Select Committee on European Communities Seventh Report


Future take-or-pay contracts

  72.    Most witnesses made a clear distinction, in relation to the granting of derogations, between existing and future take-or-pay commitments. Those who dissented from this consensus-Professor Desama, the Norwegian Government and Gaz de France-thought the distinction unnecessary since, rather than derogations, the Directive should provide a legal and economic framework in which future agreements could be agreed (pp 115, 98, 70). But for GasNatural, a Directive that distinguished existing and future contracts would help Member States negotiating with outside suppliers to show that "something was changing in the European gas market and that `take-or-pay' commitments could be, eventually, substituted by the guarantee offered by an open market" (p 74, Q 246).

  73.    Centrica regarded derogations for future contracts as "a serious threat to the extent of liberalisation", while a Directive containing such derogations would only be worth signing, according to Ofgas, if the provisions were "as constrained as possible", with beneficiaries "required at least to demonstrate genuine financial hardship" (Q 12, p 41). The Minister was very sceptical about supporting any derogations for future contracts, unless they were "very tightly controlled" but was not yet sure that he could persuade other Member States of this position (QQ 270-2).

  74.    A wide range of dates was proposed for when take-or-pay contracts should cease to be eligible for derogations, based on varying estimates of when it became apparent that the Community was intent on liberalising the gas market. Although Shell argued that "any new regulations should not be retrospective", most witnesses agreed with Enron that, unless the cut-off date was earlier than the date on which the new Directive came into force, the effect would be to "invite incumbent market players with monopoly positions to try to pre-empt EU legislation by signing long-term deals in advance of a political agreement" (p 125, p 119).

  75.    Wintershall advocated 15 October 1996, the date when the first draft Directive was published under the Irish Presidency (p 131). Enron and GasNatural both chose 25 July 1996, the date on which a Common Position was reached on the Electricity Directive (p 119, p 74). BG wanted to exclude contracts signed "since negotiations on the Directive restarted in 1996 and probably earlier" (p 106). For Ofgas, the cut-off date should be no later than summer 1996, while Centrica proposed 1 January 1994, but both recognised that a particular date was less important than the principle that the cut-off should apply from when it became "fairly clear that change was coming" (p 41, Q 192; p 3, QQ 5-6). For the Electricity Association, the relevant date was January 1992 when the first draft Directive was published, while for Mr Stern it was arguably as early as 1988, when the Commission published its first document on the internal energy market (p 116, p 25). IFIEC wanted derogations for existing contracts to be limited to a maximum of five years starting from the date on which the contract was agreed (Q 58).

Alternatives to take-or-pay

  76.    Centrica was one of a number of witnesses convinced that take-or-pay contracts would not cause the same problems in Europe as they had in the United Kingdom and North America since, as Mr Stern also pointed out, Continental contracts tended to be more flexible to changes in the market (pp 4, 25). According to Ofgas, the difference was that British Gas had agreed take-or-pay contracts which specified fixed prices and volumes, while there was a tradition elsewhere in Europe of contracts where, in general, the producer took the price risk and the gas company the volume risk. This was principally achieved by "price re-opener clauses" which allowed prices to be re-negotiated where the market price changed substantially and which Ofgas believed benefitted the gas companies at the expense of the consumer. Ofgas found it surprising that the governments of import-dependent Member States relied on take-or-pay contracts to protect their monopolistic industries against price risks, when such contracts principally protected producers' interests (p 41, Q 191).

  77.    Various suggestions were made as to how gas companies with take-or-pay commitments could insulate themselves against the price risks involved in the introduction of competition. Centrica was one of a number of witnesses who believed that greater use could be made of price re-opener clauses, and also suggested the introduction of "hardship clauses" that could be invoked when one party suffered hardship as a result of changed circumstances. Supplier countries could offer reductions in take-or-pay commitments in return for pipeline access rights, while gas-importing countries could require new entrants to share take-or-pay commitments, or impose levies on gas transported to spread take-or-pay costs (Q 13). BG proposed "margin sharing", where gas could be sold by mutual agreement in markets other than those originally envisaged if the price was higher, and gas swaps, which could help to overcome the costs of transporting gas over long distances (p 106).

  78.    For IFIEC, the alternative to take-or-pay contracts lay in improved negotiating and contract skills, including re-opener clauses. Both gas producers and purchasers had too easily assumed that traditional take-or-pay contracts were the only option available (Q 71). Ofgas saw some reassurance in the over-supply of gas in western Europe, while financial mechanisms for hedging against risks were likely to become available in a liberalised market (p 41). Professor Desama saw as a possible solution a clause allowing both sides rights to re-negotiate in the light of exceptional events (p 115).

Take-or-pay and security of supply

  79.    The Commission believed that take-or-pay contracts had been important in addressing the issue of security of supply and would continue to play a role, but they were likely to become more flexible and short-term as gas-on-gas competition developed. Other means of ensuring security of supply included underground storage, flexibility of production, interruptible contracts, greater integration of the pipeline network and developing trading arrangements with external suppliers (QQ 103-4).

