Conditions For Truly Competitive Gas

DEPARTMENT OF TRADE AND INDUSTRY
Conditions for Truly Competitive Gas

Markets in the EU
Report Prepared By:
ENERGY MARKETS LIMITED

UNITED KINGDOM
Volume 1
Final Report
November 2005
Energy Markets Limited

Half Acre Mews
37 Half Acre
Brentford Middlesex
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Tel: +44(0) 208 232 1570
www.energymarkets.eu.com
Conditions for Truly Competitive Gas Markets in the EU
Final Report - November 2005
The views and judgements contained in this report are those of Energy Markets and
do not necessarily reflect the views of the Department of Trade and Industry, who do
not necessarily endorse the conclusions.
TABLE OF CONTENTS
EXECUTIVE SUMMARY .........................................................................................11
International Experience ..........................................................................................11
Current Conditions in the Key Markets ...................................................................12
Barriers to Competition and Changes Required ......................................................15
Transition to Competitive Markets ..........................................................................18
Actions for Consideration by the UK Government .................................................21
1. INTRODUCTION ...................................................................................................25
1.1. Background .......................................................................................................25
1.2. Report Structure ................................................................................................25
2. DEFINING A COMPETITIVE MARKET FOR GAS ...........................................27
2.1. Economic Definition .........................................................................................27
2.2. Characteristics of Truly Competitive Markets..................................................34
2.3. Markets and Geographies .................................................................................40
2.4. Conclusions.......................................................................................................44
3. INTERNATIONAL EXPERIENCE........................................................................47
3.1. US Experience ..................................................................................................47
3.2. UK Experience..................................................................................................51
3.3. Australian Experience.......................................................................................54
3.4. Common Themes and Lessons for the EU .......................................................57
4. CURRENT CONDITIONS IN THE KEY MARKETS ..........................................61
4.1. Production Market in the EU ............................................................................61
4.2. Wholesale Market in the EU.............................................................................68
4.3. Retail Market in the EU ....................................................................................96
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4.4. Pipeline Supply Area ......................................................................................102

4.5. LNG Supply Area ...........................................................................................131
5. BARRIERS TO COMPETITION AND CHANGES REQUIRED.......................139
5.1. Barriers to Competition...................................................................................139
5.2. Changes Required in Key Markets .................................................................147
6. TIMING OF THE TRANSITION .........................................................................163
6.1. Overview of Scenarios....................................................................................163
6.2. Market Characteristics by Scenario ................................................................175
7. IMPLICATIONS OF A COMPETITIVE GAS MARKET...................................183
7.1. Gas Price Implications ....................................................................................183
7.2. European Gas Supplies ...................................................................................190
7.3. UK Supplies ....................................................................................................196
7.4. Price Signals....................................................................................................198
7.5. Summary .........................................................................................................201
8. ACTIONS FOR CONSIDERATION BY THE UK GOVERNMENT.................203
8.1. Options and Recommendations ......................................................................203
8.2. UK Government Strategy ...............................................................................213
9. CONCLUSIONS....................................................................................................217
INDEX OF FIGURES
Figure 1 Services Offered by US Pipelines .................................................................49
Figure 2 US Gas Consumption Production and Imports 1950-1995 ...........................50
Figure 3 The Structure of the Dutch Gas Industry.......................................................63
Figure 4 Eon Interest in the Proposed NEGP Route to UK.........................................72
Figure 5 EML Assessment of Gas Flows in Europe..................................................104
Figure 6 Forecast Production for Gazprom from existing fields ...............................105
Figure 7 Production by Russian Independent Producers 1999 to 2004 .....................107
Figure 8 Soyuzgas view of Russian production.........................................................111
Figure 9 Structure of Norwegian Gas Production......................................................120
Figure 10 World LNG Exports 2003 .........................................................................131
Figure 11 European Gas Flows in 2015/6 Constrained $30 Oil Price Case ..............192
Figure 12 European Gas Flows in 2015/6 Most Competitive Base Case ..................193
Figure 13 European Gas Flows in 2015/16 Fully Competitive Case.........................194
Figure 14 Comparison of Spot Flows With the Price Differential Between Zeebrugge
Hub and NBP .....................................................................................................199
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INDEX OF TABLES
Table 1 EU Wholesale: Changes Required..................................................................15
Table 2 EU Retail: Changes Required .........................................................................16
Table 3 Pipeline Supply Production: Changes Required .............................................17
Table 4 Pipeline Supply Wholesale: Changes Required..............................................17
Table 5 Summary of UK Spot Prices 2015/16.............................................................19
Table 6 Gas Prices by Scenario ...................................................................................20
Table 7 Ranking of Changes Required ........................................................................23
Table 8 Characteristics of Truly Competitive Gas Markets ........................................39
Table 9 Definition of Market / Geographical Sectors..................................................42
Table 10 Importance of Competition by Sector and Geographical Area.....................43
Table 11 EU Gas Reserves ..........................................................................................62
Table 12 Current Status of the Production Market in EU............................................67
Table 13 Examples of Cross Border Flow Flows and Capacity ..................................83
Table 14 Comparison of Transportation Tariffs ($/mcm/100 km) ..............................85
Table 15 Current Status of the Wholesale Gas Market in EU .....................................95
Table 16 Throughput of Snam Rete Gas System.........................................................99
Table 17 Current Status of the Retail Gas Market in EU ..........................................101
Table 18 European Gas Imports by Country 2003 ....................................................102
Table 19 European Gas Imports by Company 2003 ..................................................103
Table 20 Russian Gas Contracts with Europe............................................................106
Table 21 Algerian Gas Contracts...............................................................................117
Table 22 Libyan Gas Contracts..................................................................................118
Table 23 Norwegian Gas Contracts ...........................................................................123
Table 24 Norwegian Export Pipelines .......................................................................125
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Table 25 Investment Interests in Langeled ................................................................126

Table 26 Caspian Area Gas Contracts .......................................................................127
Table 27 Current Status of Production and Wholesale Markets in the Pipeline Supply
Area....................................................................................................................130
Table 28 LNG Imports to Europe by Origin..............................................................131
Table 29 LNG Supplies to Europe Market Shares..................................................132
Table 30 LNG Gas Contracts to Europe ....................................................................135
Table 31 Cost Reductions in the LNG Chain ............................................................136
Table 32 Current Status of Production Market in the LNG Supply Area..................137
Table 33 Barriers to Competition ..............................................................................146
Table 34 EU Wholesale: Changes Required..............................................................148
Table 35 EU Retail: Changes Required .....................................................................154
Table 36 Pipeline Supply Production: Changes Required .........................................157
Table 37 Pipeline Supply Wholesale: Changes Required..........................................158
Table 38 Gas Demand in Europe by Scenario (Net of Producers Own Use) ...........165
Table 39 Pipeline Infrastructure Assumptions by Scenario.......................................167
Table 40 LNG Liquefaction Plant Assumptions By Scenario ...................................168
Table 41 LNG Regasification Plant Assumptions by Scenario .................................169
Table 42 Key Outcome of DOE Reference Case.......................................................171
Table 43 Key Outcome of DOE Restricted Supply Case ..........................................172
Table 44 High Level Overview..................................................................................174
Table 45 Market Characteristics by Scenario - EU Production.................................175
Table 46 Market Characteristics by Scenario - EU Wholesale (Part 1) ....................176
Table 47 Market Characteristics by Scenario - EU Wholesale (Part2) .....................177
Table 48 Market Characteristics by Scenario - EU Retail.........................................178
Table 49 Market Characteristics by Scenario Pipeline Area Production................179
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Table 50 Market Characteristics by Scenario Pipeline Area Wholesale ................180

Table 51 Market Characteristics by Scenario LNG Area Production.....................181
Table 52 Market Characteristics by Scenario LNG Area Wholesale .....................181
Table 53 Gas Prices by Scenario ...............................................................................184
Table 54 Constrained Case Sensitivities to US Wellhead Price ................................185
Table 55 Sensitivity to Oil Prices (Real 2004 Prices)................................................186
Table 56 Most Competitive: Transport Tariffs From Russia to Germany.................188
Table 57 Most Competitive: UK and German Spot prices ........................................189
Table 58 Fully Competitive: Gas Transportation Costs to Germany ........................189
Table 59 Fully Competitive: UK and German Spot Prices........................................190
Table 60 European Gas Supply by Scenario..............................................................190
Table 61 Russia/Gazprom Market Share of European Imports by Scenario .............195
Table 62 Algerian/Sonatrach Market Share by Scenario...........................................195
Table 63 Norwegian Market share.............................................................................196
Table 64 UK Supplies by Scenario ............................................................................197
Table 65 UK Supply Shares by Scenario...................................................................197
Table 66 Summary of UK Spot Prices 2015/16.........................................................201
Table 67 Actions to Remove Barriers: EU Wholesale ..............................................210
Table 68 Actions to Remove Barriers: EU Retail......................................................211
Table 69 Actions to Remove Barriers: Pipeline Supply ............................................212
Table 70 Barriers and Achievability Matrix ..............................................................213
Table 71 Ranking of Changes Required ....................................................................214
Table 72 Barriers to Competition ..............................................................................221
Table 73 Summary of UK Spot Prices 2015/16.........................................................222
Table 74 Ranking of Changes Required ....................................................................224
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EXECUTIVE SUMMARY
The UK is now a net importer of gas, with prices and access to supply increasingly
depending, therefore, on markets elsewhere. In this context, it is critical to understand
what might stand in the way of effective and efficient competition in European as well
as global gas markets in the next 5-10 years. As a consequence the Department of
Trade and Industry (DTI) decided to commission a report to consider the Conditions
for Truly Competitive Gas Markets in the EU (and Globally).
The objective of the report was to identify the potential barriers to the development of
truly competitive natural gas markets on the Continent (and globally) and, where
appropriate, identify ways in which the UK Government could influence the political,
regulatory and market outcomes in order to maximise the benefits of competitive gas
markets to UK consumers.
The report firstly considers international experience of how competitive markets
develop, current conditions in the key gas markets, the barriers to competition and
changes required to remove the barriers, the transition to competitive markets and the
implications for prices in particular and actions for consideration by the UK
Government.
For the purposes of analysis the overall gas market was divided into three distinct
markets the producer market, the wholesale market and the retail market and three
distinct geographies the EU25, plus accession and candidate countries, the Pipeline
Supply Area and the LNG Supply Area creating a total of 9 sub-markets. The
importance of each of the 9 sub-markets differs, however, in the context of
competition in the EU market. Four key markets were identified as being the most
important in respect of competition in the EU market the EU Wholesale market, the
EU Retail market, the Pipeline Supply Production market and the Pipeline Supply
Wholesale market. The focus of the report, therefore, is largely on these 4 key submarkets.
International Experience
The study considered, in terms of international experience, the gas markets in the US,
UK and Victoria in Australia which are very different, ranging in size, diversity and
complexity. Each market, however, has successfully introduced competitive gas
markets particularly at the wholesale level. The common themes arising from the
experience of these differing markets are as follows:
Effective Gas Release - If the existing market structure is one of a monopoly

supplier of gas to end users or Local Distribution Companies (LDCs) then new
entrants will require access to gas supplies to compete. In all 3 markets the release
of gas happened relatively quickly, not only on the gas purchase side but also on
the gas sales side with incumbents rapidly losing market share.
Access to and Availability of Capacity - Fundamental changes in moving towards

competitive markets are often focused on the market for transportation capacity,
especially at the transmission level. In the US there was a very effective large
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release of capacity on the interstate pipelines as their merchant sales business

disappeared and they were forced by FERC to open up their pipelines to regulated
third party access. In the UK and Victoria, in contrast, the process of opening up
the pipeline systems to third party access was much more of a planned transition,
aided by the US experience, with a key difference being the adoption of common
or market carriage as opposed to contract carriage in the US.
Unbundling - The unbundling of the pipeline services into transportation, supply

and storage in Order 636 in the US was seen as the culmination of the market
liberalisation process and the final confirmation that a fully competitive gas
market, at least at the wholesale level, had arrived. Again in the UK and Victoria,
building on the US experience, unbundling was seen as an essential prerequisite
right at the beginning of the liberalisation process.
Other factors which were seen as important in the introduction of competition

included the size and diversity of the market in the US, and to a lesser extent in the
UK, government and regulatory commitment to liberalising the markets, the
development of trading hubs as a consequence of access to capacity and gas and the
harmonisation and standardisation of rules, procedures and the transfer and
dissemination of information.
Current Conditions in the Key Markets
Four key markets were identified for more detailed analysis. The current conditions,
or status, in each of these key markets is considered below. For purposes of analysing
the current conditions the Pipeline Supply Production and Wholesale markets are
considered together:
Wholesale Market in the EU
Market dominance continues to be a major issue. Many national markets continue

to be dominated by the incumbent gas company. We are also seeing the advent of
powerful pan-European gas and power companies with high profile strategies
based on acquisition and investment programmes aimed at controlling large
sections of the physical infrastructure and access to end users via ownership of
distribution companies. The implementation of the 2nd Gas Directive may go some
way towards limiting any market dominance but on its own we do not believe it is
enough. Major producers are also trying to establish market positions but they are
lagging somewhat behind the gas and power companies in terms of sales. Whilst
there are some banks trading, notably absent from the market are the independent
wholesalers such as Enron, Dynegy and other US companies who were trying to
enter the market a few years ago.
Legal unbundling of transportation, storage and supply has largely been

implemented but how effective this has been in creating a level playing field for
new entrants is uncertain. Gas release schemes have also been introduced, which
conceptually is good progress, but their real effectiveness is uncertain. Better
progress is being made in respect of gas contracts with more flexibility being
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introduced, the removal of destination clauses and the German cartel office
declaring 75% of the 750 contracts between the transmission system operators
(TSOs) and the LDCs as anti-competitive.
The main issues regarding third party access relate to allocation of capacity. Many
TSOs operate a first come first served system which effectively denies access to
capacity to new entrants. Transit is generally treated separately from domestic
transportation. Capacity in transit lines is frequently booked up under long term
contracts and there are cross-subsidies between transit and domestic charges.
Analysis suggests that cross-border capacity is generally under utilised, except
maybe into Italy, and that there are also large discrepancies between transmission
tariffs within EU countries for transporation of similar loads and distances. It is
certainly noticable that tariffs are lower where regulators have taken an active role
in forcing out inefficiency and economic rent than in countries where independent
regulators have been less forceful in regulating tariffs.
Balancing regimes also differ between countries, with a mixture of hourly and
daily balancing, and evidence of overly penal charges. There is, therefore,
considerable scope for network operators to adopt a regime that implicitly favours
their associated supply business. Progress is being made on the publishing of
conditions for access to both LNG terminals and storage facilities with a mixture
of regulated and negotiated TPA.
At the institutional level the regulatory authorities in some countries would appear
to be more proactive than in others, particularly where state ownership is still
important. Germany has only just established a regulator but the cartel office has
been active.
Retail Market in the EU
The process of introducing competition to the retail sector is in its infancy in

Europe. Experience so far shows that just changing the law to allow consumers to
change supplier does not necessarily lead to effective competition. Many
companies are finding it difficult to enter certain markets and there has been a low
rate of customer switching overall. However, in Spain there has been some
significant switching of industrial and commercial customers amid a situation of
over-supply and a price war. In Italy the Letta decree is forcing down the market
share of Eni wth Edison proving to be the main competitor.
Apart from access to infrastructure and gas supplies, adequate systems are also
required at the LDC level to ensure a smooth switching process and to ensure that
information flows are maintained to support proper customer billing. In addition it
should be noted that a large proportion of customers bills are for components
which are beyond the control of the gas supplier (gas and transportation costs and
taxes). This makes it difficult for new entrants to undercut the prices offered by
the incumbent company and makes the financial advantage of switching
questionable in relation to the potential problems and worries that switching can
bring.
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Analysis by Energy Markets (EML) indicates prima facie evidence that there is a
significant amount of inefficiency and/or economic rent in the distribution and
supply sector in particular, making the cross subsidisation of the supply side by
the incumbents pipes business much easier to achieve. This would indicate that
distribution is yet to come under effective regulatory control and supply to small
users (households and small industrials) has not been subjected to competitive
pressure.
Pipeline Supply Area
Europe (EU25 plus Romania, Bulgaria and Turkey) imported just over half its gas
supplies in 2003. Russia accounted for half of the imports, Norway 25% and
Algeria 20%. Russia and Algeria will increase their exports to Europe in the next
10 years, but new pipeline supplies are expected from Libya, Iran and the Former
Soviet Union countries in the Caspian Sea area (Turkmenistan, Azerbaijan,
Kazakhstan and Uzbekistan). Europe will remain highly dependent on gas flowing
from Russia through the Ukraine to Slovakia. However, alternative routes through
Belarus and Poland (Yamal) and direct to Turkey under the Black Sea
(Bluestream), are now flowing gas with volumes expected to increase over the
next few years. A third route to Germany under the Baltic Sea (North European
Gas Pipeline) is also planned although the timing of this project remains subject to
uncertainty.
Gazprom dominates Russian production at the moment but a decline in volumes

from existing fields is forecast and Gazprom will need to develop other deposits
mainly in Western Siberia. Independent production has doubled between 1994 and
2004 to just under 100 bcm per year. Gazprom has been trying to buy up some of
the independent producers and exercises effective control over all exports of gas.
Most of the exported gas is routed through Ukraine but Yamal has diversified
some of the gas and Blue Stream into Turkey some more. The proposed Baltic
pipeline will result in more diversification away from Ukraine. Gazprom is
effectively blocking any reforms of the gas sector in Russia.
Algerian exports to Europe were 55 bcm in 2003 30 bcm by pipeline and 25

bcm by LNG. Pipeline routes are to Italy and Spain (via Morocco) but the Medgaz
pipeline, which is under construction, will deliver gas directly to Almeria.
Sonatrach dominates the gas industry and although foreign companies area
allowed to participate they may do so only in partnertship with Sonatrach.
However, Sonatrachs share is planned to fall as part of the reform to encourage
more foreign investment.
Norway is the second largest importer into the EU market and recent reforms have
led to the break up of the GFU and producers selling their gas directly. The
offshore transportation regime has also been reformed by the creation Gassco
(operator) and Gassled (owner) with open access and an entry exit methodology.
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Barriers to Competition and Changes Required

Some 20 barriers to competition were identified in the 4 key sub-markets. The tables
below describe the main barriers to competition which need to be addressed in each of
the 4 key sub-markets EU Wholesale and Retail and Pipeline Supply Production and
Wholesale and the changes required to remove the barriers.
Table 1 EU Wholesale: Changes Required
Barriers to Competition
Changes Required
Main Drivers/Factors
Introduce market carriage TPA

model to provide more flexibility in
capacity booking including UIOLI,
and allow rolled in treatment,
where appropriate, for capacity
expansions
Some resistance from incumbents

on freeing up capacity and will need
incentives
from
regulatory
authorities to make unused capacity
available and encourage investment
Diverse tariff and TPA structures

make
transmission
of
gas,
particularly transit, over long
distance difficult
Harmonisation of TPA structures

across the EU but need to avoid the
pancaking of charges
The widespread adoption of entry

exit
is
a
move
towards
harmonisation of regimes but needs
to be modified to incorporate
transit
Separate transit regimes
Transit to be incorporated into main

domestic transmission systems.
Increase importance of UK as a
transit country.
Many transit contracts will be long

term legacy contracts with very
different terms and conditions. Will
be difficult to incorporate
Lack of regulated TPA in storage

and
inappropriate
balancing
regimes
Presumption that all storage should

be regulated TPA, unless it can be
shown there is true competition.
Simplified, non-punitive, balancing
regimes, with daily being the
minimum balancing period
There has already been resistance

from incumbents and some
governments. Strong pressure from
European Commission needed
High import dependency and

dominance of single import
company in many countries or
insignificant competition between
multiple suppliers. Creates local
monopolies
Introduction of effective gas release

programmes
Release at the gas purchase end

needs to be accompanied by release
at the sales end as well. Current
schemes not ambitious enough.
Lack of liquid and transparent spot

markets and hubs
Spot markets and hubs will develop

once the conditions for effective
competition are in place
Will follow other changes
Oil price escalation and anti

competitive clauses in gas purchase
contracts
Removal
of
anti-competitive
clauses
from
contracts
and
encouragement of shorter term
contracts
European Commission making

good progress on anti competitive
clauses
Perceived lack of transmission

capacity and problems with
capacity booking
Introducing full competition into the EU Wholesale market is seen as a key priority
and an area where there are significant barriers to entry. This is particularly the case in
respect of access to, and availability of, pipeline capacity at reasonable tariff levels.
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Gas storage is also another key area and the Second Gas Directive and the Guidelines
for Good Practice have failed to provide real access to storage at a reasonable price.
For gas release programmes to be effective it will be important to release gas not only
from purchase contracts but also at the sales end as well.
Table 2 EU Retail: Changes Required
Changes Required
Lack of TPA access to Distribution

systems
Introduction of consistent and

coherent
Network
Codes,
specifically for distribution if
separate from transmission
Overcoming
resistance
from
incumbents and concern about the
possible high cost of introducing
retail competition
Dominance of pipeline companies

in relation to sales to LDCs
Removal
of
exclusive
arrangements, shorten duration of
contracts and institute gas sales
release programmes.
Strong incumbent resistance falling

back on the security of supply
argument. Strong regulatory and
competition
authorities
action
required
Minimal supplier switching as a

result of customer inertia and
inadequate administrative structures
to enable customers to change
suppliers
Increase customer awareness of the

benefits of switching. Introduce
cost effective and efficient supply
point administration
Fear of the high cost of introducing

necessary systems but there are
lower cost alternatives which can be
utilised
Lack of unbundling. Incumbents

can subsidise the supply business
Proper
legal
unbundling
of
transportation, supply and storage.
Privatisation of state owned
businesses.
Cost
reflective
distribution charges to eliminate
excess profits and inefficiencies
Incumbent and possible government

resistance. Strong action required
from regulatory authorities, backed
by governments.
A large proportion of the retail gas

bill is outside the suppliers control,
including gas cost, transport fees
and taxes, making it difficult to
undercut the incumbents prices.
Introduction of full competition in

the EU Wholesale market and the
Pipeline Supply Production and
Wholesale markets and firm
regulatory
oversight
on
transportation tariffs
Refer to sections on EU Wholesale,

Wholesale
Introducing full retail competition is seen as a Medium to High priority. It is not

considered essential for competition to develop at the retail level in order for the
benefits of competition at the wholesale level to filter down to retail customers, as has
been shown in the US and the UK. However, it is possible that the extension of
competition to the retail sector may assist the introduction of competition at the
wholesale level. It would reduce the ability of the incumbent gas supplier to crosssubsidise between its competitive and monopoly customers and also overcomes the
problem of defining where the boundary between the competitive and monopoly
markets should lie. In addition, if accompanied by effective unbundling of
transportation and supply, the regulatory authorities can ensure that the distribution
network charges are set at an efficient level.
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Table 3 Pipeline Supply Production: Changes Required

Dominant
national
largely state owned
producers,
Restrictions
on
exports
independent producers
by
Few foreign investors
Changes Required
Encourage privatisation of national

producers
Expect some resistance from

governments but generally these
countries are in need of foreign
investment
Allow independent producers to sell

their own gas directly
Introduction of foreign investment

combined with opening the
wholesale market through regulated
TPA should help independent
producers to sell their gas directly
Put in place legal and tax structure

to encourage foreign investment
Many countries do not have well

developed legal and tax structures
which respect property rights
Because of the dominance of supplies to the EU by a few countries and largely state
owned companies introducing more competition in this area is seen as a High Priority.
Table 4 Pipeline Supply Wholesale: Changes Required
Changes Required
Lack of TPA to infrastructure in

producer and transit countries
Introduce regulated TPA regimes

consistent with EU
Some countries are still resistant to

the introduction of regulated TPA
Lack of spare capacity in export

pipelines
Promote privatisation of pipeline

systems and introduction of foreign
investment
Infrastructure is generally in poor

condition and there is still resistance
to privatisation and foreign
investment in key infrastructure
No
transmission
connections
directly with specific (FSU in
particular) countries with abundant
gas reserves. Inhibits diversification
of EU supplies
Promote the construction of new

pipeline links and try to reduce the
influence
of
the
incumbent
producers
The incumbents will try and keep

control of any new pipeline links or
try and prevent them. Investment
funds could also be an issue in some
countries
Gazprom in particular can exploit

its exclusive access to information
in order to control the entire
wholesale market.
Unbundling of Gazprom, separating

transportation and supply, or
enforcement of regulated TPA
regime
Could
encounter
powerful
resistance from Gazprom and
Russian Government
The wholesale markets in the Pipeline Supply area are also seen as a High Priority for
competition because of the importance of diversifying supplies to the EU. The
diversification of supplies will require the construction of new pipeline links,
particularly those adding to Russian and Gazproms routes.
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Transition to Competitive Markets

