The European Union Legislation on Gas - Term Paper Example

THE ANALYSIS OVER THE EXEMPTION REGIME UNDER THE CURRENT EU LEGISLATION (THE GAS DIRECTIVE): WHAT ARE CHALLENGES AND CONCERNS OF THE EU IN PROMOTING THIRD PARTY ACCESS IN LNG TERMINAL? ABSTRACT: This article is an attempt to remove the ambiguities in the EU gas market by making an attempt to know the current practices and challenges faced by the regulating agencies. Required conditions to the opening of new LPG terminals have been analysed through the actual working of the internal market in the light of the exemptions granted under the current EU legislation. A lot of work needs to be done by the regulators to promote competition, develop internal market and for ensuring the security of supply and making the market mechanisms robust for the benefit of all stakeholders. TABLE OF CONTENTS TABLE OF ABBREVIATIONS............................................................................................ ..iii 1. BACKGROUND INTRODUCTION................................................................................................4 1.1 First Gas Directive……………………………………………………………5 1.2 Second Gas Directive…………………………………………………………5 2. Regulation of Gas in Europe…………………………………………………… 6 2.1 Regulatory Challenge before the EU………………………………………… 6 3. Access to Existing LNG Terminals in the European Union Current Practice 3.1 Conditions to New LNG Terminals…………………………………………...8 4. The Concept of LNG Storage………………………………………………… 11 5. Exemptions in Practice…………………………………………………………12 6. Measuring Regulatory Risk……………………………………………………13 7. Measuring the Role of the Security of Supply………………………………...14 8. Impact on Market Competition………………………………………………..15 9. Relevant Markets……………………………………………………………….16 10. Competition Analysis…………………………………………………………...17 11. Conclusions……………………………………………………………………...17 Bibliography……………………………………………………………………………19 TABLE OF ABBREVIATIONS CEER Council of European Energy Regulators EU European Union GTE Gas Transmission Europe LNG Liquefied Natural Gas RTPA Regulated Third Party Access TPA Third Party Access TSO Transmission System Operators UK United Kingdom USA United States of America 1. BACKGROUND INTRODUCTION The European Union (EU) legislation on gas industry was offered by the Commission Working Document ‘The Internal Energy Market’ (CEC, 1988) enabling the crossover of internal market to gas industry. The purpose was to make the existing market structure compatible to competition in the energy sector (Correljé et al., 2003, p. 135)). This document was the first step to neutralise the monopoly in gas industry. Liberalising the internal market was at that time was a daunting task as the industry was against this step for the reason that it could affect their profit margin. There was fear of antagonising the industry and trade unions. Benefits of liberalisation were not sure. Other concerns of the member states were related to security of supply and public service duties. Next in line were Price Transparency Directive and Electricity and Gas Transit Directives. In comparison to gas industry, the electricity industry was faster in market liberalisation, so for each of them different approaches were needed (Stern, 1998, pp. 90-92)). Member states in the gas industry were also not willing to liberalise the gas market lest it might loosen their grip on the economy. Actually, each member state of the European Union had its individual market structures created by its specific conditions like its resources, spatial distribution of activities and production, reach to technology, political likings, role of its institutions and market condition (Spanjer, 2008, Pp. 80-81). Other than the obstacles created by the member states and the private players in opposing liberalisation of the gas market, it should be recognised that it was not an easy task to regulate the market in a situation where chances of failing the objectives were maximum. 1.1 First Gas Directive A specific regime of common legal framework was laid down by issuing the first gas directive in 1998 to propose an alternative to traditional market structure. It was deemed necessary to open the market in stages, bringing the third party access (TPA) into the system and inaugurating the competitive and non-competitive activities. The first gas directive didn’t resolve all issues; implementation of the gas directive was not unanimous by member states, access regimes were not same for all member states and market powers were of high level (Cameron, 2005, p. 9, 10, as cited by Spanjer, 2008, p. 90). 1.2 Second Gas Directive The second Gas Directive was necessitated to develop a fully functional gas market and was issued in July 2003. It was meant to stop member sates running and safeguarding their own gas markets. It recommended changes in the market opening process, TPA and unbundling features. There was one exception to the storage rule in the second Gas Directive related to Liquefied Natural Gas (LNG) facilities of ancillary services and temporary storage. These facilities were necessary for re-gasification and later on gas delivery to the transmission system under the RTPA regime (Article 19(2)). Some storage facilities were to be exempted from the TPA; it was put under the non-legal provisions that storage facilities were especially kept aside for transmission system operators (TSOs) and for production functions to be exempted from the TPA provisions. 