MONDAY 23 JULY 2007

Mr David Halldearn

  Chairman: Thank you very much indeed for coming at short notice. We are going to focus on energy regulation. I will just ask my colleagues on the Sub-Committee to briefly introduce themselves.

  Lord St John of Bletso: Anthony St John, Crossbench member of the House of Lords.

  Lord Powell of Bayswater: Charles Powell, Crossbench member of the House of Lords.

  Lord Haskel: Simon Haskel, Labour member of the House of Lords.

  Lord Whitty: Larry Whitty, Labour member of the House of Lords.

  Baroness Eccles of Moulton: Diana Eccles, member of the House of Lords sitting on the Conservative benches.

  Q232  Chairman: Is there anything that you would like to say by way of introduction?

  Mr Halldearn: Very, very briefly, if I may. First of all I ought to perhaps introduce myself. I am David Halldearn from ERGEG but I work at Ofgem, the British regulator, and I sit for the UK on ERGEG and also on the Council of European Energy Regulators as the representative of the UK. The things I will be saying probably fall into three high level areas. First of all, I want to say that for energy the way events are unfolding demonstrates that we are moving from a world where relying on national policies to provide for security of supply and competition is giving way to more emphasis on pan-European approaches being needed. The second point is that we really need to have the pan-European framework of regulation so that we can meet the needs for this European energy policy that the world is pushing towards us. The third point I will be making is if we are to achieve that there is a rather large mountain to climb for the politicians and a huge amount of political will is needed to fulfil those ambitions.

  Chairman: We are going to start with Lady Eccles.

  Q233  Baroness Eccles of Moulton: Thank you very much. My questions very much focus on exactly what you have just been saying. The EU is going to become increasingly dependent on fossil energy supplies coming from the east, from Russia. At the moment, before unbundling becomes properly accepted, it is very difficult to control cross-border transmission from the east, so assuming that unbundling does take place and, therefore, transmission can be treated as a separate entity, as it were, would you think that there is much chance of the national governments, both from an economic and political point of view, becoming totally EU minded and allowing their systems of transmission to be used equally by both their own country and the countries to which the supply will be passing through, for instance Germany to Portugal? Or do you think that it is not going to be possible for the national regulators to achieve this and, therefore, exceptionally this could be a case for a more centralised form of regulation? I say that with great hesitation personally, not being a believer in central regulation.

  Mr Halldearn: Maybe I could start with the world as it is today where already, particularly in gas, we see transports of gas in sequence through national transmission networks through Poland, through Germany, through France, and normally those transports happen without incident. The work that we have been doing in Europe up to now has very much been focused on trying to ensure that we get greater visibility of how this process works so that we can ensure that looking forward the networks are up to the challenge the future brings. Of course, we have seen incidents where networks have been used to curtail supplies and that, I think, has been rather a new feature. From the regulatory perspective, regulators can play a role in ensuring that the day-to-day operations of networks are undertaken so that there is sufficient capacity, sufficient transparency and proper new investment, although I will go on to talk about the additional tools that regulators will need to ensure that happens on a pan-European basis. Of course, what regulators cannot do is ensure that the change of mind happens, the cultural shift happens, so that individual Member State governments recognise that security of supply, particularly in gas, is moving from what essentially has been historically more of a national responsibility to something that is really more a pan-European challenge. I am not sure we are quite there yet from my observation. Clearly that goes beyond the remit of regulators.

  Q234  Lord St John of Bletso: If I could just get on to the issue of regulation. Clearly a hallmark of the success of the Single Market is going to be effective partnerships and more transparency between the Member States, but in our previous meeting they were talking about the importance of strong and independent regulators. Could you elaborate on the communication between the various regulators and where you think there are deficiencies in the market, particularly in terms of independent and strong regulators?