In order to consider the timing, and implications, of the transition to competitive
markets, three distinct scenarios were identified and these were then tested using
Energy Markets unique European Gas Model (EGM) for a spot gas supply year
2015/16 (i.e. 10 years ahead). The three scenarios were:
The Fully Competitive Case - The Fully Competitive Case represents the best
possible world from the point of view of competition in the gas market. It depicts
a fully competitive gas market in EU and globally by 2015/16. Within the EU the
liberalisation process has been completed and there has been substantial reform in
the gas market in Russia and other gas producing countries. The LNG market
becomes fully commoditised with extensive spot trade. The Fully Competitive
case is included as a benchmark against which to measure the other scenarios
and is not necessarily considered to be a realistic picture of the market in
2015/16.
The Most Competitive Case - This case represents the most positive outcome
from the point of view competition in the gas market that can reasonably expected
to be achieved over the next ten years. Long term contracts continue to play an
important part in the market but pricing terms move away from oil price
indexation to market-related pricing. Liberalisation within the EU itself is
substantially completed but there remain problems beyond the EU borders. Whilst
some reform has been attempted in Russia, and Russia has signed the Energy
Charter Treaty, Gazprom remains dominant over Russian production and still
effectively manages to exclude gas from the Caspian area from direct access to the
European market.
The Constrained Case - This case represents a fairly pessimistic view of

competition in the gas market by 2015/16. Whilst the second gas Directive has
been transposed into national law by all member states there has been little real
enthusiasm for competition and the European gas market continues to be
characterised as a series of national markets. Trade continues to be dominated by
long term contacts with price escalation clauses linked to oil prices. Gas prices,
therefore remain sensitive to oil price outcomes.
In respect of key data inputs to the EGM, the assumptions were as follows:
Demand - We have used a conventional view of gas demand in Europe which is

broadly consistent with forecasts by IEA. In 2002 demand was just under 500
bcm. This is expected to rise to 715 bcm by 2015/16. In the UK demand would
rise from 93 to 103 bcm. For the Most Competitive scenario, we have added a
sensitivity case with slightly higher demand assuming greater use of gas in the
power sector in Germany, Italy and other countries. Total European demand in
2015/16 would be 747 bcm and in the UK some 118 bcm.
- 18-
Oil prices - We have used the DTI assumption for the oil price of $30/bbl (real
2004 prices in 2015/16) and tested the sensitivity of the constrained case (the only
case with gas prices linked to oil) to $20/bbl and $40/bbl (real 2004 prices).
Exchange Rates The exchange rates used to convert $ figures to and

equivalents were the average of the 5 years 1999 to 2004. The :$ rate therefore is
$1.585 and the :$ rate is $1.033. These do, of course, represent a significantly
stronger $ than is currently the case. However, we would not expect a materially
weaker $ to result in lower p/therm or /MWh prices, since a sustained period of $
weakness would result in resource costs being higher in real $ terms than we have
assumed in our production supply costs and pipeline tariffs, leaving and prices
little changed.
Supply and Infrastructure - The Fully Competitive and Most Competitive cases
both assume plentiful supplies and infrastructure. In the Fully Competitive case
the pipeline supply area is extended by new pipelines from Egypt to Turkey and
from Nigeria to Algerian and on to southern Europe. Supplies from the Caspian
can transit Russia using TPA in this case as well via Turkey and the Nabucco
pipeline. In both the Most Competitive and Constrained, Russia does not introduce
TPA. Caspian gas can be routed via Turkey and, in the case of Most Competitive,
in the Nabucco pipeline to Austria. Russia is able to continue to buy supplies from
Caspian area producers to help supply its own exports to Europe.
Table 5 shows the projected UK prices in real terms for 2015/16 for the three
scenarios. It gives an indication of the magnitude of the beneficial impact on prices of
increasing degrees of competitiveness in the EU gas markets.
Table 5 Summary of UK Spot Prices 2015/16
P/Therm Real 2004
Prices
Constrained Case
Most Competitive
Most Comp Sensitivity
Fully Competitive
UK Spot Price
Q1
32.0
22.2
23.7
17.3
Q2
33.6
22.2
23.7
18.7
Q3
30.1
18.7
20.3
15.2
Q4
30.1
18.7
20.2
15.2
Average
31.5
20.4
22.0
16.6
Gas prices in the scenarios are summarised in Table 6 for 14 of the 25 countries
included in the EGM. Generally, price (or basis) differentials between countries,
including between the UK and other Member States, should reflect the transportation
tariffs on the connecting pipeline systems. In the Constrained Case and the Most
Competitive Case contractual and physical constraints on the pipeline systems result
in basis differentials between countries diverging from the transportation tariffs. In the
Fully Competitive Case, where almost all constraints have effectively been removed,
basis differentials do reflect the tariffs. Also in the Most Competitive and Fully
Competitive cases, the general pattern is for prices to get higher the further west in
Europe the country is. However, in the Most Competitive cases it is noticeable that
prices in Central Europe are relatively higher than in neighbouring countries, which is
- 19-
a result of capacity constraints preventing these countries accessing cheaper Russian

gas. This would signal the need to build more capacity and over time these large
differentials could be expected to be reduced.
In the Constrained case the spot price is higher than WACOG that is marginal costs
are higher than the long term gas contract price based on a $30/bbl oil price. The UK
spot price is around 31.5 p/therm set by arbitrage with USA in the LNG market. On a
range of reasonable assumptions for US prices, the UK spot price could fall within a
range of 27.0 to 36.4 p/therm. Under this scenario many of the European countries
prices are closely linked with US prices, since US prices are the main driver of LNG
spot prices, which in turn are the marginal supplier to much of Europe. Long run
gas supply contracts linked to oil in this scenario determine some European prices.
However, this gas is limited in supply and is assumed to be unable to arbitrage into
the UK market.
Table 6 Gas Prices by Scenario
P/therm Real 2004 Prices
Austria
Belgium
France
Germany
Greece
Ireland
Italy
Netherlands
Poland
Portugal
Spain
Switzerland
Turkey
UK
Constrained Case
Most
Competitive
MC
Sensitivity
Fully
Competitive
WACOG
Spot Price
21.3
18.9
21.1
21.1
14.6
27.1
31.7
23.0
20.1
36.6
31.0
37.4
22.8
18.6
36.6
19.5
20.6
14.6
11.9
24.6
20.8
21.7
15.5
11.9
26.1
15.3
16.1
14.2
12.9
18.2
22.4
23.7
19.0
21.7
18.3
19.7
26.1
11.5
12.7
30.6
10.0
16.1
9.8
20.5
13.6
11.8
16.5
10.7
21.5
16.0
14.1
12.7
9.2
17.6
15.0
28.0
23.5
31.4
32.8
34.9
31.5
20.5
14.1
20.4
21.1
14.1
22.0
15.2
11.2
16.6
It is important for Europe to secure adequate low cost supplies from Russia, FSU and
other sources. The alternative is that potentially higher prices result from the EU
competing with the US for LNG supplies. The Most Competitive case would bring in
sufficient supplies to Europe to lower prices in general. For the UK the gas price
would be around 20.4 p/therm, or 11.1 p/therm less than in Constrained case. Supplies
from Russia are now the key in setting spot prices, with LNG supplies becoming a
price taker, as opposed to the price setter as in the Constrained case.
The Fully Competitive Case would not only help contain gas prices, through greater
pipeline capacities and increased liberalisation and competition, but also improve
security of supply to Europe because there is a much more diversified range of supply
countries contributing to supply. Russia will contribute a significant proportion of
- 20-
European gas requirements under any scenario because of its reserve position.
However, in the Fully Competitive Case, the Russian share is limited to less than 35%
and more importantly the gas is produced by a wider range of producers, because of
the assumed break up of Gazprom, and independent gas producers can market their
gas directly to Europe.
European imports are currently dominated by three producers Gazprom, Sonatrach
and Statoil who control 84% of imports. The combined market share of these three
producers declines to 69% in the Constrained Case, 59% in Most Competive and 51%
in Fully Competitive.
Actions for Consideration by the UK Government
The possible options and recommendations are linked directly to the barriers to
competition and the changes required in key markets as described above. The changes
required in the key markets can be divided into the EU area and the Pipeline Supply
Area, since the actions that the UK Government can undertake will differ between the
two areas. Direct action that the UK Government can take is relatively limited since
almost all the changes required are outside the UK. Much of the actions, therefore,
will be limited to influence and persuasion, although under certain circumstances it
may be possible in the future for direct legal action to be taken under EU Competition
Law.
The changes are ranked in terms of their relative priority and possible achievability
and linked with potential actions by the UK Government. The ranking of the changes
is shown in Table 7 below.
Out of the top 10 changes required, 6 relate to the EU Wholesale market, focussing
particularly on access and availability of transmission capacity and the flexibility on
gas supplies both in terms of volumes and contractual terms. Changes in the EU Retail
market are of less importance, apart from the requirement to unbundle transportation
and supply and reforming the gas sales contracts to LDCs. In the Pipeline Supply area
the focus is very much on expanding pipeline capacity both in terms of diversification
through new connections and privatisation of existing pipelines.
It is perhaps not too surprising that 3 of the top 5 ranked changes relate to acesss to
and availability of capacity, effective gas release and unbundling, all of which were
seen as integral in the introduction of competition in the US, UK and Victoria in
Australia. In addition, the other 2 in the top 5 new pipeline connections and more
transit through the UK - are designed to increase the EUs diversity of supplies, also a
key factor in the US and the UK.
A number of the recommended changes required, especially at the EU Wholesale
market level, go well beyond the Second Gas Directive and further than has been
suggested at the Madrid Forum. If these changes are to be implemented, therefore,
most, if not all, of the other countries in the EU and the European Commission will
have to be persuaded of the merits of the changes.
- 21-
In trying to achieve these changes in the EU, a programme of influence and

persuasion of the reforms required can be undertaken at EU and national government
level. A further factor could be redressing the informational advantage, for example
concerning capacity availability, that the incumbents have over their customers and
regulatory and governmental authorities. This can be done through a detailed and
thorough benchmarking study together with the aggressive use of EU competition
law.
In the Pipeline Supply area, apart from encouraging UK company involvement in
infrastrucuture developments, the strategy would be more concerned with negotiating
for reform within the producer and transit countries and implementation of the Energy
Charter Treaty.
- 22-
Table 7 Ranking of Changes Required

Rank
Code
Title
Change Required
EUW1
Market Carriage TPA and

Capacity Availability
Introduce market carriage TPA model to provide more flexibility in capacity

booking including UIOLI and allow rolled in treatment, where appropriate,
for capacity expansions
EUW5
Effective Gas Release
Introduction of effective gas release programmes
PSW3
New Pipeline Connections
Promote the construction of new pipeline links and try to reduce the influence
of the incumbent producers
EUR4
Unbundling of Transportation and

Supply
Proper legal unbundling of transportation, supply and storage. Privatisation of

state owned businesses. Cost reflective distribution charges to eliminate excess
profits and inefficiencies
EUW3
Transit Regimes
Increase importance of UK as a transit country.
EUR2
Gas Sales to LDCs
Removal of exclusive arrangements, shorten duration of contracts and institute

gas sales release programmes.
EUW4
Storage and Balancing
Presumption that all storage should be regulated TPA, unless it can be shown
that there is true competition. Simplified balancing regimes, with daily being
the minimum balancing period
EUW2
Harmonisation of TPA in the EU
Harmonisation of TPA structures across the EU but need to avoid the

PSW2
Export Pipeline Capacity
Promote privatisation of pipeline systems and introduction of foreign

investment
10
EUW7
Gas Purchase Contracts
Removal of anti-competitive clauses from contracts and encouragement of

shorter term contracts
11
PSP3
Foreign Investment
Put in place legal and tax structure to encourage foreign investment
12
PSW1
Regulated TPA
Introduce regulated TPA regimes consistent with EU
13
PSW4
Gazprom Market Control
Unbundling of Gazprom, separating transportation and supply, or enforcement

of regulated TPA regime
14
EUW3
(EU)
Transit Regimes
Transit to be incorporated into main domestic transmission systems.
15
PSP2
Restrictions on Independent
Producers
Allow independent producers to sell their own gas directly
16
EUR1
Distribution TPA
Introduction of consistent and coherent Network Codes, specifically for

distribution if separate from transmission
17
PSP1
Dominant National Producers
Encourage privatisation of national producers
18
EUR3
Supplier Switching
Increase customer awareness of the benefits of switching. Introduce cost

effective and efficient supply point administration
19
EUR5
Upstream Costs
Introduction of full competition in the EU Wholesale market and the Pipeline

Supply Production and Wholesale market and firm regulatory oversight on
20
EUW6
Spot Markets and Hubs
Spot markets and hubs will develop once the conditions for effective
- 23-
- 24-
1. INTRODUCTION
1.1. Background
The UK is now a net importer of gas, with prices and access to supply increasingly
depending, therefore, on markets elsewhere. In this context, the Department of Trade
and Industry (DTI) believe it is critical to understand what might stand in the way of
effective and efficient competition in European, as well as global gas markets, in the
next 5-10 years. While the Government is already very active in influencing EU
liberalisation, there are likely to be political, regulatory, technical and market factors
that can either slow down or limit the extent of true competition on the Continent.
Identifying these ahead of time will be key. As a consequence the DTI decided to
commission a report to consider the Conditions for Truly Competitive Gas Markets
in the EU (and Globally).
In the context of the DTIs remit, the objective of the report would be to identify the
potential barriers to the development of truly competitive natural gas markets on the
Continent (and globally) and, where appropriate, identify ways in which the UK
Government could influence the political, regulatory and market outcomes in order to
maximise the benefits of competitive gas markets to UK consumers.
The full terms of reference are reproduced in Appendix 1. However they included the
following sets of key questions that would need to be answered:
1. What conditions (regulation, structure, conduct) would be required for the EU
(and global/LNG) gas markets to be truly competitive around 2010-15?
2. What will be the most important drivers/factors, between now and 2010-15, which
will determine whether these conditions will be met?
3. What are the likely outcomes on these key factors, and, on balance, how
competitive is the European/global gas market likely to be around 2010-15?
4. What are the implications of this level of competitiveness for UKs energy
markets, especially the prices and security of supply issues we might face?
5. Based on the above, what, if any, action (including influencing strategies) should
the UK Government consider in order to facilitate the development of competitive
gas markets?
1.2. Report Structure
In considering the requirements in the terms of reference, Energy Markets added a
further 3 questions to the 5 that the DTI had posed:
1. Are there any truly competitive gas market in the world and what lessons can be
learned from them?
2. What actions are needed by the EU and Regulatory Authorities in Member States?
3. What are the implications of a competitive gas market for responses to price
signals both in the short term and the medium term?
- 25-
In respect of answering these and the DTIs questions and in the context of achieving
the objectives outlined in the terms of reference, this report is structured as follows:
Section 2 defines what we mean by a competitive market for gas, expanding on the
definition in the terms of reference, describes the conditions required in a competitive
gas market. It also considers different markets within the gas chain and different
geographies, including those outside the EU.
Section 3 outlines the international experience with reference to the USA, UK and
Australia, describing how the competitive markets developed and considering
possible lessons for the EU.
Section 4 considers the current conditions in each of the key markets and geographies.
Section 5 considers the barriers to the development of competition and the changes
required.
Section 6 considers the timing of the transition in the context of the 2010 to 2015
timeframe using different possible scenarios and discussing the likely outcome.
Section 7 looks at the implications of a competitive gas market, describing the gas
price differentials between scenarios, differences in gas flows and transportation
capacities, assesses the implications for security of supply to the UK and Europe as a
whole and how the market may respond to the price signals and differences.
Section 8 looks at actions for consideration by the UK Government outlining a series
of options, both for the UK Government and the EU and Member States Regulatory
Authorities, and describes a strategy for the UK Government for the implementation
of the reports recommendations.
- 26-
2. DEFINING A COMPETITIVE MARKET FOR GAS

As was outlined in section 1, the objective of this study is two fold:
1. To identify the potential barriers to the development of a truly competitive natural
gas market on the Continent (and globally); and,
2. Where appropriate, identify ways in which the UK Government could influence
the political, regulatory and marketing outcomes in order to maximise the benefits
of a competitive gas market to UK consumers.
As a starting point it is essential to develop a clear understanding of the meaning of
truly competitive natural gas markets, particularly as it relates to conditions we
might find in the European gas market.
In this section of the report we develop our understanding of this concept. We
explore, conceptually, the issues involved and also the outcomes that one might
expect to occur in a truly competitive gas market. The characteristics of a competitive
gas market are also discussed. In later sections of the report, we then apply these
concepts to the market structures we observe in Europe and the gas producing areas
that supply gas to Europe, so that we can understand the barriers that may exist to
inhibit the development of truly competitive gas markets. Some barriers may be due
to the behaviour of individual players in the gas market, while other barriers may be
structural.
2.1. Economic Definition
In the Terms of Reference for this study a definition of truly competitive natural gas
markets was included as follows:
we would consider a competitive market to be one where no company holds and/or
exercises significant market power, where prices reflect the costs of marginal supply
(and not, for example, contract prices conventionally linked to oil prices) and where
gas is available to anyone anywhere willing to pay the competitive market price.
The nub of this definition is recognition of the need to be able to identify how, where
and when players in the natural gas market could exercise market power. The natural
gas industry in Europe has been historically organised as either statutory or natural
monopolies, which have enjoyed local market power. The political and regulatory
challenge of market liberalisation is to remove that market power, without either
expropriating the legitimate property rights of the existing players, or causing the
market or existing players to fail during transition.
The definition also uses the phrase where prices reflect the costs of marginal
supply. Pricing at marginal cost underpins the economists concept of a competitive
market. However, it is not always a straightforward concept in the gas industry. For a
gas producer, selling gas at its marginal cost is not the same as simply looking at the
variable costs of production, since the choice is between selling the molecule of gas
now or selling it at the end of the gas fields life, which could be in 20 or 30 years
time. This lost opportunity cost could outweigh the variable costs, making the
- 27-
effective marginal cost negative1. At the infrastructure level there is a high level of
fixed costs and the short run marginal cost is very low. The gas supplier, on the other
hand, faced with possibly buying at the spot price is looking at a marginal cost much
closer to the economists concept. Depending on the point of view of the buyer or
seller of gas and also whether or not there is an excess supply of gas and/or capacity,
the marginal cost of gas can vary enormously. Appendix 2 reviews the concept in
more detail.
For the purposes of this report, however, it is helpful to add more detail to the
definition. A useful expansion of the definition of a truly competitive gas market was
recently published by the New Zealand Ministry of Economic Development2, who are
responsible for policy relating to competition and regulation of gas markets, in the
context of the establishment of competition in their market. The key definitional
points were as follows:
1. A market where there is full competition in production, wholesaling and retailing
natural gas, and where gas can be freely traded between producers, wholesalers,
retailers and consumers.
2. An interconnected transmission and distribution system with clear rules for access
by all prospective participants. Where pipeline capacity is in competition,
capacity is tradable and transmission prices are set by reference to the market.
Where natural monopoly exists, clear rules for reference pricing are available
and disclosure arrangements and legal remedies are available at an economic
and timely manner to redress concerns.
3. Arrangements in the transmission, distribution and retail sectors that provide
confidence in the market that cross-subsidising is not occurring in vertically
integrated organisations.
4. A market where clear market signals encourage the efficient allocation of
resources along the gas supply chain by providing information to market
participants through flexible pricing arrangement, contracts of variable length,
efficient gas trading mechanisms, and the scope for commercially negotiated
settlements.
5. A market where pricing is established according to a consumers willingness to
pay and market power does not interfere with the ability of consumers to exercise
this preference. This means that product differentiation does not occur between
consumer groups exhibiting similar willingness to pay.
6. Contestability in the market with the aim of achieving freedom of choice by all
consumers to access gas on the most attractive conditions in terms of price,
quality and reliability of service from retailers, wholesalers and producers.
Industrial consumers able to negotiate supply and pricing terms that are
compatible with their business needs.
However, exploration and production (E&P) company management do not always take rational
economic decisions. Their bonuses will often be based on the accounting profit of the business, which
has, as a cost, depreciation on a unit of production basis. This makes the accounting marginal cost
much higher.
2
This definition was not selected because what might, or might not, be happening in New Zealand is at
all relevant for the EU market, now or in 10 years time, but simply that this definition provided a good
and succinct summary of what any competitive market for gas might look like anywhere in the world.
- 28-
The first point highlights the importance of competition in all steps of the gas chain as
an introductory statement. The second point deals with the rules of access to the
essential facilities of the natural gas networks. The remaining four points, however,
address in different ways the issue of market power and possible abuse of market
power:
Point three highlights the need to avoid cross-subsidies in vertically integrated

companies, which could inhibit competition. This could be usefully extended to
include the elimination of cross-subsidies in horizontally integrated companies.
For example a company which enjoys a monopoly in its home market may be able
to cross-subsidise its entry into a neighbouring market. Cross subsidisation would
normally only be achievable if there were significant economic rents available in
parts of the gas chain.
Point four focuses on the need for transparency of information through flexibility
in prices and contract terms and conditions. It also implicitly confirms the
importance of transparent price signals to the market.
Point five emphasises that prices should not be distorted by market power nor
should there be any form of price discrimination.
Point six highlights that the terms of supply and service offered should be set by
customers requirements and not by what a supplier dictates as being appropriate.
There is one further issue that is alluded to in this definition, but which would benefit
from further clarification. This issue is the importance of market information being
freely available to all. In a perfect market information must be available to both
buyers and sellers about market prices, product quality and conditions of sale. A
particular risk arises where an advantage could arise from a players interests
elsewhere in the supply chain. For example, if a supply affiliate of a gas transportation
company has better knowledge of the system capacity and gas flows, from its
ownership of the transportation business, than its competitors.
In the above definition, two clear issues are identified market power and access to
essential facilities. These are considered in more detail in the following sections.
2.1.1. Market Power
In considering the issues of market power, two aspects need to be considered. Firstly
it is essential to define the market in which market power might exist, and secondly
assessing the extent of market power.
The OFT recently published guidelines on the application of competition law to the
UK energy sector3. This guideline provides insights into the problems of defining a
market in the gas sector for the purposes of assessing whether market power exists. A
fuller discussion of the OFT guidelines is contained in Appendix 3.
OFT. Application in Energy Sector. Understanding Competition Law. January 2005
- 29-
Market Definition
In these guidelines it is noted that a market definition usually contains a product, a
geographical area and a temporal dimension. The guidelines are also applicable to the
European gas market because it is based on interpreting Articles 81 and 82 of the EC
Treaty.
In product terms, superficially, natural gas might be regarded as a homogenous
commodity4. However, gas consumers do not receive the same molecules that their
shipper delivered at the entry point and natural gas has different values at different
times and in different locations. In a gas market, the product has to be defined both in
terms of the commodity (which is homogenous) and also when it is delivered. Ofgem
points out, in its response to consultation on this issue5, in gas markets there is a
limited ability to substitute transactions in one time period with another. There is
limited capacity available to put gas in and out of storage from a day-to-day.
The temporal dimension conventionally used in market definition is one year.
Transient distortions to prices are usually ignored. However, in the OFTs guidelines
it is noted that the gas system in the UK is balanced daily. Due to the inelasticity of
demand, high price spikes can occur for short durations resulting from severe weather
or supply outages. The OFT notes that large price increases for a short period of time
can be as damaging to the market and to competition as small increases that endure
over a longer period.
The OFT paper also addresses the issue of geography. Again, the OFT notes that a
situation, at one particular point on the network, may have a surprisingly
disproportionate effect on the market. They note, for example, that a market might
reasonably be defined as a particular entry point into the system, because there might
be limited scope for substitution at that point.
This analysis serves to show that gas markets need to be defined carefully to assess
whether there is market power and also helps to explain why companies may claim
that their market is open to competition, while retaining sufficient control at key
points to restrict competition. It also helps to explain why the liberalisation process
takes time, as regulators progressively expose and remove problems which emerge at
these key points. During this process the incumbent has a considerable informational
advantage over the regulator, as the company will have a much better understanding
of where key points exist and how to retain effective control of them.
It is not within the remit of this study to discuss, in detail, issues surrounding gas quality, whether it
be the low-cal and high-cal systems in some EU countries e.g. the Netherlands, or the issues
surrounding UK gas quality relative to the rest of the EU. DTI have been leading an exercise on gas
quality in the UK for the last 2 years and Marcogas and EASEE-Gas have been doing work on the EU
aspect. Gas quality issues can be resolved, but at a cost which will need to be factored into the overall
cost of gas supply, whether the market is fully competitive or not.
5
OFT and Ofgem. Responses to the Energy Sector Consultation. January 2005
- 30-
Assessing Market Power

The starting point for assessing market power is market share, but it is no more than a
starting point. There are no established market share thresholds for defining
dominance. For example a company could have a very high market share, but in a
contestable market (see below) where the barriers to entry and exit are low, it will not
be able to exercise market power because raising prices would simply draw in new
entrants which could leave the market in response to any subsequent price reductions
by the incumbent without incurring undue losses. Thus market share is only a starting
point in this assessment.
As market share, per se, cannot be regarded as sufficient evidence of market power,
the OFT considerers a number of other factors:
Customers behaviour and options ( for example awareness of competition, the

extent to which alternative providers are chosen, the extent to which substitutes
are available)
Competitors behaviour and capacities ( for example their range of offers, their
ability to increase output within the relevant time period)
Market Operations (for example the extent of barriers to entry and exit)
An undertakings conduct in the market with regard to price setting as well as
financial performance (such as consistently earning a rate of return of profit
significantly above competitors levels)
These are considered in more detail in Appendix 3.