2. Regulation of Gas in Europe Regulation of gas in Europe is a big issue; more than 60% of consumed gas crosses at least one country’s border to reach the end user. It is because gas resources are not distributed evenly throughout Europe. Gas needs to be passed through transmission systems before reaching the consumers covering long routes to reach destinations. There are technical, political and institutional reasons against the setting up of a single European gas market (Arentsen, 2004, p. 69). 2.1 Regulatory Challenge before the EU It is a big challenge to unite the working of European pipeline system and possess the logistic capability to enter into long-term contracts. Transmission companies have been using their own terms of access and tariffs; it is the most alarming bottleneck in the cross-border gas flow. These transmission companies have not provided any justification for charging tariffs on their own terms. The EU has pointed towards the TPA terms of big European gas transmission companies. As per the European Commission’s revised document dated November 9, 2000 standardisation is the minimum applicable condition for a comparison between the applied access systems in Europe. System operators had been using various balancing regimes like hourly versus daily and fines. No information was given on available capacity besides there was no clarity on terms of access. Further, cross-border transmission of gas added the cumulative costs known as ‘pancaking’, which happens when a transmission company involves more than one system if (i) unexplained costs are added and/or (ii) network users have to pay for the part of the system they haven’t used because of swaps happening ‘on the way’ from the point of input to the point of outtake, as stated in the strategy paper drafted for the Joint Working Group of the European Gas Regulatory Forum of the 4th meeting of the Madrid Forum on 2-3 July, 2001, p. 17. As it comes out, the harmonisation of the gas market is a very complex and critical issue. In the Madrid forum all stakeholders were present including the Gas Transmission Europe (GTE) the group of European system operators and transport companies and the Council of European Energy Regulators (CEER) bringing together the European gas market regulators (Arentsen, 2004, Pp. 98-100). It is not that only the legal regulatory reform needs to play its part in the harmonisation of the internal gas market but other stakeholders like economic and political forces, consumers, the European competition authorities and political pressure from the European Union should also induce the harmonisation process (Arentsen, 2004, p. 103). 3. Access to existing LNG terminals in the European Union – Current practice Currently, re-gasification terminals are run by LNG system operators. According to EC law, “LNG system operator is a natural or legal person who carries out the function of liquefaction of natural gas, or the importation, offloading, and re-gasification of LNG and is responsible for operating a LNG facility”. The LNG system operator is duty bound to run, upkeep and develop the LNG facilities. He is bound to be impartial in either serving to the system users or other segments of system users. Being a part of the company, he cannot make favours to the associate companies; the system operator is bound by duty to provide all necessary information to create confidence in the efficiency and effectiveness of the system and share all information with the user of the system for effective use of the system (Talus, 2009). All parts of the gas supply chain including the LNG facilities, transmission and distribution systems are charged published tariffs. EU-member states can only charge excess tariffs from the shippers, given that the national regulatory authority has given permission as per the Gas Directive and has made the information public before their application. Access to the facility i.e. the LNG terminals can only be denied only when the capacity is full or it might come in the way of public service obligations. Chances of such a situation are few in re-gasification terminals than with crucial pipelines or interconnectors. Only serious financial problems can otherwise come in the way of not obliging access to the LNG facility. Some times the technical and available capacity of gas can create problem as there are three processes namely, unloading, storing and send-out that require vaporisers and pumps. The transmission capacity of the pipeline can create problems as well. It can be a possibility that the available capacity of the LNG terminal is fully used and the importer is unable to use it. In that case, the crucial solution could be building a new terminal (Talus, 2009). 