Spain: The Past And Future Of The Spanish Electrical Market

Last Updated: 7 August 2007
Article by Carlos Vázquez

1.- The process of liberalisation of the Spanish Electricity Sector

In the middle of the fifties, the installed electrical power in Spain did not exceed four thousand MW and production was just fourteen-thousand GWh. Since then, the Spanish economy has grown at rates never achieved before. As if governed by the law of physics, this economic growth has inexorably gone hand in hand with an increase in electrical production in such a way that the installed electrical power at the end of 2005 stood at almost eighty-thousand MW and production exceeded 292,000 GWh.

This spectacular change has not just been quantitative. In 1956, almost eighty-five percent of Spanish electrical generation had its origin in hydroelectric plants, "fábricas de luz" or "electricity factories" as they were known, which were used for directly supplying the needs of areas within a certain distance. The development of the sector permitted these utilities to become consolidated, and they grew according to models of vertical integration. The distribution grids expanded and electrical utilities shared out the entire country.

With ups and downs, economic progress and growth in electrical production followed their inexorable course in parallel during the last quarter of the 20th century. The utilities were grouped into a business association, the Spanish National Association of Electricity Industry (UNESA), which, during those years, was something more than a mere representation of employers’ interests. In turn, the need to have new sources of energy, in some cases with a high technological risk, sometimes required public encouragement. For that reason, Endesa was created in order to tackle the use of domestic coal as raw material for electricity generation. The utilities in turn formed themselves into groups in order to undertake the construction and operation of large nuclear power plants.

With the passing of time, the presence of the State became more intense as a result of the need to meet new challenges in the sector, among them the creation of a national transport grid, the overcoming of the oil crisis and the halt called on the construction of nuclear plants. The State asserted its integrating power and set up the Unified Exploitation System for the Electrical Sector: the transmission of electricity became centralised and energy activities started to be paid for on the basis of recognising the costs incurred. The guarantee of the supply and the quality of it constituted the main pillars behind the new system. Parallel with this, a process of combining the different electrical utilities commenced, mainly by means of political encouragement, though there were important exceptions, such as those that led to the creation of Iberdrola or Unión Fenosa.

It was in this context that Spain became a full member of the European Community. Facilitating the aim of a common market required the deregulating of the national electrical sectors. Though the deregulating process had to be carried out, respecting other equally essential Community principles, especially the defence of concepts such as competition, non-discrimination for reasons of nationality and environmental concerns, had to be integrated into each of the sector policies. Following the signing of the Protocol between the Administration and the main energy utilities in the country, signed on December 11, 1996, the existing Electrical Sector Act 54/1997 commenced the deregulation, with the introduction into national laws the provisions contained in European Directive 96/92/EC, dated December 19/1996, concerning common rules for the internal market in electricity.

With this aim, after deregulating the generation and commercialisation activities, which came to be regulated by the principles of objectivity, transparency and free competition, the legislator identified those energy activities which, due to constituting natural monopolies, were not suitable for operating under a market system: transport and distribution. As with other economic fields, however, maintenance of the monopoly in managing the transport and distribution networks required guaranteeing free access to them by third parties, and subjecting the exercise of those regulated activities to the control of an independent body, the Comisión Nacional de Energía (CNE, the National Energy Commission), and to the control of the System Operator, a task which the legislator assigned to the company owning the distribution network, Red Eléctrica Española (REE), though setting down limitations in terms of the control of its share capital, which ensure its shareholding independence.

