The Quo Vadis Study on the EU Gas Regulatory Framework – What does it tell us? (and what not?)
By Gijs Kreeft, PhD
Researcher on the Regulation of Power-to-Gas at the Groningen Centre of Energy
Law
The absence of a legislative proposal on the
gas sector under the Clean Energy for All Europeans Package could be
interpreted as a regulatory standstill in the EU gas market. Nothing, however,
is less true. During the past 12 months, a deal has been struck between the European Commission and
Gazprom through which the Russian gas giant committed itself to tune down its
dominant behavior in Central and Eastern Europe, an information exchange
mechanism has been established with regard to agreements in the
field of energy by Member States with third countries (Decision (EU) 2017/684),
a new Security of Supply Regulation (Regulation (EU) 2017/1938) has been adopted, and amendments to the 2009 Gas
Directive have been proposed in light of North Stream 2.
Earlier, in 2016, the Commission already decided on revised exemption conditions for the OPAL
pipeline, capping the exemption for third party access at 50% of the pipeline’s
capacity. Besides these recent measures, the Commission is in a process of
looking beyond 2020 by exploring what long-term regulatory reforms are required
to improve the functioning of EU gas markets. Part of this forward-looking
process was the commissioning of a so called “Quo Vadis Study” on the EU Gas Regulatory Framework. After a long
period of consultations and stakeholder evaluations, this report, drafted by EY
and REKK, has now been made available to the public.
The Latin term “Quo Vadis” translates into “where are you going”? A Quo Vadis study
with the regulatory framework of the EU gas market as its focus is thus
intended to shine light on the regulatory path ahead. According to the report
itself, the objective thereof is to analyse whether the current regulatory
framework in the EU gas sector, assuming the full implementation of the Third
Energy Package and related gas Network Codes, is efficient in maximising
overall EU welfare, and to make regulatory recommendations. The strength of the
report lies in the first part, the analysis of the current EU gas market. The proposed
regulatory pathways are, however, characterised by stakeholders as somewhat
incomplete and unrealistic.[2] Admittedly, the issue of
incompletion is caused by the commissioned scope of the study, which is limited
to an assessment of welfare maximisation and lacks any reference to the future
role of gas in an increasingly electrified and decarbonised EU energy system.
What it tells us
First, what does the report tell us? The report
starts with an enquiry into the inefficiencies in the EU gas market. As
starting benchmark, it is stated that high-level price convergence is an
important sign of an integrated and well-functioning gas market, as this
illustrates that there are no serious trade barriers for transporting gas to
where it is valued the most. The provided analysis of the gas wholesale prices
of 2016 shows, however, that a significant price spread exists between
countries in the North-Western part of the EU, which can be regarded as one
single market, and those on the Eastern border of the Union. Several
inefficiencies are identified in the study as causing this spread:
i.
Lack
of competition in the (extra-EU) upstream sector, leading to higher wholesale
prices than in the US. Exposure to pressure from extra-EU suppliers differs per
EU Member State;
ii.
Lack
of (bidirectional) interconnectors. For example between France and Italy or
Poland and Lithuania;
iii.
Current
level and structure of cross-border tariffs which leads to “pancaking”, i.e.
the accumulation of tariffs when gas flows via multiple intra-EU
interconnection points;
iv.
Physical
and contractual congestion and market foreclosure (caused by long-term contracts).
Capacity hoarding and unused bookings by dominant suppliers may block access to
crucial interconnection points for competitors. As proof of such capacity
hoarding, the report refers to the PRISMA capacity auction in May 2017 where
Gazprom was the only party acquiring long-term capacity rights for the period beyond
2019 (notably, all this capacity was booked at the entry point of North Stream
2 and downstream pipelines such as the Gazelle);
v.
Local
regulation and limited transparency. This category points to a collection of
inefficiencies due to administrative costs, technical standards (such as gas
quality) which may hamper interoperability, and retail price regulation;
vi.
Network
operation inefficiencies due to the fragmentation between TSOs. According to the
report, this fragmentation results in cost-inefficient infrastructure
investment decisions.
Notably, the analysis in the study on the
effectiveness and potential of current regulation to remedy these inefficiencies
is rather positive. It is expected that most inefficiencies can be addressed
through Regulation 347/2013 on the guidelines for trans-European energy
infrastructure, the new gas security of supply Regulation ((EU) 2017/1938), the
network code on rules regarding harmonised transmission tariff structures for
gas (the TAR NC), the amended network code on capacity allocation mechanisms
(CAM NC), and the guidelines for congestion management procedures (SWD (2014)
250).
Nevertheless, the modelling of the EU gas
market in 2020 in which the Third Energy Package and Network codes are fully
implemented (the “2020 Reference” scenario) reveals that an increase in imports
due to lower domestic production and a growing reliance on spot contracts results
in more congestion. The authors of the report expect that, unless regulatory
reforms are undertaken, the shift from long-term to spot contracts will lead to
increased price spreads among EU Member States.
Four different pathways for regulatory reform
are present in the study:
i.
