The worldwide phenomenon of energy liberalisation took another step forward last month with the agreement by European Union (EU) leaders to accelerate the opening of their gas and electricity markets to cross- border competition.

It was not a major advance, because French politicians could not risk offending union members of their state-owned gas and power companies in the run-up to elections.

Existing EU legislation was due to liberalise one third of the gas and power markets in several years time; this will now rise to around 60 per cent by 2004.

However, the move will keep Europe abreast, or even ahead of the global trend towards energy deregulation, which is now evident in the US, Asia and Latin America.

The aim of deregulation is to achieve lower prices or at least to drive out inefficiencies in gas and power by means of competition; because it is easier to transport, oil is traded in a world market that has long been competitive.

Its main mechanism is "unbundling" of all the various functions from generation, transport and distribution of gas and electricity to its eventual sale to factories and households.

Deregulation can, or should, only ever be partial. Power lines and gas pipelines are largely a "natural monopoly" because they cannot be duplicated endlessly. They therefore still require regulation to ensure that all power and gas providers have fair and equal access to them.

National regulators in the EU's 15 states are needed to ensure such access, a job done in the US by the Federal Energy Regulatory Commission (Ferc).

The actual state of deregulation on both sides of the Atlantic is also partial. In those EU states which stick to the minimum EU norm, households will not yet be free to choose their gas and electricity supplier. The US is at a similar halfway stage.

The Ferc has used its remit over wholesale electricity trading between generators and traders to deregulate but has to bow to the states on the regulation of retail power markets.

Only 24 US states are in the process of opening up retail markets. Others are pondering the lessons of California, where bungled deregulation caused blackouts in 2000-2001, and a few, like New Mexico, have put their deregulation plans on hold for five years.

Is partial deregulation a problem? Lop-sided liberalisation can certainly cause political tensions, as the example of Electricite de France (EdF) has shown.

EdF, the western world's largest electricity company with 55 nuclear power stations, has been able to make sales and acquisitions in liberalised neighbouring EU markets, while its home French market is largely off limits to its rivals. Spain and Italy in particular have complained about this lack of reciprocity. However, the EU Summit in Barcelona last month successfully pressed France to open its markets.

This situation is not entirely unknown in the US. Some competitors of the Atlanta-based Southern Company complain that it is encouraging states to resist regulation in areas where it has influence (such as Georgia, Alabama, Mississippi and the Florida panhandle) while at the same time making forays into deregulated markets further afield.

Southern says this lack of interest in the liberalisation in US south-east is not the result of its lobbying, but rather the already low cost of its nuclear and coal generated electricity. However, it does not baulk at being described as an American version of EdF.

Ideologically, Pat Wood, the Texan Republican appointed by President George W. Bush to be chairman of the Ferc, says he would like to see deregulation everywhere. The important thing, he says, is that wholesale markets should be subject to competition because 70 per cent of the cost of electricity comes from generation compared with 20 per cent from transmission and distribution and 5 per cent from retailing.

Another feature of deregulation is the strains it places on grids. Out goes the classic vertically integrated utility with its captive customers and in comes the energy merchant set on pinching his neighbour's customers. As energy companies win or lose customers through competition, so they have to buy or sell extra amounts of energy. Trading, therefore, is an inevitable consequence of deregulation and that is the reason why Enron, the failed US trader, was such an advocate of deregulation.

But the old grids in Europe and the US were not designed to carry large amounts of power across national or state borders. Only 8 per cent of EU electricity crosses national borders, while even the US has three separate grids - east of the Rockies, west of the Rockies and Texas.

Gas, whether in Europe or North America, has always been moved across long distances and therefore deregulation has brought less of a change. However, Finland and Greece are isolated from the rest of the EU pipe network. The European Commission has been lobbying member-states to fill in the physical gaps between their grids but has no power to order them to do so.

Weakly linked to the rest is the Iberian peninsula that has import capacity equal to only 2 per cent of total installed capacity. The UK (with 3 per cent) and Scandinavia (4 per cent) are in a similar situation.

The Ferc in Washington is in much the same position. While it has the authority to decide where natural gas pipelines will go, the siting of power lines is a matter for individual states.

However, the Ferc is trying to encourage the creation of big regional grids, run by Regional Transmission Operators (RTOs) which may be able to persuade groups of states to take the necessary joint decisions on where to put new inter-state power lines.

Some of these RTOs are working well. For instance, one grouping of Pennsylvania, New Jersey and Maryland appears to be particularly successful.

Deregulation by degrees

Deregulation also raises the old issue of energy security in a new form, which does not mean governments will abdicate responsibility for this to the private sector.

As a Ferc report quoted with approval in the UK government's recent energy review, put it: "The short time horizon and/or limited liability of private investors leads them to ignore the possibility of low probability, high consequence events like energy cut-offs."

Likewise, the European Commission's consultative document on energy security released in 2000 stated that it was "not seeking to maximise energy self-sufficiency or minimise dependence, but rather to reduce the risks linked to such dependence".

The US is more nostalgic about its former self-sufficiency, but has to face the reality of importing 52 per cent of its oil and 15 per cent of its gas. President Bush wants to increase domestic oil and gas output most controversially in Alaska but his ambition in this regard falls well short of Richard Nixon's energy proposal, "Project Independence", of 30 years ago.

Much of Mr Bush's plans seek to make better use of existing resources by plugging holes in the country's electricity grid or in its balkanised gasoline market.

Deregulation can create energy diversity and flexibility by multiplying the number of fuels or the sources of any one fuel.

Equally, however, the more uncertain commercial climate it brings may undermine the economics of two energy sources, nuclear power and renewable energies such as wind or solar power. These are largely home-grown energy resources, self-evidently in the case of renewables. Nuclear fuel often has to be imported, but it has many dependable sources and it is a minor element in the overall cost of atomic power. More importantly, these are two carbon-free energy sources and all industrialised countries will need them in order to combat global warming.

The nuclear sector has greatly improved its efficiency and economics of its existing reactors, especially in the privately-owned US industry where some of the world's most incompetent operators have turned into the most competent.

In liberalised markets, renewable energy is struggling. In the UK, windpower is penalised for being intermittent and in Denmark, where 18 per cent of generation is powered by renewable energy, it is now counting the cost of doing so. Its new conservative government has said it will axe three new windpower projects on grounds of expense.