Contestable Markets
While market power is an important measure in terms of considering the
competitiveness of a market, it is also important to consider the issue of contestability.
The term contestable markets has been used by Baumol, Panzer and Willig6.
A contestable market requires barriers to entry to be low and perfectly contestable
markets require a total absence of barriers to entry. If the barriers to entry are low then
incumbent companies have to consider the threat of potential as well as actual
competition making it difficult to abuse a dominant position. If incumbent companies
are making super-normal profits and there are no, or low, barriers to entry then it is
argued that new firms may enter the market quickly and existing firms will have an
incentive to keep prices at a level where only normal profits are made.
It is also necessary that barriers to exit should be low otherwise there will be a threat
that incumbents can use predatory pricing to force new entrants out of the market with
associated losses. For barriers to exit to be low would require that sunk costs are very
low since they cannot be recovered if the company leaves the market.
Baumol W J, Panzer J and Willig R.D. (1986) Contestable Markets and the Theory of Industrial
Structure, Harcourt Brace and Jovanovitch.
- 31-
In practice few markets are perfectly contestable but scale is important. For example
the gas supply market will be closer to being contestable if new entrants can enter the
market without investing in infrastructure which would involve significant level of
sunk costs or entering into long term contracts for gas which could involve serious
loss in the event of exiting the market.
Summary
This analysis indicates that the potential for companies to distort the market is not
necessarily predicated on dominance of the entire market at all times. In some cases it
is sufficient to exercise control at key points in the network such as cross border entry
points. Even then, this control may only need to be exercised for a short period such
as the peak demand period.
Prima facie evidence of market power can be found from excess profits and also the
existence of economic rent, which could still exist even if excess profits did not.
Conversely, evidence for predatory pricing behaviour can be found from prices which
set temporarily below variable costs with a view to driving out competitors from the
market and returning to high prices in the longer term. In addition there is other
evidence that can be considered including the presence of real competitors in the
market; barriers to entry and exit; and the choices and options available to customers.
2.1.2. Access to Essential Facilities
The concept of essential facilities is key to understanding the economics of operating
a competitive gas market. In a gas network essential facilities may include pipelines,
compressors, gas storage, gas treatment and LNG terminals. The concept of Third
Party Access (TPA) to gas systems is based upon the idea that these are essential
facilities and competition will only occur if competitors are allowed access to them
on the same terms as the incumbents the level playing field.
The World Trade Organisation defines an Essential Facility as a facility that is
Exclusively or predominantly provided by a single or limited number of

suppliers
Cannot feasibly be economically or technically substituted to provide a
service.
With a few exceptions gas infrastructure meets this definition. Whilst there are some
examples of pipe to pipe competition in gas infrastructure, these are rare. Even in
these cases the number of operators is limited. Thus the rationale for TPA is that
competing gas suppliers need to be allowed fair access to these facilities to enable
them to compete, because it is not feasible to duplicate them.
Long Life Irrevocable Investments
The key issue in respect of essential facilities is that natural gas infrastructure is
largely a long life investment. Natural gas pipelines are conventionally given
accounting lives of 40 years or more and so are most gas storage installations,
although technically they can last much longer if well maintained. The long life, and
- 32-
the high initial cost of gas infrastructure, means that the costs have to be recovered
over a long period of time.
In addition to being long life, natural gas infrastructure is, for the main, an irrevocable
investment. Once the investment has been made it is dedicated to the purpose for
which it was built and cannot be used for other purposes. Construction and planning
lead times are also a factor. Major gas infrastructure projects have a lead time of at
least 2 years and often more. The planning lead times are even longer and it can be a
decade or more between the time a project is first proposed and the date when
construction actually begins.
Impact of TPA on Network Development
The introduction of TPA introduces a new dimension into the decision making
process on investments. Where a gas utility is operating as a conventional vertically
integrated business, the investment risk in long life assets can be managed in the
following ways:
The utility understands the expected future pattern of gas flows and can, to some
extent, exercise control over them;
The cost of any mistakes can be smeared across all of its monopoly customers:
and,
It is not exposed to competition, even at the margin (for example, competitively
supplied gas storage can act as a substitute for pipeline capacity).
With the introduction of TPA, exposure to risk and the management of these risks
change. An operator of a TPA gas network has less information about the pattern of
future supply and demand on which to base investment decisions. While the network
operator will have good information about future gas demand supplied from the
network, there is some degradation on the information that they have because they no
longer control the selling price of the product and do not have direct contact with new
and future customers to assess market trends.
On the supply side the degradation of planning information is more marked. A private
sector monopoly minimises its costs by exactly matching gas supply to demand and
only providing the minimum capacity to meet that requirement plus an operating
margin to allow for flexibility to respond to unforeseen circumstances such as
equipment failure on or upstream of the operators system. Barring contingencies for
operational problems, a monopoly will only plan for one pattern of supply to meet its
peak demand. With the introduction of competition, sources of supply become a
matter for the gas producers and market wholesalers and not for the transport
company. A competitive market will want more capacity than a monopoly market as
various suppliers compete for the same customers. The problem that has to be solved
under TPA is to devise a method that gives the operator an incentive to invest in new
capacity by managing its risks.
There are a number of methods that have emerged in various jurisdictions:
Rolled in Rates (any new investment is added to the transporters asset base and
reflected in its charges this method essentially maintains the risk at the same
- 33-
level as a vertically integrated monopoly). In some cases different rates of return

are used for existing assets and new investments.
Joint venture projects to build interconnectors with participation limited to parties
involved in associated gas deals and/or the operator in the transit countries
involved
Open Season (the pipeline is charged for on an incremental basis and gas shippers
are invited to bid for capacity under long term contracts the capacity can then
be traded in a secondary market).
Exemption from TPA requirements for major new projects
The development of TPA is discussed later in the report and these methods will be
addressed in more detail then. However, what will become clear is that effective
arrangements are needed to ensure that there is an incentive for network operators to
invest in new capacity. Moreover the arrangements have to be compatible with the
development of the market. A shortage of capacity can severely constrain the
introduction of competition.
Summary
Investments in gas infrastructure are long life with significant lead times for
construction. Traditional vertically integrated monopolies have in-built structures for
managing the risks with these long life investments. The introduction of TPA alters
the risks from these investments and introduces complexity.
The network operators have less information about the patterns of supply and demand.
Price signals from the market are of little value beyond indicating that there is a need.
New arrangements need to be put in place when TPA is introduced to ensure that
there is an incentive to invest in new infrastructure.
2.2. Characteristics of Truly Competitive Markets
In this section we address one of the questions posed in the terms of reference
What conditions (regulation, structure, conduct) would be required for the EU

(and global/LNG) gas markets to be truly competitive around 2010-15?
The characteristics specific to the Production, Wholesale and Retail markets are
discussed below. Many of the characteristics apply equally to the three geographical
areas (EU, Pipeline Supply and LNG Supply) so we do not present these separately in
the text as that approach would become repetitive. Following on from the discussion
above the conditions, or characteristics, for competitive markets are considered in the
context of the key identified areas of Market Power and Access to Essential Facilities.
In addition a third category is added entitled Institutional, which is not a direct
characteristic of a competitive market, but includes those institutional, legal and
regulatory factors which are seen as important. Table 1 summarises the characteristics
which are described in more detail below by market.
- 34-
2.2.1. Production Market

An important prerequisite for a competitive market in the production sector is to have
a multitude of producers involved in exploration, development, production and sale of
the gas reserves. This clearly requires open and non-discriminatory licensing regimes
and a tax regime which encourages investment.
The requirement for multiple producers is certainly met in the USA with 6,800 Oil
and gas companies and to a lesser extent in the UK. One problem in the UK, which is
also typical in other countries as we shall see below, was that all gas produced was
sold to British Gas. That problem was addressed first through a requirement for
producers to sell 10 per cent of the output of new fields to buyers other than British
Gas and secondly through the gas release scheme described in section 3.2.3.
Even where a large number of producers are active there may be concentration of
sellers power through the operation of a cartel such as the GFU in Norway (now
disbanded) or by joint venture partners in specific field developments selling gas
jointly under identical terms with the revenue split between the partners. A
characteristic of competitive producer markets is that producers move away from the
joint market approach and start to sell their equity shares in field production
separately to separate buyers. For example in the UK equity partners now have the
option to sell their shares on long term contracts to a third party such as a power
generator or another gas supply company or else sell the gas to their own down stream
marketing affiliates for direct sale to retail customers.
It is often said that producers would never develop gas fields without the comfort of a
long term sales contract for all (or a high proportion) of the output of the field.
However this need not necessarily be the case as evidenced by the UK market where
even some large offshore fields, such as Britannia, have been developed for sale into
the spot market. This development clearly requires the spot market to develop
sufficient liquidity and transparency to be able to absorb the producers quantities
without a material impact on the price.
In respect of long term contracts, a competitive market should not include anticompetitive contracts between producers and buyers which could involve exclusivity
arrangements or destination clauses. Nor should there be any special purchase
arrangements for incumbent utlities.
On institutional side there should be open and non-discriminatory licensing
procedures, tax regimes which encourages investment including in declining
production areas and the active encouragement of foreign investment. Licensing
procedures should also ensure that large companies cannot just buy up licences and
then delaying field development.
2.2.2. Wholesale Market
The wholesale markets in the EU and Pipeline Supply area are regarded as high
priorities for this study. On the institutional side the development of competition
will be greatly assisted by proactive regulatory and competition authorities.
- 35-
As gas markets move from monopolistic structures to truly competitive markets it is

necessary to tackle the issue of market power and dominance by one, or a small
number of companies. This will require:
Multitude of wholesalers and suppliers: multitude of alternative

producers/importers willing and able to sell gas on the wholesale market,
competing with each other through gas-to-gas competition
Diversity of supply: low reliance on a dominant source of supply aided by

effective gas release schemes
Flexibility of supply; medium term responsiveness of supply to price

movements
Customer pressure; pressure from customers for lower prices and/or

improved or innovative services.
Multitude of customers: many alternative buyers of gas.
Effective unbundling: clear financial and physical separation (establishing

Chinese Walls and the supply function probably housed in separate
buildings) of the transportation and supply functions within the network
provider such that the supply function is treated like any other shipper.
Information provided to Transmission System Operators (TSOs) and
Distribution System Operators (DSOs) by shippers needs to be protected
from leaking out to the supply function.
Entry of new players: entry of new, strongly capitalised and committed

players into the market.
Short term price elasticity of demand: degree of fuel switching and

commercial interruptibility in contracts.
Shorter term and smaller contracts: a trend towards one day to one year
contracts, away from the more traditional longer term contracts.
Decline in take-or-pay commitments: removal of take-or-pay clauses on

contracts.
Removal of destination clauses: removal of anti-competitive clauses in

long term contracts which restrict the resale of gas or the sale outside the
specified territory.
Spot and future price indexation: use of price indices from futures markets
and/or price reporting services as escalators in longer term contracts, thereby
increasing their importance above physical share of the total market.
In respect of access to essential facilities the following will be important

characteristics:
- 36-
Regulated access7 to networks, LNG terminals and storage facilities:

mandatory third party access on a non-discriminatory basis with clear and
transparent access rules.
Regulation of network charges: regulated control of tariffs and prices for

transportation, storage and LNG facilities, in the absence of true
competition.
Effective capacity allocation process; allocation procedures and booking

arrangements which allow new entrants to obtain capacity on an equal basis
to the incumbent gas supplier. Measures such as use it or lose it (UIOLI)
enable capacity to be transferred from incumbents to new entrants as the
latter build up market share.
Maturity of networks: mature industries with heavily depreciated networks

such that risks have been significantly reduced.
Removal of transmission constraints and the absence of capacity

bottlenecks, by ensuring that the proper incentives are in place to invest and
make capacity available.
2.2.3. Retail Market
International experience suggests (see section 3), that it is not essential for
competition to develop at the retail level in order for the benefits of competition at the
wholesale level to filter down to retail customers8. On the other hand a truly
competitive wholesale market is a pre-condition for successfully establishing a
competitive retail market as suppliers need to be able to obtain the gas and
transmission capacity they need at market prices to supply their customers.
All of the characteristics discussed above for truly competitive markets at the
wholesale level generally apply equally to the retail markets. Consequently they are
not repeated here in the interest of brevity.
However, the retail market presents additional challenges particularly in relation to
the need to supply large numbers of customers consuming small amounts of gas
annually. Customers in the wholesale market are LDCs and large end-users such as
industrial companies and power generation companies. For these customers, energy
costs represent a significant proportion of total costs and most employ professional
buyers. By contrast the retail market consists of smaller industrial and commercial,
and household customers, where energy costs may not be significant and inertia may
7
Regulated access (and charging) is required in the case of natural monopolies which is most obvious
in terms of transmission and distribution networks. It is less obvious for LNG terminals and storage
facilities where there could be, and in some cases, is, competition. This will be developed in more
detail particularly in the context of storage.
8
End user prices at the retail level would still have to be regulated, if there was no competition at this
level, to ensure that the impact of competition at the wholesale level would be passed through. This
is effectively what happened in the US and UK.
- 37-
be a big problem. This means that there is a need to develop awareness of the ability
to switch suppliers and the benefits of doing so. To some extent this can be
undertaken by the market but in practice there is often a need for agencies such as
Regulatory Authorities to become actively involved raising awareness among
customers of their right to choose supplier and what is involved in making the switch.
Appendix 6 briefly reviews some of the UK experience in the retail market.
Even for large industrial users, experience has shown that there can be administrative
difficulties involved in switching supplier. For retail markets these issues become
even more complex because of the vast increase in numbers involved. For example in
the UK there were 18 million customers who became eligible to choose supplier when
the market was opened to all customers in 1996. This required heavy investment in IT
systems to keep track of each shippers customer portfolio and the development of the
supply side administration dimension of the Network Code. It is easier to
underestimate the time required to develop such systems and there is a danger that
systems may not be fully developed in time for market opening.
The issue of Public Service Obligations also needs to be handled carefully. Public
Service Obligations relate to security of supply, regularity, quality and price of
supplies, and environmental protection including energy efficiency and climate
protection. Customer protection measures include safeguards to protect vulnerable
customers including measures to help them avoid disconnections. Standards need to
be established for transparency regarding contractual terms and conditions, general
information and dispute settlement. Unless these standards are applied equally to all
suppliers some classes of customer will effectively have no choice but to remain with
the incumbent supplier.
There is also a need for standards to govern suppliers sales activities to limit
instances of bad practice particularly in relation to door-step selling and/or telesales.
Finally arrangements need to be considered for one or more supplier of last resort to
step in and maintain supply to customers on an interim basis in the event of failure of
a gas supplier.
- 38-
Table 8 Characteristics of Truly Competitive Gas Markets

Production
Institutional
Open and non-discriminatory licensing procedures
Retail
Wholesale
Proactive regulation by both energy regulators and
competition authorities.
Proactive regulation by both energy regulators and

competition authorities.
Multitude of Producers. No dominant national producer
Multitude of Wholesalers and Suppliers
Customer access to liquid wholesale markets
Equity partners sell own shares of gas on shorter term

contracts instead of being aggregated by JVs
Multitude of Customers and Customer Pressure
Multitude of Suppliers
Effective unbundling of transportation, supply and storage
Effective gas release schemes.
Effective unbundling of transportation and supply
Lack of anti-competitive contracts between wholesalers and

buyers such as LDCs
Effective gas release schemes
Tax regime which encourages investment including in

declining production areas
Foreign investment encouraged
Market Power
Producers have access to liquid wholesale markets within EU

Lack of anti-competitive contracts between producers and
buyers
No special purchase arrangements for incumbent gas utilities
Development of liquid spot markets and hubs
Active development of public awareness and education about

the ability to switch suppliers.
Smooth administrative process for switching supplier.
Access to
Essential
Facilities
Regulated TPA to transmission networks, storage and LNG

facilities (in the absence of true competition between
networks and facilities)
Regulated transmission network, storage and LNG facility
charges (in the absence of true competition)
Maintenance of standards of service, public service

obligations, customer protection and security of supply
measures
Regulated TPA to Distribution networks.
Regulated distribution network charges.
Incentives to invest and make capacity available
Simple not over penal balancing regimes

- 39-
2.3. Markets and Geographies

So far in this section the discussion on competitive markets for gas has focused on
how a competitive market could be defined and what some of the main issues might
be. However, the gas market is not simply one single market in one geographical area.
For the purposes of further analysis therefore the gas market will be divided into three
distinct markets the producer market, the wholesale market and the retail market
and three distinct geographies the EU25, plus accession and candidate countries, the
Pipeline Supply Area (those countries which are already, or can be, connected to the
EU by pipeline9) and the LNG Supply Area (remaining countries where the principal
supply to the EU is by LNG10). This, in effect, gives nine separate markets to
consider. These are described in more detail in Table 9 below. However, given the
short period of time available for this study and as required by the Terms of
Reference, we have assigned priorities to each of the nine markets as set out in Table
10.
2.3.1. The EU Markets
Production plays an important part in the gas markets in some EU member states
particularly UK, Netherlands, Germany, Italy and Denmark. However, with the
exception of Netherlands, production is expected to decline over the next 10 years,
leading to increased import dependency, so that by 2015 we see the producer market
in EU as only medium priority for this study.
The wholesale market within the EU is the primary focus of this study. Competition
will be essential to drive down gas wholesale prices in EU and this will have a direct
impact on the UK. By 2015, a significant proportion of the gas used in the UK will
have to transit other EU member states before entering the interconnector with
Belgium or the proposed interconnector with the Netherlands. Consequently access to
European infrastructure and traded markets for capacity will be important for
competition to develop within the EU and for security of gas supply to the UK.
Retail competition is an important aspect of the European liberalisation agenda and
the second Gas Directive requires every member state to open their gas markets
completely by 2007. However, as we note in Section 3 on International Experience,
many of the benefits of competition can be achieved through reform at wholesale
level and retail competition can be less significant than wholesale competition.
Furthermore, whilst retail competition in Europe might be expected to benefit
consumers throughout Europe itself, the benefits to the UK are second order
compared with the benefits to the UK from liberalisation of the wholesale market in
Europe.
The Pipeline Supply Area countries will principally consist of Russia, other Former Soviet Union
countries, Norway, North African countries such as Algeria, Libya and Egypt and Middle East
countries such as Iran and Iraq. It also includes any transit countries, with little or no production for
export, such as Ukraine.
10
The LNG Supply Area countries would include Qatar, Trinidad, Nigeria, and Malaysia
- 40-
2.3.2. The Pipeline Supply Markets

Looking beyond the EU, the Pipeline Supply markets are of highest relevance and
importance to this study. The wholesale market within the Pipeline Supply area is also
a high priority because access to the pipelines and other infrastructure in the producer
countries and the transit countries will be of key importance to achieving truly
competitive markets within the EU itself.
2.3.3. The LNG Supply Markets
The supply of LNG to the EU market is becoming increasingly important and there is
a spate of import terminals undegoing expansion and new projects under construction
or planned within the EU. Approximately two-thirds of LNG imported into Europe in
2003 was supplied by Sonatrach of Algeria, However the situation is changing
markedly with increased supplies coming on stream from Nigeria and Qatar and new
countries such as Egypt starting to suply LNG to Europe. State-owned oil and gas
companies typically own between 25 and 70 per cent of these projects, compared with
100% in the case of Sonatrach leaving more room for involvement of international oil
and gas companies.
LNG is also becoming increasingly commoditised, particularly as the importance of
the US as a market increases. As will be noted in the discussion of LNG Supply Area
in section 4.1.3, the LNG suppliers are competing amongst themselves to supply the
US and Europe. Introduducing more competition in the LNG producer market is seen
as a Medium priority not because it is unimportant but because competition seems to
be developing naturally in the market, at least between countries, and therefore does
not require as much attention from the policy point of view as the development of
competition in the pipeline supply area.
- 41-
Table 9 Definition of Market / Geographical Sectors

Market Sector
Production/ Upstream
EU
Indigenous gas production in EU countries plus Turkey,

Bulgaria and Romania
Wholesale /Midstream
Retail/ Downstream
Wholesale gas market in EU countries plus Turkey

Bulgaria and Romania.
Supply to end users in EU countries plus Turkey, Bulgaria

and Romania.
Gas trading and transportation, storage, and LNG

infrastructure within the EU area.
Small industrial, commercial and residential customers

supplied by local distribution systems.
Supply to major customers including power generators and

large industrials from high pressure networks.
Gas production in non EU countries with existing and

potential exports to Europe by pipeline.
Geographical Areas
Pipeline
Supply Area
Wholesale gas market in producer and transit countries.
Supply to end users in producer and transit countries.

infrastructure within the producer and transit countries.


large industrials from high pressure networks.
LNG
Supply Area
Gas production in non EU countries with existing and

potential exports to Europe by LNG
Wholesale gas market in LNG producer countries.
Supply to end users in producer countries.

infrastructure within the producer countries.


large industrials from high pressure network.
- 42 -
Table 10 Importance of Competition by Sector and Geographical Area

Market Sector
Geographical Areas
Production/ Upstream
EU
Medium.
EU production has an important but declining role in the
supply mix due to increasing import dependence
Pipeline Supply
Area
High
Competition is essential between producer countries
seeking to supply Europe and between producers within
in each supply country to reduce dominance.
LNG Supply
Area
Medium
Competition is developing naturally in the LNG market
requiring less attention from a policy point of view than
the Pipeline Supply Area.
Increased commoditisation of the global LNG industry
will increase competition to supply Europe, while LNG
countries will compete against each other to supply the
EU.
Wholesale /Midstream
High.
Competition in wholesale markets is important to drive
down wholesale prices.
Access to gas and capacity in liquid transparent markets
is essential for retail competition to develop
High
TPA to infrastructure in producer and transit countries
will be needed for competitive supplies to reach Europe
Active wholesale markets in producer countries would
also be beneficial
Medium/Low
Producers supplying the LNG liquefaction plant should
be able sell gas independently using shared access to
liquefaction plant and ships
- 43 -
Retail/ Downstream
Medium/High
Competition in retail delivers the benefits to final
customers in EU.
However we note that benefits can be achieved without
retail competition e.g. in North America
Low
Retail competition in supply areas is not essential for
competition to develop in Europe
Low
Retail competition in supply areas is not essential for
competition to develop in Europe
2.4. Conclusions
The terms of reference for this study included a definition of truly competitive
natural gas markets as follows:
we would consider a competitive market to be one where no company holds and/or
exercises significant market power, where prices reflect the costs of marginal supply
(and not, for example, contract prices conventionally linked to oil prices) and where
gas is available to anyone anywhere willing to pay the competitive market price.
More detail was added including defining the competitive market to include
competition along the whole gas supply chain production, wholesaling, and
retailing. Two key areas were identified in terms of ensuring that there is a truly
competitive market. The first was open access to the essential gas facilities and
second the issue of market power. In the case of market power, four areas were
discussed:
Elimination of economic rent and cross-subsidies between steps in the gas supply
chain;
Efficient market with transparent price signals;
No distortion to gas prices; and,
Supply terms dictated by gas consumers and not suppliers.
Analysis of market power indicates that the potential exists for incumbents to distort
the market by controlling the position at key points in the network. Even then this
control may only need to be exercised for a short period. They do not need to control
the networks all the time. A company can control a market even if it appears that open
access exists.
Evidence of market power can be found by looking at indicators in the market;
The presence of real competitors in the market;

Barriers to entry and exit; and
The real choices and options available to customers.
Excess profits may be observed, although companies may give a priority to preserving
their monopolies.
In respect of access to essential gas facilities, it was noted that investments in gas
infrastructure are long life with significant lead times for construction. Traditional
vertically integrated monopolies have in-built structures for managing the risks with
these long life investments. The introduction of TPA alters the risks from these
investments. The network operators have less information about the patterns of supply
and demand. Price signals from the market are of little value beyond indicating that
there is a need in terms of possible volume and/or location. New arrangements need
to be put in place when TPA is introduced to ensure that there is an incentive to invest
in new infrastructure, such as rolling in the cost of new investment into the cost base
for assessing tariffs or identifying a specific supplementary charge for new investment
as in Italy, as described in Section 4.
- 44 -
Finally, for the purposes of further analysis the gas market will be divided into three
distinct markets the producer market, the wholesale market and the retail market
and three distinct geographies the EU25, plus accession and candidate countries, the
Pipeline Supply Area and the LNG Supply Area. The importance of each sub-market
differs, however, in the context of competition in the EU market. The Pipeline Supply
and LNG Supply area retail markets and the LNG Supply wholesale market were
considered to be of low or medium to low importance and will not be discussed much
further in this study.
- 45 -
- 46 -
3. INTERNATIONAL EXPERIENCE
The focus of the study is largely to consider the conditions for truly competitive
markets in the EU, with the implications for the UKs energy markets taken into
account and also any actions the UK Government might consider in order to facilitate
the development of competitive gas markets. However, in reviewing the conditions
for truly competitive markets, the following question can be posed:
Are there any truly competitive gas markets in the world and what lessons can be
learned from them
This section will address that question largely by considering the experience in the
USA, but also referring to what has happened in the UK and the state of Victoria in
Australia. Much has been written and talked about the US experience and a multitude
of studies have been completed on the relevance for the European gas markets. It is
not intended to revisit all this work but simply to briefly summarise what we would
consider to be the major developments and lessons. Following discussion of the UK
and Victorian experience, any common themes that emerge will be considered.
A number of key factors will be considered for each market. These include:
Market size and diversity
Regulatory change
Effective gas release
Access to and availability of capacity
Unbundling
Development of hubs
Harmonisation and Standardisation
As the analysis proceeds in respect of the EU market it will be seen that these factors
become very important in respect of competitive markets
3.1. US Experience
Appendix 4 provides a brief account of the recent history of the introduction of
competition in the US, describing the development of competitive markets for gas in
the producer and wholesale markets. What were the key factors in all this which
resulted in the competitive markets?
- 47 -
3.1.1. Market Size and Diversity

The sheer size of the US market, with consumption of over 20 tcf (560 bcm) during
the period of competitive market development is certainly a key factor. The diversity
of the market as well with almost 7,000 producers, 1,400 gas utilities and upwards of
1,000 gas-fired power plants meant that the conditions of a multitude of buyers and
sellers were easily met. When the gas marketers moved onto the scene, as
deregulation took hold, this simply added to the diversity in the market. The market
size, together with the available infrastructure, also meant that economies of scale
could be realised by many players in the market and not just a handful. In 1996 the
top 20 gas marketers all traded more than 2 bcm per day which is more than enough to
realize significant economies of scale.
3.1.2. Regulatory Change
The regulatory authorities in the US, certainly at the Federal level through FERC,
responded to the problems faced by the natural gas industry of alternate surpluses and
shortages, with major changes aimed at introducing more competition. However, it
was hardly a gradual approach with Order 380 in 1984 and Order 436 in 1985
throwing the industry, especially the interstate pipelines, into an entirely new world
all at once. The removal of the minimum bill requirements (Order 380) on the LDCs
resulted in many pipelines facing potential bankruptcy and hence the necessity of the
provisions in Orders 500 and 636 to allow pipelines to recover some of their
restructuring costs in buying out the costly take-or-pay contracts. It has to be said,
though, that FERC pursued the reform of the wholesale and producer markets, over
which it had jurisdiction, with something approaching a regulatory zeal11.
3.1.3. Effective Gas Release
Prior to Order 380, almost all the sales of gas to LDCs were by interstate pipelines,
who in turn bought gas from producers. High regulated gas prices and falling demand
created a supply overhang which virtually overnight became available to the LDCs
following Orders 380 and 436. The result was a sharp change in the structure of
services provided by pipelines away from direct gas sales to transportation. This is
shown in the chart below.
11
This can be contrasted with the electricity industry where FERC has much less influence because
there was less interstate commerce.
- 48 -
Figure 1 Services Offered by US Pipelines
Choices of Pipeline Services Have Changed in the 1990s

