Utilities Policy 13 (2005) 247–255

www.elsevier.com/locate/jup

Competition in electricity markets: internationalexperience and the case of Italy

Alessandra Ferraria, Monica Giuliettib,*

aDepartment of Economics, University of Reading, UKbAston Business School, Aston University, Birmingham B4 7ET, UK

Received 23 October 2003; accepted 21 July 2004

Abstract

As a result of European Directives 96/92 and 2003/54 on the liberalisation of the internal market for electricity, the Italian

electricity sector has been subject to extensive institutional changes which have affected the competitive nature of the market. In thispaper we attempt to assess the likely effect of these institutional changes on the Italian electricity industry, and focus particularly onthe impact of the introduction of a centralised wholesale market. The assessment of the likely impact of these institutional changes is

based on the comparison with the international experience of countries where extensive liberalisation measures have beenimplemented (such as the US, UK and the Scandinavian region). On the basis of this international comparison, we draw somelessons about how to promote effective competition in the Italian market and in other electricity markets which have not been fullyliberalised.

� 2004 Elsevier Ltd. All rights reserved.

JEL classification: L590; L940; L980; K320

Keywords: Electricity market; Institutional reforms; Wholesale market; Italy

1. Introduction

The electricity sector is undergoing a major trans-formation. From the 1980s a series of cultural,

* Corresponding author. Tel.: C44 121 3593611.

E-mail address: m.giulietti@aston.ac.uk (M. Giulietti).1 From art. 189 (now art. 249) of the Treaty of Rome, which

instituted the European Community ‘‘In order to carry out their task

and in accordance with the provisions of this Treaty, the European

Parliament acting jointly with the Council, the Council and the

Commission shall make regulations and issue directives.. A directive

shall be binding, as to the result to be achieved, upon each Member

State to which it is addressed, but shall leave to the national authorities

the choice of form and methods’’. This means that member states have

a duty of implementation (by ‘transposing’ the Directive into the

national legal system) of the aims set by the directive, usually within

a time constraint, but are free to choose the legal instruments and the

methods for doing so.

0957-1787/$ - see front matter � 2004 Elsevier Ltd. All rights reserved.

doi:10.1016/j.jup.2004.07.003

technological and economic changes resulted in a reas-sessment of the efficiency of the sector’s traditional,vertically integrated structure. Some countries began torestructure and/or privatise the sector, and subsequentlyEU directive 96/92 made the changes compulsory to allthe countries in the Union1. The aim of the directive wasto gradually introduce competition in order to createa European market for electricity. However, only a fewbasic principles were established clearly for all thecountries by the Directive including the unbundling ofdifferent production stages, the introduction of trans-parent rules for the building of new generation plants,the gradual extension to final customers of the right tobuy electricity directly from the producers and the rightof access to the network. The actual details as to how toimplement these basic principles were left to theindividual countries.

248 A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

From July 2004 Directive 2003/54 repeals Directive96/92. The general aim of the new Directive is to speedup the integration process and the development of com-petition, partly because the liberalisation process wasprogressing very slowly in some countries, and partlybecause new countries have in the meantime joined theUnion. The new directive is therefore more detailed thanthe old one on several issues, the most relevant of whichare clearer rules about the unbundling of the manage-ment of production stages (especially the separation ofthe grid from the supply), the compulsory creation of anational energy regulator in every country, the enlarge-ment of its powers, the increased powers of a Europeanregulator and the immediate opening of the market toall customers, with the exception of the domestic onesfor whom the deadline is 2007. This last provision isactually the only one which affects significantly Italycompared to the previous directive; all the others werealready part of Italian law. Our analysis of the Italiancase will therefore focus mainly on the legal provisionsand policies introduced as a result of the 1996 directive.

The structure of this paper is as follows. Section 2provides a general introduction to the characteristics ofthe industry and the possible models of competition.Section 3 analyses wholesale electricity markets, withparticular reference to England and Wales, Scandinaviaand California. Section 4 analyses the case of Italy, afterthe implementation of EU directive 96/92 with theBersani decree, in 1999. Section 5 concludes.

2. The industry structure

The electricity production process can be divided intofour different stages:

(a) Generation;(b) Transmission, along the high voltage network;(c) Distribution along the medium and low voltage

network;(d) Supply to final customers.