The process that has been commenced will be completed with the draft bill on reform of the electrical sector, approved by the Government at the end of July 2006, and which is on the point of being passed by Spain’s upper chamber, the Cortes Generales. As a means of transposing European Directive 2003/54/EC, of 26 June 2003, concerning common rules for the internal market in electricity and repealing Directive 96/92/EC, the Act would have an effect on this process when it probes into the demand for the juridical and economic separation of the activities regulated and, finally, imposing the distinction between manager of the distribution network and end supplier at last resort tariff. For that reason, in the future the distributor will no longer deliver electricity to the end consumers but will instead be limited to guaranteeing free access to the network for third parties and continuity of the supply. Nevertheless, further probing into these principles might possibly lead to a consideration of the debate already underway within the European Union on the full separation of this regulating activity from the rest of the activities in the sector. It first has to be confirmed, however, whether it is possible, in a competitive and diversified energy market, to maintain, within a single business grouping, full independence of the decisions of the manager of the distribution networks with respect to the decisions of the producer, the commercialiser or the supplier of last resort.

2.- The Spanish Electricity Market problems

Nevertheless, the deregulating process has not made such clear progress in the implementation of the electrical market. The approach with which the creation of that market was tackled in Spain was essentially correct; since replacing a unified operating system with recognised costs could only be based on a wide-ranging pact with the sector, as was the Protocol signed in 1996 which permitted certain Competition Transition Costs to be attributed to the electrical utilities. Moreover, it is also true that the technical and legal work developed since then by the CNE, the Electricity Market Operator (OMEL) and the Electricity System Operator (REE) has been praiseworthy. It is no less true, however, that the wholesale market for electricity, which was the product of the circumstances of the time and place, was born with important limitations, since, although adequate instruments were created for carrying out the exchanges, it was not clear from the beginning who were going to be the leading players in the market, nor what the real price of the transactions was going to be.

Of course, in relation to the first question, we are not referring to who the agents were going to be and who could act in the electricity market, (which the new regulation specified with absolute clarity: producers, commercialisers, distributors, outside agents), but rather, whether it was possible or advisable to maintain the initial business status quo in the new electrical market. As is logical, the first attempts which pointed to the change in that status came from the interested parties themselves, but the criteria established by the competent authority, with respect to applying the rules of competition, on the one hand, and the protection of the regulated activities, on the other, prevented any culmination of the business concentration operations that were originally planned (take-over bid by ENDESA of Iberdrola and by Gas Natural of Iberdrola). The recent take-over bid on ENDESA, initially launched by Gas Natural, and after that by E.On and finally by Acciona and Enel, has highlighted the complexity of this question and has opened up the debate, not just in Spain but also in the whole of Europe, on the real degree of openness of the electrical markets and the compatibility with the Treaty of the European Union of certain national regulations which have the aim of guaranteeing particular strategic national interests (as in the case of Royal Decree Act 4/2006) in the electrical sector.  

Along with this question, another question has been asked since the beginning of the deregulation process, which while less talked about, is equally as important. This question concerns the real functioning of the electrical market and the price of the transactions carried out within it.

The initial restrictions of the functioning electricity generation market (the "pool") in terms of price determination, aside from those originated for exclusively physical reasons owing to the scarcity of existing international interconnections, where established with the purpose of protecting business interests (recognizing to the companies the competition transition costs –"CTCs"-) as well as those of consumers (maintaining a public tariff), both equally respectable. In this regard, it seemed obvious to everyone at the time that in a competitive market, companies would not have the opportunity to recover certain costs which required the recognition and recovery of the CTCs. It seemed equally logical that, even in a deregulated market, the single setting of the prices of an essential service would not be left in private hands: a service which until recently, had been considered to be a public service.

In spite of this initial good faith, administrative restrictions on markets are usually harmful in the medium and long term. Indeed, if the CTC initially implied a barrier for the appearance of new competitors (since their recovery acted as an incentive to keep prices artificially low), the existence of an electricity tariff has led to the commercialisers being expelled from the retail market since they cannot compete with regulated prices when, as is currently occurring, the size of that tariff is not enough to meet production costs. It is also evident that, while there exists a general tariff, no consumer is going to find any incentive in bilateral contracts or medium term contracts (within the framework of the Iberian Market for Electricity, MIBEL, now in operation) in order to cover themselves against the swings of the daily generation market, since there are no better guarantee against such risk than the official tariff approved by the Government.