25
Released Capacity
Quadrillion Btu
20
Interruptible Transportation
15
No-Notice
Service
10
Sales
Firm Transportation
0
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Source: US Department of Energy
In effect this was a gas release programme, with gas being released from the
traditional high-priced sales contracts, and replaced with spot gas moved initially
under interruptible transportation contracts.
3.1.4. Access to and Availability of Capacity
This effective gas release because of Orders 380 and 436 also opened up the
availability of transportation to third parties. The capacity was no longer needed for
sales by pipelines to LDCs and, following Order 436, pipelines could no longer
discriminate against third parties requesting transportation in favour of their own
merchant sales. For the pipelines to get at least some revenues, therefore, they had to
sell transportation on an interruptible basis12. Access to pipeline capacity, therefore,
became relatively simple. This was also helped by the fact that gas demand had
declined in the early 1980s, because of high gas prices, and there was spare capacity
anyway on the interstate system.
12
Although this was interruptible transportation it was effectively almost firm, because much less gas
was flowing under the firm sales contracts.
- 49 -
Figure 2 US Gas Consumption Production and Imports 1950-1995
25
20
15
10
5
0
Consumption
Production
Imports
1950195519601965197019751980198519901995
Source: US Department of Energy
3.1.5. Unbundling
The culmination of the restructuring of the wholesale and producer markets in the US
in Order 636 involved the complete unbundling of transportation, supply and storage
for the interstate pipelines. Gas sales had largely been unbundled anyway as a
consequence of earlier FERC Orders, but Order 636 went as far as absolutely
prohibiting sales by pipelines. Additionally, all the separate pipeline services such as
transportation, gathering, processing and storage, which had previously been bundled
together, now had to be unbundled and priced separately, giving equal nondiscriminatory access to all parties including pipeline affiliates.
3.1.6. Development of Hubs
Hubs (or market centres) were a natural evolution in the US gas industry restructuring
process. They evolved to provide new gas shippers with many of the physical
capabilities and administrative services previously provided by the pipelines as part of
their bundled sales services. Two of the key services offered by the hubs were
transportation between, and interconnections with, other pipelines and the physical
coverage of short-term receipt/delivery balancing needs13. Because of this latter point,
13
In 2000, FERC issued Order 637 in an attempt to lessen the impact of imbalance penalties on
shippers and the issuance of operational flow orders by pipelines. Order 637, in part, required that the
interstate pipeline transporter must provide, to the extent practicable, parking and lending or other
services that facilitate the ability of shippers to manage transportation imbalances.
- 50 -
hubs are often found near to storage facilities. The development and existence of hubs
or market centres, as independent commercial operations, provides good evidence that
competition is being developed in the respective market.
3.1.7. Harmonisation and Standardisation
With the increasing complexity of the deregulating and competitive gas industry it
quickly became clear that harmonisation and standardisation of the rules and
procedures of the pipelines were necessary. This ranged from mundane matters such
as the timing of the gas day through to the exchange of information electronically.
Immediately following Order 636, each pipeline had its own proprietary system for
handling all the issues dealing with capacity booking, nominations, allocations,
balancing etc. For the active gas marketer, therefore, this led to the requirement to
have individual dedicated computers and lines for each and every pipeline14. In
September 1994, therefore, the Gas Industry Standards Board (GISB) was established
as an independent and voluntary North American organization to develop and
promote the use of business practices and related electronic communications
standards designed to promote more competitive, efficient and reliable gas service.
In 2001 GISB took over responsibility for the electricity industry harmonisation of
standards and became the North American Energy Standards Board (NAESB).
3.2. UK Experience
It is not the intention to spend a lot if time on the UK experience since readers of this
report should be reasonably familiar with it. In this brief review, we will merely
highlight the similarities and differences in respect of the key factors with the US.
While the UK is a significantly smaller market than the US, it is still the largest gas
market in Europe, with annual consumption currently around 100 bcm. The key
difference between the UK and the US was that prior to deregulation there was only
one gas supplier and transporter British Gas. On the production side, there are over
45 oil and gas producers in the North Sea, with the largest six producers account for
71% of gas production. The development of the competitive market was assisted by
the willingness of large industrial customers to switch from British Gas to alternative
suppliers and also the construction of new gas-fired power stations brought new
buyers into the market. The UK also pushed ahead with retail competition and that
brought in more players such as the regional electricity companies to compete with
the supply arm of British Gas, now unbundled as Centrica. Centrica remains the
dominant supplier of gas in the household sector but there is no evidence of any abuse
of this dominant position.
14
Although only just over 10 years ago, this was before the internet really took off!
- 51 -

As with the reform in the US, there was a very strong drive by Ofgas (and then
Ofgem) for the introduction of competition in the market. Arguably the regulatory
zeal was even greater in the UK than in the USA!
As part of the early drive towards introducing competition, British Gas was forced
first by the MMC and then by OFT to embark on a gas release programme.
The MMC enquiry in 1988 recommended that BG be required to contract for no more
than 90 per cent of gas from new fields in the UK Continental Shelf. Producers were
also given partial release from their obligations to supply BG, under swap contracts
involving fields already in production, with the volumes being repaid to BG at a later
date once new fields came into production.
In 1991, the Office of Fair Trading (OFT) concluded that the so called 90/10 rule
had not been effective since much of the gas released had been sold into the newly
emerging power generation market. The volume of gas acquired by non-BG buyers
for use in the industrial and commercial market, other than power generation,
represented only about 7% of the needs of that market.
As a result BG made undertakings to release gas from its contracted portfolio in order
to allow the development of competition in advance of competitors having access to
their own contracted gas. The release programme required BG to release stated
minimum volumes of gas and such additional quantities as would be necessary to
achieve the market share targets which had been set by the MMC. The minimum
quantities were 500 million therms in each of the gas supply years 1992/3, 1993/4 and
1994/5 and 250 million therms in the supply year 1995/96. The undertakings included
that British Gas would not be required to buy new gas for the express purpose of
release.
The gas release programme was conducted as a series of auctions in which the price
was fixed and participants were invited to bid for volumes of gas. The price was fixed
at the weighted average cost of gas (WACOG) which British Gas paid for gas from its
suppliers, plus a small handling charge (0.25 p/them). This price was set to ensure that
BG made neither a profit nor a loss from the release of gas.
The later MMC report in 1993 acknowledged that there had been a number of
criticisms of the way in which the release gas programme had been implemented but
concluded that it had achieved its purpose of pump priming competition.
- 52 -
The other element in assisting gas release was the introduction of Accord15 into the
UK market in 1994. At that time British Gas Exploration and Production had surplus
uncontracted gas supplies and as part of the Joint Venture agreement between British
Gas and NGC that set up Accord, these supplies were sold through Accord. Accord
sold these volumes aggressively which led to a sharp decline in UK wholesale prices.
In the UK there was only one transmission and distribution company in contrast to the
US with multiple pipelines and LDCs. In the US capacity was fairly easy to come by
following Orders 380 and 436. British Gas, however, resisted third party access until
they bowed to the inevitable and introduced the Network Code. One of the key
elements of the Code was the entry-exit capacity booking and tariff system. In the
early stages, any shipper that was willing to pay for entry capacity under a fixed tariff
was allowed to book it and if capacity was overbooked then in the event of more gas
being nominated than capacity available, there was a pro rata reduction16. Exit
capacity at the NTS offtakes was allocated based on the customer profile of each
shipper in the LDZs.
3.2.5. Unbundling
The legal separation of British Gas transportation and supply businesses into separate
subsidiaries was effected by the 1995 Gas Act and it went one stage further in 1997
when the supply business Centrica was demerged from the rest of the business.
Also in 1997 the transportation and storage businesses were separated. Since then the
storage business has been sold twice17. There has been clear and effective unbundling
and separation in the UK.
One of the side effects of the entry-exit capacity system was the establishment of the
National Balancing Point (NBP) and with it Transco offered a free title transfer
facility. The NBP rapidly became a virtual hub18 and the pricing point for physical
gas in the UK and in 1997 the IPE futures market.
Since the UK had only one transmission and distribution company, all the standards
were already applied to the whole country so harmonisation was not an issue. As the
UK is now set to become more heavily reliant on imported gas, issues of
15
Accord was a 50:50 joint venture between British Gas and NGC (now Dynegy). In 1997, NGCs
50% share was bought by Centrica who had inherited the share held by British Gas upon the demerger
of British Gas.
16
This system was eventually replaced with 6 monthly auctions of entry capacity and then long term
auctions, supplemented by short term auctions.
17
Ironically the Rough storage facility is now owned by Centrica.
18
The NBP is not a physical location like the Henry Hub in the US.
- 53 -
harmonisation with other European countries, particularly with respect to gas quality,
have become more relevant. We note here that interoperability can be facilitated by a
harmonisation of gas quality specifications, by suitable blending arrangements or by
the provision of gas processing facilities to which there is open access.
3.3. Australian Experience
At the other end of the scale from the US and, to some extent, the UK is the state of
Victoria in Australia. A full description of the development of a competitive gas
industry in the State of Victoria is included as Appendix 5.
Total consumption in Victoria is around 5.5 bcm with 1.4 million customers. In the
mid 1990s the State of Victoria decided to privatize and restructure its gas industry.
Before the reform the state-owned Gas and Fuel Corporation of Victoria (GFCV)
purchased virtually all the gas required from one offshore supply source (owned and
operated by BHP and Exxon) and sold the gas on to all the customers. The process of
restructuring the gas industry in Victoria is described in the section on Unbundling.
The change in Victoria was driven through by the State Government based on their
aim of privatising the gas industry and introducing competition. As a consequence the
industry underwent a major restructuring.
The experience in Victoria is useful in providing some key lessons in how to handle a
dominant producer and a relatively small market. Before being separated, Gascor was
handed the responsibility of dealing with the gas supply contract with BHP and
Exxon. The first step was to separate this contract into 3 parts and vest each part
with a retailer. Retailers were then encouraged to go and contract with other potential
gas suppliers once interconnections were constructed with other parts of Australia19.
A major element of the success of the industry restructuring related to the booking of
transportation capacity, which is done under the so-called market carriage model.
The traditional contract carriage model was not introduced because of the risks and
inflexibilities it would create. Under the traditional contract carriage model, parties
may only transport gas to the extent that they have contracted for capacity, and that
they pay for the capacity whether or not they actually use it in full.
For Victoria, contract carriage was felt to be insufficiently flexible to be compatible
with the proposed market arrangements. The intention to completely deregulate the
19
As of today there are 12 retailers with licences in Victoria.
- 54 -
market, including domestic customers, meant that retailers would have no long term
guaranteed customer base. Retailers would not therefore be well placed to enter into
long term ship or pay capacity contracts.
Also, because there were expected to be several different gas sources within the next
few years, and because market participants may purchase gas from the spot market,
market participants and customers will not know where their gas will be sourced
from. The pool gas spot market (see below) was therefore believed to be much less
flexible if parties had to contract for point to point capacity flows on the pipeline.
A transportation model, the Market Carriage Model, was therefore developed that is
consistent with the designed spot market, and which achieved the following
objectives:
It provided confidence that parties will be able to obtain a transportation

service which is both financially and physically firm; and
It provided appropriate incentives for parties to undertake and pay for

augmentation of the pipeline, that is, in return for funding pipeline
augmentations, parties will receive a legally enforceable property right which
they can subsequently trade if they wish.
The main features of the Market Carriage Model are:
VENCorp (the system operator) and GPU GasNet (the transmission asset
owner) entered into a Service Envelope agreement, which defines the level
of transportation capacity to be provided by GPU GasNet under its access
arrangements. This has to meet the needs of the existing authorised large
customers, plus anticipated load growth amongst small (Tariff V) customers;
Small (Tariff V) customers receive an Authorised Maximum Daily Quantity

(MDQ) for whatever they actually use, and until the spot market began,
existing large (Tariff D) customers received an initial allocation;
Where a party subsequently negotiates with and pays GPU GasNet to augment
the pipeline, it will receive an additional MDQ authorisation which is related
to the agreed increase in the Service Envelope for that augmentation;
Where transmission constraints lead to Ancillary Payments being made, uplift

charges are allocated in such a way as to penalise those parties who
contributed to the constraints (for example, by using gas in excess of their
authorised MDQ). This is how the Market Carriage Model provides the
holders of authorised MDQ with financially firm transportation rights; and
If a transmission constraint is sufficiently serious that it would result in gas

supply interruptions, then VENCorp will seek to cut off customers using gas
without authorised capacity, or above their authorised MDQ before curtailing
authorised customers. This gives authorised customers physically firm
rights.
Each customer is categorised as authorised or unauthorised. The amount of

authorised use of the system is restricted to that which can be accommodated by the
existing physical capacity. Use above that is unauthorised. If a customer wishes to
- 55 -
increase its authorised capacity and there is no existing spare capacity, then it must
arrange for augmentation to take place.
Each retailer received an authorised Maximum Daily Quantity (MDQ) for each of its
customers when the spot market began. This was based upon the MDQ that each
large customer had been allocated by Gascor (the State owned precursor of GPU
GasNet), as well as an allowance for domestic (Tariff V) customers. The authorised
MDQ then moves with each customer as they change retailers20. New small
customers are automatically authorised; new large customers (or their retailers) must
apply to VENCorp to gain authorisation, which will depend on spare capacity being
available.
3.3.5. Unbundling
In December 1994 GFCV was split into two entities GTC to manage the
transmission system and Gascor to manage the distribution and retail functions. In
March 1997, three stapled businesses were created out of Gascor, each comprising a
separate distributor and retailer21. They were fully corporatised in December 1997
and were privatised during the first half of 1999. Distribution and retail were
stapled together because they were considered to be separate activities but it was
believed that retailers on their own would not create enough interest from buyers.
Each retailer was therefore stapled with a distributor before sale.
At the same time the Gas Transmission Company was established as Transmission
Pipelines of Australia (TPA, not to be confused with Third Party Access). The
System Operator was also set up as Victorian Energy Networks (VENCorp), which
also now manages the gas wholesale market. In May 1999, TPA was privatised and is
now called GPU GasNet.
A key feature of restructured gas market is the way the spot market works, which is a
pool model. The pool model is based on the notion that decentralised bilateral
transactions may not always lead to an economically efficient outcome because of the
technical characteristics of natural gas pipeline systems. In transmission networks
where there are a large number of interconnections with potentially significant costs
arising from congestion of the network, this approach may offer a better model for the
establishment of a market in the absence of sufficient depth and liquidity in a
domestic market. In this model, market participants inform the pool operator how
much gas they want to buy or sell and at what prices they are willing to complete
transactions. The pool operator aggregates this information into system supply and
20
This is effectively how the allocation of exit capacity also works in the Transco Network Code. The
capacity is allocated on a daily basis and if a customer changes supplier the capacity automatically
moves to the new supplier. There is no risk to the distribution or transmission company in this
arrangement since for every end user someone will be paying the capacity charge.
21
The clever part of the stapling exercise is that the boundaries for the retail and distribution
businesses did not match. Each distribution business was stapled with retail businesses covering part
of the other 2 distribution areas. In this way no monopoly was created in any one geographic area.
- 56 -
demand and calculates the system price that will clear the market. The system price
then becomes the spot market price for the day and is applied to all balancing
transactions.
Harmonisation and standardisation was not an issue in Victoria, since it was an
integrated industry before the restructuring with one source of gas supply.
3.4. Common Themes and Lessons for the EU
The US, UK and Victoria in Australia are very different gas markets, ranging in size,
diversity and complexity, yet each have successfully introduced competitive gas
markets particularly at the wholesale level. The common themes from these differing
markets can be considered in a number of different categories. Firstly, the key market
structure changes which have taken place, secondly what external exogenous factors
have been important and thirdly what have been some of the consequences of the
market structure changes. Finally, some general observations will be made.
3.4.1. Market Structure
If the existing market structure is one of a monopoly supplier of gas to end users or
LDCs then new entrants will require access to gas supplies to compete. In the absence
of an unanticipated new source of supply, then the incumbent(s) will have to release
gas from their own contractual portfolio. In the US, the availability of alternative
sources of supply made the requirement for formal gas release unnecessary but the
impact of Orders 380 and 436 in effect allowed the purchasers of the gas (in this case
the LDCs) to buy the alternative gas. In the UK the regulatory authorities compelled
British Gas to release some gas from its portfolio as well as preventing them from
buying too much of the newly discovered gas from the North Sea. This together with
the impact of Accord on the wholesale gas market and the dramatic desertion of
British Gas by industrial and commercial customers also ensured that gas was
released on both the buying and selling side. Finally, in Victoria, the whole reform of
the industry was built on the premise that the one single large gas purchase contract
needed to be split into three and matched with an equivalent amount of gas sales to
produce viable competition which would be supplemented by new sources of gas
supply and new entrants into the sales market.
A key lesson in gas release, therefore, is that gas should not only be released on the
purchasing side at the wholesale level but also some mechanism found for releasing
gas sales from the grasp of the incumbent(s).
Access to and Availability of Capacity
Fundamental changes in moving towards competitive markets are often focused on
the market for transportation capacity, especially at the transmission level. In the US
there was a very effective large release of capacity on the interstate pipelines as their
- 57 -
merchant sales business disappeared and they were forced by FERC to open up their
pipelines to regulated third party access. Because of the availability of competing
pipelines and the excess capacity that was available on most main pipeline routes, this
process happened relatively quickly. In the UK and Victoria, in contrast, the process
of opening up the pipeline systems to third party access was much more of a planned
transition, aided by the US experience, with a key difference being the adoption of
common or market carriage as opposed to contract carriage in the US. The adoption of
a market carriage regime, where no willing shipper can be denied access to capacity to
enter the pipeline system and where exit capacity is allocated rather than booked,
would seem to have positive advantages in respect of the promotion of a competitive
market. Under a market carriage regime, incumbents cannot deny access to the market
to new entrants and capacity is automatically granted to any shipper/supplier who has
contracted to supply gas to an end user. There is no need for exit capacity, at least, to
be released by incumbents to new entrants since the allocation process happens
automatically.
Unbundling
The unbundling of the pipeline services into transportation, supply and storage in
Order 636 in the US was seen as the culmination of the market liberalisation process
and the final confirmation that a fully competitive gas market, at least at the wholesale
level, had arrived. Again in the UK and Victoria, building on the US experience,
unbundling was seen as an essential prerequisite right at the beginning of the
liberalisation process. In the US unbundling did not go as far for the pipelines as
separation of ownership and the pipeline affiliate marketing companies remain
important players in the wholesale market. However, the tight rules on pipeline access
and the large numbers of independent producers, marketing companies and LDCs, as
well as large industrials and power plants ensured that no single entity or groups if
entities could build a dominant position. In the UK unbundling went much further into
ownership separation, although this was a commercial decision by British Gas rather
than a regulatory one. In Victoria, transmission was separated from distribution and
supply, and within transmission asset ownership was separated from operation. The
distribution and supply businesses were the subject of a quasi-separation in that
distribution and supply were privatised together but the distribution and supply areas
did not overlap.
3.4.2. External Factors
Market Size and Diversity
An important factor in determining the ease with which a competitive gas market can
be introduced is the existing market structure in terms of size and diversity. In the US
the sheer size of the market and the diversity of participants from the thousands of
producers, multiple pipelines, the many LDCs and large end users, meant that the
foundations for competition were mostly in place. The UK certainly had the market
size plus a significant number of producers in the North Sea, which meant that the
main issue in respect of diversity was the structural break up of the British Gas
monopoly. The gas market in Victoria really had no natural foundations for the
- 58 -
introduction of competition, which meant that the diversity had to be artificially

created through the unbundling and privatisation process. However, it does show that
this can be achieved through the appropriate structural reforms even in a relatively
small market with only one main supply source.
The US and the UK also had other advantages in introducing competition. In both
countries there was an excess supply of gas trying to get to the market, which was
coupled with the prospect, and ultimate realization, of growth in demand, mainly
fuelled by the increased use of gas in power stations, and finally no significant
capacity constraints on the main high pressure transmission systems22. The
combination of these factors meant that lower prices were quickly fed through to the
majority of end users, even though there was no competition at the retail level,
allowing the proponents of competition to trumpet its success23.
Regulatory Change
In all examples of international experience, a common thread has been the strong
commitment and fervour on the part of the regulatory authorities and governments
behind the process of introducing competition into the gas markets. This was also
helped by the fact that there was a single regulatory, or governmental, authority
controlling and managing the process. In the US it was FERC, in the UK Ofgas (now
Ofgem)24 and in Victoria the State government, which set up the privatisation
programme.
3.4.3. Consequences
Development of Hubs
The development of hubs (or market centres) is sometimes quoted as a prerequisite for
the development of competition. In fact what the development, and proliferation, of
hubs illustrates is that the competitive market, at least at the wholesale level, is alive
and well. For hubs to function in the manner required access to, and availability of,
transportation capacity to input and offtake gas is a necessity, as is the availability of
gas to trade and facilities to store gas, all at a reasonable cost. Almost all hubs have
been developed on a commercial basis by the private sector and have not been
established by legislation or regulatory diktat. They have also not required any form
of regulation since they have not generally conferred any market power and the hub
operators have an incentive to encourage diverse gas flows in a competitive market in
22
In the UK there were some capacity issues at St Fergus, which led to the introduction of capacity
auctions.
23
The fact that governments often announce the success of competition in terms of lower prices to
consumers can come back to haunt them. Many of the opponents of moves towards competition point
to the UK as an example of the dangers of competition because of rising and volatile prices, despite
low prices historically and compared to other EU countries.
24
While this is cited as a benefit, there can also be dangers in this concentration of power and authority.
Some of Ofgems proposed reforms, such as hourly balancing, have been unrealistic, while the
introduction of entry capacity auctions, at the time, did little to resolve the real problem of entry
capacity shortage at St Fergus and caused significant disruption to the market.
- 59 -
order to have a commercially viable operation. Even if an incumbent monopoly set up

a hub which tried to limit the trading of gas, a rival hub could easily be established to
provide appropriate services.
Harmonisation and Standardisation
The introduction of a competitive market in the US raised a number of issues in
relation to harmonisation of various rules and procedures, particularly in respect of the
transfer of information electronically. The harmonisation of all these various factors
will assist the smooth operation of a competitive market, but are not, in themselves,
key factors or drivers in establishing the competitive market in the first place25.
3.4.4. Observations
A final observation goes back to the three distinct markets we have identified the
producer market, the wholesale market and the retail market. In the US and, to a lesser
extent in the UK, the introduction of competition into the retail market was not an
integral part of the drive towards a competitive gas market. The US already had
sufficient participants in various aspects of the market to ensure healthy competition.
In the UK competition in the wholesale market and producer market was operating
effectively before the introduction of retail competition in 1996-7. Only in Victoria,
where the whole restructuring of the industry was based on eventually opening up the
retail market to competition (hence the division of Gascor into three retail and three
distribution entities and the stapling process), could it be said to have been an
integral part. This would suggest that the introduction of retail competition is
relatively more important in smaller markets, if the real benefits of competition are to
be realised, and less so in larger markets where more players can enter purely at the
wholesale level. However, even in Victoria there was a key focus on getting the
wholesale market structure correct.
A key question, to be addressed later in this report, therefore, is which of the three
markets is the most important in ensuring there is a competitive market in gas. The
international experience would suggest that the wholesale market is the key area,
followed by the producer market with the retail market of less importance26. Whether
this conclusion holds for Europe as a whole will be considered later in the report.
25
Similar harmonisation efforts are underway in Europe, including efforts to minimise the impact of
gas quality differences on cross-border trade.
26
This is not to argue that competition shouldnt be extended to the retail market throughout Europe,
since it may be a good thing in itself, but that the main benefits of competitive gas markets can be
achieved through wholesale market reform. It could also be argued that to achieve wholesale market
reform, that a competitive retail gas market is required, as we would argue was the case in Victoria.
- 60 -
4. CURRENT CONDITIONS IN THE KEY MARKETS

This section considers the current conditions, or status, in each of the key markets In
describing these various areas this section will also consider in particular the major
European gas companies, supplies to Europe from different areas and the
infrastructure map.
The Production, Wholesale and Retail markets in the EU will be considered in turn,
followed by the Pipeline Supply and LNG Supply markets. We have tried here to
distil an extremely complex picture across 25 member states into a relatively short
narrative.
4.1. Production Market in the EU
The EU has some 3,364 bcm of proven gas reserves at the end of 2002 (latest IEA
figures). More than half (52%) of the proven reserves are located in Netherlands. The
UK holds 21% of the reserves. Germany holds 10% of reserves and Italy holds 7%.
Smaller levels of reserves also exist in other member states but at significant levels.
Netherlands is a major exporter to other European countries (although it also imports
gas from Norway, Russia and UK). UK exports gas under contracts related to the
Interconnector and to Ireland. Germany also exports small quantities of gas to
neighbouring countries as does Italy to a lesser extent. Although Danish reserves are
small in the overall European context they are large enough to supply the entire
Danish market and to support exports to Germany, Sweden and more recently,
Netherlands. With these exceptions indigenous reserves are typically exploited by
each member state for its domestic market.
With the exception of Netherlands, production is expected to decline in most member
states so that by 2015 only Netherlands and UK are likely to make significant
contributions to gas supply as import dependency rises.
Below we outline the structures of the production sectors in UK, Netherlands,
Denmark, Germany and Italy.
4.1.1. UK
The UK offshore production industry certainly satisfies the requirement for a
multitude of suppliers with 45 companies involved in oil and gas Exploration and
Production in the UKCS. All of the major oil companies are represented (Shell, BP,
ChevronTexaco, ConocoPhillips, ExxonMobil, Marathon, Total, Statoil) as well as
European gas companies (GdF, RWE, Eni) together with many smaller independent
companies.
- 61 -
Table 11 EU Gas Reserves