These four stages have different economic character-istics. Generation and supply (including metering andbilling activities) are potentially competitive, as thetechnology allows more than one firm on the markettherefore avoiding the market failure problems associ-ated with natural monopolies2. Transmission and dis-tribution are instead natural monopolies, at the nationaland regional level, respectively, because of the networkfixed sunk costs. Transmission usually includes also theactivity of plant connection and dispatch. This is

2 In generation, this became true especially by the end of the 1980s,

as the introduction of combined cycle gas turbines (CCGT) reduced

the minimum efficient scale.

because one of the main characteristics of electricity isin fact its non-storability, which makes the instanta-neous balance of demand and supply a necessity to keepthe system safe and avoid interruptions.

The traditional structure of the industry is a verticallyintegrated one. The driving idea behind liberalisationand restructuring is to separate the potentially compet-itive stages from those with natural monopoly charac-teristics, subjecting the latter to regulation in order toavoid the creation of monopolistic rents.

In general, competition among generators shouldincrease efficiency, by reducing costs and thereforeprices to final customers. If prices are correctly deter-mined they should also give correct signals as to whetherand where to install new generation capacity. This,however, depends on the structure of the whole indus-try, and on the effectiveness of competition, effectivenessbeing dependent on the number of agents both on thedemand and the supply side, the kind of plants theyhave, the characteristics of the wholesale market, etc.

Nevertheless, in general terms, the separation of trans-mission and distribution makes it necessary to define therules for access to the network (regulated or negotiatedaccess)3. Moreover, different pricing systems (uniform,zonal or nodal) shall reflect more or less the underlyingtransmission costs. Finally, rules must be set to guar-antee the safety, stability and equilibrium of the network.

Following Hunt and Shuttleworth (1996), three mainmodels of electricity markets can be identified, withprogressive degrees of competition. These are the SingleBuyer model, competition between distributors andgenerators, and competition among suppliers.

2.1. The Single Buyer model

This is a monopsonistic model. Competition is intro-duced only among generators, which sell their productto a single agent, the Single Buyer (who might or mightnot also be the System Operator4). The Single Buyersells the electricity to the distribution companies whichin turn sell it to the final customers, over which theymaintain monopoly power. All costs are therefore trans-ferred to the final customers.

In the wholesale market, electricity is bought and soldvia long term agreements based on the offers of theproducers and the demand forecasts of the Single Buyer.The long term nature of these agreements protects theproducers from market risk and, by reducing the cost ofcapital, it facilitates investment.

This model is therefore still substantially integrated.For the competition to be effective it is essential to have

3 The European Council of Barcelona has recently suggested the

compulsory use of regulated access.4 This is the organisation (private or public) which manages the

transmission grid.

249A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

a sufficient number of generators and that they areseparated from the Single Buyer/System Operator, toavoid unjustified discrimination among plants. The lowmarket risk of the producers can nonetheless reduceeffective competition between them especially if deci-sions about new generation capacity are slowed down bycentralised bidding systems. In countries with growingdemand, the presence of a Single Buyer can constitutea bottleneck to dynamic growth.

2.2. Competition among generators and distributors

In this model, competition is extended to the distri-butors, who can choose whom to buy their electricityfrom, whilst retaining their monopoly power over finalcustomers. In other words, the first three stages of pro-duction are separated but distribution and supply arestill integrated.

The increased number of agents on the demand sideshould increase competition among generators, and it isnow necessary to create a proper wholesale market. Thiscan be based on bilateral contracts or on a spot market,or both. It is also necessary to create a network operatorand to identify the rules and tariffs for the access to thenetwork, for the balance of supply and demand and forplant dispatch.

For competition to be effective in this model, it is notonly necessary to avoid market power in generation, it isalso necessary to separate it from distribution, wheremonopoly power over final customers continues to exist.This makes it necessary to also regulate the regionalmonopolies, which can be done by using comparativecompetition to mimic the outcomes of a competitivemarket. This approach was adopted in England andWales just after privatisation.

2.3. Competition in supply

This is the most open model of all: competition isextended to supply, as final customers are now free tochoose their own supplier. Distribution companies donot have a monopoly over final customers anymore, andthe link between distribution and supply will now bedriven by market forces. The same goes for the linkbetween distribution and generation: if generation iscompetitive, it will be in the interest of the distributioncompany to buy electricity from the cheapest possibleproducer. The separation of supply makes it necessary todefine criteria for the access to the distribution network.

