Brussels says 17 EU member states including the UK have failed to fully implement measures designed to make their energy markets more competitive.
Some member states could potentially face large fines
The European Commission has put their governments on formal notice, the first step in an enforcement process which could see countries being fined.
Brussels said the countries had failed to ensure sufficient price flexibility, consumer choice and proper regulation.
States have until 2007 to open markets as part of a common energy strategy.
Brussels has begun legal action against most of the EU's 25 members - including the UK, Germany, France and Italy - for failing to ensure directives on opening energy markets to full competition were incorporated into national law.
In addition, it is taking Spain and Luxemburg to the European Court of Justice for failing to provide information about how they plan to implement EU directives.
"The member states must implement the directives on gas and electricity quickly and in full," said EU Energy Commissioner Andris Piebalgs.
Austria, Belgium, the Czech Republic, Germany
Estonia, Spain, Finland, France, Greece, Ireland
Italy, Lithuania, Latvia, Poland, Sweden, Slovakia, UK
Countries could potentially face heavy fines for violating EU law although the Commission could end up being challenged and taken to the European Court of Justice.
Brussels said not enough had been done to tackle unfair price controls which have favoured state-owned firms and harmed competition.
Other shortcomings highlighted were a failure to give consumers more choice and inefficient overall regulation.
Several European countries have backed the creation of so-called "national champions" - state-controlled companies with large market share - as a way of improving energy security.
But critics believe that state intervention and the dominance of state-owned firms is distorting open competition and forcing up prices.
The legal action was welcomed by UK business groups which have argued that uncompetitive practices on the continent have forced up prices for consumers.
"The Commission is to be applauded for backing its recent words with firm action against those who have been profiting from the current distorted environment," said Martin Temple, director of manufacturers' organisation EEF.
Brussels also signalled a crackdown on anti-competitive practices by states in other industries, including telecoms, aviation and gambling.
Energy markets are not functioning properly, Brussels says
Among a host of actions, it has told Portugal to give up its preferential shares in Portugal Telecom and insisted that Greece must recover illegal state aid given to national carrier Olympic Airlines.
Brussels has also asked France to explain why it passed a controversial decree in December giving the government the authority to block foreign takeover of firms in "strategic" sectors of the economy.
It has given Paris two months to clarify how its so-called strategy of "economic patriotism" - justfied on the grounds of national security - can be reconciled with the EU's single market.
Brussels said it was worried that French laws did not sufficiently recognise fundamental freedoms enshrined in European Union treaties.