European Union and the liberalization of the energy market

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1 11.1 European Union and the liberalization of the energy market Introduction The impact of European Union (EU) law on the hydrocarbons sector has differed considerably between oil and gas. The oil market is global in character and has long been subject to competition. Legal action to promote liberalization in EU oil markets has therefore been deemed unnecessary. There are two exceptions to this. Firstly, in the market of petroleum products, the European Commission (hereafter the Commission ) used its powers under art. 31 of the EC Treaty 1 to pursue the dismantling of oil products monopolies in France and Greece during the 1980s. 2 This pre-dated the current drive for an Integrated Energy Market (IEM) that began with the White Paper of 1988, 3 and, though taking a very long period of time, was largely successful. The second exception was the hydrocarbons licensing legislation, which is examined below. This formed part of the IEM programme and was one of the first legal measures that it introduced. For the gas sector the situation is more complex. Firstly, the sector has an international character with the bulk of supplies coming from non-eu countries on the basis of long-term contracts, though it is much less exposed to competition in pricing than the oil sector. Secondly, there are elements of natural monopoly in the high-pressure pipeline network that impose limits on the scope of competition. Finally, gas operations have a vertically integrated character from production to consumption (the so-called gas chain). This means that regulatory action in one segment of the chain can easily have an impact on other segments. When the IEM programme began in 1988, the gas sector came under scrutiny by the Commission mainly because of the exercise of monopoly power in the transmission and distribution segments of its operations. However, legislation designed to liberalize these segments has usually had significant implications for the upstream activities of exploration and production as well. The sections below examine firstly the EU Hydrocarbons Licensing Directive (EC) 94/22/ and secondly the rules introduced for the gas sector through Directive CEE 2003/55/, which provided common rules for an internal market in gas and replaced earlier legislation on the subject. The supplementary rules introduced for network access through the gas regulation are also discussed. 4 Finally, there is a brief examination of the impact of primary EU law on the hydrocarbons sector, where the rules of competition law have increasingly played a complementary role to the Directives in the liberalization process Hydrocarbons licensing Directive 94/22/EC The conditions for access to hydrocarbons and their management are governed by Directive (EC) 1 Art. 31 requires member states to progressively adjust state monopolies of a commercial character through which a member state supervises, determines, or appreciably influences imports or exports between member states. This is enforced by the Commission. 2 Sixth Report on Competition Policy (1977), points (France); Commission v. Greece (1990) Court of Justice of the European Communities, case C 347/88, ECR The internal energy market, COM (1988) 238 final, 2 May Regulation (EC) No. 1775/2005 of the European Parliament and of the Council of 28 September 2005 on conditions for access to the natural gas transmission networks, OJ L 289/1, VOLUME IV / HYDROCARBONS: ECONOMICS, POLICIES AND LEGISLATION 591

2 SUPRANATIONAL LAW 94/22/CEE (the Hydrocarbons Licensing Directive and from now on to be referred to as Directive ). 5 This framework Directive has its roots in the widespread use of discriminatory provisions by member states to limit access by foreign companies on the one hand, and a lack of transparency in hydrocarbons licensing procedures on the other. For many years there had been mandatory landing obligations and rights of first refusal to produced hydrocarbons, which were frequently enjoyed by state monopolies in exploration and production. However, because of the uneven distribution of hydrocarbons in the EU, these practices were evident in only a few of the member states usually those with offshore petroleum deposits. Although this use of discriminatory provisions appeared to be in decline by the late 1980s, it was nevertheless clearly inconsistent with the framework of rules being developed for the IEM. The Directive was adopted on 30 May The objectives The declared objectives of the Directive are to set up common rules to ensure that: procedures for granting authorizations to prospect or explore for and produce hydrocarbons are open to all entities that possess the necessary capabilities; authorizations are granted on the basis of objective, published criteria; the conditions under which authorizations are granted are known in advance by all entities taking part in the procedure. Transparency and non-discrimination are central to the achievement of these objectives. The Directive rests on a careful balance between respect for the member states rights based on sovereignty and the Community interest in the way in which those rights are exercised. It avoids the path of detailed regulation in favour of establishing a framework of general principles to which the rules made by member states must conform. In line with the principle of subsidiarity, each member state remains free to choose or to maintain the rules that it considers most appropriate to its natural and operational circumstances, as well as its national policies on resource management. The approach taken by the Directive involves the establishment of common rules but in a way that is quite distinct. It resembles the focused approach followed by the Directives on public procurement contracts, rather than the broader approach of the two Directives on common rules for the electricity and natural gas sectors. This reflects its origins in an attempt to achieve its aims through the public procurement arrangements provided for under art. 3 Utilities Directive (EEC) 90/531/CEE, since repealed by Directive 2004/17/EC. 6 The provisions of the Directive do not directly affect the sovereignty or sovereign rights of member states