3.1 Conditions to New LNG Terminals The tradition of entering into short-term contracts or spot contracts has also affected the capacity of LNG terminals other than the reasons stated above. In that case to ensure commercial viability of the operations for market access a new re-gasification LNG terminal can be built to offer the importer of gas use the whole facility or a part of it. Rest of the part not used by the importer can be allotted to third parties as per the access rules (Talus, 2009). As per the article 22 of the Gas Directive, a LNG facility can be exempted from the applied third party access rules and tariff systems on the condition that (a) the investment would for sure boost competition in gas supply and ensure safe supply; (b) it would be mandatory to grant exemption keeping in view the level of risk associated with the investment; (c) the facility must be possessed by a legal entity who is different from the legal type of the system operators under whose infrastructure the facility would be constructed; (d) only users of the facility would have to pay for using it; (e) the exemption won’t affect competition, the efficient working of the internal gas market or the effective working of the regulated system to which that facility or infrastructure is attached (Talus, 2009). Another possibility to ask for an exemption can be in case the capacity of the current facility has increased or due to some changes it can develop new sources of gas supply. In LNG re-gasification terminals, such addition of the new resources of gas is possible. Other than the above stated reasons for granting exemption to a facility on the conditions that it must encourage competition in gas supply and ensure security of supply, an exemption is normally not provided so that the facility might not become prominent or the exemption might decrease the chances of downsizing the current formidable positions or such an exemption might decrease the scope of building a similar competing facility i.e. LNG. The investor needs to justify that the level of risk in investing is so high that demands the granting of exemption from the applied third party access rules and tariff systems (Talus, 2009). Further, according to the principle of proportionality, the limits on the conditions of time and scope of the exemption should match with the level of risk. As exemption is not a routine practice as it is against the general rule, it should be used scarcely. Level of risk can be measured by factors that affect the cost of the facility, the return on the investment, the expected amortisation time and the cost of capital. Other than these risks to the investment, the investors need to show the real risks related to their project which could be business risks, technical, governance related or political (Talus, 2009). The condition that the investor needs to be a legal person other than the national transmission system operator (TSO) can be met if the investor is not the TSO or the investor TSO has initiated a separate company to run the project and the exempted part of the supply chain. It is related to the condition that charges must be made by the users of the infrastructure. These conditions also imply that exempted part of the facility from price control should not have underwritten costs via regulated charges (Talus, 2009). The final condition is that the exemption should not be damaging to competition, the internal market and the system controlling the related infrastructure. Any exemption granted is not automatic to the whole facility; it can be partial to be applicable to the new capacity only. Duration of the exemption is decided by the authority on the conditions met regarding impartial use of the capacity by inspecting the additional capacity, its time duration and the national circumstances. Authority can frame rules on the distribution of the additional capacity in so far it does not come in the way of fulfilling long-term contracts (Talus, 2009). 4. The Concept of LNG Storage The concept of liquefied natural gas storage was introduced in the European Gas Directive of 2003. The purpose behind was to provide free access and promote competition in the market but due to lacking in clarity on the definition and scope of LNG storage, the concept has not been fully examined on how to provide temporary storage needed for the re-gasification process and later on delivered to the transmission system. There are identified technical benefits of LNG storage in the European gas market, which need to be exploited. The LNG storage according to Article 19 of the Gas Directive has two types of facilities: (1) Open access LNG storage facilities that are a technical and/or economic necessity for offering effective access to the system for the supply and (2) Non-open-access LNG storage facilities that are not necessary for technical and/or economic reasons to make access to the system for the supply. Other than the sole purpose of storage, the LNG storage is needed for production and transmission also. Actually, the regime of LNG facilities does not cater to its storage needs. There are reasons behind the absence of any straightway definition and scope of storage in the Gas Directive. Discussing them in detail is out of the scope of this question but the regulators need to define the scope of LNG storage and temporary LNG storage in the Gas Directive. The ongoing practice of LNG storage is insufficient. The whole concept of LNG storage needs to be defined and worked out in the European context. Further clarification of the statement ‘temporary storage necessary for the re-gasification process and subsequent delivery to the transmission system’ is necessary in the context of the European gas market to avail the benefits of the LNG storage (Gao, 2008). 