Country
Austria
Belgium
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Luxembourg
Netherlands
Poland
Portugal
Slovak Republic
Spain
Sweden
UK
Total EU
Turkey
Romania
Reserves BCM
End 2002
24
4
84
14
320
1
34
20
227
1,756
165
15
3
697
3,364
8
101
Production BCM 2003
R/P ratio
2.1
0.1
8.0
1.6
22.2
2.9
0.7
13.6
73.1
5.6
0.2
0.2
108.4
238.7
0.6
14.6
11.4
40.0
10.5
8.8
14.4
11.7
28.6
16.7
24.0
29.5
7.5
15.0
6.4
14.1
13.3
6.9
Source: IEA/OGJ
4.1.2. Netherlands
The Dutch gas market structure is more a partnership between the State and the
private companies and there is considerable overlap between the upstream and
downstream segments. Gas production and exports are vital to the Dutch economy
and the government has kept tight control over the industry, especially depletion
policy, since the gas market structure, or Gasgebouw as it is known, was developed in
1963 after the discovery of the Groningen field.
- 62 -
Figure 3 The Structure of the Dutch Gas Industry
Shell and ExxonMobil are pre-eminent among private sector actors in the Dutch gas
industry through their 50:50 joint venture NAM. These two companies also own
interests of 25% each in Gasunie with the state owning the other 50%. The states
direct interest in gas production is operated by EBN27. NAM holds the concession for
the Groningen field. EBN and NAM are also involved in development of other
smaller fields. Other E&P companies active in Netherlands include BP, Wintershall,
Total, GDF and ConnocPhillips.
Production from the so called small fields started to come on stream in the mid
1970s. There are now around 200 small fields in production, the majority of them
being very small. Just over half of the fields are offshore. Under the small fields
policy Gasunie is required to buy all gas on offer from small fields if requested. The
prices paid for this gas are about the same as gas import prices. Gas from small fields
does not have to be sold to Gasunie, however.
The purpose of the small fields policy which was introduced in 1973, was to
encourage the development of other smaller fields to prolong the life of Groningen
27
Energie Beheer Nederland.
- 63 -
field which has unique flexibility with production ranging between zero and 500 mcm
per day. This is enough flexibility to cope with seasonal variations in the Dutch
market and to increase the value of Dutch exports by adding swing.
The state has the power to decide the annual production rate of the Groningen field. In
practice a cap of 80 BCM per year was placed on total production in 1996. Because
Groningen acts as the swing producer it is the only field affected by the cap. As
production from small fields has started to decline production from Groningen has
increased in recent years to compensate. This has led to speculation that the
Government may in future impose a specific cap on Groningen to delay its depletion
which could then result in total production falling below 80 BCM as the smaller fields
decline further. Because of the cap on domestic production, Gasunie and other players
have increased imports to supply both the domestic market and exports.
The government continues to regard the small fields policy as important for security
of supply and the long term future of the Dutch gas industry based on the Groningen
field. The gas producers on the other hand regard continuation of the small fields
policy as incompatible with liberalised markets.
The industry has been calling for improvements in the mining climate which
governs Exploration and Production activities in Holland. The industry argues that
developing small fields is very sensitive to cost overruns and therefore more risky
than larger fields. The Netherlands Oil and Gas Exploration and Production
Association (Nogepa) estimates that changes to the tax regime in 2002 led to the
cancellation of 27 projects and to the evaluation of numerous other projects with a
total volume of production amounting to 39 BCM. A study by Gaffney, Cline &
Associates for EBN at the request of the Ministry of Economic Affairs, concluded that
fiscal conditions in Netherlands are relatively unfavourable for new projects28.
On behalf of the state, EBN participates in all stages of offshore gas exploration, and
development. Gas revenues still represent a significant part of government revenue.
Gas Production is subject to a State Profit Share (SPS) amounting to 40% of the
profits for offshore fields and 40% to 95% for onshore fields. Since January 2003,
royalties have been levied only on onshore projects at rates that vary between 0% and
7%.
4.1.3. Denmark
Denmark is more than self sufficient in gas and exports to Sweden and Germany.
Production in 2003 was 8.0 BCM with 2.2 BCM exported to Germany and 1.0 BCM
exported to Sweden. Reserves stood at 84 BCM at end 2003.
Exploration, Development and Production of oil and gas is concentrated in the hands
of the DUC (Dansk Underground Consortium) which is a joint venture between A.P.
Mller, Shell and ChevronTexaco.
28
Quoted by IEA: Energy Policy of Netherlands, 2004
- 64 -
Until recently all gas production was sold to DONG which also owns the national
transmission system and much of the distribution system. However, following an
investigation by the Competition Commission29, the DUC partners agreed to dissolve
its so-called DUC Gas Team and to market their shares of new gas quantities on an
individual basis without any co-ordination of sales efforts or joint marketing taking
place. The agreement covers both sales to DONG in Denmark and to other buyers
within the rest of the EU.
4.1.4. Germany
Germany is a sizeable gas producer. In 2003, indigenous production amounted to 22.2
bcm and covered 24% of domestic gas demand. There are 16 exploration and
production companies. Two of them are responsible for three-quarters of German
production, namely BEB Erdgas und Erdl (50%) and ExxonMobil (25%). BEB is
jointly owned by ExxonMobil and Shell so these two companies are dominant in the
German production sector.
Most production is onshore with limited offshore production in the North Sea which
is exported to Netherlands.
Germany has already been fully explored for gas deposits. Proven gas reserves are
estimated at 264 BCM and probable reserves at 113 BCM; considering the current
production volume, the proven reserves would be enough to cover 12 years of supply.
Without major new discoveries (which seems unlikely), German production will go
into decline some time before the period of interest of this study, i.e. 2010 to 2015 and
Germany will become even more dependent on imports.
4.1.5. Italy
In 2002, domestic production in Italy reached 14.9 BCM an 11% decline compared
with 2000 and accounted for 21% of total gas supply. Most of Italy's natural gas fields
are located in the Po Valley and offshore in the Adriatic Sea.
Proven gas reserves are estimated at over 200 BCM. A decrease in indigenous
production is expected, owing to major difficulties in obtaining permits for new
exploration and production activities, in particular in the Adriatic Sea. The
development of the Adriatic fields project (Alto Adriatic project), financed by Eni,
has been on hold for several years because of a moratorium on production in the
Adriatic Sea established by the Ministry for Environment and Territory in 1995.
During 2001, only 40 wells were drilled in Italy, eleven of which were for exploration
(the lowest figure in the past 20 years), while 53 wells were drilled in 2000. This is
the consequence of the depletion of existing fields and of a lack of new discoveries
put on stream, and confirms the challenge facing the upstream sector. In comparison
with 1994, domestic gas production declined by about 25%.
29
Case Comp/E-3/38.187-DONG/DUC, later referred to as case Comp/E-4/38.187-DONG/DUC
- 65 -
The production forecast for 2010 is about 8 bcm to 11 bcm.

Eni is the largest gas producer in Italy as well as controlling the import infrastructure
as discussed below in 5.1.2.
4.1.6. Summary
The Netherlands is the largest holder of gas reserves in the EU, while the UK is
currently the largest producer. Germany and Italy also have reasonable levels of
reserves. With the exception of Netherlands, production is expected to decline in EU
member states such that by 2015 only Netherlands and UK are expected to be
significant producers of gas. Netherlands is likely to continue to be an important
exporter to the rest of Europe, whilst the UK is now a net importer.
Apart from the UK, the production markets in EU are characterised by small groups
of two or more dominant producers. The Dutch gas market is tightly controlled by the
government which has set a cap on production to preserve the Groningen field, and
also operates the small fields policy.
- 66 -
Table 12 Current Status of the Production Market in EU

Characteristic
Institutional
Market Power
Status
Generally true
Tax regime which encourages investment including in declining production areas
Netherlands operates the small fields policy and UK taxation can be adjusted to
encourage development
Notionally encouraged but many EU countries operate opaque policies in gas

industry
Multitude of producers in EU member states. No dominant national producer
Only UK could be said to have a multitude of producers
Equity partners sell own shares of gas on shorter term contracts
Only really happening in the UK
Producers have access to liquid wholesale markets in EU
Poor liquidity generally. Only UK has genuine liquid market.
Lack of anti-competitive contracts between producers and buyers
Not thought to be a problem at the producer level
Special purchase arrangements
Some arrangements exist e.g. Dutch small fields policy gives Gasunie
monopsony over Dutch production
- 67 -
4.2. Wholesale Market in the EU

4.2.1. Market Power
Dominant Companies
The gas markets in many member states continue to be dominated by a single
company. This dominance reflects the traditional industry structure including a
monopoly often with sole rights to purchase gas from the domestic or import sources
and sole rights to sell to end users. The main exception to this structure was Germany
which was essentially an oligopoly with 7 companies involved in gas importing.
In some of the EU15 countries including Austria, Belgium, France, and Sweden, the
volume of gas controlled by a single entity is still in excess of 90%, four years after
the first Gas Directive was implemented. Challenges to the dominant company could
typically comes from four classes of competitor:
Oil and gas producers seeking to move downstream to sell their product.
Other national gas utility companies seeking to replace losses in market

share in their home markets with gains in other member states.
Large energy users such as power generators importing gas primarily for
their needs
Pure wholesalers or traders who enter the market to trade gas and possibly
sell to very large industrial and power generators
Oil and Gas Producers
Foremost among the first group are Shell, ExxonMobil, BP and Gazprom. All are
active in the UK wholesale market and seeking to expand into other countries. Shell
and ExxonMobil have established positions in the German market arising from their
joint venture company BEB. Last year the two companies decided to spin off the gas
marketing arm of BEB into two separate companies with each taking a 50% interest in
the gas sales contracts of existing customers. Potentially a similar arrangement exists
in Netherlands where Shell and ExxonMobil each own 25% of Gasunie. However, a
proposal to break up Gasunie with the state retaining control of the pipeline and the
two oil majors splitting the market arm between them broke down over failure to
reach agreement on financial issues.
BP has been particularly successful in building up a wholesale business in the Spanish
market and has an ambition to build up a 15% share in Germany. In doing so it is
seeking to replace by organic growth, the strategic holding it had in Germany before it
disposed of its interest in Ruhrgas. It will be difficult to establish a 15% market share
without significant sales to power generators.
- 68 -
Gazprom
As discussed below, Gazprom is by far the largest exporter of gas to Europe with
49% of exports in 2003. Gazproms influence is particularly strong in the new
member states where it supplies even higher shares of gas. For example Gazprom
supplied 79% of Polish imports in 2003 with the remainder being supplied by
Norway, Germany, Uzbekistan and Turkmenistan. Attempts by Poland to further
diversify supplies have met with strong opposition from Gazprom resulting in a
planned pipeline from Norway and associated supply contracts being cancelled.
Gazprom is also seeking to exert influence over gas transit pipelines including a 49%
interest in the SPP transit system in Slovakia and a 48% interest in EuroPolgaz which
owns and operates the Polish Section of the Yamal pipeline. The company retains an
involvement in Ukraine as part of the consortium to manage the transit system and is
also seeking to increase its influence in Georgia which lies on an important route for
gas from the Caspian to Turkey and thence into Europe. Gazprom recently
amnnounced interest together with Lukoil in pursuing privatisation of gas
transmission systems in Romania, Bulgaria and Hungary.
Gazprom signed a Memorandum of Understanding with E.ON in July 2004 which
identifies four main areas of cooperation:
Joint Development of the Yushno Russkoje gas field in Western Siberia
Investment by E.ON in the North European Gas Pipeline (NEGP)
Joint ventures in downstream cooperation in Europe (still to be defined)
Cooperation in the Russian power sector
The fact that Gazprom is talking to western companies at all about this particular field
is significant, in terms of its willingness to embrace foregin investment, since the
reservoir is shallow and easily exploited, whereas Gazprom usually only looks for
western help with more challenging projects. The clue to this change in attitude may
be seen in the linkage with the NEGP which Gazprom is keen to progress but E.ON is
less convinced about the need.
The signficance of this particular MOU is difficult to assess at this stage because the
details in many areas were left open in the MOU and even those that were spelt out in
more detail now appear to be changing. For example, the MOU gave E.ON exclusive
rights to negotiate investment in the gas field but Gazprom has widened participation
to include Wintershall and RWE, citing impatience at lack of progress in talks with
E.ON. For E.ON the MOU offers the opportunity to increase its equity gas base but
the company has made it clear that it will only invest in the project if it is sufficiently
profitable in its own right.
E.ON is just one of many many potential investors in the NEGP and it is not clear
what percentage interest the company will take if and when the project eventually
goes ahead. The decision to cooperate downstream in Europe was only loosely
- 69 -
defined in the MOU and the extent of co-operation may be expected to depend
ultimately on E.ONs involvement in the gas field and pipeline projects.
Gazprom is also increasingly becoming an owner of natural gas utilities in the Baltic
region. Gazprom holds a 34% stake in Latvia's Latvijas Gaze and a 37% stake in
Estonia's Eesti Gaas (along with other major foreign shareholders, Germany's E.ON
and Finland's Fortum). Most recently, in January 2004, Gazprom finalized its
acquisition of a 34% stake in Lithuania's natural gas company, Lietuvos Dujos. After
the three Baltic states' entrance into the European Union in May 2004, Gazprom plans
to raise natural gas wholesale prices from the current price of around $80-$85 per
thousand cubic metres to be more in line with European prices (around $120-135 per
thousand cubic metres). Gazprom plans to gradually increase the tariffs depending on
the pace of the Baltic region's economic development.
Gazprom has hitherto sought to develop its downstream interests through Wingas its
joint venture in Germany with Wintershall (35% Gazprom, 65% Wintershall). More
recently it has established itself as player in the UK market both in its own name and
indirectly through a joint venture between Norsk Hydro and Wingas. Gazprom has
indicated a desire to win 10% of the UK market.
National Utility Companies
The second class of wholesale market participants comprises major European gas and
power companies who are seeking to replace any losses of market share in the home
markets, with growth in other EU member states as they open up to competition or
privatise their infrastructure. Here there is an issue of reciprocity which arises from
the unequal pace at which member states have opened their markets to competition.
For instance, continental European companies can build significant interests in the
UK when their home countries are slow in opening their markets to companies from
UK and elsewhere?
Some of the major national utility companies involved are described below. The
strategies of these companies have been largely asset led.
E.ON
E.ON was formed in June 2000 by the merger of VEBA and VIAG, two of Germany's
largest industrial groups. Acquisitions including Ruhrgas in Germany and Powergen
in UK have made E.ON the biggest privately owned Energy utility in Europe.
Strategy is focused on the core power and gas businesses and five target markets
(Market Units): Central Europe, Pan-European gas, UK, Nordic and US Midwest.
E.ON uses an integrated business model for its gas and power businesses which
emphasises both vertical and horizontal integration. Growth is being pursued both by
strong investment in existing power stations and gas and power networks and through
- 70 -
an aggressive acquisition strategy. Its ambition is to be the worlds leading power

and gas company30. E.ONs major interests are as follows:
Responsible for 58% of all imports into Germany and handles 57% of all
gas consumed. Its transmission interests in Germany and elsewhere are held
as a series of joint ventures with other companies rather than as 100%
ownership of the grid. The joint venture parties include gas producers
(Statoil, Shell, Exxon) and foreign gas companies (GdF, Dong, Eni) as well
as other German gas transporters such as BEB.
Owns 24.5% of SPP the Slovak gas import, transport, storage, distribution
company. SPP is of enormous strategic importance because it carries around
75% of Russian gas supplies for Western Europe. Gas arrives from Ukraine
and is transited to the Czech Republic (and on to Germany and France) and
to Austria (and onwards for Italy and Slovenia).
Through Ruhrgas also has a 20% interest in the BBL pipeline and an 11%
interest in the Interconnector.
Owns 6.49% of the shares in Gazprom. It has signed a Memorandum of

Understanding with Gazprom for the development of Yushhno Russkoje
field in western Siberia which has proved reserves of 700 BCM and is
expected to start production in 200831. (See the discussion above on
Gazprom for a more detailed discusion of the MOU)
A potential equity partner in the North European Gas Pipeline. It is

interesting to note that, if the NEGP project goes ahead, E.ON will have
ownership interests along almost all the sections of a major delivery route
for Russian gas from Vyborg in Russia to Bacton in the UK; only the
relatively short Dutch section has no involvement from E.ON (see Figure 4).
30
31
E.ON Presentation to Investors February 2005

E.On recently lost exclusive rights to this project.
- 71 -
Figure 4 Eon Interest in the Proposed NEGP Route to UK
Controlling stakes in two Hungarian gas distribution companies, KOGAZ

and DDGAZ and a 16.36% share in the gas distribution company FOGAZ
Thuga, which is mainly active in the gas business
The Dutch trading company , D-Gas
RAG of Austria( gas producer and gas storage company).
Romanian gas supplier Distrigaz Nord (51% share). E.ON Ruhrgas AG had
already acquired stakes in the Romanian power and heat generator CCNE
and in gas supplier S.C. Congaz S.A.
Gasum (Gazprom 25%, Fortum 25%, Ruhrgas 20%) is the main buyer for
Russian gas in Finland.
Sydkrft, a joint venture between E.On Ruhrgas (55%) and Statkraft (44.6%)
in Denmark.
RWE
RWE has expanded its control of gas assets through its 4.1 billion purchase of
interests in the Czech Republic. The acquisition included a 97% stake in Transgas
which is part of the largest east-west artery in European gas infrastructure supplying
20% of NW European gas consumption and 34% of all Russian gas exports. Transgas
also has underground storage facilities with total available capacity of 3.2 BCM. At
- 72 -
the same time as buying Transgas, RWE also acquired controlling interests in 8 of the
9 Czech Local Distribution Companies. In the same year RWE acquired Innogy plc
in UK. In May 2003 RWE bought out Shells interest in the German gas company
Thyssengas to become the sole owner of that business.
RWE is the second largest gas company in Germany (after E.ON) and also has
significant involvement in the Dutch and Hungarian gas markets through ownership
of distribution assets with a customer base of 3.5 million customers in Europe. It has
1.9 BCM of gas storage capacity and 2BCM of gas production through RWE-DEA. It
is active in gas trading through RWE Plus/Trading.
Gaz de France
Gaz de France (GdF) is the incumbent monopoly in France. On the 19th November
2004 GdF and Electricite de France (EdF) changed their status to limited liability
companies. Partial privatisation of GDF will begin in July 2005 and the state will
maintain at least 70% in each company. There has been considerable opposition to
this from the powerful French unions.
GDF and Total signed a protocol agreement under which they will separate their cross
holdings in two small French gas companies. GDF will become the sole shareholder
of Compagnie Franaise du Mthane (CFM) of which GDF previously owned 55%
and Total 45%. Total will become the sole shareholder of Gaz du Sud-Ouest (GSO),
in which GDF previously had 30% equity interest and Total 70%. CFM transmits and
markets natural gas via a 6,700 kilometre network of pipelines in western and central
France. It sold 100 billion kWh of natural gas in 2003. GSO operates a 4,200
kilometre network in south-western France and sold 36 billion kWh of gas in 2003.
GdF own 24.5% of SPP the Slovak gas import, transport, storage, Distribution
Company. SPP is of enormous strategic importance because it carries around 75% of
Russian gas supplies for Western Europe. Gas arrives from Ukraine and is transited
on to Czech Republic (and on to Germany and France) and to Austria (and onwards
for Italy). GdF also owns 50% of the Megal pipeline which transits Russian gas
through Germany to France (the other shareholder is E.ON Ruhrgas). GdF also owns
25% of the Segeo pipeline system which transports Dutch gas via Belgium to France.
GdF also holds a wide range of interests in gas distribution in France (Bordeaux,
Strasburg, Grenoble), the rest of Europe (including in Italy, Germany, Austria,
Hungary, Portugal, Romania and Slovak Republic) and in Latin America.
GdFs energy trading activities are carried out through Gaselys, its 50:50 joint venture
with Socit Gnrale. Gaselys trades on physical and derivatives markets in Europe;
including Oil, Gas and Electricity as well as providing risk management and asset
services and asset and portfolio optimisation covering assets such as storage
capacities, power plants, and long term contracts.
- 73 -
ENI
Eni is an integrated energy company which operates in the oil and gas industry, power
generation and oilfield services, construction and engineering. The company is active
in around 70 countries.
Enis main strategic objectives are:
Develop core business activities: in the upstream, by efficient organic growth

continuing portfolio rationalization; in the downstream, by further expansion in
the European gas market and the Italian power market.
Focus on core business.
Enhancing the programmes to improve efficiency: by further developing costcutting programmes and by an appropriate allocation of capital expenditure
throughout all operational units.
Integration of core activities in order to maximize synergies.
Financial discipline aimed at optimising capital structure.
One of the main reasons cited by the Competition and Energy Authorities in Italy for
lack of competition is that Eni retains its dominant position on the market, directly
and through its subsidiaries in the gas supply stage, both over imported gas and
Italian-produced gas, even though there are statutory ceilings on the quota of gas that
Eni may put on the Italian consumer market until 2010. In 2003 this amount was
equivalent to about 68% of total gas consumption. But this figure rises to well over
75% if account is taken of the amounts of gas assigned by Eni to its hand-picked
operators (what are called the "innovative sales").
Eni also controls the entire international transport infrastructure used to import gas
into Italy, most of which is entirely taken up by long-term gas supply contracts (take
or pay contracts) which were drawn up or renegotiated by Eni just before the entry
into force of directive 98/30/EC. The import pipelines and Enis ownership are:
Greenstream gasline, a new import route to Italy, that will carry 8 BCM
from Libyan fields booked under long term import contract, (Enis 50%
interest).
The TENP Pipeline with transit capacity of 44 million cubic meters/day and
four compression stations, transports natural gas from Netherlands through
Germany, from the German-Dutch border at Bocholtz to Wallbach at the
German-Swiss border. From Wallbach gas is transmitted to Italy in the
Transitgas pipeline. TENP is jointly owned by Ruhrgas (51%) and Eni
(49%).
The TRANSITGAS Pipeline with one compression station, which

transports natural gas from the Netherlands and from Norway crossing
- 74 -
Switzerland from Wallbach where it joins the TENP pipeline to PassoGries

at the Italian border. It has a transit capacity of 61 mcm/day.
The TAG Pipeline ( jointly owned by Eni 89% and OMV 11%) and 3
compression stations, which transports natural gas from Russia across
Austria from Baumgarten, the delivery point at the border of Austria and
Slovakia to the Tarvisio point of entry in Italy. ENI had agreed to increase
the capacity of the TAG pipeline from 28 bcm to 34 bcm under pressure
from EU and Italian competition authorities.
The TTPC Pipeline, with a transit capacity of 78 mcm and 3 compression

stations, transports natural gas from Algeria across Tunisia from Oued Saf
Saf at the Algerian border to Cap Bon on the Mediterranean coast where it
links with the TMPC pipeline.
The TMPC Pipeline for the import of Algerian gas with a transit capacity
of 101 mcm/day. It crosses underwater the Sicily Channel from Cap Bon to
Mazara del Vallo in Sicily, the point of entry into Italy.
Eni also owns 59.1% of Snam ReteGas the main gas transportation company and
controls LNG and storage facilities. Its subsidiary Italgas also holds interests in a
number of Italian gas distribution companies.
Enis other transmission assets outside of Italy include:
The Blue Stream (joint venture Eni-Gazprom 50/50) underwater gasline,

linking the Russian to the Turkish coast of the Black Sea.
Through Fortum Petroleum, interest in important gas transmission

infrastructures such as Haltenpipe(5%), Heidrun Gas Export (5.12%) and
Aasgard Transport (5%) linking the Aasgard and Heindrun fields to the
Norwegian coast. The company also holds an interest in Franpipe (1.29%)
and the related Dunkerque terminal (0.84%) in France, and in Europipe II
(3.66%) for natural gas transmission to the German coast.
Iberdrola has bought ENIs 12% stake in the Medgaz pipeline.
Eni has been actively pursuing mergers and acquisitions in the last couple of years:
In 2003 Eni purchased 50% of Union Fenosa Gas, engaged in the energy
field in Spain and 49% of the capital of Gas de Portugal.
In the same year Eni acquired the Norwegian company Fortum Petroleum
now Eni Norge ASa subsidiary of the Finnish company Fortum Oy.
January 2004 Eni sold the entire capital of Stargas SpA to Gas Plus.
In July 2003 Tigaz (a subsidiary in which Eni holds 50% interest) purchased
a majority stake in 3 natural gas distribution companies (Mol-Gaz (now
- 75 -
Tigaz), Zsamberkgaz and Turulgaz) from the Hungarian national company

MOL.
Eni has been present on the German natural gas market since late 2002
through GVS in which it acquired a 97.8% interest in joint venture with the
German electricity operator EnBW
Eni owns 51% interest in the Slovenian distribution company, Adriaplin.
In 2004 Eni sold 33.34% interest in Galp energia (Portugal) to the state
owned Portuguese company.
Eni sold 50.9 bcm of gas in Italy in 2003 a modest increase of 0.8%, despite losses to
industry and wholesalers due to competition. The reduction in market share was
compensated for by higher sales to the power segment (up 2.55 billion cubic metres)
and the colder weather.
Sales in the rest of Europe were 14.15 BCM an increase of 4.23 BCM or 42.9% due
mainly to:
the progressive coming on line of long-term supply contracts with operators of the
natural gas market (1.54 BCM);
the start-up of marketing activities in Northern Europe (1.36 BCM);
the start of LNG supplies to the Spanish electric company Iberdrola (0.70 BCM)
in the second half of 2002 and of supplies to the Turkish market via the Blue
Stream pipeline in February 2003 (0.63 BCM).
Sales of natural gas in secondary distribution outside Italy (4.4 BCM) increased by 0.7
bcm, up 17.2% due to increased consumption, mainly on the Hungarian market and
the purchase of three distribution companies in Hungary
Large Energy Users
In this category of competition are companies which act mainly at the national level
and have a background as power generators or utlities in their own countries.
Examples include Edison and Plurigas in Italy, Essent and Nuon in the Benelux
countries and Iberdrola and Cepsa in Spain. Previously this would also have included
National Power and Powergen in the UK and could still be said to include companies
like Scottish and Southern.
Independent Wholesalers
This fourth category of possible competition is notably absent from the EU market.
This was not the case a few years ago when the US companies such as Enron,
Dynegy, Williams, Duke, AEP, Reliant etc. were active in the European markets. The
role of the indpendent wholesaler, especially in contributing to a liquid spot market
was important in the development of competitive wholesale markets in the UK and
US. The more aggressive traders bias for short selling was a key factor in helping to
- 76 -
reduce prices in these markets and their limited presence in recent years in the UK
could be said to have been a contributory factor in the very high forward winter prices
that have been seen32.
Effective Unbundling
Traditionally gas supply, transportation and storage were integrated in a single
company selling gas at prices which covered the costs of all three activities. The first
gas Directive required unbundling in the form of accounting separation only. The
second Directive goes further in requiring legal separation but not separation at the
level of ownership. This means that transportation and supply businesses may be held
in separate subsidiaries but can be owned by the same parent company.
Unbundling means among other things that TSOs must not behave in any way that
favours its affiliate supply company. The affiliate has access to the same services as
any other shipper on the same terms and must pay the same charges. There are also
strict rules on protection of data which make it illegal for the TSO to pass on
information received from other shippers to its own affiliate. National Regulatory
Authorities have the responsibility to ensure this non-discrimination.
The unbundling requirements do not prevent the operation of a combined
transmission, LNG, storage and distribution system operator provided it is legally
independent from other activities, including the supply business.
Most of the EU15 member states have implemented at least legal unbundling and two,
UK and Denmark have unbundling at ownership level.
Gas Release Schemes
Some Member States have introduced gas release programmes which require the
dominant companies to release gas from their long term contracts to new entrants. Gas
release was first used effectively in the UK and with varying degrees of success in
Italy, Spain, Germany and France.
Early attempts in the UK to break British Gas control over wholesale gas focussed on
limiting British Gass purchases of new supplies to 90% of output from new
developments. This was followed in the early 1990s by a requirement to release gas
from existing contracts. The gas release measures greatly assisted development of the
spot gas market and resulted in the creation of a number of small gas supply
companies. Today the UK has the lowest degree of concentration of control of
wholesale gas and Centrica (the marketing arm of the old British Gas) still controls
around 50% of gas supply.
Gas release, combined with limitations on gas import activity, has also been tried in
Spain and Italy which have resulted, in each case, in the percentage of wholesale gas
controlled by the largest company being reduced to 75%. In Italy, Eni Gas and Power
32
This has also been recently noted in the Trade and Industry Committee report on Fuel Prices. HC
279-1.
- 77 -
is required to release further gas such that its share of wholesale gas will be reduced to
61% by 2009.
In the recent approval of the merger between E.ON and Ruhrgas, the German
authorities imposed gas release on Ruhrgas.
Such gas release schemes have to be effective, however, and result in a real release of
gas at competitive prices. The incumbents can sometimes establish a scheme which no
one will participate in and then point to that as evidence that they have tried to
introduce competition but no one was interested33.
Gas Contract Changes
Long term contracts continue to play an important role in the European gas wholesale
business. There has been no indication whatsoever, that interest in signing long term
contracts has diminished with the prospect of market liberalisation. However, we do
see changes in the terms of these new contracts compared with the traditional
contracts signed in the era of national monopolies. These changes affect
Shorter contract terms
Equity partners selling gas individually without joint marketing
Changes to escalation terms
Examples of contract changes are:
Price review clauses are being activated more frequently in respect to some
of the existing long term contracts which were signed in the monopoly era.
Contract prices are being indexed to a wider range of markers including the
NBP spot price in the case of Centrica in its contracts with Statoil and
Gasunie. Electricity pool price has also been included in Gas Natural
contract with Atlantic LNG.
Distrigaz bought 25% of its supplies on the spot market in 2002. Gas
Natural buys spot LNG to cover winter sales.
Large buyers such as power generators and consortia of distribution

companies (Enel, Edison,GdF, Union Fenosa, Cepsa, Endessa, Iberdrola and
Plurigas) are entering into import contracts with producers, by-passing the
former national monopolies. Some of these companies are buying gas for
their portfolios as opposed to being for specific power plant, for example,
EdF purchased gas from Statoil for delivery at Zeebrugge keeping open the
decision as to whether to use the gas for its own power plant or to re-sell on
the wholesale market.
33
For example setting a high reserve price can render a scheme ineffective.
- 78 -
Multiple contracts with relatively small volumes are replacing the large
volume deals which would have underpinned infrastructure development in
former times. For example, Sonatrach is selling gas which will become
available in the new 8 BCM Medgaz pipeline to Spain in a series of
contracts for around 1 BCM per year to buyers including Total, Cepsa and
Iberdrola.
Anti Competitive Wholesale Contracts