over hydrocarbon resources within their territory. Member states retain their rights and responsibilities with respect to the management of hydrocarbons, including revenues that arise from their development. In particular, they retain the right to decide: a) which areas must be opened for exploration and production; b) the level and the rates of tax, royalties and other revenues such as those arising from state participation; c) who the licensees will be; d) how their activities are to be monitored. The Directive expressly gives member states the right to be involved both in areas of public policy including the central one of depletion policy and in the protection of the member state s financial interest (art. 6.2). Common rules Award of licences It is required that the procedures for authorization applications be publicized. Three conditions are set out to ensure that procedures are transparent and objective (arts. 3 and 4): firstly, decisions must be based on objective, pre-established criteria, published in advance. Secondly, all general conditions and obligations imposed on undertakings must be established and made available to entities before applications are submitted. Thirdly, criteria, conditions and obligations must be applied in a non-discriminatory way. The kind of procedures that are permitted include the concession or licensing system (authorizations granted administratively or by auction after the member states have published a notice in the Official Journal), and the open door system (authorizations granted on a permanent basis for a pre-declared territory). Individual awards are also possible. 5 Council Directive (EC) 94/22/CEE on conditions for granting and using authorizations for the prospection, exploration and production of hydrocarbons, OJ L 164/3, The Directive of the European Parliament and of the Council of 31 March 2004 coordinating the procurement procedures of entities operating in the water, energy, transport and postal services sectors, OJ L 134/1, This measure applies to the exploration and exploitation of both oil and gas: see art. 7(a) and Annex VII. Also relevant is Commission Decision 2005/15 on the detailed rules for the application of the procedure provided for in art. 30 of Directive (EC) 2004/17/CEE of the European Parliament and of the Council co-ordinating the procurement procedures of entities operating in the water, energy, transport and postal services sectors, OJ L 7/7, ENCYCLOPAEDIA OF HYDROCARBONS

3 EUROPEAN UNION AND THE LIBERALIZATION OF THE ENERGY MARKET Some examples of member states efforts to comply with these provisions include the following: The United Kingdom made an announcement of an out-of-round offer of blocks for on-land territory summarizing the conditions. Germany made a formal declaration in accordance with art. 3.3 stating that the entire area of Germany (except where there are individual authorizations) was available for licensing within the meaning of art Ireland published a notice stating that all areas of the Irish offshore were permanently available for licensing (with a large number of exceptions listed by block number). France issued a notice defining the geographical areas available for hydrocarbons prospecting and setting out the procedure to apply for a prospecting licence. The principles of transparency, objectivity and non-discrimination must be met in the criteria on which decisions on applications for authorizations are made (art. 6). The criteria must be based on the financial and technical capability of entities and on the manner in which they propose to prospect, explore and bring into operation the area in question. They must be published in the Official Journal. Denmark obtained a derogation from this provision in connection with an authorization with a 50-year term that had been granted in 1962 (art. 13). State participation The aim of the detailed provisions on state participation is to ensure that if a member state wishes to link the grant of a licence to state participation, it may do so. It may also manage such participation, directly or indirectly. However, the member state is required to ensure that the principles set out in the Directive, especially those of transparency, non-discrimination and equality of treatment are respected (art. 6). 7 Participants other than the state should not be subject to undue pressure. The state is required not to be party to information nor exercise any voting rights on decisions regarding sources of procurement for entities. Moveover, it shall not exercise majority voting rights on other decisions. In addition, the state or its legal representative shall not prevent the management decisions of the licensee company from being taken on the basis of normal commercial principles. Voting by the state or its legal representative must also be based on transparent, non-discriminatory and objective principles. Much of the above, set out in art. 6.3, subpara. 2, was designed to meet the Danish insistence on a continued state presence in the exploration and production of hydrocarbons while ensuring that the Directive s principles were respected. By contrast, an earlier United Kingdom (UK) experiment with state participation had been abandoned by this time. Another member state, the Netherlands, had concerns that the state should be able to influence depletion policy and to protect the state s financial interests. This led to art. 6.3, subpara. 