Tariff Reform Scenario: the pancaking of tariffs is
considered to be a barrier for the flow of gas from low-priced countries to
high-priced countries as it cancels-out the potential profit from spatial
arbitrage. Under this first scenario, the authors propose to abolish intra-EU
cross-border tariffs and replace these with higher tariffs at the EU
entry-points where gas is imported from outside the Union. The revenues then
need to be re-allocated among the different TSOs through a new TSO compensation
fund which would also pay for intra-EU infrastructure investments. As this
scenario is intended to level-out current price spreads, wholesale price levels
in current low-price levels (e.g. Germany and the Netherlands) will likely
increase;
ii.
Trading Zone Merger Scenario: this involves the merging of multiple
markets into a single market with one entry/exit zone, wholesale price, and the
abolishment of intra-zone tariffs. Voluntary and bottom-up market mergers, in
combination with the full implementation of third energy package, were also considered
the right way forward under the ACER European Gas Target Model. Notably, the Quo Vadis study, at
multiple occasions, states that voluntary mergers have until now been slow and
few. However, according to ACER, voluntary market mergers have already led to a
50 per cent reduction in the number of markets between 2006 and 2017 (54 versus
28)[2];
iii.
Combined Capacity-Commodity Release
Scenario: long-term
capacity bookings on intra-EU pipelines may lead to strategic capacity hoarding
by dominant extra-EU suppliers (read: Gazprom) to the detriment of their
competitors. As a result, only limited pipeline capacity remains accessible for
short-term trading, which negatively affects the flexibility of the gas
markets. This scenario proposes a so-called “50-50-50” reform. It simultaneously
proposes an increase up to 50% in the share of short-term transmission capacity
for both existing and new infrastructure (50-50) and an obligation for gas
producers/importers to sell at least 50% of their gas at the nearest Virtual
Trading Point when entering the EU (50);
iv.
Extra-EU Upstream – EU Downstream
Strategic Partnership Concept: this scenario is, at least for the moment, the most challenging from the
political point of view. I entails a cooperative concept in which the producing
country (Russia) agrees to liberalise its upstream sector in favor of increased
foreign investment and allows to apply the provisions under the Third Energy
Package to its export pipelines (e.g. North Stream 1 and 2). In return, the EU
will not set a cap on the share of Russian gas and will introduce a benefit
sharing agreement which allows Russia to share in the downstream welfare
benefits caused by the partnership compared to the 2020 reference scenario.
The stakeholder responses to the report have
been, for the most part, critical of the proposed scenarios.[2] The main point of criticism is that
the proposed reforms will bring about high transitional and institutional
costs, while the benefits presented in the study of implementing the different
scenarios compared to the 2020 reference scenario are considered to be rather
modest. Notably, the scenario which is expected to bring about the largest
increase in overall welfare is the Russia-EU partnership under the fourth
scenario. This scenario assumes, however, a political goodwill which is clearly
absent under the current EU-Russia relationship. Furthermore, the costs related
to the implementation of the different scenarios are for the most part
neglected.
The general sentiment among stakeholders is
that the focus for the short- to mid-term should rather be on the full and
coherent implementation of the third energy package and network codes. Also,
the stakeholders are more optimistic about the future occurrence of voluntary
market mergers under the current regulatory scheme than the authors of the Quo
Vadis Study.
As said, the strength of this report lies in
its analysis of the current EU gas market. It rightfully points to the dominant
position of extra-EU gas suppliers such as Gazprom and the lack of
(bi-directional) interconnection between certain market areas. These
efficiencies have, however, already led to the wide range of measures covered
under the introductory paragraph of this blog. In addition, the Commission has presented an EU strategy for liquefied
natural gas and gas storage which should mitigate the current dependency on
only a few supply routes. Together with a full implementation of the Third
Energy package and subsequent Network Codes, these measures should already for
a large part be capable of addressing the identified efficiencies by the Quo
Vadis study.
What it doesn’t tell us
As the scope of report is limited to welfare
maximisation, and thus price, the study only covers a part of the story which
will define the future EU gas market. The report states: “[t]he issue of inland gas production is beyond the scope of this
study, but institutional support of EU energy production, especially from
renewable resources (e.g. biomethane, power-to-gas) can be one of available
mitigation actions aimed at reduction of the EU imports needed” (p.98). The
role of renewable gas as alternative source of supply is, hence, not accounted
for. A recent report by ECOFYS illustrates, however, that alternative, sustainable,
and decentralised gas production options may play an important role in the
Union’s future gas supply by annually producing 122 billion cubic meters of gas
by 2050.[3]
A positive development is, therefore, the
European Commission's intention to carry out a study analysing the interactions
and possible synergies between inter alia
the gas and electricity sectors, as well as the prospects of renewable gases
and decarbonised gas.[4] This study will thereby assess what
role gas and the gas infrastructure can play in the decarbonisation process. With
these insights, a clear strategy can be developed on where the EU gas sector
should be going.
[4] Conclusions of the 30th Madrid Forum
of 19-20 October 2017, available via link
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