5. Exemptions in Practice Since the coming into force of the Second Directive in July 2003, exemption has become a practice to major LPG infrastructures from third party access. So far six applications have been granted exemptions under Article 22. EC didn’t put any hold on their approval. A number of projects are in the UK: three LNG terminals in Dragon, South Hook and Isle of Grain and an interconnector between the UK and the Netherlands. The other two projects granted exemptions are located in Italy (Rovigo and Brindisi) (Hernandez & Gandolfi, 2005, p. 3). An analysis of the various exemptions points out towards the three characteristics that connect to conditions (a), (b) and (e). Security of supply is the foremost condition guaranteed to be adhered to as most of the to be developed infrastructures have been marked on the top of the preferential list under the trans-European energy network programme; The alternative projects ensure a greater degree of competition for the supply to reach the destination. It would increase the risk of recovering cost under a regulated third party access system; New players’ entry in the market would have no bottlenecks or there would be no worth-mentioning increase in the power of present operators. The characteristics stated above necessitate the need to exempt new infrastructures by the regulators, namely Ofgem in the UK and AEEG in Italy so that these developments add to the competition in the LPG utility market. The conditions: (a) (b) and (e) are necessary to be met for granting exemption to future infrastructures. Analysis of such issues of economic significance is helpful in mapping the infrastructure by the investors and the regulators. 6. Measuring Regulatory Risk It needs to be observed that the investments granted exemptions are of new type and are unregulated. These investments include also international pipelines joining two or more nations having distinct governed TPA systems. Already some infrastructure projects are being run under a regulated TPA regime. Regulatory risks for the future projects can not be fathomed in advance but some of the risk factors can be related to the following: The cost and the related risks to the investment; Regulatory limitations on permitted profits and creating of user tariff both of which could be decisive to recovering cost, thus creating the risk; The presence of competing infrastructures, generating risk to the profit margins of the project in question; Regulatory limitations on the building capacity of the alternative project making it unprofitable. All the above risk factors need to be considered and analysed before investing in such a project if it ensures long-term contracts between the owners and the users. Further, it needs to ensure that the income generated would be equal to the total project cost in addition to the rate of return on the project (Hernandez & Gandolfi, 2005, p. 3). 7. Measuring the Role of the Security of Supply As per the exemption condition (a), the security of supply needs to be guaranteed by the owner investor. So the application for exemption needs to “provide a comparative and quantitative analysis of the security of the supply position with or without the piece of infrastructure in question and identify the likely outcome if the project did not proceed, including the likely alternatives to the investments”. Thus, first of all an analysis needs to be made of the fact whether the currently functioning gas injecting infrastructure fulfills the long-term gas consumption requirements with a reasonable security margin without considering the new investment in question and other competing projects. Such an analysis will help in judging the timing and size of the upcoming facility. Next consideration needs to be made of the demand fulfillment of the upcoming investment. The proposed infrastructure might carry with it the comparative advantage of base-load capacity and/or peak capacity; the timing of the upcoming infrastructure to start functioning; its nearness to current gas flows; and the normal financial advantages accruing from more costly upcoming capacity (Hernandez & Gandolfi, 2005, p. 4). Besides, the upcoming infrastructure needs to be evaluated of the effect the diversification of gas supply will have as for a re-gasification project, the extent to diversify depends on the agreements ideated for the supply of LNG to the infrastructure and the current supply obligations. For an import pipeline, the extent of diversification depends on the availability of physical connection from the plant to the source of gas, which earlier was not available or had a limited market share (Hernandez & Gandolfi, 2005, p. 4). 8. Impact on Market Competition The two competition requirements made clear by DG Energy and Transport that an incumbent investor should fulfill is increased competition in gas supply. For example a particularly dominant player holding sufficient capacity cannot get exemption to the alternate facility although it may help the investor to compete better. Another after-effect should not result in any harm to the competitive environment of the relevant markets. Fulfilling of this condition depends on the current limit of competition. For example, if the market is fully competitive, there is less scope of an infrastructure project exempted from TPA of having a crucial impact on competition and new entry as access via other facilities can be made. On the contrary, in a highly focused market without access, a project initiated by the investor would be seen as hindering competition and entry. It can be accrued that two main issues need attention to evaluate competition: finding all relevant markets to prove the point that infrastructure promoters and capacity users can use the market power to raise prices and the other issue is analyzing the existing and future state of competition in all related markets with or without the projected investments (Hernandez & Gandolfi, 2005, p. 5). 