3 which provides that the state or its legal representative may oppose a decision by the licence holders if such a decision does not respect the conditions and requirements on these matters as they are set out in the licence. The state as the public authority may also impose conditions and requirements on the exercise of licence activities based on specific public interest reasons such as national security, public safety, public health, security of transport, protection of the environment, protection of biological resources and of national treasures possessing artistic, historic or archaeological value, safety of installations and of workers, planned management of hydrocarbons resources (depletion rates or optimizing recovery) or the need to secure tax revenues (art. 6.1). The final subparagraph of art. 6.3 concerns the situation where the state company is also a licence holder. It was developed to meet the demands of Norway, which was present as an observer in anticipation of its future accession to the EU (this plan was subsequently withdrawn, following a domestic referendum result in 1994). While rejecting a proposal to divide the Norwegian state hydrocarbons company, Statoil, into two separate parts, it accepted a provision to create a division or chinese wall between its business activities and its role as manager of the state s participation interest. In particular, it required that no information should flow from the part responsible for the management of the state s participation share to the part that holds licences in its own right. This could be circumvented, however, if the manager of the State participation share engages the part of the licence holder as a consultant. In such cases, information necessary to carry out such consultancy activities may be handed over. Article 6.4 imposes a general constraint upon the monitoring of licensees by member states. This is limited to what is necessary to ensure compliance with the conditions, requirements and obligations following the grant of a licence. The thrust of this, however, is concerned with avoiding any 7 See generally on the British National Oil Company: Cameron, Property rights and sovereign rights: the case of North Sea oil, London, 1983, pp VOLUME IV / HYDROCARBONS: ECONOMICS, POLICIES AND LEGISLATION 593

4 SUPRANATIONAL LAW requirement to provide information on actual or intended sources of procurement. Article 7 requires member states to abrogate legal, regulatory and administrative provisions reserving the right to obtain authorizations in a specific geographical area within the territory of a member state to a single entity. Such exclusive rights conflict with the principle of equal access to resources and were to be abolished by 1 January Essentially, this article addresses a specific problem faced by Italy over authorizations held by the then state-owned entity, Eni. The Commission is required to monitor the treatment of EU entities in third countries to ascertain whether they receive treatment comparable to that which is granted to entities from the same third countries in the EU (art. 8). The Directive lays down a procedure for evaluating this situation and, if the need arises, for initiating negotiations with third countries to establish reciprocal rights. Links to other legislation: procurement The Directive establishes a link in art. 12 with the relevant public procurement legislation. A member state is automatically allowed to utilize the alternative regime in relation to upstream markets in that legislation, once it has implemented the Hydrocarbons Licensing Directive in its national law (that is, implemented in national law by 1 July 1995). The relevant legislation has been modified during the life of the Hydrocarbons Directive. 8 Under the current arrangements there is a general procedure allowing for exemption of sectors directly exposed to competition. This has to be without prejudice to the four Commission Decisions that grant special exempted status to the exploitation of geographical areas in the Netherlands, the UK, Austria and Germany. 9 If a member state has implemented and applied the Hydrocarbons Directive, access to a market is not deemed to be restricted, 10 and contracts in the hydrocarbons sector may be subject to special arrangements. However, member states are required to ensure that any entity operating in the hydrocarbons sector observes the principle of non-discrimination and competitive procurement in respect of the award of supplies, as well as works and service contracts. This is especially with regard to the information which an entity makes available to economic operators concerning its procurement intentions. These are admittedly vague notions and there is no definition in the Directives or other guidance of what exactly they should entail. Such entities also have to communicate to the Commission information relating to the contracts that they award. Implementation Member states were required by art. 14 of the Directive to adopt the necessary legal, regulatory or administrative measures to comply with it by 1 July 1995, and to inform the Commission of the fact. The Directive s operation was the subject of some scrutiny in The conclusion was that its provisions were being implemented correctly. In four years of operation, no reciprocity problem had been detected, not least because the Directive was operating in a context of progressive international opening-up of hydrocarbons exploration and production. Neither the oil companies nor the entities in the member states reported any discriminatory treatment and no entity had complained directly to the Commission. All of the member states except Finland and Luxembourg which have no commercial hydrocarbon deposits had transposed the Directive into national law. Norway, acting through the European Economic Area (EEA) Agreement, has also transposed its provisions into national law. The Directive was adopted after the Treaty of European Union entered into force and was therefore made subject to the co-decision procedure with Parliament for the last stages of its passage. The inclusion of natural gas in this Directive (being subject to similar physical, technical and legal conditions as oil) ensured that the first Gas Directive on common rules for the natural gas sector (under discussion at that time) would be limited in scope and would exclude production. This approach was continued with the second Gas Directive. 8 Originally, this was art. 3 Directive (EEC) 90/531/CEE, then Directive 93/38/CEE, now repealed by Directive (EC) 2004/17/CEE of the European Parliament and of the Council of 31 March 2004 co-ordinating the procurement procedures of entities operating in the water, energy, transport and postal services sectors, OJ L 134/1, This applies to the exploration and exploitation of both oil and gas: see art. 7 (a). Also relevant is Commission Decision 2005/15/EC on the detailed rules for the application of the procedure provided for in art. 30 Directive 2004/17/EC of the European Parliament and of the Council co-ordinating the procurement procedures of entities operating in the water, energy, transport and postal services sectors, OJ L 7/7, Commission Decisions 93/676/EC, 97/367/EC, 2002/205/EC and 2004/73/EC. See art. 27 and recital 38 Directive (EC) 2004/17/CEE. 10 Directive 2004/17/EC, art and Annex XI of that Directive. For gas transport and distribution see Annex I. 11 COM (1998) 447 final: Report from the Commission to the Council on Directive (EC) 94/22/CEE on the conditions for granting and using authorizations for the prospection, exploration and production of hydrocarbons. 594 ENCYCLOPAEDIA OF HYDROCARBONS