This is the model adopted in Scandinavia from 1991.In England and Wales this was introduced gradually: atthe time of privatisation only large customers (with con-sumption levels above 1 MW) could choose their sup-plier; medium-size customers (with consumption levelsbetween 100 kW and 1 MW) followed in 1994, with therest of the market becoming competitive in 1998–1999.

To sum up, competition in electricity begins withcompetition in generation, where the main cost reduc-tions can be expected, and can then proceed with openingof the market to different buyers. The advantage ofseparating supply from distribution lies partly in thepossible cost reductions, but also in the potential increasein the competitiveness of the whole system. Indeed thisseparation makes it possible to increase the number ofagents on the demand side and eliminate monopolypower over final customers. This eliminates both thepossibility of abusing monopoly power and also the needfor regulation and control5. In theory the regulator’swork is reduced, as no more control is needed to preventdistribution companies from operating also at the genera-tion stage: the competitive mechanism should eliminatethe incentives towards discrimination among plants.

As a key role for the competitiveness of the system isplayed by the functioning of the wholesale market, thistopic is discussed in more detail in the next section.

3. The role of the wholesale market in price

determination

In a deregulated market effective competition is anessential requisite for the efficient use of existing capacityand to promote dynamic efficiency. The possibility ofexerting market power can, however, be influenced bythe mechanism chosen for buying and selling energy onthe wholesale market. In general, two main systems exist:bilateral contracting and/or bidding mechanisms. Thelatter can in turn entail uniform price systems or pay-as-bid systems, depending on whether the same ordifferent prices are paid to the plants selected forproduction. In perfectly competitive markets the priceshould reflect the marginal costs of generation andtransmission. If the market is not perfectly competitive,producers can make offers higher than their marginalcosts; this would translate into higher prices andconsequent welfare loss, as well as inefficiency in theuse of existing capacity and in the allocation of resourcesfor creating new capacity. In the light of this discussion,we can consider the different market systems and theirrespective incentives to (in)efficient behaviour.

As mentioned before, wholesale market transactionscan be based on bilateral contracts or on a biddingmechanism. Contributions in the literature6 haveconcentrated on systems such as the ones adopted inEngland and Wales and California which are based ona compulsory pool, looking at the effects of market

5 Price controls might not be immediately removed, to allow

competition to develop. Indeed in England and Wales, they were

removed gradually between 1998 and 2002.6 See for example Green and Newbery (1992) and Kahn et al.

(2001).

250 A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

power on the bidding mechanism. These compulsoryarrangements have now been abandoned and have beenreplaced by voluntary schemes, as we discuss later.

In a compulsory pool, prices are determined viaa bidding mechanism that pays the same price (marginalsystem price) to all the plants selected for production;this price is based on the offers of the marginal plants,which are usually mid-merit plants. The final poolpurchase price will also include capacity payments7.Alongside the pool operates a system of bilateral con-tracts and of contracts for differences to shed the risk ofprice volatility.

Other countries, such as France and the Scandinaviancountries have chosen to base all wholesale transactionson bilateral contracts, alongside a voluntary power ex-change (which in Scandinavia is identified as the NordPool8). The idea is that an intense bargaining processshould lead to price reductions, especially if strongbuyers operate on the demand side (big firms or theSingle Buyer, for example). The lack of a uniform priceshould make it possible for operators to get discountsand to pay prices closer to marginal costs. It should alsohinder collusion, as price monitoring is more difficult. Onthe other hand, if competition is not effective this lack oftransparency can make it difficult for the regulator toidentify instances of market power abuse (Newbery,1999). Another problem is that a system with no directinformation about existing capacity, costs and demandwill have much higher transaction costs, and couldtherefore be dynamically inefficient (Kahn et al., 2001).

Nevertheless, according to Borenstein (2002) the lackof bilateral contracts has been one of the main causes ofthe California electricity crisis. The exclusive use of thespot market made prices extremely volatile, and in-creased risk. Such volatility in prices would be the resultof low demand and supply elasticity, especially in theshort run. As electricity cannot be stored, costs and thusprices will increase significantly at peak demand times.

The failure of the English pool to reduce prices andthe collapse of the California electricity market led bothcountries to reform their systems, by opening them to theuse of bilateral and financial contracts to hedge the risks.