  Mr Halldearn: We do think that independent and strong regulators are an important part of the mix, the regulatory framework, and the reason for that is pretty straightforward. First of all, when companies are operating in this area, particularly when we get to a situation where we have got properly competitive markets and proper unbundling, in order to get people to enter the market they have to have confidence that the market rules are going to be interpreted and applied fairly and if people are putting enormous amounts of money into the network and the infrastructure they have to be pretty confident that the decisions that are going to be taken now and in the future are going to be taken on a fair and independent basis where the criteria for those decisions are known upfront, the sort of regulatory certainty that we have known in the UK for quite a long time now but does not exist everywhere in Europe. That is one of the fundamental things that we are calling for. The fact that it does not exist across Europe today and what we see are regulators that in many Member States are not independent and, in fact, we have seen from time to time at our meetings that a face disappears from the table because the regulator has taken decisions which are not quite as favourable as the government might like, that is not the kind of independence we need. That is bad enough on a national basis but if we start to look at the world in the future where some of these are decisions that simply have to be taken at a European level for infrastructure which is truly of a more European cross-border nature, we have to have the confidence that the regulatory framework is going to provide the referee, if you like, who is going to take decisions in a fair and unbiased way. We think that it is pretty fundamental.

  Q235  Lord Powell of Bayswater: Following on from that, in our discussion with the Commission they had a sort of menu of possible ways of regulating different sectors ranging from a European regulator, a single figure who might or might not be part of the Commission, down through a system of co-ordinating national regulators through to relying on national regulators. Where do you think it is going to come out on the energy side? There are always concerns about giving too much power to European institutions but, on the other hand, this does seem to be one sector, rather like the competition area, where maybe it will be necessary to have increased powers at a European level to ram through some of the things which so plainly need to be done.

  Mr Halldearn: Looking into the far distant future, if we have a single set of networks that is run by a single organisation across Europe with one set of market rules to cover all of Europe in our electricity and gas markets then perhaps there is quite a strong argument for having a single European regulator suitably independent, suitably powerful, to oversee the market. Today that is just not where we are. Today we have what essentially are national markets. In some areas we have markets which are more joined together, such as in Scandinavia. We have something like 38 transmission networks in electricity and many in gas and those are overseen today by national regulators essentially. The immediate future is one where we see national network companies acting in a way where there is more co-ordination and co-operation between what continue to be essentially nationally based network companies to form a European grid and, looking at the other side of the coin, a regulatory framework and regulators which are aimed more at ensuring we have better co-ordination and a capability to take joint European decisions between what continue to be essentially national regulatory bodies. I do not think that in one leap we are saying we should move to a single European regulator. There is another reason for that which I am afraid is just a fact of European life. We have looked quite hard at the Treaty and European case law and the ability to create such an all-powerful European regulator, frankly, would need a change of the Treaty. For those two reasons, the reality is that the market is not yet in a situation where one would say naturally that a single European regulator is the right answer, we see a more evolutionary approach, and we would have to go through that rather tricky thing of changing the Treaty.

  Q236  Lord St John of Bletso: The Commission are coming forward with proposals both on the energy market and the Single Market more generally in the autumn. Do you get a sense of which way they are moving in the case of the energy market as to how they will structure and strengthen it?

  Mr Halldearn: We get the sense that they may move towards a regulatory agency which is probably going to be constituted of national regulators. We would like to see this regulatory agency being given proper authority to be able to take decisions, as far as we can within the framework of what is possible within European law, so that we have the independent, predictable decision-making that we think is necessary. I want to stress that the sort of model we are putting forward is one that we would call the minimalist model. It is one which still relies on national regulators doing things that national regulators should do, perhaps looking slightly more broadly than just at national issues and looking across the border to see how their market interacts with the one next door, but there are some decisions which need to be taken at a European level and that will be done through the regulatory agency.

  Q237  Lord St John of Bletso: Will the Commission be part of this regulatory agency? Will it chair it or share in it?