5 EUROPEAN UNION AND THE LIBERALIZATION OF THE ENERGY MARKET The Directive in question was an early example of pan-european co-operation on energy legislation, as countries linked to the EU by the EEA participated in its development. The involvement of Norway was of great importance to the final result. Essentially, liberalization of hydrocarbons licensing has proved relatively painless to all entities established in the EU, including subsidiaries of non-eu companies. Since the Directive was adopted, the Commission has become more active in the supervision of hydrocarbon exploration and production, for example, with respect to competition aspects of joint marketing of gas (discussed below), and certain areas of environmental management - such as the decommissioning of oil and gas installations 12 as well as impact assessment Gas Directive 2003/55/EC The principal legislation aimed at establishing common rules for an internal market in natural gas is Directive (EC) 2003/55/CEE (the Gas Directive ), 14 which was adopted by the European Parliament and Council on 26 June Its structure and many of its provisions were built upon similar provisions in the preceding Gas Directive (EC) 98/30/CEE, 15 which it repealed. Each member state had to transpose it into national law by 1 July It is supplemented by a regulation that sets out basic principles and implementation measures for Third Party Access (TPA). 16 The aim of the Gas Directive is to establish common rules for the transmission, distribution, supply and storage of natural gas. It lays down rules relating to the organization and functioning of the natural gas sector, access to the market, criteria and procedures applicable to the granting of authorizations for transmission, distribution, supply and storage of natural gas and the operation of systems (Gas Directive, art. 1). The scope of the Directive extends to Liquefied Natural Gas (LNG). It also extends to other gases provided that they may be technically and safely injected into and transported through a natural gas network or facility. The Directive has two principal aims: firstly, to increase quantitative market opening and bring about full liberalization (understood as market opening ) by 2007, and secondly, to enhance qualitative regulation and bring about more uniformity and co-ordination of national regulation. It was decreed that by July 2004 there was to be full freedom of choice for non-household customers, and indeed, all customers are to enjoy this right by 1 July In practice, a number of member states have already opened up their markets entirely to competition ahead of the 2007 deadline. Derogations are possible but these are tightly defined. To ensure that the measures are effective, the Directive provides for monitoring and reporting requirements for member states and the Commission. A principal, but not the sole instrument to achieve this end is an expanded use of the benchmarking reports to meet the reporting requirements envisaged in art. 31 of the Directive. Building upon established practice, such reports are to be published on an annual basis from the end of 2004, covering the issues listed in the Directive. A detailed coverage of public service issues is required every two years through art. 28.3, and a detailed assessment of the market prior to full market opening had to be produced before the end of The Gas Directive differs from its predecessor in two important ways, namely, its clear advocacy of regulated TPA and the regime on unbundling. The first is intended to promote network access to new market entrants more effectively than either the negotiated form of access or the weak form of regulatory access contained in the first Directive, while the second addresses the barriers to competition created by corporate structure. In both cases, practical success depends upon institutional enforcement by National Regulatory Authorities (NRAs), which have a minimum set of competences outlined in the Directive. The NRAs have an advisory role on implementation and further steps through a newly-established body called the European Regulators Group for Electricity and Gas (ERGEG). Gas Regulation Like the Electricity Regulation, the Gas Regulation 17 provides a set of principles to be respected, with detailed minimum requirements on access conditions outlined in lengthy guidelines 12 COM (1998) 49 final: Communication on the removal and disposal of disused oil and gas installations. 13 Directive (EC) 97/11/CEE, Annexes II and III. 14 Directive 2003/55/EC of the European Parliament and of the Council of 26 June 2003 concerning common rules for the internal market in natural gas and repealing Directive (EC) 98/30/CEE, OJ L 176/57, Regulation (EC) No. 1775/2005 of 28 September 2005 on conditions for access to the natural gas transmission networks, OJ L 289/1, Gas Regulation, Common Position approved 5/ See note 4 above. VOLUME IV / HYDROCARBONS: ECONOMICS, POLICIES AND LEGISLATION 595