However, it could be said that the worst problem with which we are faced is what is known as the ‘tariff deficit’ (that happens when the tariff does not cover all the electricity generation costs), which is currently at the point of reaching the considerable sum of six-billion Euros. Present legislation does not state who has to take on the economic risk of production costs of electricity when the supply is made at regulated tariff. The reason was that the Electrical Sector Act started from the assumption of the existence of a tariff surplus, which would permit the CTC to be recovered from the difference existing between the initial estimated tariff and the generation cost at that moment. Consequently, the distributor, (the present supplier at tariff), is limited to allocating the cost of the electricity he delivers to the end consumer to the liquidation mechanism, and it is not established what happens when the price of the pool rises an the tariff cannot cover that cost and, in general, who has to support this difference.

3.- Solutions adopted or in process to resolve the problems of the Spanish Electricity Market

As the deficit was a reality, Royal Decree-Act 5/2005 identified the companies which have to finance it. There could be no requirement to support the deficit, since it is evident that in a state governed by Rule of Law, one cannot demand, not even by virtue of a regulation having the rank of an Act, that certain individually designated companies have to meet a particular pecuniary obligation, unless it is a tax or a penalty, without proper compensation. In 2005, this was organised by acknowledging the right to recover the financing of that deficit charged to future tariffs. As the problem remained unsolved, however, Royal Decree-Act 3/2006 introduced two measures in an attempt to halt the economic draining that was taking place:

  1. The discount from the price of the pool of the cost of the freely attributed emission rights; and
  2. The introduction of a regulated price for transactions corresponding to sales by the producer to the distributor in a single business group.

When, after a certain length of time, the legal measures adopted ceased to have any effect, the true nature of the problem became obvious: it was the apparent incompatibility between the development of an electrical market and the permanence of a regulated tariff. The fact is that the consumer, as demander, feels comfortable with that tariff, since it protects him from a market with few and powerful providers. It is difficult to imagine that we are talking about a market where there are no intervened prices, but rather, one that the consumers receive no signal about, but which is tied to the repercussions of the cost of the product on the prices they are paying. For that reason, the new European Directive (2003/54/EC) limits the regulation of prices of the universal service, which have to be reasonable, comparable and transparent, to the "last resort tariff." The Spanish legislator sought to delay the application of that rule since the draft bill approved by the Government establishes the date of 1 January 2011 as the moment in which the tariffs for high tension supply should disappear. Nevertheless, the pressure resulting from the infringement proceedings instigated by the European Commission on presumed State aid deriving from that regulation has forced the disappearance of high tension supply tariffs to be brought forward to 1 January 2009.

Together with the final opening of the market, by means of the removal of the high tension tariffs, the Government is facing up to resolve the tariff deficit encouraging the signing of bilateral contracts for the supply of that electricity prior to the holding of auctions. So, instead of being passed on to the tariff as is currently happening, the risk associated with those purchases will be borne by the parties to said bilateral agreements, who will be able to manage the risks both in the spot (OMIE) and future (OMIP) markets. This new regulation will not just help the solvency of the tariff, it will also promote competition on the market; eliminate discrimination with the commercialisers on the free market; and will improve price determination.

The Spanish electrical market must nevertheless overcome one final challenge which derives from the application of environmental principles presiding over Community policy. The recent passing of Royal Decree 661/2007, relating to the promotion of renewable energies, has to provide the stability that the sector has been demanding It also needs to combine the need for new energies, such as solar and biomass, with those already firmly established, such as wind., The full integration of the environment into the definition of energy policy must not, however, signify that certain rebuffs from the media towards the use of particular sources of energy ought to be maintained indefinitely. If, in the end, consumers have to pay the price of the energy, then it is not fair that political decisions dictate their being unable to make use of other forms of energy such as nuclear which could turn out to be more efficient and effective for fighting against the primary environmental problem of our century. That is, the emission of greenhouse gases.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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