Select Committee on European Union Fourteenth Report


1. The Commission's Green Paper on Energy Security, which forms the subject of this inquiry[1], is one among a number of recent indications that energy security is back on the agenda, after a long period of neglect in both the United Kingdom and the European Union.[2] We welcome this renewed interest—energy is vital to the economy, to society and to our everyday life. Recent events have reminded us that energy supplies can be vulnerable and volatile—higher oil prices and the resurgence of the Organisation of Petroleum Exporting Countries (OPEC), the shortages of electricity in California and Brazil and, nearer home, the fuel price protests in the United Kingdom. The terrible events of 11 September 2001 and their aftermath have underlined the risk of unpredictable attacks on our economic infrastructure and way of life.

A market solution, or should governments intervene?

2. These developments followed a period of relative calm in energy markets during the 1990s, when supplies were abundant and the focus of policy makers was on market opening and liberalisation—a calm which led some to conclude that energy was simply another commodity and that energy security could be left to the market.

3. We do not share this view. We reported on the Commission's earlier Green Paper For a European Union energy policy in 1995[3] and have also monitored carefully the Commission's Gas Directive[4]. We believe that energy security is of increasing importance, and that there remains a role for Government—but that it is essential to define that role carefully. Energy security is a broad and sometimes slippery concept. Concerns about energy security have on occasion been used to justify other policies—for instance, as an excuse for opposing energy market liberalisation, or as an argument for a European energy policy. We believe that it is important to clarify the concept at the outset. Security should be considered in its own right, not used as an excuse for some quite distinct objective.

Liberalisation and regulation

4. Our own position is clear—we welcome the liberalisation of energy markets, and would like it to progress faster across Europe. We also believe that liberalisation will help promote energy security. But we do not think that it can be the whole answer, for a number of reasons. For a start, even in liberalised markets, there remain significant monopoly elements requiring regulation. So effective regulation is one important aspect of energy security.

5. In any event, the problem is wider. Security can not simply be a matter for individual consumers. Gas and electricity are provided through networks, and failure impacts on all consumers connected to the portion of the network affected—their security is inevitably collective. In any event, it is unreasonable to expect individual consumers to take responsibility for their own security. They cannot, for instance, build private gas storage or trade in the electricity futures market. While security of supply can be provided indirectly, through the customer's gas or electricity supplier, there are information problems—how is a consumer to judge the level of security required, how much security a supplier is in practice providing and how much it is reasonable to pay for it?

6. There is also the matter of financing energy infrastructure. Monopolies, whether state-owned or private, are able to raise the necessary capital more easily than companies operating in liberalised markets where competition and regulation combine to drive down prices and companies have no guaranteed customer base. Because the risks are higher, competitive markets tend to favour the short-term over the longer-term, but infrastructure is both capital-intensive and long-term in giving a return on capital invested. It is important therefore that in liberalised markets regulators consider how to accommodate the financing of infrastructure when setting prices (see also paragraphs 68-71).

Dependence on a limited number of suppliers

7. In addition, there is the well-known problem of the concentration of hydrocarbon (oil and gas) resources in a few countries, many of which are politically unstable. Dependence on such regions involves risks. Hydrocarbon supplies, or the transit routes, may be vulnerable to disruption for political reasons or simply because law and order break down in the regions concerned. Liberalised consumer markets cannot isolate themselves from these risks and markets on their own cannot cope with the geo-political problems.

8. For all these reasons, there continues to be a role for governments and regulators. Energy security needs to be redefined for liberalised markets. Historically, energy security was seen as the product of central planning and control, with the government taking ultimate responsibility for building sufficient capacity to meet demand. Import dependence was seen as inherently risky and energy policy focussed to a significant extent on self-sufficiency, sometimes blinding policy makers to the fact that domestic sources can also be disrupted, by strikes, accident or terrorist action, for example.

Managing risk

9. Energy security should not, in our view, be seen in such simple terms. We believe the key criterion should not be self-sufficiency, but effective risk management. Pure self-sufficiency would be an enormously expensive aim, even if it were practicable. The United Kingdom and Europe will inevitably be reliant on world markets, as the Green Paper shows. This should not be seen as a weakness—energy trade, like other forms of trade, is beneficial to producers and consumers alike and should be welcomed, not rejected. But this does not mean that it is without risks. The aim of energy security policy should be to understand, reduce, and mitigate those risks, rather than to attempt the impossible, of avoiding risk entirely.

10. Sometimes, it will be possible to identify risk clearly and take specific protective measures. More commonly, the nature and scale of the risks will be uncertain, so the protective measures will need to be generic. Risk management from this perspective has three main elements:

·  diversity: of fuels, of the sources of those fuels, and of the transit routes, to avoid over-dependence on any particular source;

·  flexibility: so that the system can respond quickly to any disruption;

·  back-up: via the existence of stocks, alternative sources which can be expanded in an emergency, and so on.

Diversity and flexibility, in particular, are characteristic of competitive markets. We believe there is no fundamental incompatibility between energy market competition and security, although, for the reasons given, we believe the Government will have to set the framework within which the market operates.

Energy security needs to be redefined for liberalised energy markets. We recommend that the focus should be on risk management and that the main tools should be diversity, flexibility and the availability of back-up, not central planning or self-sufficiency.

1   5619/01 COM (200) 769 final: Green Paper presented by the Commission-Towards a European Strategy for the Security of Energy Supply Back

2   Evidence from Professor Paul Stevens Q 61 Back

3   European Energy Policy, 17th Report, Session 1994-95 (HL Paper 87-1) Back

4   EU Gas Directive, 7th Report, Session 1997-98 (HL Paper 35) Back

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