6 SUPRANATIONAL LAW annexed to it. The scope goes beyond cross-border issues, however, covering not only interconnectors but also gas networks within the member states. Its aim is to complete the provisions of the Gas Directive. While the Directive defines the objectives of TPA as the principal instrument for opening the market and for introducing competition, the Regulation aims at providing minimum conditions to be satisfied with respect to this central element if the Directive is to be successful. The assumption is that the internal market cannot work effectively in the gas sector if access conditions to the networks do not correspond to certain minimum standards on key aspects of TPA. For this reason, a set of guidelines were included in an annex to the Regulation. These guidelines on good practice were adopted by the Gas Regulatory Forum (the so-called Madrid Forum) at its meeting on September 2003 after extensive discussions with the gas industry and the NRAs. The set of guidelines annexed to the Regulation covers six main areas: The criteria according to which charges for access to the network are determined, to ensure that they fully take into account the need for system integrity and effectively reflect incurred costs. A common minimum set of TPA services for example concerning the duration of transportation contracts offered and on an interruptible basis. Common rules regarding contractual congestion of networks that balance the need to free up unused capacity with the rights of the holders of the capacity to use it when necessary. Information on technical requirements and available capacity. Rules ensuring that transmission system operators use balancing systems in a manner compatible with the internal market. Common basic requirements regarding the trading of primary rights to capacity. The objective of the guidelines is for customers to have potential access to a varied portfolio of available primary sources of gas. To achieve this, a well-developed network is required which operates according to coherent rules on a European scale. A principal aim of the Regulation is to ensure that the new guidelines are fully applied by all Transmission System Operators (TSOs) across the internal EU market for natural gas. The rules and principles contained in the guidelines form the core of the Regulation itself to ensure the highest level of compliance. However, the Regulation also contains enforcing provisions that spell out the underlying principles concerning: a) charges for network access; b) TPA access services; c) capacity allocation mechanisms and congestion management procedures; d) transparency requirements; e) balancing and imbalance charges, and secondary markets. Finally, the Regulation is equivalent to and procedurally the same as the one already adopted for cross-border exchanges in electricity. The instrument is one that does not require implementation in the way that directives do. It is directly applicable. The legal regime is based on the European Commission s (EC) competence to adopt measures for the harmonization of national standards to complete the single market (art ). Similarly, these supplementary rules are viewed as having an evolutionary character, requiring additions on issues such as the alleviation of contractual congestion. The Regulation therefore provides that the rules in the annex may be modified according to a `comitology procedure for the exercise of implementing powers granted to the Commission. 18 However, as a result of Council amendments to the proposal, this version of regulatory evolution by committee is weaker than that found in the Electricity Regulation and, in addition, any such modifications are not to be permitted before 1 January The following sections consider the principal subjects treated in the Gas Directive: access to pipeline networks including upstream pipeline facilities and exemptions; regulation; unbundling; public service obligations; cross-border trade; and derogations including those arising from take-or-pay commitments and uneven market development. Where relevant, provisions of the supplementary measures in the Regulation are noted. The first section however summarizes the use of transmission and distribution in the Directive. Key Terms Transmission Transmission is defined in the Directive as the transport of natural gas through a high-pressure pipeline network other than an upstream pipeline network with a view to its delivery to customers, but not including supply (art. 2.3; Regulation, art. 2.1). A general duty is imposed on transmission, storage, and LNG undertakings to operate, maintain, and develop a secure, reliable, and efficient transmission network, storage facilities and, if appropriate, LNG 18 Regulation (EC) No. 1775/2005, art. 14. The procedure is based on arts. 5 and 7 of Council Decision 1999/468/EC, OJ L 184/23, ENCYCLOPAEDIA OF HYDROCARBONS

7 EUROPEAN UNION AND THE LIBERALIZATION OF THE ENERGY MARKET facilities. They are required to do so under economic conditions and with due regard to the environment (art. 8.1). These undertakings must not discriminate between system users or classes of system users, especially in favour of their related undertakings. They are placed under an obligation to provide any other transmission, storage or distribution undertaking with sufficient information to ensure that the transport and storage of natural gas takes place in a manner compatible with the secure and efficient operation of the interconnected system. The confidentiality of commercially-sensitive information obtained in the process of carrying out the business must be preserved (art. 10). In particular, transmission undertakings must not abuse commercially-sensitive information obtained from third parties in the context of providing or negotiating access to the system. Distribution The provisions on distribution and supply as set out in arts. 11 to 15 of the Directive are almost identical to those applicable to arts. 7 to 10 on transmission, storage and LNG. The definition of distribution provided in art. 2.5 is given as the transport of natural gas through local or regional pipeline networks with a view to its delivery to customers. Note that this does not include supply. Each distribution undertaking must operate, maintain and develop under economic conditions a secure, reliable and efficient system, with due regard to the environment (art. 12.1). No discrimination may take place between system users or classes of system user especially in favour of its related undertakings. Each distribution undertaking must provide any other distribution undertaking and/or transmission and/or storage undertaking with sufficient information to ensure that the transport and storage of natural gas may take place in a manner compatible with the secure and efficient operation of the interconnected system. Confidentiality requirements on information are imposed on distribution undertakings in art. 14. Each distribution undertaking is to preserve the confidentiality of commercially-sensitive information obtained in the course of carrying