Select Committee on European Communities Seventh Report


PART 2 VIEWS OF WITNESSES (continued)

EXTENT OF MARKET OPENING AND THRESHOLDS FOR ELIGIBLE CUSTOMERS

  53.    A key question for witnesses was how far and how fast the market should be opened to competition. The initial threshold for "eligible customers" of 25 million m3 per annum which had been proposed represented around 30 per cent of the market, which the Commission regarded as "a significant market opening in the first stage" (QQ 88, 261). But GasNatural, while congratulating the Commission on a combination of thresholds and percentages that would "enable the industry to adjust to the new framework without causing unnecessary upheavals", said that for Spain an initial market opening of 30 or 40 per cent would involve an initial threshold of 100 million m3, falling to 50 million m3 after 10 years to achieve 50 per cent market opening (p 74, Q 243).

  54.    The majority of witnesses advocated a greater market opening at the first stage, or a more rapid timetable for subsequent stages, or both. An initial threshold of 25 million m3 was "far too high for the industrialists of Europe", according to IFIEC, as it would introduce market distortions between a very few major consumers and smaller firms producing competing products, while also penalising smaller consumers who were self-generators of power. IFIEC called for an initial threshold of 10 million m3, falling to 3 million m3 and then 1 million m3, with the 5-year intervals between stages open to downward revision if market conditions permitted (p 12, QQ 50-7). The Union of Industrial and Employers' Confederations of Europe (UNICE) wanted similar thresholds but with only three years between successive stages (p 126).

  55.    Centrica described the proposed timetable as "frustratingly slow" and advocated an initial threshold of around 3 million m3, falling to 750,000 m3 after five or six years and with full market opening after ten years. This would strike a balance between giving customers the benefits of liberalisation fairly quickly while allowing companies a reasonable period of transition (pp 2-3, Q 31). The Confederation of British Industry (CBI) called for "the widest opening of the EU gas market in the shortest time possible, consistent with public service obligations and supply security considerations". Most CBI members wanted the initial market opening to include all power generators, distribution companies and large, intensive gas customers, with thresholds falling from 5.45 million m3 in 1998 to 204,000 m3 by 2000. Full competition should be achieved by 2002, and the effectiveness of the Directive reviewed after 3 years rather than ten as proposed (pp 110-12).

  56.    Mr Chichester described the proposed thresholds as "pathetically under-ambitious" and advocated an initial market opening of at least 40 per cent. The initial threshold should be 70,000 m3, the same as that applied in the United Kingdom, falling to 7,000 m3 after 5 years and including all consumers after 10 years. Although Mr Chichester recognised these targets were not politically realistic, he believed they were "eminently attainable bearing in mind our experience here in the United Kingdom"; and if the proposed thresholds were not lowered, at least the timescale should be shortened (QQ 150-6, 160, 164).

  57.    Ofgas was less concerned about precise numbers than about ensuring that the initial market opening encompassed all gas-fired power generation and a significant proportion of industrial and commercial consumers, after which market demand could be expected to take over and force thresholds ever lower (p 40, Q 184). The Minister, likewise, was "not fixated on a particular figure" so long as the initial opening generated sufficient pressure from companies for access to drive the process forward. This would not happen as a result of market pressures alone, but needed "a push from the legislators to make it happen" (QQ 250, 261). The figure of 28 per cent market opening proposed in the July text was close to what the Government had been seeking, but the timetable proposed for further liberalisation was "nowhere near" what they had hoped for. Given the United Kingdom's experience, the Minister believed that more than half the market could be opened to competition in the ten-year period proposed (QQ 247-50).

  58.    The main danger Enron saw in the slow, staged transition proposed was that it created incentives for producers and suppliers of gas whose business was only partly exposed to competition to seek maximum recovery of their costs from the captive rather than the competitive sector. Ten years was unnecessarily long to leave captive customers-mostly small commercial, industrial and domestic consumers-exposed to such "cost shifting". If the intention was to give utilities time to address the problem of stranded costs[14], it was "without intellectual underpinning", given the lack of provisions in the Directive to achieve that end and the fact that the stranded cost problem would become more difficult to resolve as the market moved towards full liberalisation (pp 117-8). The Electricity Association wanted thresholds lowered at one or two-year intervals (p 115).

