Select Committee on European Communities Seventh Report


  18 November 1997

  By the Select Committee appointed to consider Community proposals, whether in draft or otherwise, to obtain all necessary information about them, and to make reports on those which, in the opinion of the Committee, raise important questions of policy or principle, and on other questions to which the Committee considers that the special attention of the House should be drawn.


Un-numbered Amended Proposal for a European Parliament and Council Directive concerning common rules for the internal market in natural gas



  1.    Natural gas already has an important share in the total primary energy consumption of the European Community and this is forecast to increase from 20.2 per cent in 1995 to 23 per cent in 2000 and 26 per cent in 2010[1]. A substantial part of this potential growth is attributable to the increasing use of natural gas in electricity generation, but gas is also important for certain industries, including steel, glass and paper manufacture, where it is used as a fuel, and fertiliser production where it is used as a feed stock. In these industries, all of which compete on the global market, the cost of gas constitutes a substantial part of the overall costs of production. The establishment of a competitive gas market and the reduction in prices that can be expected to result is therefore an important element in improving the industrial competitiveness of the Community.

Europe's natural gas supplies

  2.    The Community's natural gas market is substantially and increasingly dependent on imports of natural gas. In 1995 the Community was dependent on imports for 40 per cent of its gas, and this is expected to rise to 45 per cent in 2000, 55 per cent in 2010 and 70 per cent in 2020. Almost all of the Community's gas imports come from Russia (64 per cent), Algeria (33 per cent) and Norway[2].

  3.    Of the EU Member States, only the UK and the Netherlands have substantial proven indigenous reserves. Germany and France have small reserves; others little or none. Most of Europe's indigenous natural gas is located under the North Sea, from where raw or partly processed gas is transported by pipelines, in many cases over distances of 200 miles or more, to onshore terminals where it is converted into a product suitable for use by final consumers. In most cases, only minimal processing takes place before transportation, because the cost of installing and operating processing equipment offshore would be prohibitive.

The gas industries of the Member States

  4.    The natural gas industries of most Member States were established in the 1970s and are now mature industries with well developed pipeline networks. Greece, Spain, Portugal, Finland and Ireland have relatively new gas industries with underdeveloped pipeline networks[3].

  5.    The principal Community gas suppliers are state-owned or state-controlled, with the exception of the major gas transmission/distribution companies in Germany, which have always been in the private sector, and those in the United Kingdom. Here, the British Gas Corporation (BGC) was a state-owned national monopoly until 1986, when the Gas Act transferred its business to British Gas plc, the shares of which were sold to the public. The Gas Act 1986 also introduced competition in the supply of gas to major industrial and commercial users, provided negotiated access rights to pipelines and created an independent regulatory body, the Office of Gas Supply (Ofgas). In February 1997, British Gas de-merged, with Centrica plc taking over the gas supply business and BG plc retaining responsibility for the transmission and distribution networks.

Take-or-pay contracts

  6.    The vast majority of gas handled by the gas suppliers of the Member States is purchased under long-term "take-or-pay" contracts. This included, until recently, most gas supplied in the United Kingdom, but since the introduction of a substantial degree of competition this practice is no longer generally followed. Under a take-or-pay contract, which is often of 20 years' duration or more, the buyer agrees to take delivery of a specified minimum quantity of gas in each 3, 6 or 12 month period, and must pay for that minimum quantity even if less gas is, in the event, taken. These contracts are frequently defended on the basis that the sellers require a minimum revenue from a gas contract to enable them to finance infrastructure development costs and that they enable the buyers to ensure security of supply.

  7.    All such contracts include mechanisms for automatically adjusting the price paid under the contract to reflect changes in the market prices of competing, alternative fuels (particularly fuel oil and gas oil). In addition most contracts for the supply of gas to Continental Member States, but not those for supply to the United Kingdom, include "price re-opener" clauses, which make provision for price re-negotiation where significant changes in the gas purchaser's market affect the profitability of gas supply in that market. Such clauses are not, however, intended to accommodate gas price changes as a result of gas-on-gas competition.