out its business. Further, distribution undertakings are prohibited from abusing commercially-sensitive information obtained from third parties in the course of providing or negotiating access to the system. Access to pipeline networks At the core of the Directive are the provisions on system access. Member states are required to ensure the implementation of a system of TPA is provided to the transmission and distribution networks and LNG facilities on the basis of published and regulated tariffs (art. 18). However, this general rule is subject to a number of exceptions. Firstly, for storage facilities (including line pack, which is a means of gas storage that relies on compression of the gas in the transmission and distribution systems), access is to be either on a negotiated or regulated basis or both (Gas Directive, art. 19.1). For access to upstream pipeline networks the regime continues to be separated out to give member states discretion over the arrangements adopted (Gas Directive, art. 20). Finally, exemptions from TPA may be granted for major new gas infrastructure investments such as international interconnectors, LNG and storage facilities (Gas Directive, art. 22). The general requirements of regulated TPA are set out below, followed by an examination of the three aforementioned exceptions. Regulated TPA in gas Member states are required to ensure that the system of TPA implemented is based on published tariffs, is applicable to all eligible customers and is applied objectively and without discrimination between system users (Gas Directive, art. 18.1). This concerns both transmission and distribution. The role of the NRAs is underlined by the requirement that tariffs or the methodologies underlying their calculation are approved prior to their entry into force. These tariffs or the methodologies once approved by the NRAs are also to be published prior to their entry into force. The rationale behind this promotion of the regulated TPA option over the text of the first Gas Directive is to secure competition in the wholesale market, not in the retail market. Refusal of access by a Transmission System Operator (TSO) or Distribution System Operator (DSO) is still possible where there is no available capacity (Gas Directive, art. 21.1). The reasons for this refusal have to be substantiated, taking any public service obligations into account. Where appropriate and where there has been a refusal, member states are obliged to ensure that the TSO or DSO provides relevant information on measures that would be necessary to reinforce the network. Three notable features of this form of TPA concern long-term transportation contracts and cross-border transmission. Firstly, the implementation of the TPA provisions must not prevent the conclusion of long-term contracts in so far as these comply with European Commission (EC) competition rules (Gas Directive, art. 18.3). Secondly, a refusal of TPA may be made on the ground that it would give rise to serious economic VOLUME IV / HYDROCARBONS: ECONOMICS, POLICIES AND LEGISLATION 597

8 SUPRANATIONAL LAW and financial difficulties with take-or-pay contracts (Gas Directive, art. 21.1). 19 However, in such (and other) cases of refusal, the member state may take the necessary measures to ensure that the natural gas undertaking which refuses access makes the necessary enhancements to the pipeline network, as far as it is economical to do so or when a potential customer is willing to pay for them (Gas Directive, art. 21.2). By contrast, in the Electricity Directive 20 the refusing party is only required to provide information on measures that would be necessary to reinforce the network. Finally, and partly in order to facilitate cross-border transmission of gas, those TSOs that need to transmit across borders shall have access to the network of other TSOs (art. 18.2). The above provisions are supplemented by the common rules contained in the Annex to the Gas Regulation. The additional technical rules cover network access and TPA services, congestion management procedures, transparency requirements, balancing, as well as the trading of primary capacity rights. Choice for access to storage In contrast to electricity, the optimal functioning of a gas system is heavily dependent on the existence and use of storage facilities. The Gas Directive therefore includes provisions that address the issue of access to storage facilities (art. 19). Member states have a choice with respect to the access regime for gas storage facilities, line pack and ancillary services. It may be either negotiated or regulated TPA or both (Gas Directive, art. 19.1). 21 Irrespective of the system chosen, it has to be operated in accordance with objective, transparent and non-discriminatory criteria. Such access is important for new market entrants since storage is an important flexibility tool. It may assist market actors in using the opportunities of spot markets to reduce the price of electricity and gas, and for power generators, access to storage may enhance continuity of supply. The differences between this provision and its predecessor may seem insignificant, but the definitions are wider and the goal is more ambitious. The guiding principle is that experience gained with the first Gas Directive in developing an internal market requires the current measure to act as a step towards clarification of the provisions for access to storage and ancillary services (Gas Directive, recital 20). 22 This idea is less evident in the Directive itself than in the Interpretation Note issued subsequently by the Commission. 