The EC has said that it no longer intends to question the role of long term contracts
recognizing that they play an important role in managing the risk for high capital cost
production and transportation projects. However, the Commission does regard certain
contract terms, which are common in long term contracts, to be anti-competitive. In
particular the so called destination clauses specify that the buyer can only use the gas
in a specific country. Contracts also frequently prohibit buyers from selling surplus
gas on to other gas suppliers.
A problem for the EC is that the most important sellers are non-EU countries and
there may be political constraints on enforcing any changes on sellers. The
Commission has announced that it has reached agreement with Eni and Gazprom on
these clauses and also, more recently, a similar agreement with Gazprom and OMV.
Sonatrach has stated that it would not be averse to allowing buyers to re-sell contract
quantities but would require a facility to share in any profits made. The Nigerians
have also voluntarily dropped destination clauses from their LNG contracts.
Summaries of the volumes and duration of the long term contracts from each of the
major exporters to Europe are included in the Pipeline Supply and LNG Supply
sections.
Anti Competitive Contracts between TSO and LDCs
The transmission companies in Germany buy gas on long term (20-25 year) take-orpay contracts from producers abroad and on depletion contracts from producers in
Germany.
The contracts that the transmission companies have with the LDCs are typically long
term and can run up to 15/20 years, but do not normally have take-or-pay clauses.
Traditionally the LDC contracts did not specify fixed quantities but rather required the
LDC to take all existing and future demands from the transmission company. More
recently contracts have been limited to specific volumes which in theory left LDCs
free to purchase a proportion of its needs from alternative suppliers. In practice the
volumes specified represented a high proportion of the LDCs demand and difficulty
with gaining Third Party Access to pipelines means that LDCs are locked into buying
virtually all of their gas requirements from the transmission companies(s) to which
they have a physical connection. Typically LDCs have only one or a maximum of two
suppliers.
- 79 -
This kind of contract was challenged legally in 1999 when Stadtwerke Aachen
(STAWAG) declared its contract with Thyssengas null and void. Two courts decided
in favour of STAWAG on the grounds that the contracts breach both German and EU
competition law. Thyssengas appealed to the High Court but withdrew the day before
the court was due to announce its decision. Subsequently two other LDCs have
challenged their contracts which also resulted in out of court settlements at the last
minute.
These cases were settled in November 2003 and triggered an investigation by the
German anti-trust authority the Bundeskartellamt. The investigation was at first a
low-key affair but the Bundeskartellamt has now confirmed it has completed its
investigation of 750 contracts and has judged 75% of them as anti-competitive
because they make it impossible for new entrants to gain access to the customers.
All contracts are judged anti-competitive if:
they have a duration of more than two years and oblige the buyer to buy more than
80% from the supplier; or
they have a duration of more than four years and oblige the buyer to buy more
than 50% from the supplier.
The Bundeskartellamt has decided not to outlaw every single contract because that
would take too long to achieve significant change. Rather it has decided to target
Ruhrgas, Wingas and RWE Energy to make voluntary changes and has started a
negotiation process with them. The authority is willing to accept different solutions,
such as a release of contracted gas volumes, improved cancellation rights or reduced
contract duration. The criterion for acceptable solutions is that customers gain a
genuine right to switch supplier.
It argues that past gas release programmes have been ineffective and had no impact on
the market. The companies either offered rebates to keep the customers or offered
contract conditions which made it difficult for customers to switch suppliers.
Some market observers believe that the authoritys initiative will bring about genuine
moves towards a competitive market in Germany. However, it can be expected that
the companies involved may be looking for solutions which satisfy the Cartel office
but minimise the impact on company sales.
The LDCs procurement contracts cover both gas and transportation as a bundled
service. Nevertheless, the price frequently has a binomial structure with a commodity
component and a capacity component roughly representing the supply of gas at the
import point and the provision of transportation to the city gate respectively. The
commodity component is usually linked to an inland Germany heating oil index,
whereas the capacity component is linked to inflation.
- 80 -
4.2.2. Access to Essential Facilities

Third Party Access
At the time of writing the situation with regard to Third Party Access to pipelines
remains very fluid. First there has been a strong trend away from point-to-point
systems towards entry exit systems for capacity booking and tariff setting. This is a
trend very much supported by the EC and regulatory authorities. Point-to-point
systems were considered to be too inflexible to be compatible with a competitive
market. The authorities were attracted to the entry exit approach because
a) it is much more flexible than a point to point system
b) it had been seen to work well in the UK, and
c) it makes possible the development of virtual trading hubs such as the NBP in the
UK, TTF in Netherlands and PSV in Italy.
One drawback of entry exit is that it creates a pancaking effect because two charges
become payable at cross border points an exit charge from the upstream system and
an entry charge to enter the downstream system. In Germany, Austria and France
entry-exit has been implemented on the basis of multiple balancing zones, with
additional charges for moving from one zone to another even within the same
operators system. The entry exit system is now migrating to the new member states
(Slovakia) and candidate countries (Turkey).
The 4th Benchmarking report34 provides a full review of current progress towards the
implementation of competition in the gas sector in the EU, and it is not intended to
repeat that analysis in this study. The report does conclude that there are still
numerous difficulties associated with access to the network for new entrants.
Availability of capacity remains a problem at certain points in the network which are
the subject of long term reservations. Allocation of capacity is still largely on a first
come, first served basis, which benefits the incumbents. Only the UK and Italy could
be said to have complied fully with the Madrid Guidelines on network access (even so
Italy still requires a minimum one year booking for firm capacity). In addition. Of the
remaining countires, only Belgium, Denmark, the Netherlands, Hungary and Slovenia
could be said to have reasonable network tariffs and a flexible TPA service. An
inflexible TPA service remains the norm in most EU countries.
Further improvements to TPA arrangements are required by the draft EU Regulation
on Third Party Access to pipeline systems. The Regulation is intended to give legal
force to the Guidelines for Good Practice which, despite being agreed at the Madrid
Forum, have not been satisfactorily adopted by many of the TSOs on a voluntary
basis.
The enforcing provisions of the regulation spell out the underlying principles of:
34
European Commission {SEC (2004) 1720}
- 81 -
Charges for access to networks.
Third Party access services.
Capacity allocation mechanism and congestion management procedures.
Transparency requirements.
Balancing and imbalance charges
Secondary markets.
Detailed implementing rules are contained in guidelines annexed to the Regulation,

which can be modified pursuant to a Committee procedure foreseen in Article 5 and 7
of Council Decision 1999/468/EC35, usually known as the regulatory Comitology
procedure. It is important in this respect that the Regulation is an instrument that
permits these guidelines to be evolved and completed. For example, as recognised at
the September 2003 meeting of the European Gas Regulatory Forum, detailed work
now needs to be progressed on the issue of contractual congestion management (useit-or-lose-it) rules. The regulatory comitology procedure provides for such a
mechanism.
EML has carried out some analysis which compares available cross-border transit
capacity with actual gas flows. The analysis draws on two sources:
The cross border capacity figures published by GTE on its website. This
data is quoted as hourly capacity for specific cross-border locations. We
have aggregated the data for country-country capacity (for example
Olbernau, Sayda and Waidhaus were combined to give the total capacity for
gas to flow from the Czech Republic to Germany) and convert the hourly
capacity to an annual equivalent.
EMLs own assessment of flows of gas in the European Grid in 2003. The
assessment is based on import and export data combined with our
assessment of the physical routing of gas between countries. We draw up
our assessment as a flow map (see section 4.3.5), which is circulated widely
throughout the European gas industry and the work has benefited from
feedback from a number operators.
The following table summarises the findings for selected cross border flows and
capacities in NW Europe. We show the annual flow, the annual capacity and the load
factor (flow/capacity*100%).
The table shows that utilisation of capacity at many borders is very low, often less
than 40%. We would not expect pipelines to operate at a 100% load factor because of
35
OJ L 184 of 17.7.1999, p. 23.
- 82 -
seasonal variations. However, the amount of swing in international transport is

typically less than 130% so we do not consider a pipeline to be congested if the load
factor is less than 75%. An exception to this rule is the Netherlands which exports at
higher swing than is typical because of the flexibility afforded by Groningen. Even so
we would not expect load factors of significantly less than 60% on the Dutch export
routes, whereas the analysis shows load factors of 35-40%.
Whilst we would not claim that the analysis is definitive it does lend support to our
view that capacity constraints are often contractual, that is more capacity is contracted
than is actually used, rather than physical, i.e. a true shortage of physical capacity.
An exception would be Italy where the pipelines importing gas through Switzerland
and Austria do appear to be approaching full capacity.
Table 13 Examples of Cross Border Flow Flows and Capacity
From
To
Border Points
Czech Rep
Germany
Germany
Netherlands
France
Germany
Netherlands
Belgium
Belgium
France
Belgium
Austria
Switzerland
Germany
Italy
Italy
Olbernau, Sayda,
Waidhaus
Obergailbach
Oude, Bocholtz
Zavenaar
Hilvarenbeek, Obbicht,
s Gravenvoeren
Quevy,
Taisinieres,
Blaregnies
Eynatten
Tarvisio
Griespass
Annual
Flow
(BCM)
20.0
Annual
Capacity
(BCM)
57.4
Load
Factor
%
48.8
6.7
27.6
14.3
76.8
40.0
35.9
14.7
34.2
43.1
16.3
27.7
58.9
0.8
22.9
14.5
9.0
28.2
22.2
8.9
79.5
65.4
Source: Energy Markets Analysis

A significant problem in relation to transportation is that transit gas is often treated
separately from domestic transportation. Historically, gas transit contracts were
arranged simultaneously with long term gas supply contracts. The pipelines were
often built by consortia which included the parties to the gas supply contract (either
the buyer or seller or both) and the gas company in the transit country. The transit
contracts were for the same long term duration as the gas supply contracts and
typically included all (or at least a substantial proportion) of the pipeline capacity.
This leads to two distortions in the market for transit capacity. Firstly, there was
frequently little or no transit capacity available for third parties because the available
capacity is booked out under long term legacy contracts irrespective of whether the
holders of transit require their full entitlement to that capacity. In other words,
perceived capacity constraints are often contractual rather than physical.
The second issue is that charging for transit is not harmonized with domestic
charging. For example, RWE has acknowledged that Transgas of the Czech Republic
has historically made significant profits in its transit business, but these have been
partially offset by cross-subsidies to its domestic (i.e. Czech) customers, particularly
- 83 -
in 200036. RWEs expectation was that the introduction of regulated tariffs in January
2002 and consequent removal of cross-subsidies would further enhance its return from
the Czech acquisitions.
On occasions the distinction between transit and domestic tariffs has carried over into
TPA arrangements. This is particularly the case in Belgium where Fluxys publishes
entirely separate tariffs for transit and domestic transportation.
The distinct concept of transit (within the EU) was enshrined in the 1991 EU Transit
Directive, which is being repealed, although the Energy Charter Treaty also contains
transit provisions which covers EU trade.
Tariffs
Energy Markets have undertaken a lot of work in looking at transmission tariffs across
Europe. Table 14 below summarises tariffs for use of High Pressure systems around
Europe. The tariffs are shown in $/mcm/100km for transmission over two distances
50km and 350km for different load factors, as represented by hours used . The
results have been ranked in increasing order of the tariffs on a case by case basis.
For purposes of this report we are most concerned with transit of gas over longer
distances at high load factor so we concentrate for the moment on the 350 km, 8,000
hours case. On this measure there is the very large variation between countries
ranging from $0.9/mcm/100km for Belgium to $4.5/mcm/100km for Greece.
Generally, the lowest tariffs are shown for more mature networks in large well
developed gas markets including Austria, Belgium, Germany, Netherlands and UK.
Tariffs in emerging gas markets such as Spain and Greece are higher partly because of
relatively large investment costs during the rapid growth phase of the market.
However, even among the more mature gas markets there is considerable variation in
the tariffs. For example the German tariff is more than twice the UK tariff. In
principle these countries have broadly similar geographies and cost structures and we
would expect tariffs to be more closely aligned. One obvious difference is that tariffs
in UK and to a lesser extent Holland have been subject to downward pressure from
regulators which has squeezed out inefficiencies as well as economic rent.
The Greek tariff is up to 9 times the UK equivalent tariff though it should be noted
that Third Party Access does not yet exist in Greece and the figures shown are based
on tariffs which have been agreed but not yet implemented. The high tariffs can be
partly explained by the relatively high capital cost required to develop a gas industry
from a low base compared to a mature network where annual growth in throughput is
relatively small in percentage terms. In the Greek case, the transportation tariff has
been smoothed over a period of 15 years (otherwise increasing volumes would result
in very high tariffs in the first few years with high capital costs being recovered from
relatively few consumers and very low tariffs in the future when costs are spread over
an increasing number of consumers).
36
RWE. Creating a Strong European Player in Gas, December 16,2001
- 84 -
Table 14 Comparison of Transportation Tariffs ($/mcm/100 km)

50 km on HP System
Case 1
Germany
Austria
UK
Belgium
France
Netherlands
Italy
Denmark
Ireland
Spain
Greece
8,000
hours
2.9
3.7
5.9
6.4
6.4
6.4
15.6
19.4
20.7
23.8
31.3
Case 2
Germany
Austria
UK
Netherlands
Belgium
France
Italy
Denmark
Ireland
Spain
Greece
5,000
hours
4.6
6.0
6.7
9.5
10.2
10.4
20.9
30.3
31.3
33.4
47.2
Case 3
Germany
UK
Austria
Netherlands
Belgium
France
Italy
Denmark
Ireland
Spain
Greece
2,500
hours
9.2
9.2
12.0
17.6
19.7
20.8
34.8
59.1
59.8
59.8
89.5
350 km on HP System
Case 4
Belgium
UK
Netherlands
Italy
France
Germany
Austria
Denmark
Ireland
Spain
Greece
8,000
hours
0.9
1.2
1.4
1.8
2.1
2.5
2.7
2.8
3.0
3.4
4.5
Case 5
Belgium
UK
Netherlands
Italy
France
Germany
Austria
Denmark
Ireland
Spain
Greece
5,000
hours
1.5
1.6
2.1
2.3
3.2
3.9
4.3
4.3
4.5
4.8
6.7
Case 6
UK
Belgium
Italy
Netherlands
France
Germany
Denmark
Ireland
Spain
Austria
Greece
2,500
hours
2.6
2.8
3.6
4.0
6.2
7.8
8.4
8.5
8.5
8.6
12.8
Source: Energy Markets Analysis
Many TSOs require shippers to book capacity on an annual basis and that is often
restricted to specified gas year for example October to September. Some TSOs now
offer more flexible contracts for shorter periods but often at a disproportionately high
tariff compared to a full year. The availability of interruptible transportation capacity
is also limited or non-existent on some systems.
Balancing
Potential new entrants into the emerging liberalised gas markets are often obliged to
purchase gas in a contract for a fixed flat volume during a year, which does not match
the seasonal requirements of their customers. This means that access to storage or a
flexibility instrument is usually a necessary condition for new entrants to obtain
- 85 -
effective network access. In addition, the policy of TSOs relating to balancing of the
network over shorter periods is an important part of the conditions for network access.
For both balancing and storage, practice varies considerably and a number of
countries place various restrictions on the access of third parties to storage facilities,
with storage charges apparently significantly higher than in the UK for example.
For balancing the most developed system is that in the UK, where there is a balancing
market similar to that in place for electricity and the margin between the sell and buy
price is usually relatively low. As discussed above in the Netherlands balancing
services are supplied predominantly from the Groningen field which is controlled by
Gasunie (as the purchaser of the gas) and this combined with the hourly balancing
requirements results in significant costs and uncertainties for shippers.
For most other Member States imbalance energy is charged at a multiple of the
wholesale price without reference to market mechanisms. These multiples range from
1.2 to over 4 depending on the country and the circumstances. It is also notable that
few TSOs allow pooling of imbalances and this is a disadvantage to new entrants with
smaller portfolios of customers. Only Austria, Italy and the UK are considered to have
a favourable cost/market based balancing system.
Overall there remains considerable scope for network operators to adopt a regime that
implicitly favours their associated undertakings. Requirements for third parties to
balance over hourly periods, when combined with restricted access to flexibility and
storage instruments, lead to significant barriers to new entrants, who are likely to have
much smaller loads and portfolios of customers, subjecting them to greater variability
throughout the day.
TPA to Storage and LNG
The second Gas Directive extends TPA to LNG and Storage. Conditions for access to
LNG plants have been published on websites by most operators of existing LNG
plants, including Spain, Belgium, France, Greece and Italy. The tariff for Italy, at
least, is regulated.
The Authority for Electricity and Gas of Italy has been particularly proactive in
pressing for TPA to LNG facilities. It overruled attempts by Eni subsidiary, GNL to
deny access to its Panigaglia plant to Gas Natural on the grounds that the entire
capacity was contracted to Eni S.p.A. GNL was fined 50,000, for its refusal to grant
access but this was the minimum fine allowed in recognition that GNL had promptly
complied with the ruling37.
The Belgian regulator, CREG, has also ordered changes to Fluxys proposals for a
system of short-term bookings of unloading slots at the Zeebrugge LNG terminal. The
first proposal was judged to underestimate the number of slots available. There has
been a lengthy negotiation between Fluxys and CREG over the terms for third party
37
The decision can be viewed at www.autorita.energia.it
- 86 -
access (TPA) to the terminal, which is currently used mainly by Distrigas, the owner
of Fluxys.
The indicative programme, as the TPA regime is known, will regulate short-term
bookings this year and next. It will also be the basis for TPA after the expansion of
the terminal from 4.5 BCM per year to 9 BCM in 2007.
The regulator wants Fluxys to publish more information than they have suggested so
far. Although Distrigas owns all capacity until 2006, slots are occasionally sold to
others for spot cargoes. After the indicative programme is agreed, potential customers
will be consulted at a Shippers Day in March. They are expected to include the
three companies that booked long-term capacity after 2007: Distrigas, Tractebel and
ExxonMobil.
The CREG spokesman said they were discussing the rules for the operation of a useit-or-lose-it system. Many details such as how much notice must be given about
availability are still under discussion. There will be a secondary market for slots after
the expansion, if not before. It will be run by Fluxys LNG. Capacity owners will make
a yearly forecast of their shipping plans and a few months ahead they will confirm
which slots they want. So far no decision has been taken on how much notice will be
given.
The Spanish regulator, CNE, has ruled out a secondary market in re-gasification
capacity in Spain at least for the time being. CNE says that sales of part of a contract
are not allowed for in the current regime (although secondary trading of pipeline
capacity is covered). New rules need to be brought in to prevent an integrated
company from booking a large volume of capacity and then choosing who to sell it to.
The issue is important in Spain where LNG supplies over half the market and there
are financial penalties for not using booked capacity. There is no timetable to
introduce the new rules.
As discussed below major new infrastructure projects may be exempted from TPA
requirements.
The second Gas Directive requires tariffs or at least the methodology upon which they
are based to be approved by regulators. The Directive allows negotiated access for
storage. CSL, Edison, Enagas, Fluxys, and Stogit all have regulated storage TPA38.
BEB, BP, DONG, GDF, NAM, OMV, RAG, E.ON Ruhrgas, RWE-TG, VNG AND
Wingas also have published tariffs but these are negotiated TPA.
A proportion of storage, particularly in France and Germany, is regarded as
strategic storage, to be used in the event of supply disruptions by exporting and/or
transit countries. Such storage is unlikely to be available in the event of supply
problems in other countries.
38
July 2004 Madrid Forum European Gas Regulatory Forum, DGET. Technically speaking CSL does
not offer regulated TPA but the undertakings have pretty much the same impact.
- 87 -
Impact of TPA on Network Development

In Section 2 the impact of TPA on network development was briefly discussed. Four
different methods of capacity expansion were identified Rolled in Rates, Joint
Ventures, Open Seasons and TPA Exemptions. All of these are currently being used
in the EU
Rolled In Rates
Rolled in rates apply mostly to organic investment in the pipeline system within the
national territory of a single system operator. The concept is that new investment
costs are included in the cost base upon which regulated tariffs are calculated. In
effect the cost of new investment is borne by all customers connected to the network
not just those who will be supplied from the new infrastructure. The main advantages
of a rolled-in approach are as follows:
Enables main line extensions and new markets to be developed at lower prices to
these markets than pricing on an incremental basis.
Eventually all pipeline customers benefit from increased throughput and
economies of scale, therefore all customers should pay.
Expansions and extensions will get built which otherwise would not get built,
bringing operational and financial benefits to the system as a whole.
By bringing new shippers and customers onto the system, rolled-in pricing will
promote competition and provide a level playing field for competitors.
Encourages infrastructure development, especially applicable in immature
markets, growing markets
Provides a mechanism to extend systems to rural and disadvantaged areas,
meeting social and other national objectives
There are, however, some disadvantages to rolled-in treatment of new investment:
Higher prices to everyone initially, except the new customers