  Mr Halldearn: I think you are starting to touch on the issue of the interaction between the regulators and the other European institutions. We would like to see a position where proper regulatory decisions are taken by the regulatory body and we know that starts to push up in some areas against the boundaries of what is possible and we are fully alert to that. If it means changing the acquis, changing the framework, then clearly the Commission have to have a role in that. Do we think the Commission should be directly involved in the work of this European regulatory agency in the day-to-day business of regulation? I think the answer to that is we prefer not. The reason for that is the way the Commission is constituted means that the people who would be responsible within DG Transport and Energy have a very wide range of objectives to achieve, which change of course with different political demands, and inevitably when they take decisions which are essentially regulatory in nature they would need to bring in these different policies, which in our view does not then lead to the predictable decision-taking in regulation that we think is necessary to give the right framework for a competitive and secure market in Europe.

  Q238  Baroness Eccles of Moulton: Just a quick supplementary. You talk about the minimalist approach and allowing it to evolve, which is absolutely right and very much to be applauded, but it could be that for two reasons we are facing a galloping situation here which could introduce a sense of urgency. The two are the security of supply that we were talking about earlier and all the political implications in that and how a certain state might be using energy as a bit of hostage for Europe and the other, of course, is climate change where there is a very wide range of views on how threatening this is. If some of the scenarios that are presented to us turn out to be accurate then that surely is another reason why perhaps we cannot do what we would really like to do, which is move quite slowly.

  Mr Halldearn: I am struggling to answer the question without getting a bit technical, and I do not want to do that really. One of the things that we see as being fundamental to having a successful European market is included within the envelope of what I have called minimalist, which is looking at our networks very hard and the way investment happens and ensuring that we have a sound framework for that to happen but at a European level. At the moment it is very much a national approach that we have. If we are to achieve that European approach to investment then we would need to have a regulatory body which could take decisions which would ultimately lead to the capital markets being confident about investing in networks and infrastructure. The one thing that the regulatory framework and regulators can bring in response to the issues that you have raised is to ensure that we are able to invest in the infrastructure which can give us access to diverse sources of gas and give the network companies the right incentives so that they can respond flexibly and quickly to the changing demands of developments in renewables, to the climate change targets, to the fact that LNG terminals, liquid gas terminals, can turn up at any point on the coast, not necessarily exactly where the network has been built. We see the thing that regulators can really bring to this debate is to be able to ensure that the networks have access to the funding and the background regulatory framework which means that they can respond to the demands for meeting climate change and also security of supply concerns.

  Chairman: Lord Haskel.

  Q239  Lord Haskel: Lady Eccles reflected my thoughts. What we are doing is we are looking at the thinking behind the Single Market and, of course, regulators play a very important role in all of this. You have explained to us about the security, the regulation and competition and the role that regulators play in that, but I wonder whether you could just say a bit more about the role of regulators in reducing the carbon footprint? Do you think regulators have a role in carbon trading and the European-wide work which is going on in that? You have told us about the role regulators have in making sure that there is encouragement to invest in alternative sources of energy, could you enlarge on that?

  Mr Halldearn: You are asking me to tread a little bit further than I have to say the thinking in ERGEG has gone so far, I have to be completely honest about that. Many ERGEG members do not have explicit responsibilities for sustainability so the debate on what role regulators should play in the climate change challenge, and particularly the carbon market, is something which is an ongoing debate within ERGEG. I can give you some views but I could not ascribe them at this stage to ERGEG's views. What I can say is that the core role of regulators across Europe at the moment is in this issue of network regulation and the promotion of competition. It is of growing concern to ERGEG members in a number of areas and the way market instruments are used, sometimes to good effect and sometimes perhaps to not such good effect, in order to meet climate change challenges is something regulators should have views on. At the moment those views are focused on the extent to which these instruments are first of all the most cost-effective means of meeting the targets which are put forward and, secondly, what adverse impacts inadvertently might these market instruments have on the wider energy market and, therefore, on customers. I think regulators are becoming more active in that debate. What is still an open question is whether institutionally energy regulators, which mainly are dealing with ex-ante regulation of energy, principally energy networks, should have their remit enlarged so that they can also look at trading in carbon and, indeed, other forms of derivatives which are based on or around energy. I am afraid I cannot give you more enlightenment on that at the moment.