23 The thrust of the Commission s interpretation (which is neither legally binding nor considered to be binding on the Commission itself) is to limit exemption from the Directive s access provisions to those storage facilities that are exclusively reserved to TSOs for carrying out their functions and the portion of storage facilities used for production operations. TSOs should be required to provide a justification to the national authorities for their exclusion of facilities from the scope of the Directive s access provisions. This may be done by the use of historical data. Moreover, since the Directive requires the establishment of storage system operators, they will have to act in accordance with the Directive s provisions on system operators, which include a requirement to provide information to system users for efficient access to the system. In the Commission s view, the latter would include the following: information on available firm and interruptible capacities in relevant storage facilities over a specific time period; information on access conditions including tariffs; and information on services available. For the operation of storage access, the criteria in the paragraph above are relevant, but so is the criterion in the Directive stating that access is restricted to circumstances when it is technically and economically necessary for the supply of customers. When it cannot be proved that a request for access is linked to the supply of customers, it is not to be treated as justified. There is sufficient agreement that the Gas Directive needs to be supplemented in some way for action to be taken within the framework of the Gas Regulatory Forum (the so-called Madrid Forum, in which the key players discuss the development of guidelines and codes of practice to improve the working of the internal market legislation). 19 The provisions of art. 27 (derogations in relation to take-or-pay commitments) and the alternative chosen by the Member State according to art have to be taken into account here. Refusals of access to storage facilities on grounds of lack of capacity must satisfy certain preconditions: refusal due to a need to meet take-or-pay obligations is not regarded by the Commission as one of these (DG TREN Interpretation Note on TPA to Storage Facilities, : available on DG TREN website). 20 Directive (EC) 2003/54/CEE of the European Parliament and of the Council of 26 June 2003 concerning common rules for the internal market in electricity and repealing Directive (EC) 96/92/CEE, OJ L 176/37, Member States are also allowed to designate a separate system operator for storage (art. 7). 22 Long-term LNG storage can be included within its scope as a means of transmission support as well as linepack. 23 DG TREN, Third party access to storage facilities, The following paragraphs relate to the text in this document. 598 ENCYCLOPAEDIA OF HYDROCARBONS

9 EUROPEAN UNION AND THE LIBERALIZATION OF THE ENERGY MARKET However, storage and access to storage facilities do not fall within the scope of the Gas Regulation, and are addressed separately, in guidelines laid down under art of the Regulation or as amended under art of the Regulation. A set of detailed and clear rules was adopted on a voluntary basis on 23 March 2005, with a similar level of detail as that in the Good Practice Guidelines for Third Party Access. The Guidelines on Good Third Party Access for Storage System Operators are eventually to be incorporated into the Annex to EC Regulation No. 1775/2005. Access to upstream pipeline networks The Gas Directive contains a special regime for upstream pipeline networks, defined as any pipeline or network of pipelines operated and/or constructed as part of an oil or gas production project, or used to convey natural gas from one or more such projects to a processing plant or terminal or final coastal landing terminal (Gas Directive, art. 2.2). They constitute an important part of the gas chain and are therefore relevant to the general aim of achieving a competitive market in natural gas. Member states are required to take measures to ensure that natural gas undertakings and eligible customers can access these networks, but the form of such access is to be determined by the member state itself (Gas Directive, art. 20). 24 In doing so, member states have to observe some requirements such as the objectives of fair and open access, and the establishment of dispute settlement arrangements, so that disputes may be settled expeditiously by an authority independent of the parties with access to all the relevant information. Several considerations are listed that may be taken into account and which give some protection to the interests of the owner or operator of the upstream pipeline. In effect, a negotiated access regime is retained for upstream pipeline networks. Member states must apply the overall objectives of the Gas Directive, namely: fair and open access; achieving a competitive market in natural gas and avoiding any abuse of a dominant position - while taking into account security and regularity of supplies; capacity which is or can reasonably be made available; and environmental protection. Other areas in which the Directive s provisions may be relevant to implementation measures for upstream operations include the establishment of technical rules to ensure inter-operability and interconnections in relation to upstream gas facilities, as well as rules on information exchange and the publication of technical rules for access to these pipelines. The following specific considerations may be taken into account by member states in their implementation procedures: a) the need to refuse access where there is an incompatibility of technical specifications which cannot be reasonably overcome; b) the need to avoid difficulties which cannot be reasonably overcome and could prejudice the efficient, current and planned future production of hydrocarbons, including that from fields of marginal economic viability; c) the need to respect the duly substantiated reasonable needs of the owner or operator of the upstream pipeline network for the transport and processing of gas as well as the interests of all other users of the upstream pipeline network or relevant processing or handling facilities which may be affected; d) the need to apply their laws and administrative procedures, in conformity with Community law, for the grant of authorization for production or upstream development. These considerations will be of more relevance to gas producing companies than to eligible customers. Most of them relate to the capacity available in the upstream pipeline networks and related facilities. When establishing the detailed rules, member states must take into account which additional capacity can reasonably be made available in case of capacity constraints. Consideration a) above relates to the refusal of access where there is a technical impossibility. It might, for example, create serious technical problems