Existing customers, not the pipeline owner, assume investment risk.
New customers and markets will be subsidised by existing customers and markets,
at least for a period of time.
The new facilities may be underutilised thereby passing the risk of underutilisation
onto the existing, probably captive, customers.
Could encourage over investment and/or uneconomic investment since the true
costs of the investment are not being paid for by those causing the costs
An interesting variant of this system has been adopted in Italy39 where supplementary
charges are included in tariffs in respect of new investment (post 2001). These
supplementary charges are included for six years after the investment becomes
operational. The rate of return for new investments is lower than that for existing
assets (7.47 per cent compared with 7.94 per cent in respect of pipelines and 9.09 per
cent compared with 9.15 per cent for LNG terminals). New investment is included in
39
The Italian Authority for Electricity and Gas. Decision 120/01 as amended by decision 127/02, May
2001.
- 88 -
the tariff on the basis of increased asset values appearing on the TSOs balance sheets.
Hence only actual investments are included rather than planned investments.
Joint Ventures
The joint venture approach has been used widely in Europe for many years to develop
pipelines for international transit of gas. Traditionally capacity in these joint venture
pipelines was allocated exclusively to equity partners in the project which would
include the buyers and sellers of gas as well as the system operator in transit
countries. Third parties were often actively excluded from taking capacity (see
discussion of the Marathon case below).
This model is especially prevalent in the main pipeline system in Germany. Ruhrgas
transmission interests are held as a series of joint ventures involving other parties
including Statoil, Norsk Hydro, Eni, Dong, Gaz de France, Shell and Exxon. BEB
was also a joint venture between Shell and Exxon (now disbanded) whilst Wingas is a
joint venture between Gazprom and Wintershall. More recently the authorities in
Germany have forced Ruhrgas and Wingas to cooperate on construction of a pipeline
from Lamperhheim to Burghausen on the German Austrian border. The two
companies had originally planned to build separate systems but this was ruled out on
environmental grounds.
Similar joint ventures are used in Belgium, Austria, Switzerland and Poland for gas
transit pipelines. A similar approach was also taken for the Interconnector project
linking UK and Belgium.
These joint venture pipelines are subject to RTPA under the second gas directive in
the same way as TSOs national systems. However, it is often the case that capacity is
fully contracted to the equity parties leaving no capacity available to new entrants. In
some cases such as that of the TAG pipeline in Austria the regulatory and competition
authorities are seeking to remedy this lack of capacity available to third parties by
pressurising the equity partners to increase capacity by installation of compressors.
However, the problem is complicated because the pipeline is physically located in
Austria but also serves the Italian gas market.
The Bacton to Zeebrugge interconnector was also developed as a joint venture and
initially capacity was allocated to the equity partners in proportion to their shares in
the project. However, the project structure did allow for capacity to be sold or
assigned to third parties on a long term basis and there is an active market for
secondary capacity.
Open Season
The Open Season approach has been used widely in North America but is a relatively
new approach in Europe. The first project to be advanced under the Open Season
- 89 -
approach in Europe was the Bacton to Zeebrugge pipeline (Interconnector)40. Under

this approach the project developers produce a prospectus describing the project and
seek to sign up shippers on long term contracts before financial commitment is made
to go ahead with the project. The essential difference between this and the traditional
joint venture model is that capacity is offered to all comers and shippers need not
necessarily take equity stakes in the project.
TPA Exemptions
Under the second EU gas Directive, major new capacity projects including
interconnectors, LNG terminals and storage projects may be exempted from TPA
provisions provided the project meets a specific set of criteria. The criteria include
that the project enhances both security of supply and competition and that it would not
be likely to proceed without such an exemption. The exemption may be applied to all
or part of the capacity and may be applied for a limited period such as twenty years.
In the UK we have seen all of these methods used. All of Transcos network
investments are rolled into Transcos Regulatory Value at each periodic price review.
Although Ofgem has put in place a market mechanism, through long term auctions41,
to assist Transco in deciding which investments it should undertake, before they are
rolled in to the asset base at subsequent price reviews. Arrangements are in place to
allow capacity to be sold on a short term basis. The three new LNG terminals
operate under long term contracts and Ofgem has decided to exempt them from the
EU requirements in respect of TPA for twenty years. Ofgems decision to exempt
South Hook and Grain from TPA has been ratified by the European Commission and
ratification is awaited in respect of Dragon LNG.
Ofgem has also indicated that it considers the application by BBL pipeline for
exemption meets the necessary criteria for an exemption to be granted.
4.2.3. Institutional
Proactive Energy Regulators
All member States now have regulators. Although there is some variation in the
precise arrangements, most of the regulatory authorities are independent bodies
established separately from other government departments and direct ministerial
control. They have a high degree of independence of Government, being set up under
founding legislation which sets out the authorities objectives, responsibilities and
powers. This strong grounding in law provides an effective means for regulators to
resist political interference, especially if that would contravene the stated policies and
40
Marathons Symphony project to export Norwegian gas to the UK adopted an Open Season approach
but did not go ahead.
41
Though they were called auctions they were effectively Open Seasons since the minimum price was
set at the Long Run Marginal Cost and those who bid the LRMC were allocated the new capacity
- 90 -
objectives set out in the law. Governments can only change the regulators objectives
and powers through changes to legislation.
Although, politicians are usually involved in the appointment of members of the
regulatory bodies, appointments are typically for fixed terms and members cannot be
removed for political reasons. For example, the Italian Regulatory Authority for
Electricity and Gas (known as Autorita) was set up under Law 481 in 1995 as an
independent authority body which makes its own decisions under the terms of its
founding law, procedures and regulations. Autorita has been one of the more
proactive authorities establishing a sound methodology for setting tariffs in the SRG
and Edison networks, establishing Network Codes and enforcing gas release
programme and market share targets on Eni. Its efforts have been frustrated by the
dominance of Eni and it has joined forces with the Italian competition authority to try
to reduce that dominance (see below). In many ways the battle between Autorita and
Eni is reminiscent of the battle between Ofgas (later Ofgem) and British Gas in the
1980s and 1990s.
The Netherlands Office for Energy Regulation DTe is slightly unusual in that it falls
under the Ministry of Economic Affairs and has been included as a chamber within
the Netherlands Competition Authority (NMa). However, the tasks which DTE is
responsible for are specified by the Electricity and Gas Acts, ensuring its
independence of government. DTe has had notable success in the area of network
tariffs where it secured tariff reductions of 5% per annum under the first price control.
However, it has allowed Gasunie to impose an hourly balancing regime which is
unnecessarily restrictive42 and has to work within the confines of an industry structure
over which the government exercises tight control (see Section 4.1 above)
In France the Commission for Regulation of Energy (CRE) consists of members
appointed for six years. Three of the Commissioners (including the Chairman) are
appointed by Decree, while others are appointed respectively by the presidents of the
Senate, National Assembly and Economic and Social Council. In Italy there are three
commissioners who were appointed by presidential decree in 1996. In Spain the
National Energy Commission (CNE) is governed by a Board of Commissioners
formed by the Chairman, who is the Commissions legal representative, the Vice
Chairman, seven members and a non-voting Secretary. The Commissioners are all
professionals with acknowledged technical ability who are appointed by Royal Decree
on the proposal of the Minister of Economy following his appearance before the
relevant Committee in the Congress of Deputies (Lower House of Parliament) and the
ensuing debate.
A European Energy Regulators Group was established on 11th November 2003 by
Commission Decision 2003/796/EC to facilitate consultation, co-ordination and cooperation between the regulators. The Group is composed of the heads of the national
regulatory authorities or their representatives. The Commission shall be present at the
meetings of the Group and shall designate a high-level representative to participate in
42
As discussed in section 4.2.2, hourly balancing imposes unnecessary burdens and costs on new
entrants, particularly where they are denied access to storage or are charged excessive storage tariffs
- 91 -
all its debates. Experts from EEA States and States which are candidates for accession
to the European Union may attend the meeting of the Group as observers. The Group
and the Commission may invite other experts and observers to attend its meetings.
This new Group formalizes the activities of the already extant Council of European
Energy Regulators (CEER).
Proactive Competition Authorities
The competition authorities at both EU and national levels have been influential in
achieving changes and tackling dominance at both EU and national level.
At EU level DG Competition has had some success in
The Marathon case which goes back to the 1990s, when the Norwegian
subsidiary of Marathon requested access several times to the gas pipelines of
five gas companies in continental Europe. The Commission settled the case
with BEB43, Gasunie44 and Thyssengas45. Negotiations with Ruhrgas and
GdF were not settled until 200446. In all cases the operators eventually
agreed to changes in their TPA systems and other measures to promoted
competition such as gas release.
The break up of the Norwegian gas sales cartel see section 4.3.5
Changes to destination clauses see section 4.3.3
At national level the German cartel office has been proactive in the issue of long term
contracts between TSOs and Local Distribution Companies, as described above.
In Italy the competition authority is working with the gas and electricity regulatory to
tackle the issue of Enis dominance with notable success in the Blugas case.
The Competition Directorate is to launch an inquiry this year into gas and electricity
market competition in the EU. The three main aims of the inquiry are :
Improved empirical knowledge about the market.
Identify regulatory deficiencies.
Identify competition law infringements.
The overall aim is to have better information on what still needs to be done to create a
flexible, competitive single European gas market. Only after the inquiry has been
completed will the EC decide whether further action is required and if so, at what
43
IP/03/1129 of 29 July 2003

IP/03/547 of 16 April 2003
45
IP/01/1641 of 23 November 2001
46
IP/04/753 of 30 April 2004
44
- 92 -
level. Impetus for the inquiry comes from the Lisbon Communication, published in
January of this year, which aims to enforce the ECs competition policy. It
specifically calls for inquiries in key sectors, like financial services and energy, to
ascertain why markets do not fully function. Companies would be obliged to provide
information and would be fined if they did not comply.
4.2.4. Summary
Conditions in the EU wholesale markets vary considerably between member states,
and one aim of the second gas directive and the proposed regulation on access to
networks is to achieve greater harmonisation towards good practice.
Market dominance continues to be a major issue. Many national markets continue to
be dominated by the incumbent gas company. We are also seeing the advent of
powerful pan-European gas and power companies with high profile strategies based
on aggressive acquisition and investment programmes aimed at controlling large
sections of the physical infrastructure and access to end users via ownership of
distribution companies. The implementation of the 2nd Gas Directive may go some
way towards limiting any market dominance but on its own is not enough, principally
because of its weaknesses in the area of storage, balancing and the separation of
transportation and supply functions. Major producers are also trying to establish
market positions but they are lagging somewhat behind the gas and power companies
in terms of sales. Notably absent from the market are the independent wholesalers
such as Enron, Dynegy and other US companies who were trying to enter the market a
few years ago.
Legal unbundling of transportation, storage and supply has largely been implemented
but how effective this has been in creating a level playing field for new entrants is
uncertain. Gas release schemes have also been introduced, which conceptually is good
progress, but not all have been effective. More progress is being made in respect of
gas contracts with more flexibility being introduced, the removal of destination
clauses and the German cartel office declaring 75% of the 750 contracts between the
TSOs and LDCs as anti-competitive.
The main issues regarding third party access relate to allocation of capacity. Many
contracts and there are cross-subsidies between transit and domestic charges. Analysis
suggests that cross-border capacity is generally under utilised, except maybe into
Italy, and that there are also large discrepancies between transmission tariffs within
EU countries for transporation of similar loads and distances. Whilst relatively high
tariffs may be justifiable in growth markets where there is an intensive capital
requirement, there is less justification for differences among more mature and well
established gas markets where costs should be broadly similar. It is certainly noticable
that tariffs are lower where regulators have taken an active role in forcing out
inefficiency and economic rent than in countries where independent regulators have
been less forceful in regulating tariffs.
- 93 -
Balancing regimes also differ between countries with hourly and daily balancing and
evidence of overly penal charges with considerable scope for network operators to
adopt a regime that implicitly favours their associated supply business. Progress is
being made on the publishing of conditions for access to both LNG terminals and
storage facilities with a mixture of regulated and negotiated TPA. The issue of
network development under a TPA regime is being dealt with largely on an ad hoc
basis. The UK and Italy have better developed systems based on rolled in rates but
joint ventures, open seasons and applications for TPA exemptions are all being used.
A more consistent, coherent approach across the EU would be useful.
At the institutional level the regulatory authorities in some countries would appear to
be more proactive than in others, particularly where state ownership is still important.
Germany has just established a regulator but the cartel office has been active.
- 94 -
Table 15 Current Status of the Wholesale Gas Market in EU

Characteristic
Insitutional
Market
Power
Access
Essential
Facilities
to
Status
Proactive Energy Regulators
Mixed. Regulators are proactive in some countries.
Proactive Competition Authorities
Some competition authorities actively involved
Multitude of wholesalers and suppliers
In 14 countries there is only one company with access to 5% or more of gas. The number is three or more in Germany (12) Ireland
(5), Spain (4) UK (5) and Romania (4).
Multitude of customers and customer pressure
Switching by large industrial users is significant in Belgium (60%), Denmark (30%), Estonia (20%), France (25%), Ireland (>50%),
Italy (30%), Netherlands, UK (>50%) Romania (>50%). The rest are less than 10% or not known
Effective unbundling of transportation, supply and storage
Some progress in most countries though some are doing accounting separation only. State ownership remains in some countries
Schemes planned or implemented in Austria, France, Germany, Italy, Spain and UK, although effectiveness unclear
Anti Competitive contracts between TSO and LDCs
Contracts declared anti-competitive in Germany but still exist
Only UK has genuine spot market, but other hubs developing in NW Europe and virtual balancing points in UK, Netherlands and
TPA Transmission
Only Italy and UK judged by EC to have flexible TPA system with cost or market based balancing
TPA Storage
Negotiated access allowed by second gas directive. Regulated TPA in some facilities
TPA LNG
Conditions for access published by most operators. Only regulated in Italy
Regulated Transmission Charges
Second gas directive requires tariffs or at least methodology to be approved by regulators
Regulated Storage Charges
Negotiated charges allowed by second gas directive. Published charges starting to appear, some regulated. GGPS approved at
Madrid Forum special meeting in January
Regulated LNG facility Charges
Only Italy
Simple not over penal balancing regimes
Mixture of daily and hourly balancing. Some charges still over penal
No consistent pattern across the EU. Rolled in in Italy and UK but JVs and TPA exemptions still popular
- 95 -
4.3. Retail Market in the EU

The second Gas Directive requires full opening of the retail market by 2007. In most
countries preparations are at an early stage for this level of competition. On 16th
March 2005 ten member states had still not transposed either one or both of the Gas
and Electricity Directives into national law and the Commission sent letters to
Germany, Belgium, Estonia, Ireland, Lithuania, Latvia, Sweden, Greece, Spain and
Luxembourg initiating the second stage of infringement proceedings.
It is likely that progress in opening up retail markets will be slow. Experience
suggests that there might be a degree of inertia. Appendix 6 discusses the UK
experience in more detail.
4.3.1. Key EU Countries
In the following sections we briefly describe current conditions in the retail markets of
Germany, Netherlands, Italy, Spain and France.
Germany
The German gas market is theoretically open for all classes of customer. In practice
true competition has not fully developed. Hitherto, TPA tariffs and terms have been
too restrictive and inflexible to allow new entrants to gain much of a foothold in the
market. Some large industrial users have switched supplier but the vast majority of
customers including households have no effective ability to choose their supplier.
ExxonMobil and Shell are an established presence in the German market arising from
their joint venture BEB. BEB has now ceased trading operations to concentrate on
production and its pipeline business. All existing BEB contracts with customers
ranging from Ruhrgas and VNG to small local distribution companies have been split
50:50 between ExxonMobil and Shell. Most observers are uncertain whether there
will be active competition initially. The 50:50 split of the contracts is judged as an
indicator for this assessment.
BP is trying to gain a market share by organic growth since the company sold its stake
in Ruhrgas. The company is targeting a 15% share in the German market seeking to
replicate its success in Spain. But with only three to five customers in Germany to
date, it has a long way to go. BP is unlikely to meet its aggressive target without
selling large volumes to power stations.
Almost all of the other continental European gas players are in one way or the other
present on the German gas market. The Dutch companies Essent and Nuon have small
gas sales operations in Germany, as has Belgiums Electrabel. Essent and Electrabel
have stakes in German distribution companies, though these assets have so far played
no further role in gaining market share. Gaz de France (GdF) has interests in German
gas distributors Gasag (Berlin) and EVO. GdF with sales to industrial customers in
- 96 -
Germany of about 0.1 BCM per annum, is one of the most active foreign players in
Germany. Most of the industrial and Stadtwerke customers are based in Northern
Germany. The Danish gas major Dong has a one-man sales team in Germany. Dongs
target is to substitute losses in the home market in Denmark with sales in Germany,
the Netherlands or Sweden.
Italys Eni controls jointly with the German energy provider EnBW Gasversorgung
Sddeutschland (GVS) a regional distribution company based in Stuttgart with annual
sales of around 0.08 BCM. Eni is now supplying GVS about 10% of GVSs overall
needs. So far, neither Eni nor GVS are perceived as active competitors on the German
market. Last but perhaps not least the Austrians have an eye on the German market.
The sales company EconGas, controlled by the Austrian gas major OMV, is trying to
sell gas in southern Germany
The dominant market player E.ON Ruhrgas lost only 0.6 BCM of sales in 2003 to
competitors, according to figures presented at an analyst conference. This represents
only 1.1% of the 2002 sales total of 56.9 BCM in Germany. The incumbents remain
entrenched, their positions reinforced by the ongoing difficulties for third parties to
secure pipeline capacity at competitive prices.
A possible way for new entrants to access the German market would be through the
projected increase in demand for gas from new power stations. Total German gas
demand is projected to increase from 90 bcm in 2002 to 109 bcm in 2015 in our base
case demand projections as outlined in Section 6, mostly driven by increased use of
gas for power generation. In the UK market the emergence of new entrants in the
1990s was helped by the dash for gas in power but without the other key reforms it
is unlikely that competition would have developed as rapidly. It is certainly the case,
as evidenced by the US and UK experience that it is easier to introduce competition
into a growing market, rather than a static or declining market, but it would seem
unwise to rely on growth in the market enabling new entrants to compete, in the
absence of other reforms. If the growth in gas demand did not materialise for any
reason then new entrants would not get into the market and competition would be
unlikely to be introduced47.
Netherlands
Gas market liberalisation began in the Netherlands with the Gas Act introduced in
August 2000. The market was opened initially to all consumers using 10 million cm
per year or more, representing 45% of the entire market. The threshold was lowered to
0.17 million cm per year, representing 65% of the market, in January 2002. The
market was fully opened on 1 July 2004.
The level of switching by eligible industrial customers is open to some uncertainty.
The fourth EC Benchmarking Report does not give a figure on switching rates for
47
While the introduction of competition in the US and the UK occurred at the same time as the growth
in demand, and this growth was certainly considered to be helpful, it could be argued that the presence
of competition actually helped the growth rather than the other way round.
- 97 -
Netherlands. The third benchmarking report which covered 2002 the first year of the
lower threshold suggested that 15% of eligible customers had switched supplier. In
2003 Gasunie Trade & Supply sold a total of 15.3 BCM of gas in the liberalized
segment of the market, which comprises industrial users and greenhouse growers with
an annual gas offtake of more than 1 million cm and power stations. This was a
reduction of 15% compared to 2002 when T&S sold 18.1 BCM. Gasunie attributes
this reduction to a loss of market share to competitors in the liberalized market.
According to EnergieNed, the Federation of Energy Companies in the Netherlands,
only about 1 to 2% of small customers were expected to switch to new suppliers when
the market was fully opened on 1st July 2004 (compared with 2% for electricity
suppliers)48. The low take-up of gas competition was attributed by EnergieNed to a
lack of awareness of the possibility to switch from one gas supplier to another.
There are 26 companies with licences to deliver gas to small customers and there are
at least thirteen websites in the Netherlands which compare energy prices. However,
according to DTe only five of these sites make use of independent data, not one of
them is comprehensive, and offers complete transparency. The Dutch Consumers
Association says that many customers have no idea what their contractual details are.
According to the DTe, customers can in theory save 100 per annum or about 9% of
the average annual bill by switching gas supplier. However, based on figures
published by Nuon49, energy costs account for 30% of the average household bill and
distribution costs account for a further 16%. That leaves just 54% of the average bill
or about 599 subject to competition. A reduction of 10% on that portion would save
the customer less than 5 per month which many will think is hardly worth the trouble
of switching.
Italy
In May 2000, the government adopted the Letta Decree50, which implemented the
EU's first Directive (98/30/EC) on natural gas. The Decree set a liberalisation
schedule, which opened the natural gas market to full competition in January 2003,
and established regulated third party access to the natural gas grid. The Decree also
introduced two measures to increase competition in the retail and wholesale gas
markets:
1) no single company can supply more than 50% of the natural gas sold to final users
beginning in 2002; and
2) from the beginning of 2002, no company will be allowed to supply more than 75%
of Italys annual natural gas demand, with the limit reduced to 61% by 2010.
A new energy law, the so-called Marzano Law, was approved in August 2004
transposing into national law the requirements of the second EU Gas Directive. The
48
EnergieNed press release 30 June 2004

www.nuon.nl
50
Legislative Decree No 164/2000
49
- 98 -
law amongst other things aims to clarify the roles of the State and Regions in the field
of energy, in particular allowing co-ordination by the state.
Although Eni currently remains the predominant supplier in Italy, its market share is
declining as required by the Letta Decree. In 2003, Eni supplied 68% of the natural
gas delivered to the national pipeline grid, compared with 73% in 2002. According to
Snam Rete Gas data (see Table 16), Enel and Edison supplied 12%51 and 10%,
respectively, with Plurigas52 providing 4%.
After securing its own bank of natural gas import contracts, Edison is likely to
become Enis largest competitor in coming years.
Table 16 Throughput of Snam Rete Gas System
Eni*
Enel
Edison
Plurigas
Others
Total
2001
2002
2003
58.2
6.3
3.8
0.75
1.4
70.4
54.6
8.3
5.3
3.16
3.1
74.4
51.7
9.2
7.5
3.08
4.9
76.4
% Change
2002 to
2003
-5.2
10.9
40.3
-2.5
59.3
2.7
Source Snam Rete Gas 2003 Annual Report
There are around 300 local and regional distributors operating in the Italian market.
Ownership of these companies is diverse and varies between private, public and
municipal ownership. In 2002 Eni took full control of Italgas, the largest distribution
company, driving a wave of consolidation in the distribution market. As privatisation
of municipal utilities is becoming more widespread and liberalisation of the market
puts pressure on small distributors, a number of consortia have been formed by
municipal utilities. For instance while Plurigas has been formed by Aem Milano
(40%), Amga Genoa (30%) and Asm Brescia (30%), Blugas consists of four
municipalities in north-east Italy and the Milan-based Gas Plus consortium. In
addition, both Italgas and Edison have formed alliances with groups of municipalities.
New foreign entrants have also positioned themselves to market gas at the distribution
level. Energia, a JV of the Italian conglomerate CIR and Austrias Verbund, aims to
become a leading multi-utility business. It has also contracted gas supplies from
Norway and Libya and its gas supply business became fully operational at the
beginning of 2002. In addition, Spains Gas Natural has acquired a number of small
distribution companies, particularly in southern Italy, building a relatively strong
distribution portfolio.
51
Note. These figures relate to throughput in the SRG system so do not include direct sales by Edison
from its own network.
52
Plurigas buys gas on behalf of its shareholders a group of local distribution companies
- 99 -
Spain
Prices for industrial and commercial gas consumers in Spain are falling amid a price
war and oversupply in the liberalised Spanish market. The price fall happened quite
suddenly and the gas bubble could be a feature of the market for some years as new
supplies come on stream from LNG and there is little capacity to export the surplus
gas.
Since Spain fully liberalised its energy markets in 2003 many industrial and
commercial consumers have switched supplier. The main groups in the liberalised
market are the incumbent, Gas Natural, followed by BP with an 11% share and
Iberdrola and Cespsa both with 5% or about 1 BCM in annual sales. The liberalised
market takes the regulated tariff as its benchmark for prices, and discount obtained by
large consumers widened from around 3% at the beginning of 2004 to as much as
15% by the end of the year. Almost all small consumers have opted to remain on
tariffs set by the regulator.
France
Hardly any of Frances eligible gas customers have exercised their right to switch,
according to the latest market opening data from regulator, CRE. Of the 530,000
eligible sites, only 23,140 have used their eligible status to change contract or supplier
(4.4%). Out of a total eligible market of 350 TWh, 37.7% (or 132 TWh) has been
renegotiated, but only 9.7% of the total (34 TWh) has actually gone to a different
supplier. The switched volume has risen since July 2004 however, when it was 23
TWh, or 6.6% of the eligible volume.
There are only 10 suppliers in total, according to CRE, and the market share of
alternative suppliers has actually been decreasing slightly on a month on month basis
since last August. Of the market that exercised eligibility in December (that is, chose
to break from the old regulated tariff contract), only a 26% share went to alternative
suppliers on average. This situation is likely to improve in 2005 however as a result of
the gas release program for the south and southwest of the country. The French
residential market is still closed to competition.
4.3.2. Inefficiency and Economic Rent
Some analysis undertaken by EML, for a private client last year, on inefficiency and
economic rent in the European gas industry has some relevance to this study.The full
analysis cannot be included for reasons of confidentiality, but it indicates prima facie
evidence of a significant amount of inefficiency and/or economic rent in the
distribution and supply sector in particular, making the cross subsidisation of the
supply side by the incumbents pipes business much easier to achieve. This would
indicate that distribution is yet to come under effective regulatory control and supply
to small users (households and small industrials) has not been subjected to
competitive pressure.
- 100 -
Table 17 Current Status of the Retail Gas Market in EU

Characteristic
Institutional
Market
Power
Access
Essential
Facilities
to
Status
Proactive regulation by energy regulatory authorities
Mixed. Regulators are proactive in some countries
Proactive regulation by competition authorities
Competition authorities actively involved
Access to liquid wholesale markets
Only in UK is there a genuine liquid wholesale market
Multitude of suppliers
Most member states have fewer than 6 suppliers (Germany, UK, Poland, Czech Rep, and Hungary have 6 or more)
This may be a problem in some emerging markets for example Sweden , Greece, Portugal and Finland . Switching by large
industrial users is significant in Belgium (60%), Denmark (30%), Estonia (20%), France (25%), Ireland (>50%), Italy (30%),
Netherlands, Spain, UK (>50%) Romania (>50%). The rest are less than 10% or not known
Effective unbundling of distribution and supply
Not clear. State ownership remains in some countries. Evidence of significant economic rent.
Schemes planned or implemented in Austria, France, Germany, Italy, Spain and UK, although effectiveness unclear
Development of public awareness on ability to switch suppliers
Little evidence of significant public awareness except in UK
Smooth administrative procedures for switching suppliers
Only in UK
Maintenance of standards of service, public service obligations,

customer protection and security of supply
Covered in second gas directive and SOS directive
Regulated TPA to distribution systems
Required by second gas directive. Only really effective in UK
Regulated distribution network charges
Required by second gas directive with tariffs and methodology approved by regulators
Access to capacity more important than building new capacity
- 101 -
4.4. Pipeline Supply Area

4.4.1. Background
In 2003, Europe53 produced 48% of its gas requirements and imported the remaining
52%. Russia accounted for 49% of imports in 2003, Norway accounted for 25% and
Algeria accounted for 20% (including both pipeline and Liquefied Natural Gas
(LNG)) shipments. The remaining 6% was supplied by pipeline from Iran and by
LNG from a diverse range of exporters including Nigeria, Libya, Malaysia, Oman,
Qatar, Trinidad and Tobago and UAE.
Table 18 European Gas Imports by Country 2003
Country of Origin
Russia
Norway
Algeria (pipeline)
Algeria (LNG)
Iran
Nigeria (LNG)
Qatar (LNG)
Other LNG
Total
BCM
135.2
67.7
30.3
25.8
3.5
10.0
1.9
1.3
275.7
Share
49.0%
24.6%
11.0%
9.4%
1.3%
3.6%
0.7%
0.5%
100%
The entirety of Russian exports are supplied by Gazprom and the entirety of Algerian
exports are supplied by Sonatrach. Statoil controls almost 60% of Norwegian exports
(including the State Direct Financial Interest which it markets on behalf of the
Norwegian state). These three companies between them control 83.8 per cent of
European gas imports. The rest of the market is divided up between international oil
and gas companies most of which have interests in both Norwegian production and in
LNG export terminals which supply Europe.
53
Here by Europe we mean EU25 plus candidate countries; Romania, Bulgaria and Turkey.
- 102-
Table 19 European Gas Imports by Company 2003