  80.    Enron rejected as a myth the idea that take-or-pay contracts were necessary to finance production and downstream investment, arguing that in a liberalised market, appropriate financial instruments would emerge. Centrica agreed, pointing out that other industries undertook massive capital investment without comparable guarantees, but recognised a particular problem with building gas pipelines which tended to be specific to particular large customers and where the investment depended on assurances that the customer would continue to buy the gas. Take-or-pay contracts might be necessary in such cases, but if they were more flexible and shorter-term they could be compatible with a liberalised market (Q 4).

  81.    But Professor Desama was concerned that "long-term considerations might be forgotten in the light of the temporary situation of surplus" of the next few years. Future reserves would be further away and technically more difficult to exploit, requiring enormous investments with extremely long repayment periods, and Europe would continue to need operators capable of signing long-term contracts (p 115).


  82.    The Directive would offer Member States the option of establishing a system of either regulated or negotiated third party access (TPA). The Commission expressed no preference, but anticipated that most Member States would opt for negotiated TPA (Q 107). Mr Stern saw the lack of detailed regulation on access to the pipeline system as a major weakness of the draft Directive and described the option of negotiated access as "a recipe for discrimination and legal/regulatory stalemate" (p 24). IFIEC favoured regulated access which it believed would "accelerate the opening of the gas markets in a transparent way" (p 12).

  83.    The markets in which third party access had been introduced were associated by Ruhrgas with over-supply, indigenous sources and low integration with other energy markets. Germany, by contrast, imported 80 per cent of its gas from a limited number of suppliers, while gas-to-gas competition took place at pipeline level, without the natural grid monopoly that existed in the United Kingdom. To the private companies who had developed the German pipeline network, the freedom to build pipelines was as important as access to the system and should be enshrined in the Directive. Ruhrgas was prepared to transport gas for other companies subject to commercial agreement, and there were national competition laws to prevent it abusing its dominant position, but third party access would "threaten the very fabric of this structure" (pp 64-6, QQ 236-40).

  84.    Ideally, the Government would prefer a system of network access based on the separation of transportation and supply, as in the United Kingdom, but if this could not be achieved, it was "absolutely vital" that there were mandatory provisions to expand pipeline capacity to meet "reasonable economic demands" (QQ 247, 252). But Ruhrgas strongly objected to these investment obligations, saying that such rules contradicted the principles of the free market (p 66).

  85.    For Ofgas, the German attitude to network access presented "a real cultural problem". Regulation was seen as expropriation and Ruhrgas assumed it had a right to refuse access to protect its commercial interests. But Wingas, the joint venture company formed by Wintershall and the Russian company Gazprom, argued that, since the "established" German gas industry had benefitted from government authorisation and even expropriation to create its monopoly position, it could "reasonably be expected to grant third party access" to unused capacity for an appropriate fee, as a matter of social responsibility (p 130). Conoco supported the provisions of Article 4, requiring authorisations to build and operate transmission and distribution pipelines to be granted on a non-discriminatory basis, despite moves to remove distribution pipelines from the scope of this Article (p 113).

Network access and public service obligations

  86.    There was some concern among witnesses about a potential conflict between access to gas networks and public service obligations. Centrica saw no incompatibility in principle, but was concerned that Article 17 of the draft Directive might be interpreted to allow companies to refuse access to competitors on the grounds that their ability to fulfil their obligations would be undermined (Q 17)[15]. UNICE was concerned that public service obligations "should not be used as a pretext for preventing access to the network". Like Wintershall, it believed the burden of proof should be on the party seeking to refuse access, which should be subject to strict and objective criteria (p 126, p 131). IFIEC suggested that the verification of public service obligation status should be assigned to the "competent authorities" envisaged in Article 21[16]. Ofgas believed that liberalisation was compatible with public service obligations that were enshrined in legislation, together with a means of implementing and policing them, but not with a concept of public service that involved protecting high employment levels in public utilities (Q 186).

  87.    Some of the concerns expressed related to the interpretation of the word "prevent" in Article 17, which would allow gas companies to apply for derogations where granting access to competitors would prevent them fulfilling their public service obligations. The Commission expected "prevent" to be interpreted in absolute terms as equivalent to "stop", so that derogations would be granted only where access would make the fulfilment of these obligations impossible, rather than simply more difficult (Q 98). For Mr Chichester, while it was obvious that "prevent" should mean "only when impossible, not when a cosy monopoly is threatened by attempted market entry", there was a danger of the Article "being interpreted in a way that would thwart the spirit and intent of the draft Directive" (Q 157).

Derogations for emergent markets and regions

  88.    Most witnesses recognised the case for offering derogations to emergent markets and regions, but many, including Centrica, felt that if the relevant provisions were loosely worded, they could be used to delay or prevent large parts of the Community benefitting from liberalisation (Q 42). Gaz de France wanted to ensure that derogations for emergent markets were not used to avoid competition and were able to take account of the wide range of cases that existed, from the most underdeveloped to fully mature gas markets, a concern shared by Ruhrgas (Q 228, p 67). IFIEC wanted to see the transitional period for emergent markets reduced from 10 years to 5, with a maximum extension on review of a further 5 years (p 13, QQ 68-9).