Gas buyers and sellers

  8.    In the case of Russia and Algeria, the exporting companies (Gazprom and Sonatrach respectively) are at present state-owned companies. In the case of Norway, all export sales are currently handled through an organisation comprising three Norwegian production companies, Gassforhandlingsutvalget (GFU), although non-GFU companies may join the market in time. The Continental gas buyers are major gas companies which, except in Germany, are owned or controlled by the State. As a result, the purchase of gas for the Continental European market is conducted between oligopolies of comparable economic strength.

The Hydrocarbons Licensing Directive

  9.    The exploration, development and production of natural gas in the North Sea and within the territories of the Member States are subject to the controls laid down in the 1994 Hydrocarbons Licensing Directive[4]. The terms of this Directive also apply to the Norwegian sector of the North Sea and to Norway itself through the operation of the European Economic Area Agreement, to which Norway is a party.

  10.    The 1994 Directive requires the Member States (and Norway) to establish and operate a non-discriminatory and transparent procedure for the granting of licences for the exploration, development and production of oil and gas fields. It reserves to the States concerned sovereign rights over oil and gas resources, including the right to determine the timing of the development of reserves and the rate at which they are allowed to be depleted. It does not apply to gas storage or transmission pipelines.


  11.    The proposed Gas Directive, which is the subject of the present report, has its origins in the Single European Act of 1985 and is intended to create common rules for the internal market in natural gas and thereby promote competition in the gas markets of the Member States. In order to implement the Single European Act an internal market provision (Article 7a) was added to the EC Treaty, defining the internal market as "an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of this Treaty". Article 7a required the Community to adopt measures with the aim of progressively establishing an internal market over a period expiring on 31 December 1992. Although the measures to be adopted included those for the establishment of an internal market in energy, this was one of the sectors in which the 1992 deadline was not met.

  12.    The need to extend the internal market to the energy sector was emphasised in the energy objectives for the Community identified by the Council of Ministers in September 1986. The objectives expressly mentioned the need for "greater integration, free from barriers to trade, of the internal energy market with a view to improving security of supply, reducing costs and improving economic competitiveness."[5]

  13.    It fell to the Commission to prepare the draft measures-mainly Directives-for the creation of an internal market for the various energy sectors including natural gas and electricity. The Commission began its task in 1988 by publishing a Working Document[6] which analysed the issues involved in creating an internal energy market and identified potential obstacles to the creation of such a market in each of the energy sectors. The potential obstacles identified in relation to the natural gas sector included differing technical standards, constraints on the free movement of natural gas at Community and national levels, and issues of transportation, storage, distribution, marketing and imports and exports.

  14.    Progress in reaching agreement on the internal market Directives for the gas and electricity sectors was hindered by disagreement among the Member States and by opposition from the industries concerned and from the European Parliament to some aspects of the proposals. The Commission adopted a common approach to the gas and electricity sectors when preparing its proposed Directives on the grounds that many of the obstacles to the introduction of competition were shared between the two sectors. The Commission issued consultative draft Directives for both gas and electricity in 1991, followed by formal proposals in 1992[7] and amended proposals in 1994[8]. Later that year, the Energy Council decided to give priority to the Electricity Directive, with further progress on the Gas Directive to be suspended in the meantime. A common position was reached on the Electricity Directive in July 1996 and was approved by the European Parliament later that year. The Directive came into force on 19 February 1997[9].

  15.    In a memorandum accompanying the consultative draft Directives issued in 1991, the Commission reviewed the obstacles to the creation of a single market in the gas and electricity sectors, listing them as follows:

    -    established gas undertakings had exclusive rights which limited new entrants to the market;

    -    there was little or no gas-on-gas competition since the few importers there were had divided the market between them "through a series of long term contracts characterised by costly take or pay clauses and supply prices based on the price of competing fuels";

    -    consumers were unable to choose their suppliers, while companies experienced no competition in their markets and as a result continued to behave in a monopolistic fashion;

    -    integrated gas and electricity companies published their accounts on a consolidated basis which limited the information given to the public on the efficiency and quality of the management of the various operational activities;

    -    interventions by Member States in the gas and electricity markets, in order to influence investments and prices, were often excessive and hindered companies' adjustment to their commercial environment;

    -    the conditions in which companies operated were not harmonised;

    -    gas and electricity transmission infrastructures and interconnections between networks were often inadequate and consequently restricted justified economic exchanges.