  59.    Some witnesses thought the draft Directive went too far, too fast. Professor Desama believed that it would open the market "rapidly and substantially" and carried the long-term risk that security of supply would be "undermined by the uncertainty of a single market" (p 114). Conoco said it would take some time to achieve an orderly transition to a competitive market, and initial targets for market opening that were too aggressive could have the unintended consequence of destabilising markets and undermining customer confidence in the whole gas industry (p 113).

  60.    Opinions also differed on whether the market opening provisions allowed sufficient room for variations between countries, or too much. The Norwegian Government and Shell were among those calling for change to be introduced carefully, with flexibility for individual countries and markets (pp 98, 125). Rather than imposing the same percentages of market opening on widely different Member State gas markets, Gaz de France thought it better to "determine categories of consumers and define specific thresholds of consumption for each of them to be eligible" (p 70).

  61.    For Mr Stern, however, a major problem with the Directive was that it gave Member States resistant to liberalisation considerable scope to extend the timetable (p 25). Ruhrgas warned of market distortions if some Member States were allowed to open their markets only to the limited extent required by a Directive, while others such as Germany implemented fully open markets (p 67, Q 242). Reciprocity was threatened, in GasNatural's view if a large gap was permitted between the minimum percentage of market opening and the maximum percentage that Member States could impose (p 74).

TAKE-OR-PAY CONTRACTS

  62.    Many witnesses from within the gas supply industry were keen to explain the importance of take-or-pay contracts to the development of the gas network. For BP, take-or-pay contracts were an important feature of the market which had permitted major investment projects to be realised. Natural gas, although a very efficient and clean fuel, had the major drawback of a very low energy density, only one thousandth that of oil, making it very expensive to transport. In addition to high exploration costs, this meant that there was a substantial financial risk associated with the development of a gas distribution and supply network, a risk which had to be shared between buyers and sellers. This had usually been achieved by gas producers entering into long-term take-or-pay contracts with an "aggregator" whose own position was assured by a monopoly over the sale of gas to final consumers. In a mature market the role of the aggregator and the importance of long-term contracts would diminish (pp 107-8).

  63.    Most witnesses agreed with Ofgas that long-term contracts were "likely to remain a legitimate and possibly substantial part of a balanced portfolio of most European gas suppliers" (p 41). Mr Stern accepted they would probably continue to play some role, particularly to support early investments in less mature markets, but said that recent examples in Germany and elsewhere showed that they were no longer necessary in mature competitive markets (Q 124).

  64.    For a number of witnesses, including Conoco and Shell, it was important that contracts freely entered into were respected and that existing take-or-pay commitments should be re-negotiated only by mutual consent (pp 113, 125). BP warned that any perception that such contracts were being undermined "would bring into question the willingness and ability of [producer] countries to continue to increase gas supplies into Europe" (p 110). Norway, as a producer country, was concerned that reducing the ability of gas companies to agree long-term contracts would jeopardise the development of future supplies, which were in deeper water and further offshore. Ongoing discussion between Norwegian and British companies about new long-term contracts showed that there were still consumers who saw their benefits, even in the British market (QQ 277-80).

  65.    A particular concern of Gaz de France was that a gas company which had concluded a take-or-pay contract with a gas producer might have to pay for gas that it could not take because the producer was selling gas directly to the gas company's customers (p 70). Professor Desama described such an outcome as one of the "totally unacceptable" consequences of the sudden introduction of competition. Operators bound by take-or-pay contracts might be forced to close down "because their competitiveness would be progressively and seriously weakened by their obligation to pay for gas which they could not re-sell", while producers "could be paid twice for the same quantity of gas", once by the operator bound by the contract and once by the consumer to whom the gas was sold directly (p 114). This danger was also recognised by Mr Stern, who said that producers who supply gas to transmission companies under take-or-pay contracts and who also wish to compete directly for those companies' customers should be required to reduce their take-or-pay commitments by the amount of gas the producers sell directly (p 25).