  89.    A number of witnesses objected to the definition of emergent regions in the April draft text, but this was replaced in the June and July texts by reference to an Annex in which qualifying regions would be listed[17]. For GasNatural this was an improvement, but it believed that once a region qualified for inclusion in the Annex, the Member State concerned should be entitled to approve a derogation without further approval by the Commission (Q 227). Ruhrgas felt that special provisions for emergent regions were unnecessary (p 67).

Dispute resolution and the Commission's role

  90.    The Commission recognised from the consultations it had had that a detailed system of regulation would be unpopular among the Member States, who preferred "a broad but effective framework Directive at EU level with room for manoeuvre at national level in the form of subsidiarity" (Q 112). There was "a very strong feeling among Member States that the dispute settlement body should be at national level", following the precedent set by the Electricity Directive. The Commission did not therefore anticipate having a formal supervisory role, but would monitor how effective national bodies proved to be and would exercise its Treaty powers to consider any complaint that might be made about the settlement of a dispute (Q 105).

  91.    Mr Chichester accepted that the principal responsibility for dispute resolution should rest with competent national authorities, but if they proved not to be competent the Commission should intervene. In practice, there was no "other means of regulating the regulators than the Commission, as the guardian of the Treaty, taking action and doing so through the European Court of Justice" (QQ 166-7).

  92.    The European gas industry was terrified of a strong regulatory role for the Commission, according to Mr Stern, but he believed they would come to realise that their own position was vulnerable without clear rules and an authority to which to appeal when national decisions were taken against them. The idea that "light-handed regulation by a small regulatory body would be adequate to provide a competitive market" had been tried in the United Kingdom and found wanting (p 24, QQ 120-1).

Transparency and Chinese walls

  93.    The Government (giving evidence in July) hoped to tighten the provisions relating to transparency, including a requirement for separate management of transportation and supply activities, the publication of unbundled accounts and the inclusion of "Chinese walls" provisions to prevent pipeline companies using information obtained from other suppliers to benefit their own supply activities (p 88, Q 247)[18].

  94.    Centrica supported the Government's position, saying that Chinese walls had worked well in British Gas before the de-merger (Q 32; p 3). Ofgas agreed, but said this was only because the barriers established between its transportation and supply operations had involved more than the accountancy separation envisaged by the draft Directive and had extended to employees, buildings and computer systems. By preventing British Gas gaining any competitive advantage from remaining as a single company, this policy had been a major reason for its de-merger (QQ 198-9).

  95.    Transparency was important to the Electricity Association, which wanted integrated gas companies to keep separate accounts for production, transmission, distribution and supply, in addition to unbundling the management of their transportation and marketing divisions (p 116). Enron adopted a similar approach, citing a 1993 Monopolies and Mergers Commission report which concluded that BG's dual role as both a seller of gas and owner of the transportation system "gave rise to an inherent conflict of interest" (p 117n). Centrica did not believe that separate accounts for transmission and distribution were necessary, but it supported the publication of indicative transport tariffs to give users confidence that they were being treated equally and to allow them to quote realistic prices to their customers, despite some concerns about commercial confidentiality (p 3, Q 36).

  96.    The CBI was broadly in favour of greater transparency within integrated gas companies as a way of ensuring that natural monopolies satisfied customer needs. But some CBI members felt that forcing companies to publish details of their costs would damage their commercial interests, and that they should be required only to make the figures available to national authorities (p 111). Confidentiality was "the overriding priority" for Ruhrgas, which regarded Chinese walls provisions as "a severe and unfounded intervention in entrepreneurial freedom". Unbundling provisions might be appropriate for regulating a monopoly operator such as British Gas, but would have a very negative impact on Ruhrgas, the success of whose operations depended on "optimisation" between its purchase, sales and transport departments (p 66, Q 247).

  97.    Mr Stern was concerned that the present draft Directive, unlike the 1992 version, offered no guidance on price or tariffs and that, as a result, the various Member States would set up different and incompatible tariff systems that would be difficult to harmonise at a later date. There was a good case for looking to the expertise that existed in North America on regulation based on rates of return (QQ 131-2).

15   Article 17 permits natural gas undertakings to refuse access to the system "where such access would prevent them from carrying out the public service obligations" which are defined in Article 3(2) as obligations "which may relate to security, including security of supply, regularity, quality and price of supplies and to environmental protection". Back

16   Article 21(2) requires Member States to "designate a competent authority, which must be independent of the parties, to expeditiously settle disputes relating to the negotiations in question [ie negotiations on access to the system]". Back

17   The September and October texts reverted to a definition of emergent regions rather than an Annex (see paragraph 21 above). Back

18   The September and October texts included such provisions for the first time. See paragraph 21 above. Back

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