Forging an Energy Community in South East Europe

A new European Community

In October 2005 DG TREN of the European Commission hopes to conclude negotiations on a treaty to establish an Energy Community in South East Europe (ECSEE), putting on a legal footing many of the steps required of signatories to the Athens Memoranda of 2002 and 2003. Having put together the draft of the Treaty, lead the negotiations, and agreed to provide over 90% of the budget for the new ECSEE institutions, the Commission has shown a deep commitment to the Treaty process.

In recent months, descriptions of the proposed ECSEE have gone beyond the traditional mantra of "peace, stability and growth", with comparisons increasingly being drawn to the establishment of the European Coal and Steel Community, the forerunner of the European Union. The Treaty therefore reflects the Commission's stated aspiration that the South East Europe region, under its leadership, could surpass the level of regional cooperation achieved in the EU. More than just a route to stabilisation and cooperation, introducing regional trading to South East Europe is seen as an opportunity to apply the lessons from the EU experience and to avoid the mistakes.

For example, the single energy market in South East Europe envisaged under the Treaty is based on the corresponding EU concept, with the abolition of quantitative restrictions on imports and exports of energy. The Energy Community may, however, go further by taking steps to ensure compatibility of market designs (including mutual recognition of licences) and implement a single cross-border transport mechanism, which would build on the existing inter-TSO compensation rules successfully implemented as part of the current 'CBT' mechanism. In addition, there are obligations on the members to provide mutual assistance in the event of a crisis on a gas or electricity system.

Who will be a party?

The draft Treaty was initialled in May 2005, and the key regional parties are expected to be: Albania, Bulgaria, Bosnia and Herzegovina, Croatia, FYR Macedonia, Montenegro, Romania, Serbia, Turkey and Kosovo (UNMIK). While it is expected to be a signatory, given the comparative size of its system, Turkey is seeking to address some specific concerns in relation to its involvement in the process before it initials the draft. These are referred to as the "Contracting Parties".

Signature of the Treaty is expected to occur during the UK presidency of the EU, and the EU President would sign the Treaty on behalf of the EU. Following ratification by relevant EU institutions, specified aspects of the Treaty would apply to Member States. Some Member States, such as Austria, Greece, Hungary, Italy and Slovenia, are also likely to exercise the option of becoming formal participants in the key ECSEE institutions.

The Treaty would come into force on ratification by seven parties. Taking into account the various processes within the EU and each national jurisdiction to ratify such treaties, assuming signature in October, the earliest date on which the Treaty could come into force is around February 2006.

Overview of the Treaty

The Energy Community would:

1. seek to create a stable legal and economic framework to encourage investment and trade within the region and to promote the EC's environmental and competition principles;
2. oversee the implementation of the specified EU Directives in the fields of energy, the environment, renewables and competition; and
3. oversee the setting up of a regulatory framework to allow the creation and efficient operation of a single, regional electricity market.

The 33 page Treaty has three principal components with differing applicability and processes for decisions:

Component: Application to: Decisions on Measures or disputes by:

Compliance with specified EU Directives Contracting Parties only simple majority Operation of the regional energy market Contracting Parties and Austria, Greece, Hungary, Italy and Slovenia two-thirds majority Establishment of a single energy market Contracting Parties and to all existing and future EU Member States unanimity

ECSEE Institutions

The Treaty establishes a Ministerial Council, Permanent High Level Group, Regulatory Board and Secretariat, with representatives from the Contracting Parties, the EU and potentially other Member States that formally become participants. Together, these form the institutional framework that will implement and oversee developments.

The Council, High Level Group and the Regulatory Board will all be able to impose Decisions or Recommendations to ensure the proper implementation of the Treaty. The Treaty provides a process for determination by the Ministerial Council of the existence of breaches of the Treaty and consequent suspension of rights deriving from the Treaty.

Harmonisation with EU laws

Timetables for harmonisation with the acquis communautaire on energy, the environment and renewables are provided (see table). Laws that are perceived as being fundamental to the creation of the energy market have earlier implementation dates, principally the internal market in electricity Directive (2003/54/EC) and the corresponding gas Directive (2003/55/EC).

To indicate that this is not an obligation to blindly adopt rules duplicated from elsewhere, the Energy Community must take into account the "specific situation" of individual jurisdictions. The EU has also been careful in presenting the Treaty to clarify the EU principle of subsidiarity, which allows regional bodies to act only to the extent that action is required to deal with the particular issues at a regional level.

In addition, harmonisation will not proceed from a 'standing start'. There has already been significant pre-Treaty EU harmonisation activity in the region. A raft of new primary and secondary laws, regulatory bodies, technical codes, industry documentation, published tariffs and unbundling processes have been introduced, together with the related new processes and procedures (see table). The culture changes and training required to make these new processes and procedures work is being effected through donor-funded capacity building in key institutions, training programmes, communication, shared training and other initiatives through existing regional fora. This activity is likely to further pick up pace following the coming into effect of the Treaty.