In England and Wales in particular one of the mainchanges introduced with the New Electricity TradingArrangements (NETA9) has been the switch from

7 These are payments made in order to ensure sufficient capacity at

times of peak demand.8 Since 1996, Norway and Sweden share a single power exchange

system. Finland joined in 1998 and the full integration of Denmark

took place during 2000.9 In March 2001, the compulsory wholesale market for electricity in

England and Wales (Pool) was replaced by NETA (New Electricity

Trading Arrangements) in order to promote competition in the

market. The new system is based on bilateral contracts (98% of trade)

and a balancing mechanism (2% of trade) set up to deal with demand

and supply imbalances (see Ofgem, 2001, Appendix 2).

a uniform pricing system to a pay-as-bid system. Thetwo different payment systems can in fact give differentincentives to efficient behaviour. In a uniform pricesystem, the price reflects the marginal costs of themarginal, mid-merit plants whose control can thereforebe a strong element for market power.

According to Green and Newbery (1992), in Englandand Wales the existence of five different generatingcompanies would have prevented market power abusewith a likely effect of lower price levels. However, theactual presence of only two firms instead favouredcollusive behaviour, generating rents on the spotmarket. Several theoretical analyses of the Englishmarket (Green and Newbery, 1992; Von der Fehr andHarbord, 1993; Green, 1994)10 have identified theexistence of incentives for the producers to bid higherthan their marginal costs. According to this literature(and confirmed empirically by Wolfram, 1998), the moreinfra-marginal plants are under the control of one firm,the larger will be the firm’s incentive to bid high.

For the California spot market the low demand andsupply elasticities put companies with market shares aslow as 10% in a position to exert market power andinfluence prices (Borenstein, 2002). Several empiricalstudies have confirmed the existence of market powerabuse by generators (Borenstein et al., 2001; Joskow andKahn, 2001), although this result is not necessarily dueto the payment system itself (Borenstein, 2002). InEngland and Wales, for example, the real problem of theold system was that a small number of firms ingeneration had control of the infra-marginal plants.The situation improved as soon as other firms enteredthe market, in more recent years, making the wholesystem more competitive. The low level of concentrationis also the reason for the success of Nord Pool, whichalways relied on a uniform price system.

One of the characteristics of a pay-as-bid mechanismis demand uncertainty. Green and McDaniel (2000)have analysed the potential supply strategies forcompanies operating in this market, following the ruleof revenue equivalence (Klemperer, 1999). In their paperthey claim that uncertainty as to whether plants will beselected for production can lead many producers tooperate in the phases preceding the balancing one. Onthe other hand, incentives exist to delay trade until thebalancing is strong if they expect high prices.

Economic theory, however, does not support thisprediction. The analysis of optimal supply strategies inGreen (2000), for example, shows how inefficientsolutions can be generated even in perfectly competitive

10 Green and Newbery (1992) and Green (1994) follow an approach

based on the supply function using detailed information on the costs

and capacity of existing generating plants. Von der Fehr and Harbord

(1993) instead use auction theory models, but reach the same

conclusions as the previous two papers.

251A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

markets. The idea is that generators will have to choosebetween the possibility of being selected, which is anincentive to bid low, and the possibility of receivinghigher revenues through higher bids, which translateinto higher prices. This decision will be based not onlyon cost conditions, but also on demand expectations,and it is therefore possible that more expensive plantswill be selected. In such a system, prices are not veryreliable signals of cost conditions, and this can lead toinefficient resource allocation.

Another problem related to the uncertainty ofpay-as-bid system is that it can deter entry of newgenerators (Kahn et al., 2001). Barriers to entry can arisefrom economies of scale in the collection and processingof the information necessary to make demand forecasts,and this can translate into dynamic inefficiency. Further-more, uncertainty could also be a disincentive to investfor the incumbents. Therefore, pay-as-bid systems facethe risk of not having enough capacity especially at timesof peak demand, as happened during the Californiacrisis.

Control of capacity payments is another way inwhich generators can abuse their market power. Asemphasised by Wolak and Patrick (1999), instead ofbidding for higher supply prices, generators can keepinfra-marginal capacity in order to increase total pay-ments. A restricted capacity is more difficult for theregulator to control as it can be easily justified on thegrounds, for example, of necessary maintenance. Insupport to this hypothesis, Wolak and Patrick mentionthat in the period 1991–1995 generators in England andWales have declared the same amount of capacity bothat normal and peak demand times11. This is the reasonwhy capacity payments were later removed.

