Business Analysis: Brussels in the hot seat as EU goes to war over energy

The comments may not have been scripted but, in the end, France's foreign minister was brutally frank over the €73bn (£50) merger designed to create a new French energy giant.

Yes, said Philippe Douste-Blazy yesterday, the market must decide, but: "France is doing everything it can to create a big French group."

"Politicians," he continued, "are doing everything to have a French champion" because firms have "employees - with families - who work in these enterprises. It is normal for politicians to work to make sure that these companies are the best in the world".

Normal is not the word to describe the reaction across the Continent to what would be an energy mega-merger. The proposed tie-up of Gaz de France and Suez has provoked a storm, prompting bitter complaints of protectionism and even comparisons with the economic nationalism that preceded the First World War.

The Italian prime minister, Silvio Berlusconi, has condemned the tie-up, news of which emerged after Italy's Enel said it was considering a hostile bid for Suez. Since the French prime minister Dominique de Villepin withdrew his objections to a full merger between GdF and Suez on Saturday, the reaction from Rome has been furious. The Italian opposition leader and former European Commission president, Romano Prodi, has attacked his former employer for weakness in not intervening.

And Italy's economy minister, Giulio Tremonti, argued: "The tendency of European states to build protective barriers must be stopped. We still have time. If not, we risk an August 1914 effect."

Meanwhile the EU authorities have warned Spain against blocking a takeover bid by Germany's E.ON for the Spanish power company Endesa. That bid has sparked a frenzy of merger activity and alarm in Madrid where ministers had already agreed the fusion of two Spanish firms, Endesa and Gas Natural, subject to 10 conditions.

Spain's energy secretary, Antonio Fernandez Segura said: "We were in a situation where anyone could come along and buy our biggest power company."

What authority the EU has over France's planned merger is unclear. Yesterday, at a meeting of senior commission officials, many believed that there was little that Brussels will be able to do to prevent it. Officially the tie-up plans have not yet been notified to the commission so no view can be taken, but a spokesman for the EU's internal market commissioner, Charlie McCreevy, said he was "concerned about the spirit of the law", even if France was staying within the letter of the law while encouraging the merger.

There is a competition issue concerning Belgium, where Suez's Electrabel subsidiary dominates and GdF has an electricity power-generation joint venture. But under EU rules, because this is mostly about one national market, the clearance decision may be referred back to the competition authorities in Paris. In Britain, the only EU member state to have opened its energy sector entirely to outsiders - with the result that more than half the industry is now in foreign hands - events on the Continent have been met with a mixture of exasperation and resignation.

Centrica, which by coincidence already has a joint venture in Belgium with GdF and has long pressed for the full opening of Europe's markets, warned it would press for strict controls on the deal.

How much success it will have remains to be seen because similar protests about the proposed tie-up between Endesa and Gas Natural in Spain fell on stony ground, leaving Centrica with little option but to start thinking about withdrawing from the Spanish market.

National Grid said yesterday it, too, would love to enter the continental energy sector but a combination of the closed nature of the market in many countries and the absence of value-creating deals left it few opportunities.

For the commission, recent developments have been a wake-up call. In October last year, Tony Blair performed a sharp U-turn, coming out in favour of a common EU energy policy, something traditionally opposed by the UK.

Now at the top of the agenda, energy will dominate a summit of EU leaders next month in Brussels. Ahead of that meeting the European Commission will produce a Green Paper on the issue next week.

More embarrassing is the regulatory context. On 16 February, the European competition commissioner, Neelie Kroes, made a series of scathing criticisms of the EU's big energy giants. Without naming names she warned companies to "take a close look at their practices", since she was "just at the beginning of a period of more intensive anti-trust enforcement".

The result is that the companies, threatened with more liberalisation, scramble to consolidate. Worse, they have retreated into national markets. Following the Endesa-Gas Natural merger move, the French plans underline the emerging pattern.

The Brussels blueprint is for liberalisation to permit competition across national boundaries. It is happy to see the creation of European champions as long as they compete across borders. But Ms Kroes's report reveals how far away that vision is.

While naming no names, her document was an implicit attack on continental former monopolies such as Electricité de France, Germany's E.ON and Belgium's Sibelgas.

Ms Kroes's officials concluded that wholesale markets retain a high level of concentration, creating scope for operators to raise prices and that, because of barriers to new entrants, consumers lack choice. The document found little cross-border competition, with new firms unable to get transit capacity on key routes in the gas market and international competition in electricity hampered by lack of inter-connector capacity.

Former monopoly suppliers, she said, "retain a firm control of the liberalised markets". Little gas is traded on continental gas hubs and the big electricity players tend to control generation assets.

In the gas market, new entrants have trouble acquiring transit capacity on key routes; for electricity, "the inquiry shows an overall lack of interconnector capacity" with what there is "not fully available to new entrants". The commission also targets contracts that link gas and oil prices.

Reformers point out that there are precedents for successful liberalisation, pointing to the telecommunications market.

Two elements will determine whether Europe can produce a functioning, competitive market. The first is cross-border links to ensure competition between companies from different nations. Only heads of government can make this happen and the EU summit will illustrate if there is the will to go ahead.

The second condition is a regulatory framework to ensure companies cannot rig the market in specific countries. Ms Kroes's pledge to act against firms that abuse their dominant market position will be a test of whether those powers are in place.

As one official put it: "The credibility of the commission as a regulator is at stake. But it will be more difficult if the regulator is facing a network of national monopolies."