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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