Overview of Treaty

Area Relevant EU Law Timetable for implementation

Energy

Directives 2003/54/EC and 2003/55/EC– on the establishment of an internal market in gas and electricity One year;
market opening to all non-domestic customers by 2008 and all customers by 2015

Environment Kyoto Protocol None - Parties are to "endeavour to accede"

Directive 1985/337/EEC – the assessment of the effects of public and private projects on the environment.

Directive 1979/409/EEC – conservation of wild birds Immediate effect

Directive 1999/32/EC – reduction in sulphur content of certain liquid fuels

Directive 2001/80/EC – on emissions of certain pollutants from large combustion plants By end of 2011

Directive 96/61/EC – integrated pollution prevention and control None – Parties are to "endeavour to implement"

Renewables

Directives 2001/77/EC and 2003/30/EC – on the promotion of renewable electricity and promotion of renewable fuels for transport One year to draw up a plan to implement the directives

Competition

EC Treaty: Article 81 (on restriction or distortion of trade)
Art. 82 (on prohibition on the abuse of a dominant position)
Art 87 (on state aid)
Art. 86(1) & (2) (on extending competition rules to public undertakings) Immediate effect (only for trade in energy) with six month grace period for public undertakings

General Standards

List of technical standards will be drawn up by the Secretariat for adoption, which will comply with the generally applicable standards of the EC. Development plans to be drawn up within one year of adoption of the list

EU Pre-accession

The EU has previously emphasised that the Stabilisation and Association Process is part of the process by which the Western Balkans States can achieve full membership of the EU. With ten new Member States having joined the EU in May 2004 and Croatia and Turkey both having been granted candidate status, the expectations in the region for speedy progression into the EU are high.

However, the failure of the proposed EU Constitution in some key Member States raises (for some) issues on the viability of EU enlargement. The establishment of the ECSEE is a key component of the achievement of a single South East Europe energy market in line with EU principles and is, by its nature, a highly political undertaking. Any equivocation on the issue of enlargement is likely to raise questions within each country's political establishment about the appropriate level of commitment to the ambitious plans and timetable for the ECSEE.

In addition, other key political questions remain in the region, the most prominent perhaps being the status of Kosovo (legally a part of Serbia, but de facto an international protectorate). Parliamentary and presidential elections in the region over the coming year are likely to give a better indication as to the feelings in the region on the pace of the EU integration process.

Impact on investment

A Commission funded generation investment study reviewing capacity requirements published in 2005 concluded that security of supply in the region requires investment in construction of new capacity of 13.5GW and rehabilitation of over 11GW of existing capacity, and also specifies a number of critical major transmission investments. With the number of donors active in the region, the lack of coordination between different programmes has been criticised in some quarters.

The ECSEE institutions will alleviate this to some extent by assisting in the coordination of the substantial amounts of financial aid into the region, giving some Contracting Parties a significant incentive to ratify, meet their obligations under the Treaty and participate actively in the regional institutions. In addition, considering critical investments at a regional level should lead to a substantial reduction in overall investment needs.

Environmental obligations

One area in which the region is likely to face a difficult transition process is in relation to the obligations to be assumed in the field of the environment and renewables, including the obligation to seek to accede to the Kyoto protocol. There is currently limited understanding in the region of what compliance will entail, or the economic cost of seeking to implement some of the requirements. For example, given that the average age of plant in the region is over 30 years, there are likely to be issues on the practicality of implementing stringent rules on emissions and other environmental requirements in the required timescales.

On the other hand, 'carbon financing' for projects qualifying for Joint Implementation (JI) and Clean Development Mechanism (CDM) projects could assist in attracting private foreign investment, although investors will need to consider carefully whether the additionality test, if applied strictly, would be met. As identified in a December 2004 report for the Commission on the environmental acquis, under the Kyoto Protocol projects may be disqualified for JI and CDM for having been covered by new policies and targets on renewables, or for having been dealt with through the ECSEE regional planning process for large capacity expansion projects.

The road ahead

The countries and jurisdictions in South East Europe will be scrutinising the ECSEE Treaty carefully over the months leading to signature and subsequent ratification.

Opposition to plans for restructuring of utilities in the energy sector, which may result in redundancies and retraining, could fuel some opposition to the Treaty. In addition, on the critical issue of "affordability", while regional trade may help reduce prices the adoption of more cost-reflective tariffs would lead to overall rises in the price of energy. The adoption of 'public service obligations' may shield the most vulnerable consumers, but this is unlikely to be possible for large industrial energy users currently enjoying below-cost tariffs.

However, with energy demand almost back to 1990 levels in the Western Balkans, ageing plant and huge investment needs being highlighted by recent studies, there is generally a recognition that the ECSEE is a move in the right direction. The economic benefits of a regional approach are potentially very great, particularly in relation to security of supply, operational efficiencies and transmission and generation capacity planning. In addition, the increased opportunities from regional trade together with predictable regulatory environments will be important factors in helping to attract the private investment and financing the ECSEE requires.