The use of zonal pricing for the solution ofcongestion problems, as adopted in Scandinavia, createsother possibilities of market power abuse. With zonalpricing, the market is divided into two or more zonesdepending on their congestion costs, so that higherprices are paid where demand is higher than supply andvice versa12. This shall, in theory, efficiently allocate theexternality costs of congestion, using prices as signalsof the transmission costs. The problem is that the rele-vant market dimensions change continuously, and pro-ducers can abuse market power by choosing smallermarkets13. Empirical evidence of this phenomenon inScandinavia can be found in Johnsen et al. (1999), whichshowed forms of market power abuse by producers in

11 A similar argument can be found in Newbery (1997), when

analysing the capacity payment in the English pool.12 In the English system, the costs related to congestion constraints

are shared among all consumers.13 A theoretical discussion of this issue can be found in Borenstein

et al. (1999).

areas with congestion constraints and little demandelasticity.

A final point should be made about the role ofdemand. The physical characteristics of electricity pro-duction limit the possibilities of adjusting supply, andthis makes demand variation extremely relevant in pricedetermination. Nevertheless, demand conditions areoften not sufficiently emphasised by the market system;this was the case for the wholesale market in Englandand Wales and California, but not in Scandinavia. Oneof the main characteristics of Nord Pool is in fact the socalled demand side bidding, where the demand side canmake price–quantity bids at the same conditions as thesupply side of the market. This, together with the verylow market concentration in generation, is one of themain reasons for the success of Nord Pool in limitingmarket power abuse and lowering prices.

According to Borenstein (2002, 2004), one of thecrucial factors for the high prices during the Californiacrisis was the low demand elasticity, namely the inabilityof consumers to adjust their demand to different costconditions. His suggested solution is not to change therole of demand in the bidding process, but rather tobring prices closer to costs via the use of real timepricing. In this system, prices reflect congestion costsover time: this should give incentives to save energy atpeak times and use it when demand is low, in this wayalso reducing the need for reserve capacity. The higherdemand elasticity should reduce price variability as wellas their average level, because of the reduced possibil-ities of market power abuse14, and should also generatelong-run efficiency gains (Borenstein, 2004).

To sum up, efficiency of the wholesale marketdepends on the possibility for operators to control andmanipulate the price level, which in turn depends onmarket design. International experience, however, sug-gests that the most important element is a structuralone, i.e. the degree of concentration of the system. Aswill be discussed in the next section, this appears to bethe main problem for the Italian electricity market.

4. The case of Italy

This last section is devoted to the analysis of theItalian market and its developments after the imple-mentation of Bersani decree of 1999, which transposedEU directive 96/92 to Italy15. The Bersani decree hasintroduced many key changes to the traditional verti-

14 For both practical and economic reasons, it is advisable to use this

pricing system only for large customers, such as business and

commercial ones.15 As discussed in Section 1, the new Directive 2003/54 does not

affect Italy much, so the transposition of the previous one and its

analysis remain perfectly valid.

252 A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

cally integrated Italian electricity system, althoughseveral delays in its implementation have led only toa partial liberalisation of the Italian electricity market.Since 1963, the whole electricity sector was under thevirtual monopoly of one single firm, ENEL. Afterprivatisation, the Government still retains a majoritystake, in excess of 60% of the companies operating atvarious stages of this sector.

The main changes implemented with the decree werethe introduction of competition in generation and,partially and progressively, of supply to final customers,and the vertical separation of the production stages. Thelatter has been implemented via the creation of separatecompanies, all operating under the control of ENELSpA as a financial holding.

In generation, the decree allowed ENEL to retaina maximum market share of 50% after 2003. This meantthat ENEL had to sell 15,000 MW of capacity by thattime. As a consequence, three of its generation com-panies (or Gencos) had to be sold on the market: the saleof Elettrogen, Eurogen and Interpower were completedby the end of 2003.

The majority control of the transmission networkremains with ENEL Terna16, but all related activities areperformed by the system operator (Gestore della Rete diTrasmissione Nazionale or GRTN), which was createdin April 1999. The GRTN must guarantee open accessto the network, according to the conditions and tariffsdetermined by the regulator (Autorita per l’energiaelettrica ed il gas or AEEG).