  16.    In September 1996, following agreement on the Electricity Directive, work was resumed on the Gas Directive. A compromise proposal, based in many important respects on the solutions adopted in the electricity sector, was prepared and circulated to Member States by the Irish Presidency. Its most controversial aspects related to market access and the treatment of long-term take-or-pay contracts. On market access it proposed an initial minimum market opening percentage, which was unspecified, with the Commission required to publish a minimum market percentage figure for each subsequent year. On take-or-pay it provided for the granting of "transitional regimes" in respect of access obligations only for contracts entered into before 25 July 1996, such transitional regimes to be granted by the Commission on application from the Member States concerned[10]. Despite extensive negotiation, no agreement had been reached by the time the Presidency passed to the Netherlands in January 1997.

  17.    The Dutch Presidency issued a new text on 25 April 1997 which proposed that, in the first stage of market opening, all power generators and other consumers using more than 25 million m3 per year should qualify as "eligible customers" able to benefit from competition in the supply of gas; that this threshold should fall to 10 million m3 after five years and to 1 million m3 after ten years; and that the resulting market opening should amount to at least 30 per cent initially, rising to 40 per cent after five years and 50 per cent after ten. The 25 April text also provided that "derogations" (the term now used instead of "transitional regime") could be granted in respect of access obligations for long-term take-or-pay contracts entered into at any time (that is, before or after 25 July 1996).

  18.    A further Dutch text of 6 June 1997 replaced these indicative figures with letters of the alphabet, indicating the extent of the disagreement that remained. It also proposed different procedures for applying for derogations from access obligations in respect of take-or-pay contracts, depending upon whether the contract was entered into before or after 25 July 1996. In respect of the former, Member States could grant derogations without reference to the Commission, but in respect of the latter they were required to notify their intention to grant a derogation to the Commission, which could require amendments to the derogation or refuse permission to grant it. No agreement was reached during the Dutch Presidency.

  19.    The incoming Luxembourg Presidency produced a compromise proposal on 18 July 1997 which proposed qualifying thresholds for eligible customers (other than power generators) of 25 million m3 initially, 15 million m3 after 5 years and 5 million m3 after 10 years, and minimum figures for market opening of 28 per cent, 40 per cent and 45 per cent respectively. This July text included recitals for the first time and incorporated a number of other changes[11].

  20.    Foremost amongst these was a revised two-stage procedure for the granting of derogations from the access requirements of the Directive to gas undertakings which, as a result of the introduction of competition, encounter economic difficulties or hardship under long-term take-or-pay contracts entered into either before or after 25 July 1996. The procedure would allow a gas undertaking to which an application for access has been made to apply to the Member State concerned for a derogation, either before or after access is refused. When considering such a request, the Member State would be required to take into account the terms of the contract in question, including the extent to which it allows for changes in market conditions. If it proposed to grant a derogation, the Member State would have to notify the Commission, which would be required to apply the same criteria as the Member State and could, within four weeks, request the Member State to amend or withdraw the proposed derogation. This procedure replaced that proposed in the 6 June draft, increasing the powers of the Commission to refuse or amend derogations proposed by Member States.

  21.    When the Committee began to take evidence in June, many of the basic elements of the draft Directive had been agreed, but a number of key issues were still to be resolved. These included the application of the Directive to offshore pipelines, the level of market liberalisation and the criteria for granting derogations from the application of the Directive. The Committee finished taking evidence in late July, since when negotiations on these outstanding points have continued, with the Working Party on Energy issuing new compromise texts on 22 September and 6 October. The most significant change in these texts was an addition to the criteria for granting derogations under Article 23, which requires the Member State and the Commission to take into account "the extent to which, when accepting the take-or-pay commitments in question, the undertaking could reasonably have foreseen, having regard to the provisions of this Directive, that serious difficulties were likely to arise"[12]. Other changes included a revised definition of "transmission" which would have the effect of excluding from the scope of the Directive production pipelines subject to the 1994 Hydrocarbons Licensing Directive; the introduction of Chinese wall provisions to prohibit transmission or distribution undertakings from abusing "commercially sensitive information obtained from third parties in the context of providing or negotiating access to the system"; and a reversion to a definition of "emergent regions" in place of the list of qualifying regions in an Annex proposed in the June and July texts.