due to incompatibility of gas qualities; b) is designed to safeguard current and planned production against serious difficulties that could have been caused by the implementation of the Directive. Operational considerations such as those that may act to hamper access to upstream pipeline networks must be fully substantiated and justified; c) refers to existing commitments and needs of current users that must be respected in the same way as with downstream pipeline networks. The assumption here is that access must be provided only to the extent that uncommitted capacity is available; d) refers to the need for balance between national laws and EU legislation as well as the interface between the Gas Directive and other legislation such as the Hydrocarbons Licensing Directive (see above). The measures taken must be reported to the Commission (art. 20.1). To deal with any possible disputes, member states are required to have in place an authority which is independent of the parties and which has access to all relevant information (art. 20.3). The 24 Compare the wording of art. 23 of the first Gas Directive, which has wording that is almost identical. 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10 SUPRANATIONAL LAW aim is to settle such disputes relating to access to upstream pipeline networks expeditiously, taking the above criteria into account as well as the number of parties that may be involved in negotiating access to such networks. Where the disputes have a crossborder character, the arrangements for settlement for the member state with jurisdiction over the upstream pipeline network that refuses access must be applied (art. 20.4). Consultation between member states is necessary where more than one member state has jurisdiction over a network and a cross-border dispute arises. The aim is to ensure that the provisions of the Directive are applied consistently. Exemptions The general rules for TPA in gas may be waived in specific cases involving new major infrastructure projects and significant increases in capacity in existing interconnectors (Gas Directive, art. 22). There are detailed criteria for grant of an exemption. The investment proposed for an exemption must contribute to competition in supply (and in the case of gas infrastructures, must enhance security of supply), and not be detrimental to the functioning of the internal market. Importantly, the level of risk attached to the investment must be such that investment would not take place unless an exemption is granted. The rules on exemptions are to be applied (and monitored) very carefully. 25 They do not apply to existing infrastructure. That is, if the main financial commitment to construction was taken before 15 July 2003 (the date of publication of the Gas Directive). No block exemptions may be applied for specific types of infrastructure, and exemptions are to be granted on a case-by-case basis, with applications assessed on their merits. Exemptions cannot apply where the result would create or reinforce a dominant position or where it would reduce the scope for diluting existing dominant positions. Applications for exemptions are made to the NRA but member states may elect to require the NRA to submit an opinion on the application to the relevant body in the member state. The decision has to be duly reasoned, published and communicated to the Commission with all the relevant information. Crucially, the Commission may request that the NRA or member state concerned amend or withdraw the decision to grant an exemption. This must be done within a two-month period. The absence of express criteria by which the Commission might reject the NRA decision is a source of uncertainty, compensated only slightly by the publication of information in an interpretation note. 26 It appears that the Competition Directorate of the Commission would also be closely involved in any Commission decision to accept an exemption in this context. It may be noted that none of the above prejudices the power of the NRA to choose specific rules for specific pieces of infrastructure both existing and new including the grant of incentives to develop specific types of investment. The Gas Regulation also contains a provision specifically directed at this subject. In art. 16, on Derogations and Exceptions, the Regulation sets out to establish consistency of application of EU law in this area. It does not go beyond the scope of the derogations already laid down in the Directive, but grants a member state with a derogation under art. 28 of the Directive the right to apply for a temporary derogation from the application of the Regulation, subject to the approval of the Commission. Regulation Member states are obliged to charge one or more competent bodies with the function of regulatory authority (art. 25.1; Cameron 2005). The requirement is more precise than in the previous Gas Directive. 27 However, it may be noted that regulatory functions may be spread over several authorities if that is deemed appropriate by the member state, and thus there may be, say, local or regional regulatory bodies, but also a combination of NRA, ministry and say, a competition authority. The independence of the regulatory authority (or authorities) is obligatory but is defined in relation to the interests of the gas industry rather than in relation to existing government structures. Nonetheless, those member states with state-owned utilities may have to develop mechanisms to separate the regulatory authority from the ministerial body that supervises the state-owned energy utility. In addition, member states are required to take measures to ensure that the regulatory authorities are able to carry out their duties in an efficient and expeditious manner (art. 25.7). 25 DG TREN Interpretation notes, Exemptions from certain provisions of the third party access regime, ; Security of supply provisions for gas, , pp Id. 27 Compare the wording in art. 22 of the first Gas Directive: Member States shall create appropriate and efficient mechanisms for regulation, control and transparency so as to avoid any abuse of a dominant position. In practice, however, the competences of many NRAs have usually gone far beyond this. This wording reappears in the new Directive as art ENCYCLOPAEDIA OF HYDROCARBONS