The incumbent distribution companies have beengranted licences for a period of 30 years in 1999. Thedistribution network is again virtually controlled byENEL, with the exception of a few cities/towns, wherethe local municipalities own the distribution compa-nies17. Finally, supply remains integrated to distributionon the market for non-eligible customers, and open tocompetition on market for the eligible ones, whereENEL Trade operates together with other traders.

One of the main changes introduced with the Bersanidecree is the creation of two parallel markets: a progres-sively larger open market for eligible customers, whichwas a specific requirement of the EUDirective 96/92, anda market for all others, with access restricted to a limitednumber of companies. The thresholds for eligibility havejust been lowered by Directive 2003/54 that opens themarket to all customers, with the exception of residentialones, which will become eligible in 2007. Eligiblecustomers are able to contract directly with the producersand the distribution/supply companies, and to carry outtransactions in the pool market, which started operating

16 ENEL Terna’s stock (50%) was floated in June 2004.17 According to the Bersani decree, if more than one distributor

operates in any single city/town they will have to merge into one

company.

in January 2001. However, the bidding rules for the poolwere actually defined only in May 2001 by the MarketOperator (Gestore del Mercato Elettrico or GMO),created and controlled by the GRTN in June 2000.

A Single Buyer system (AU, created in November1999 by the GRTN) will instead be implemented fortransactions in the market with restricted access. As seenin Section 1, this is a monopsonistic system in which theSingle Buyer buys electricity on the pool from theproducers and sells it to the distributors who in turn sellit to the final customers. As neither the pool nor theSingle Buyer are fully operating yet, a transitory systemexists based on bilateral contracts between producersand the distribution/supply companies, with regulatedtariffs for non-eligible customers.

The wholesale market should work through a ‘‘semi-compulsory’’ pool alongside a system of bilateralcontracts. The pool comprises several different markets.Energy transactions between demand and supply takeplace on the day-ahead and the adjustment markets,whereas resource allocation and dispatch (in merit order)are done on the congestion, reserves and balancemarkets.Both demand and supply side operators can participate tothe pool. Their bids are ordered by the GMO separatelyon each market and the intersection of these bids willdetermine the uniform price for electricity, whereasa zonal price system will be used to deal with congestions.

These are the main legal provisions for the introduc-tion of competition in the Italian electricity market. Theactual or even potential competitiveness of this market is,however, another matter: the main problem, as will beseen shortly, is the dominant position of ENEL inbasically all the stages of the production process. Anadditional relevant obstacle to the development ofeffective competition is the majority Government stakein ENEL, which entails a strong influence of politicalforces on ENEL’s activities. Complete private ownershipis not a necessary condition for effective competition andindeed in some Scandinavian countries partial publicownership has been maintained, with publicly ownedcompanies competing alongside private ones. In theItalian market, however, the Government’s majoritystake can translate into significant political interferenceon the definition of the objectives as well as themanagement of the company18. This goes beyond theusual golden share problem experienced in otherEuropean countries, such as the UK and Spain, becauseof the already very powerful influence that the Italianpublic sector exerts on the country’s financial markets19.

18 For example, via the direct appointment of members of the board

of directors.19 The European Court of Justice has recently (in June 2002 and

May 2003) ruled against state golden shares as they can obstruct the

free capital movements within the Union.

253A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

We now turn to a discussion of actual marketconditions following the order of the production stages.

After divestiture, in generation, ENEL has a domi-nant position with 49.5% of production and 51.7% ofinstalled capacity, a share that rises to 59% whenincluding its imports. This position is made evenstronger by the fact that the company has virtuallytotal control of mid-merit plants; as seen in Section 3,these are the key determinants of the market price ina uniform price system. Moreover, it will take a fewyears before the divested plants are fully operative, dueto their obsolescence and conversion needs. Finally, thefragility of the transmission network and insufficientinternational interconnections limit the ability to importelectricity from abroad20, so overall the whole system isfar from competitive.

An attempt to deal with the problems of electricityinfrastructure was made with the Marzano decree, inearly 2002, which simplified the administrative proce-dures for building new generating plants. However, italso reiterated the maximum share of 50% of grosscapacity in generation (which also includes imports) forany single operator, which is an extremely high limitespecially for the electricity market, where shares as littleas 10% have been proved enough for abuse of marketpower.