  66.    Centrica had first-hand experience of the problems caused by take-or-pay commitments in a liberalised market. British Gas, when it was a monopoly supplier with statutory obligations to supply the whole United Kingdom market, had entered into various long-term contracts which Centrica had then inherited. Despite some subsequent re-negotiation, British Gas Trading (BGT), Centrica's gas supply business, had until recently been forced to buy, at an average price of 20p per therm, more gas than it could sell, while its competitors could benefit from a market price that had fallen to 13-14p per therm as a result of liberalisation. The company was convinced that the difficulties it had experienced with long-term contracts had contributed to pressures from Continental companies for protection of their take-or-pay positions (pp 3-4, Q 7).

Derogations for take-or-pay

  67.    The Commission, which described the interplay between market opening and the take-or-pay issue as the "key axis to the Directive", said there was now general agreement that some derogations were necessary, but they should be the exception rather than the norm, the criteria should be strict and the Commission should have the final say on whether they were granted (Q 102). Gaz de France, however, did not accept that derogations were the answer. It argued that companies were entitled to rely on take-or-pay contracts, but could not realistically do so without knowing in advance what losses they might be liable for, something that would depend on whether, should they encounter difficulties in the future, a derogation would be granted. Its preferred solution was for the Directive to give companies the right to refuse access where this would prevent them carrying out their take-or-pay commitments (p 70, QQ 214-5). Norway agreed, saying that if the Directive were amended to secure the basis for existing and new contracts, there would be no need for derogations (p 98).

  68.    Most witnesses who favoured liberalisation were concerned that offering derogations in respect of take-or-pay commitments could, as Ofgas put it, "frustrate the intended liberalising purposes of the Directive" (p 40). The Electricity Association warned they "could be used to shelter entire national markets from competition" (p 116). For Mr Stern, claims by gas transmission companies that they should be protected from competition for the duration of a contract, while their investments were amortised, should be treated with caution. The onus should be on the company to show that a given investment was linked to a take-or-pay contract and that it was reasonable for its amortisation to take place over a long period (p 25).

  69.    Some witnesses called for amendments to the Directive to tighten the criteria according to which take-or-pay derogations could be granted. Enron wanted the Directive to ensure that derogations, full details of which should be published, caused the least possible disturbance to the market, were of the minimum duration necessary and did not significantly affect the proportion of the market in a particular Member State open to competition (pp 118-9). IFIEC wanted the Directive to ensure that derogations were only considered where the interests of consumers were given as much weight as those of producers and where gas companies had taken reasonable efforts to sell surplus gas (p 13, Q 63). The German company Wintershall called for take-or-pay derogations to be subject to a fixed time-limit, perhaps three years from the entry into force of the Directive, and to be granted only where there was an enduring risk to the reliability of supply, where the survival of the company concerned was in question and where the freedom to construct pipelines would not be impeded (p 131).

  70.    Some witnesses, such as BG, were particularly concerned that take-or-pay derogations should be granted "only by an independent authority at EU level, such as the European Commission" (p 106). The Electricity Association said that leaving responsibility to national authorities would act as a barrier to trade and inhibit the development of a single gas market (p 116). Ofgas also thought it "essential that the final decision as to whether a derogation should be granted in a particular case should be taken by a party independent of the Government of the Member State concerned, operating under clear duties to secure effective competition". But it recognised that, since Germany's opposition in particular might prevent the Commission being given this role, it could be assigned to national authorities, despite the fact that suitably independent bodies did not currently exist in some Member States. A separate European regulator would be "a very bad idea", as it would be the product of compromise and so incapable of taking the measures necessary to force the pace of change (p 41, QQ 178-9).

  71.    Ruhrgas said it would "strongly oppose bureaucracy and control by the EU Commission", suggesting that giving Commission officials rights to scrutinise multi-billion dollar contracts could threaten the confidentiality required in commercial negotiations (QQ 225, 230). Gaz de France believed the Commission was less interested in removing restrictive regulations at national level than in transferring these regulations to European level under Commission control (Q 232). But the Minister, while he did not see the Commission as an "all-singing, all-dancing super-regulator for the whole of Europe", welcomed the fact that the draft Directive gave it a supervisory role in ruling on derogations, in addition to its general role as guardian of the Directive (Q 251).


14   "Stranded costs" are the costs for which gas utilities are liable under take-or-pay contracts in respect of gas which, following the introduction of gas-on-gas competition, they cannot sell except at a loss. Back


 
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