  22.    The Luxembourg Presidency called an extraordinary Energy Council on 27 October, in the expectation that a common position could be reached on the draft Directive. Since this report was still in preparation, the Chairman of Sub-Committee B, Lord Geddes, wrote to the Minister for Energy, Mr John Battle MP, on 16 October to convey to the Government, in advance of the Council meeting, the provisional conclusions that the Sub-Committee had reached. The Minister replied on 19 November, informing the Sub-Committee that a common position had not, in the event, been achieved at the Energy Council. Although differences over market opening and take-or-pay remained unresolved, the Council concluded by noting the "substantial progress made" and confirming its "political willingness to reach a common position at the next Energy Council on 8 December 1997."


  23.    The membership of Sub-Committee B (Energy, Industry and Transport), which undertook the enquiry on which this report is based, is listed in Appendix 1. The witnesses who gave evidence in the enquiry are listed in Appendix 2, while Appendix 3 consists of a table of gas prices in the EU and G7 countries which was supplied by the Department of Trade and Industry. The letter sent by the Chairman of Sub-Committee B to the Minister is printed as Appendix 4 and the Minister's reply as Appendix 5. The remainder of this report consists of a summary of the main points made in evidence in Part 2, followed by the Committee's conclusions in Part 3.


  24.    The Committee would like to thank all the witnesses who gave oral and written evidence in the enquiry, particularly those who travelled from overseas. We also wish to thank the Specialist Adviser, Mr Michael Brothwood of Denton Hall's Energy and Infrastructure Group, for the assistance he provided during the enquiry and in the preparation of this report.

1   Source: Eurogas. Comprehensive data on the European gas industry is contained in documents supplied by Eurogas and reprinted as part of the evidence accompanying this report. The data to which this footnote refers is at p 57. Back

2   Source: Eurogas, pp 59-60. Other States of the former Soviet Union are also likely to become increasingly significant exporters of gas.  Back

3   Source: Eurogas, p 57. Back

4   Directive 94/22/EC of the European Parliament and the Council of 30 May 1994 on the conditions for granting and using authorisations for the prospection, exploration and production of hydrocarbons, OJ L164 30.6.94, p 3. Back

5   Council Resolution of 16 September 1986 concerning new Community energy policy objectives for 1995 and convergence of the policies of the Member States, OJ C241 25.9.86. Back

6   Commission Working Document: The Internal Energy Market, 2.5.88. Back

7   Proposal for a Council Directive concerning common rules for the internal market in natural gas COM(91) 548 final- SYN 385, OJ C65 14.3.92, p 14; Proposal for a Council Directive concerning common rules for the internal market in electricity COM(91) 548 final-SYN 384, OJ C65 14.3.92, p 4. Back

8   Amended Proposal for a European Parliament and Council Directive concerning common rules for the internal market in natural gas, OJ C123 4.5.94, p 26; Amended Proposal for a European Parliament and Council Directive concerning common rules for the internal market in electricity OJ C123 4.5.94, p 1. Back

9   Directive 96/92/EC of the European Parliament and the Council of 19 December 1996, OJ L27 30.12.96, p 20. Back

10   Presidency Compromise Proposal for a European Parliament and Council Directive concerning common rules for the internal market in gas, Brussels, 7 February 1997. Back

11   Presidency Compromise Proposal for a European Parliament and Council Directive concerning common rules for the internal market in natural gas, Brussels, 18 July 1997. Back

12   The October text also gives Member States the right to choose whether an applicant for a derogation must submit the application before or after refusing access. Back

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