It is therefore not surprising that many advocate21

a reduction of ENEL’s market share, together witha general improvement of the transmission network.However, such an improvement is hindered by the stillcumbersome and lengthy procedures required for thepermission to install transmission lines and by theopposition of many local councils to any expansion ofthe transmission grid. These views have become evenmore widespread after the black-outs observed in 2003.

This failure of the electricity grid, which led to supplyinterruptions in large parts of Italy, can be ascribed, atleast in part, to problems which are specific to the Italianindustry and which have not been properly addressed aspart of the liberalisation process. It is a well known factthat electricity transmission grids suffer from problemsof underinvestment and lack of appropriate mainte-nance in several countries22. The Italian transmission

20 Italy is well below the minimum interconnection threshold agreed

in Barcelona, which is 10% of installed capacity. This is not due to

physical impediments but rather to cumbersome bureaucratic pro-

cesses required for the authorisation to extend the interconnection

capacity and opposition from local and environmental lobbies.21 See for example the Introduction by the President of AEEG in the

2002 Annual Report.22 In the UK for instance the electricity regulator (Ofgem) has

undertaken an investigation to ascertain whether the grid operator

(National Grid-Transco) has fulfilled the maintenance duties set out in

its licence. In this report human error was identified as the main cause

of the power failures investigation (Ofgem, 2004) and a series of

improvements in security and maintenance procedures were recom-

mended as a result of the investigation.

grid has been put under pressure as a result of theintroduction of competition and this is reflected in theincreased levels of congestion in recent years (600%increase since 1999). What makes the Italian industryeven more susceptible to power failures is the insufficientlevel of supply to cope with current demand levels due tolimited investment in generating plants, a problemrecently addressed in the Marzano decree (2002), butwhich will require several years before it can be resolved.

The problem of undersupply at the national levelcould also be addressed by extending the currentlylimited set of interconnections with neighbouringcountries (a maximum of 6500 MW can currently beimported from abroad). Although more extensive in-ternational interconnections have been indicated as apowerful tool to improve the security of electricity grids,a higher level of international coordination in trans-mission than it is currently available in Europe wouldalso be required for this tool to become effective inpreventing extensive power failures (Benintendi andBoccard, 2003).

Another problem with the transmission network isthe separation of its property (ENEL Terna) from itsmanagement (the GRTN). The (even if indirect) controlof the network by the incumbent could constitute anobstacle to its improvement as well as to its open access,which is essential to competition. However, this issue isaddressed in the Marzano decree which makes theGRTN owner and operator of the transmission grid.

At the distribution stage, ENEL again has a largelydominant position. In the market for non-eligibleconsumers, this translates into monopoly power overfinal customers. As discussed in Section 2, if distributionand supply are integrated, their separation fromgeneration is essential, to avoid biased incentives inthe choice of production plants. This is clearly not thecase in Italy, especially since the pool and the SingleBuyer are not operating yet and all transactions arebased on bilateral contracts. The same problems arise inthe open market if competition is not effective.

Today’s non-eligible customers are tomorrow’s eligi-ble ones. This opens up a further opportunity of marketpower abuse, when the incumbent turns into a multi-utility, via a process of horizontal integration. Theincumbent could in fact abuse its power in the originalmarket to facilitate its entry in new ones, with anadvantage over competitors.

These considerations were at the origin of thedecision made by the Italian competition authority(Autorita garante della concorrenza e del mercato orAGCM) in 2001, and recently confirmed by the courts,on the proposed acquisition of Infostrada by ENEL.The AGCM considered that ENEL’s entry in thetelecoms market could have negative follow-on effectson the structure of the electricity sector; in particular, itwas estimated that between 25% and 45% of the current

254 A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

non-eligible clients would have been already linked toENEL (via telecoms services) when becoming eligiblefor a change of status. It was then suggested that ENELshould sell more of its productive capacity (a fourthGenco) in order to be allowed to acquire Infostrada; thiswould be even more necessary now, since its expansioninto other utilities has continued (namely in water andgas distribution)23.

In the supply market, the number of eligible clientshas grown over time, but only reached about one-thirdof final consumption.