9. Relevant Markets Relevant markets are related to transmission capacity and wholesale gas. Vertically related markets can also be affected by operating new LPG terminals. They need to be analysed specifically markets where gas is a major input. The adherence to EC competition rules is mandatory to remove chances of any misuse of power by the new infrastructure. In Europe, the transmission capacity tariffs are regulated. Opening of any new LNG terminal, if exempted, would be under Article 22 and could be carrying a different price other than the regulated tariffs of other similar projects. Access price for long-term contracts might quote higher prices in future in comparison to short-term rates based on the sales capacity because of competition. Regulators may see it as a risk to say no to exemption or may apply rules to minimize the foreseen risk (Hernandez & Gandolfi, 2005, p. 5). Article 22 permits the regulatory authorities to frame rules and devise mechanisms for the distribution of capacity to the new LPG terminals, “in so far that this does not prevent the implementation of long term contracts”. The experience of the US long term tradable contracts for gas transmission capacity in this regard can be helpful for the European investors as it puts together the safe funding for investors with potential to enter the short-term market by any one (Hernandez & Gandolfi, 2005, p. 5). 10. Competition Analysis Any investor needs to make a competitive analysis of all relevant markets through quantitative indicators and qualitative considerations of its hold on the market. It requires proof of (1) entry bottlenecks arising out of available extra capacity in import facilities; (2) the presence of competing projects; and (3) the changing customer interest. Further, fear of the market an be minimized with the proof of the existence of the commercial structure and terms of contract are open and impartial like open season distribution of starting capacity rights, trading of main capacity rights and use-it-or-lose-it mechanisms (Hernandez & Gandolfi, 2005, p. 5). 11. Conclusions The concept of regulated third party access set by Directive 2003/55/EC has been reinforced with the Article 22 and procedure followed in applications for exemption from tariff to the newly developed liquid petroleum gas terminals. Regulated TPA based on yearly tariffs can occur in monopoly conditions. Market mechanisms can not function freely as systems are not robust enough to guarantee unbiased and competitive market conditions. On the other hand where there is competition in LPG projects, Article 22 permits settled access and long term contracts as the most preferred way of arranging finance for such gas capacity building projects (Hernandez & Gandolfi, 2005, p. 6). Some projects that were granted exemption had accomplished the purpose of building Trans-European networks and have long been recognized by the EU. The process of exemption from the regulated TPA is decided by the regulating bodies by differentiating between original essential infrastructures and projects open to competition. As in future such infrastructure needs of European projects will be facing competition, all stakeholders – investors, consumers and users – can avail the benefit of regulatory decisions by fulfilling the conditions laid down in Article 22. BIBLIOGRAPHY Book Arentsen, Maarten J. 2004, ‘Politics and Regulation of Gas in Europe’ in Finon & Midttun (eds.), Reshaping European gas and electricity industries: regulation, markets, pp. 69-103. Available from: http://books.google.co.in/books?hl=en&lr=&id=DpDUcJcC9_UC&oi=fnd&pg=PA69&dq=related:cFcG7nH7dSsJ:scholar.google.com/&ots=6gn3H5EQj0&sig=_JwEPIQNLUUyWQS1UADEkZRHc8k#v=onepage&q=&f=false [Accessed 19 January 2010]. Internet Sources Hernandez, Fabrizio & Gandolfi, Monica 2005 ‘Energy regulation insights: how markets work’, NERA Economic Consulting, July 2005, issue 24. Available from: http://www.nera.com/NewsletterIssue/ER_Insights_Issue24_7.2005.pdf. [Accessed 19 January 2010]. Gao, Ming-Zhi Anton 2008. ‘The Discovery of the concept of LNG storage in the European Gas Directive’, Institute of Energy and Environmental Law, July 21, 2008. Available from: http://ssrn.com/abstract=1167795. [Accessed 19 January 2010]. Spanjer, Abdelkader Rainaldo 2008. ‘Structural and regulatory reform of the European natural gas market: does the current approach secure the public service obligations?’, 10 September, 2008, p. 80-90. Available from: https://www.openaccess.leidenuniv.nl/bitstream/1887/13356/1/Manuscript+definitief%2C+09-10-08.pdf. [Accessed 19 January 2010]. Talus, Kim 2009. ‘Access to gas markets: a comparative study on access to LNG terminals in the European Union and the United States’, Houston Journal of International Law. 22 March, 2009. Available from: http://www.thefreelibrary.com/Access+to+gas+markets:+a+comparative+study+on+access+to+LNG+terminals...-a0201029463. [Accessed 19 January 2010]. Read More