographic regions with regard to energy market deregulation and emission reduction schemes the models on which they are based are not yet proven, and still may not be in twelve months time. But with the Kyoto Protocol being formally activated in February the EU ETS has to prove the viability of cap-and-trade schemes before the first Kyoto compliance period commences in 2008.

The counterbalance to emission reduction and environmental sustainability is supply security and the economy. Europe, through its various policy initiatives – i.e. the large combustion plant directive and the phasing out of nuclear plant in many Member States, tended to focus this year more on the environment, with the emission reduction burden placed on the power sector. Other regional economies placed a greater emphasis on supply security and the economy with some, such as the US, using this as justification for not ratifying Kyoto.

With renewable energy technologies as yet unproven there is no real equilibrium between the environment and supply security/economy – one has to take primacy over the other. And this relationship is likely to be one of key factors in the energy market’s development and prosperity in the coming twelve months. The other of course will be oil.