New traders operate on the liberalised market, butagain ENEL (via ENEL Trade) has a dominantposition, with 45% of direct sales to final customersand 38% of overall sales (that is inclusive of in-termediate sales to other distributors and traders)24.The respective shares of the second biggest operator,Edison Energia, are 16% and 15%. This is notsurprising given that the overall picture shows anincumbent firm with a dominant position all througha production process which is still quite integrated. Thepossibilities of abuse of such a dominant position arealmost self explanatory. An example is given by a recentenquiry (March 2002) by the competition authority(AGCM), regarding the use by ENEL of pre-emptiveand exclusivity clauses in its contracts with eligiblecustomers. The pre-emptive clause would affect thesupply of electricity to the foreign branches of Italiancompanies, putting ENEL in a privileged position overany competitor, whose offers it could easily match andneutralise.

5. Conclusions

Based on the arguments presented in the last section,it is clear that the Italian market is very far fromenjoying the full effectiveness and benefits of competi-tion. The market is still strongly integrated and theincumbent has a dominant position at all productionstages. This is partly the result of legal provisions (suchas the 50% threshold in generation), but also of thedelays in their application. The non-operativity of thepool and the Single Buyer, for example, have stronglylimited the development of competition, due to thepresence of two parallel markets and to ENEL’sinvolvement in both transmission (though not directly)and distribution activities.

23 The acquisition and total control of Camuzzi Gasometri SpA, via

Enel Gas SpA, has made ENEL the second biggest operator is

secondary gas distribution. Its integration in the water sector has been

realised via a joint venture between Enel Hydro SpA and Acquedotto

Pugliese SpA, and via a partnership with Acea for water supply in the

Campania region.24 Source: AEEG Annual Report 2002.

The start of the pool and the progressive opening ofsupply are therefore essential, although probably notsufficient for the development of competition. The incum-bent enjoys a dominant position in generation which isnot likely to be reduced, especially given the problemswith the transmission network and insufficient interna-tional interconnections. ENEL’s ability to influencemarket prices will be reinforced not only by the number,but also by the type of plants it controls, as illustrated bythe experience of countries which have already beenliberalised. The California market showed the effects ofa limited capacity on prices, at times of peak demand. ThePool market of England and Wales showed how controlover mid-merit plants can easily translate into pricecontrol. The British experience also showed, however,that the main problem does not lie in the particular poolsystem chosen, but rather in the presence of marketpower, as demonstrated also by the successful experienceof the Scandinavian market. A pay-as-bid system in Italywould probably be even more dangerous, as it is lesstransparent, more uncertain and consequently lessappealing to new operators than a uniform price system.

The problems of concentration and dominant posi-tion of the incumbent in Italy have been translated intoprices well above the European average25. This situationis, however, similar in other EU countries, as theEuropean Council recently confirmed at the Barcelonasummit, in March 2002. Every state will have to removesuch obstacles if the conditions for a really competitiveEuropean market for electricity are to be created.

A final observation should be made about thepotential relevance of the Italian experience of electricitymarket liberalisation for the 10 countries which haverecently joined the European Union and which will haveto implement European regulations for the liberalisationof their national markets. In this respect the mainsimilarity between Italy and these countries, most ofwhich have only recently moved to a market-basedeconomy from a communist system, seems to be thelegacy of a substantial role of the political system in themanagement of the economy. In Italy, this situation hashindered the ability of the economy to fully benefit fromthe advantages of a liberalised market and hascontributed to relatively high energy prices and a lessthan secure power supply. A further element ofsimilarity, although to a more limited extent, is thelimited development of those financial markets whichare instead necessary to provide support for the complexfinancial transactions which a liberalised energy marketrequires. In the absence of well functioning financialmarkets, the industry will have to rely on less trans-parent and more costly forms of financial transactions

25 This is, however, also the result of inefficiencies in generation,

which still depends heavily on expensive fuels and on imports. See also

Newbery (2002).

255A. Ferrari, M. Giulietti / Utilities Policy 13 (2005) 247–255

which will facilitate rent seeking behaviour and anti-competitive practices.

In general, an important lesson to be drawn from theItalian experience of liberalisation is that delays inremoving political influence and in constraining themonopoly power of former incumbents can prevent theeconomy from enjoying the benefits of effective compe-tition and can limit the ability of the economy tocompete on an equal basis in a fully liberalised andintegrated European market.

Acknowledgements

We would like to thank Diego Piacentino andMichele Pizzolato for useful information on the recentdevelopments in the Italian electricity market and DavidSaal for constructive comments on the paper. We wouldalso like to thank two anonymous referees for veryuseful comments on a previous version of this work andthe editor for comments which helped us improve thestyle and content of the paper.

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