Company
Gazprom
Sonatrach
Statoil
Total
Norsk Hydro
ExxonMobil
NNPC (Nigeria)
Shell
NIOC (Iran)
Eni
ConocoPhillips
Qatar Petroleum
NOC (Libya)
Others
Total
HHI
BCM
135.2
56.1
39.9
8.1
7.5
5.6
4.9
4.8
3.5
2.9
2.9
1.2
0.7
2.4
275.7
Share
49.0%
20.3%
14.5%
2.9%
2.7%
2.0%
1.8%
1.7%
1.3%
1.1%
1.1%
0.4%
0.3%
0.8%
100%
3,057
The map in Figure 5 shows EMLs assessment of flows from the major exporting
countries to 25 gas consuming countries in Europe. Also shown is the route taken by
the gas as it travels through transit countries before reaching its final destination. The
map is colour coded so that for example Russian supplies are shown in dark blue.
We expect that Russian and Algerian imports will increase in the next ten years in
absolute terms but fall in percentage terms as Europe seeks a more diversified import
portfolio. The extent to which Russian dominance may be reduced is subject to some
considerable uncertainty as is discussed in section 6 and 7 which discuss three
possible scenarios for 2015.
New pipeline supplies are expected from Libya, Iran and the Former Soviet Union
countries in the Caspian Sea area (Turkmenistan, Azerbaijan, Kazakhstan and
Uzbekistan). Supplies from these areas could be up to 12% of total imports. LNG is
also expected to expand to represent 14% to 17% of imports by 2013.
Europe will remain highly dependent on gas flowing from Russia through the Ukraine
to Slovakia although alternative routes through Belarus and Poland (Yamal) and direct
to Turkey under the Black Sea (Bluestream) are now flowing gas with volumes
expected to increase over the next few years. A third route to Germany under the
Baltic Sea (North European Gas Pipeline) is also planned although the timing of this
project remains subject to uncertainty.
- 103-
Figure 5 EML Assessment of Gas Flows in Europe
2003 EUROPEAN GAS FLOWS

FIN
16.5
SWE
NOR
Natural Gas Main Exporters
Algeria
Netherlands
Norway
Russia
United Kingdom
Other
LNG
1.0
6.5
4.1
IRE
5.0
DEN
UK
2.2
36.4
0.3
0.5
0.3
10.1
3.4
LNG
Source: Based on IEA data and EML analysis

Units: Standard BCM
Copyright Energy Markets Limited
27.6
14.0
9.3
Tel: +44 (0) 20 8232 1570
4.3
BEL
25.5
POL
0.4
8.5
RUS
GER
30.5
2.5
0.6
LUX
7.8
4.0 4.4
1.2
2.0
0.6
3.1
18.3
NET
76.5
37.5
1.6
SLK
CZE
0.7
6.7
LNG
0.4
5.4
0.5
SWI
LNG
POR
7.0
FRA
14.7
2.5
2.3
8.2
0.7
8.7
7.0
22.9
LNG
ITA
22.0
9.3
MOR
ALG
23.1
TUN
LIB
0.4
1.3
1.9
BUL
CRO
GRE
0.6
3.1
LNG
22.1
16.3
1.1
1.8
CAS
ROM
SLN
AUS
12.5
9.3
HUN
2.1
7.5
0.5
SPA
32.2
1.5
LNG
11.3
TUR
3.5
IRN
4.6
LNG
We expect to see at least four pipelines in place from North Africa to southern
Europe. A fifth pipeline, from Algeria to Italy, is also possible. Algerian gas is
expected to reach France through an extension of the Medgaz pipeline through Spain.
Iran is already supplying gas to Turkey and has a contract to supply Greece in the
future. Turkey is also likely to become a major transit country for gas from the
Caspian area using a new pipeline from Azerbaijan via Georgia. This route is a very
important factor in increasing the diversity of supplies to Europe since it avoids transit
of Russian territory.
LNG will play an increasingly important role in the supply mix with new or expanded
import facilities in Spain, UK, Italy and France. Europe will have its first LNG export
facility in Norway supplying gas to the USA as well as to Spain.
The remainder of this section on the Pipeline Supply Area will review current
conditions geographically.
4.4.2. Russia
Production
Russia has by far the largest gas reserves in the world at 47 trillion cubic metres. In
context it has sufficient gas to supply the UK, the biggest gas consumer in the EU, for
470 years. It is also the largest gas producer with 616 bcm produced in 2003. Almost
70% of production is used in the internal market and the remaining 30% is exported.
- 104-
Exports to OECD Europe were 128 bcm in 2003 around 24% of European
consumption.
Gazprom
For many years, Russian gas production has been concentrated on three super-giant
gas fields in Western Siberia: Urengoi, Yamburg and Medvezhye. These fields
together accounted for 80% of Gazproms production in 1999. However they are in
decline now and represented only 62% of Gazproms production by 2003. A fourth
super-giant, Zapolyarnoye, came into production in 2001 and is expected to build up
to production of 100 billion cubic metres by 2008. This new giant field will
compensate for declining production from other fields over the next two to three years
but thereafter the forecast for Gazprom gas production from existing fields is in steep
decline as illustrated by Figure 6.
Figure 6 Forecast Production for Gazprom from existing fields
Gazprom will need to develop other deposits mainly in western Siberia over the next
ten years to maintain production and export levels. Gazprom plans to give priority to
the development of smaller gas fields which utilise capacity in existing pipelines as it
becomes available due to declining output from the giants. Gas has already started to
flow from the Pestsovy field in the Urengoi area. Production is expected to build up to
27.5 bcm by 2006. Other prospects include the Kammennomysskoye fields which lie
just 150 km from the Yamburg field with the potential to produce over 50 bcm per
year.
- 105-
Table 20 outlines the current Russian (Gazprom) contracts with Europe.

Table 20 Russian Gas Contracts with Europe
IMPORTER
IMPORTER
COUNTRY
BCM/yr
From
To
OMV
Austria
6.5
1984
2024/5
Bulgargas
Bulgaria
8.0*
1998
2010
Czech Republic
9.0
1998/9
2015/6
Gasum
Finland
8.1
2014/5
GdF
France
8.0
2015/6
GdF
France
2.5
2012/3
GdF
France
1.5
2012/3
Ruhrgas
Germany
13.0
2015/6
Wingas
Germany
13.5**
1998
2030
VNG
Germany
12.0
2017/8
Depa
Greece
2.24
2013/4
MOL
Hungary
11.0
1996/7
2015/6
GdF
Hungary
0.4
1996/7
2015/6
Snam
Italy
7.4
1996/7
2013/4
Snam
Italy
8.0
1998/9
2018/9
Snam
Italy
5.5
2018/9
Italy
5.6
2008/9
2018/9
Edison
Italy
2.0
Enel
Italy
3.0
2005/6
Gasunie
Netherlands
4.0
2001/2
2015/6
PGNiG
Poland
12.5
1996
2021
SNGN Romgaz
Romania
14.0
1996
2010/11
SPP
Slovakia
9.0
1997/8
2008/9
Switzerland
0.4
Botas
Turkey
6.0
2001/2
2026/7
Botas
Turkey
8.0
2001/2
2026/7
Botas
Turkey
16.0
2002/3
2027/8
Geoplin
Slovenia
0.7
1992/3
- 106-
The Yamal peninsula is an important development area and could start producing
from around 2008 in volumes rising to 190 bcm per year by 2020 and a maximum
production of 250 bcm per year by 2030.
The Barents Sea is another potentially important production area. The Stockmanov
field contains around 3,200 bcm of gas. It was discovered in 1988 but development
plans have been delayed. Possible development of the field has been linked to the
proposed North European Gas Pipeline (NEGP) and to an LNG scheme which has
been discussed by Gazprom and Conoco with USA as the target market. However,
Gazprom has designated the South-Russkoye field in the Yamalo-Nenetsk region as
the source of gas supplies for NEGP.
Development of Shtokmanov is expected to cost some $20 billion and presents an
enormous technical challenge because of its Arctic location, and it may be some years
yet before a decision to proceed with development of this field is taken.
Independent Production
By contrast production by independent producers has doubled between 1994 and 2004
see Figure 7.
Figure 7 Production by Russian Independent Producers 1999 to 2004
100
90
80
bcm/year
70
60
50
40
30
20
10
0
1999
2000
2001
2002
2003
2004
The independent producers fall into two groups. The first group consists of oil
companies for which gas is not a major part of their activity. The group includes
Lukoil, Yukos, TNK-BP and Rosneft. The second group consists of companies which
specialise in gas production and are known as Independent Gas Producers (IGPs). The
IGPs include Novatek (which is the second largest gas producer after Gazprom),
Northgas and the production units of Itera.
- 107-
According to the Union of Independent Gas Producers (Soyuzgas)54 the oil companies
control 6.5 trillion cubic metres of explored gas reserves (proven and probable) whilst
IGPs control 4.5 trillion cubic metres.
Lukoil produced 4.7 bcm of gas in Russia in 200355 and plans to expand
production to around 33 bcm by 2013 and more than 80 bcm by 2020.
Yukos produced 5.7 bcm of gas in 2003 and expects to increase production to 15
bcm in 2005 and 50 bcm by 2015.
TNK-BP produces some 4.5 bcm of associated gas annually56. The company has
mid- and long-term options for the development of its gas business, which will be
implemented subject to the development of a market for independent gas
producers. Mid-term prospects of TNK-BPs gas business are based on the assets
of Rospan. TNK-BP manages Rospan, which controls 850 billion cubic metres of
gas (and also 1 billion cubic metres of liquid hydrocarbons) in Yamal (West
Siberia). The location of these resources near pipelines allows for gas to be
supplied to the domestic market. The company plans to bring gas output to 17
billion cubic metres a year by 2007, on the basis of Rospans gas and some other
associated gas resources held by TNK-BP.In the long term, the companys gas
output plans are connected with the development of the Kovykta field in East
Siberia. Potential gas output in this field could reach 40 billion cubic metres a
year. Extracted gas will be supplied to the domestic market and to Far Eastern
markets (in particular, China and South Korea). TNK-BP holds 63% in Russia
Petroleum which holds the exploration licenses for the Kovykta field
development.
Rosneft57 increased gas production from 4.8 bcm in 1998 to 9.2 bcm in 2004 and
plans to produce no less than 50 bcm in 2015. Expansion since 2000 has been
largely organic based on an aggressive drilling programme following completion
of its programme to modernise the fields and equipment it inherited from the
Soviet Union. Most of the drilling is performed in the Yamalo-Nenets
Autonomous Region. The company continues to progressively increase gas
production particularly in the Krasnodar area as a result of increasing the number
of gas wells at the Anastasievsko-Troitskoe field. A gas-and-condensate field
Astrakhanovskoe-Susha on Sakhalin is also planned to come into production. In
2001 Rosneft signed an agreement with Gazprom regarding joint development of
five fields in the Yamalo-Nenets Autonomous Region and on the Barents Sea
shelf, including the gigantic Shtokmanovskoe gas field, unique Kharampurskoe
oil-and-gas field and major Prirazlomnoe oil field. In 2002, Rosneft was licensed
to explore the Kaygansko-Vasyukansky sector of the Sakhalin shelf (Sakhalin-5
project), and authorized on behalf of the Russian Federation, jointly with
Kazakhstan, to develop the major Kurmangazy structure on the Caspian Sea shelf.
54
The Union of Independent Gas Producers, Presentation to IEA, Paris 25 November 2003.
www.lukoil.com
56
www.tnk-bp.com
57
www.rosneft.ru
55
- 108-
Rosneft purchased enterprises of the Yamalo-Nenets Autonomous Region with

licenses for the Kynsko-Chaselsky and Udmurtsko-Chatylkinsky blocks of fields.
ITERA has been involved in production of natural gas in the Yamalo-Nenets

Autonomous Region (YaNAO) in Western Siberia since 199858. The Company
has invested over $1.5 billion in the gas industry. ITERA is the first private
company to put gas fields into operation in the Far North of Russia: Gubkinskoye
gas field (reserves of 399 BCM) in 1999, gas deposit (reserves are 407 BCM) of
Vostochno-Tarkosalinskoye field in 2001), and Beregovoye (reserves are 325
BCM) in 2003.A total of about 90 BCM of natural gas has been produced by
ITERA in its fields in Yamalo-Nentskiy autonomous region. Over 30 BCM of
natural gas is expected to be produced with ITERA's participation in 2003.ITERA
plans to raise annual production of natural gas to 50 BCM.
Novatek is the largest IGP in Russia with production of 21 bcm in 200359. The
company aims to reach a level of production equal to 50-60 bcm per year by
2008.The company specialises in development of condensate fields. The company
claims that all its projects are paid back within 5 years on average and generate
strong cash flow which is used to repay loans and further invest in exploration,
production and social programmes. However, the company does note the risks
which arise due to the Gazprom monopoly of the gas transport system.
Northgas60 produced 3.4 bcm of gas in 2002 and expects to increase production to
12 bcm by 2015.
The success of independents in growing their production volumes has led proponents
of energy market reform inside Russia to proclaim that the market restructuring
concept suggested by the ministry of Economic Development and trade in 2002 (The
Gref Concept), which intended to establish the most favourable regime for
independents and ensure the restructuring of Gazprom was right61. However,
Gazprom has been trying to restore its own production levels by acquiring
independent gas producers (Purgaz and Vostokgazprom in 2002 and
Severneftgazprom in 2003). Northgas was also targeted in late 2004. More recently
merger with Rosneft is being considered.
Foreign interest in Russian gas producers increased in autumn 2004 when Total
offered to purchase 25% of Novatek62. The bid price was reported to be $1 billion
which would value the company at $4 billion, although this has not been confirmed by
Total. Completion of the deal has been held up by the Federal Anti-Monopoly Service
which has called on Novatek to complete a proposed re-structuring before it will
consider approving the deal. The restructuring should be finished in the first half of
58
www.iteragroup.com
Mikhelson L.V Novatek, Dynamics of a New Player in the Russian gas market, Energy Security
conference 25 November 2003 Paris
60
www.northgas.ru
61
Vladimir Milov, President, Institute of Energy Policy , Flame 2005 conference, Amsterdam,
February 22, 2005
62
Total press release 22 September 2004.
59
- 109-
2005 or possibly sooner according to Novatek. Novatek is controlled by a group of

private investors led by Leonid Mickhelson who is also Chairman of the management
board.
The Total deal was quickly followed by Conoco Phillips purchase of a 7.6% interest
in Lukoil for $2 billion63. By the end of 2004, ConocoPhillips had increased its stake
to 10%, which brings a seat on the board. The shareholder agreement allows Conoco
to bump up its stake to 20%, but its original target of a so-called blocking stake of
25% seems to have been ruled out as being politically unacceptable in Russia at this
time. The deal also prohibits Conoco from selling shares in Lukoil for four years.
The initial purchase came in an open auction by a Conoco affiliate, Spring Time
Holding, registered in the British Virgin Islands, of the Russian states remaining
7.59% in Lukoil for $1.988 billion, which was $60 million above the starting price.
Conoco and Lukoil have also formed a new strategic alliance that envisages the joint
development of oil and gas reserves in Russia and possibly Iraq. The alliance will
initially focus on projects in Russia, notably in the far northern Timan-Pechora oil
province.
Neither the Total or Conoco investments is on the same scale as BPs interest in TNKBP which was established in September 2003 as a result of the merger of two Russian
companies, TNK (Tyumen Oil Co.) and Sidanco with the majority of BPs Russian oil
assets. The company is 50% owned by BP and 50% by a group of prominent Russian
investors: Alfa Group, Access Industries and Renova (AAR). The shareholders of
TNK-BP also control 50% of Slavneft. This interest will eventually be integrated into
TNK-BP.
Around the same time, as the Total and Conoco investments, Korea National Oil
Corp. agreed to work with Rosneft on developing the Pacific Shelf off Sakhalin
Island, and Samsung and LG Group signed refinery construction and upgrading deals.
Overall Russian Production
The Soyugaz view of future Russian production is shown in Figure 8. Not surprisingly
the outlook shows most growth potential as coming from its members, the IGPs,
which are shown to increase production from 50 bcm in 2005 to 100 bcm in 2015 and
123 bcm in 2010. Gazprom is shown to maintain a flat production of 530 bcm from
2005 onwards while the oil companies are shown to show no further growth beyond
2010. In view of the amount of investment required for Gazprom simply to maintain
its production levels, it is conceivable that Gazprom production could be somewhat
lower, if the investments were not made. Against that, we see no reason why
production by the oil companies should not increase beyond 2010 particularly if there
is increased western involvement. It should be noted that the chart is based on the
current status of companies in Russia further take overs by Gazprom would shift
production from the oil companies and/or IGP sectors to Gazprom.
63
Petroleum Intelligence Weekly, October 4, 2004
- 110-
Figure 8 Soyuzgas view of Russian production
800
700
600
500
400
300
200
100
0
1998
2005
2010
2015
2020
Gazprom
Regional Companies
oil Companies
Independent Producers
Transit of Russian Gas

Ukraine
Until recently almost all Russian gas supplies for OECD Europe were routed through
Ukraine to Slovakia. Problems with Ukraine led Gazprom to diversify its export
routes including the Yamal-Europe pipeline via Belarus and Poland and the Blue
Stream pipeline which crosses under the Black Sea to Turkey, thus avoiding transit in
any FSU country.
The problems with Ukraine transit date back to the break up of the Soviet Union in
1991. The Soviet gas system had been developed without regard to national
boundaries or the need for clear contractual arrangements between states. In several
cases volumes designated as being for transit to the west did not reach their
destination with Gazprom accusing Ukraine of illegally siphoning off the gas. The
Ukraine accumulated a large debt in the 1990s. The amount of debt was the source of
heated dispute until the two sides agreed on a figure of $1.4 billion arrears for
previous gas supplies.
In June 2002 a consortium was formed to manage the Ukrainian Gas Transit System
(GTS). The GTS is over 25 years old and has a theoretical transit capacity of 170 bcm
per year of which 135 bcm is for transit to Europe via Slovakia. Actual flow in 2003
was considerably lower than this approximately 72 bcm. Despite interest from
foreign partners including E.ON Ruhrgas the consortium has so far been limited to
Gazprom and Naftogaz of Ukraine. The two sides have agreed in principle to build a
new transit pipeline parallel to the existing one with a capacity of 29 bcm per year.
Under the agreement the pipeline will be paid for with debt which will be repaid with
gas transit fees.
- 111-
Slovakia and Czech Republic

The main transit systems in Slovakia and the Czech Republic have now been
privatised. SPP of Slovakia is owned by a consortium comprising Gazprom, Gaz de
France and E.ON whilst Transgas of the Czech Repulic is wholly owned by RWE.
Both countries are new members of the EU and will be required to comply with EU
Directives and Regulations. SPP recently announced the introduction of an entry exit
system.
Yamal
The problems with Ukraine encouraged Gazprom to construct the Yamal to Europe
pipeline through Belarus and Poland to deliver gas to the German border at Frankfurt
Oder. Construction of this pipeline is almost complete and once all the compressors
are installed in 2005 the capacity of the Polish section will be 38 bcm per year.
Ironically, a dispute between Russia and Belarus caused supplies in this pipeline to be
cut off for one day in January 2004. Despite the brevity of this incident it serves to
highlight the potential problems with transit countries and may encourage Gazprom to
give priority to a direct link with Germany under the Baltic ahead of plans to duplicate
the Yamal pipeline.
The section of the Yamal pipeline through Poland is owned by EuroPolGaz a joint
venture of the Polish Oil and Gas Company (48%) and Gazprom (48%) and gasTrading SA.
In Poland POGC created a legally separate transmission company in compliance with
the second Gas Directive and introduced a Network Code. Under the Governments
privatisation proposals shares are to be floated in POGC with the state retaining at
least 51%. However, ownership of POGC Transmission will be transferred to the
Treasury before the share sale so that the state will retain full control of the pipeline
system.
Baltic
The Baltic pipeline project, known officially as the North European Gas Pipeline, is
planned to include a sub-sea section of 1,189 km under the Baltic from the Russian
town of Vyborg to the German coast. The pipeline could then be extended onshore to
Netherlands and the UK. This is an ambitious project estimated to cost US$5.7
billion. The capacity will be between 19 and 30 bcm per year. The project has official
support of the EU through the Transmission Networks Europe programme which
provides funding for feasibility studies. No formal partnership has been established
but a number of companies have shown interest in the project including Fortum
Corporation, Gasunie, Royal Dutch Shell, BP, Eon Ruhrgas, TotalFinaElf and
Wintershall. Gazprom says it plans to start operation of this pipeline by 2010.
- 112-
Russian Energy Reform Initiatives

In 2003 Russia commenced the restructuring of its electricity sector. Competition is to
be introduced into electricity production and supply, leaving dispatch, transmission
and distribution as regulated natural monopolies with non-discriminatory third-party
access to the networks. The governments stated overall goal is to combine effective
competition and effective regulation. However the plans do not include a proposal for
a powerful independent regulator and regulation remains firmly under the control of
the Government including the ability to set retail prices even after the wholesale
market has been liberalised. The risk is that the Government may use its regulatory
powers to hold down electricity prices for political reasons and that in turn could deter
investment.
Reform of the gas sector is some way behind reform of the electricity sector. The
Ministry of Economic Development and Trade has prepared several sets of proposals
on gas sector reform, including the restructuring of Gazprom itself. There has been
almost no progress, however, largely thanks to resistance from Gazprom, which
argues that its organisational integrity is critical to the smooth functioning of the
nations gas-supply system. Until early 2004 it rejected even proposals for
reorganising its subsidiaries or producing separate accounts by line of business, as it
saw any such internal restructuring as the first step towards its eventual
dismemberment. On more than one occasion Gazprom has actively and publicly
lobbied to prevent the cabinet from considering even the ministrys more moderate
proposals, which concern the internal reorganisation of Gazproms businesses in the
interests of transparency, rather than its break-up.
The major areas where reform is needed include:
Domestic gas prices. Most gas continues to be sold at regulated prices that
are below full cost recovery levels. However, regulated tariffs for all but
household consumers have been rapidly approaching cost-recovery levels.
Gazprom operates monopoly control over both the production and wholesale
sectors.
Despite its status as a joint stock company, Gazprom operates in many

respects as an organ of the state. It combines both commercial and
regulatory functions and exerts tight control over infrastructure development
and over information flows.
Gazprom and the government both accept that successful development of

the industry and the maintenance of gas exports will rely increasingly on
non-Gazprom production in the decades ahead. Yet, Gazproms dominance
is a barrier to the development of the independent sector because it restricts
access to the market for its smaller competitors and restricts the ability of
consumers to choose their supplier.
Independent Gas producers have no access at all to export markets
- 113-
While there is a regulatory authority (the Federal Energy Regulatory

Commission) they can only make recommendations and regulatory control
is effectively exercised by Gazprom and the state.
The effect of very low regulated prices has been that gas in Russia is effectively
rationed rather than there being a market. Gazprom, rather than the state, controls the
rationing process. The company and the government negotiate a gas balance for the
country towards the end of each year, for the year ahead. Since Gazprom holds all the
information on gas production, pipeline capacity and export commitments, it can
control the negotiation of the gas balance. Given the disparity between domestic and
export prices it has a powerful incentive to favour exports over domestic sales at
regulated prices.
Once an aggregate figure has been agreed for the volume of gas to be supplied on
regulated prices, industrial consumers bid for the gas they need. Gazprom then
informs consumers of their quotas for the coming year, which may be lower than their
bids. Any additional gas they need must be purchased at higher prices, either from
non-Gazprom producers or from Gazprom itself, which re-sells a good deal of other
producers gas and also sells some of its own output at higher prices to those who
exceed their quotas. In practice there is never a shortage of gas available for sale to
consumers who exceed their quota and are willing to pay the higher price casting
some doubt on the accuracy of the initial gas balance.
The administration of this rationing system is wholly opaque and there are no defined
rules for setting quotas for consumers. As a result, some consumers get what they bid
for, while others are allocated far less than their bids. Even the overall results of the
distribution are unknown; the government does not appear to have full data on the
actual allocation of regulated-price gas to customers. Some consumers report that
their quotas have simply been frozen, so that reliance on other sources grows in line
with their gas demand. This appears to be the case with respect to the power sector.
Consumers need administrative permission to bid for gas at regulated tariffs for any
new facility, and this is unlikely to be given if Gazprom objects.
In practice, quotas may be adjusted each quarter so that consumers have no certainty
about the quantity that will be supplied at regulated tariffs more than three months
ahead. Quotas for delivery of regulated-price gas can and do change at very short
notice. There are no long-term gas supply contracts. This absence of long-term
contracts is particularly a problem for anyone contemplating investment in any gasintensive activity.
Finally, regulated-price gas quotas are apparently administered on the basis of even
rates of consumption, without regard for the consumers actual usage patterns. Thus, a
consumer enterprise may forfeit unused allocations during periods of low
consumption (including weekends and holidays) while paying penalties for overconsumption during the week.
The principle of Third Party Access to pipelines is established in law but is not
working in practice. Gazprom can refuse access on the grounds of insufficient
capacity in the system or on technical grounds such as gas quality. However,
- 114-
information on pipeline capacity and usage is kept secret by Gazprom and nonGazprom producers complain that uncertainty over available capacity is a major
obstacle to concluding contracts with consumers forcing them to sell to Gazprom
instead. Refusal of access can be challenged ex post but this is a lengthy legal process
with uncertain outcome and producers remain mindful that they cannot operate
without cooperation by Gazprom.
As Gazprom wants to limit sales to the domestic market (to maximise more lucrative
exports) it would appear not to have an incentive to use its position to put other
producers at a disadvantage and it denies that it does so. Nevertheless other producers
frequently complain of abuses. For example, Gazprom may declare there is no
capacity on a given route, when the producer believes such capacity is available,
forcing the use of a longer, costlier route.
4.4.3. North Africa
Algeria
Total Algerian exports to Europe amounted to 55 bcm in 2003 including 30 bcm by
pipeline and 25 bcm by LNG.
As well as exports, natural gas accounts for 67% of Algerias domestic energy needs
and 95% of electricity in Algeria is generated using gas. Around 70 bcm per year of
gas is re-injected into the reservoirs to improve production of oil and condensate. A
further 5 bcm per year is consumed as fuel at gas liquefaction plants.
Natural gas reserves amounted to 4,523 bcm at end 2002 equivalent to 56% of total
Algerian hydrocarbon reserves.
About a quarter of dry gas production is from the Hassi RMel field. The remaining
reserves are located in the south-east and in the In-Saleh region in southern Algeria.
Exports are delivered to Europe both by pipeline to Italy and Spain and by LNG from
the countrys two liquefaction plants at Arzew and Skikda. An explosion at Skikda
early last year destroyed two of the liquefaction trains but Sonatrach managed to
honour all of its contractual commitments using spare capacity in the pipelines and at
the Arzew LNG plant. The government has announced it will replace the damaged
plant with a new liquefaction plant estimated to cost $800 - $1,000 million.
Since a price dispute in the 1980s resulted in disruption of supplies to both Europe
and USA, Algerian gas supply has been completely reliable. There have been no
problems with transit of gas through Morocco (to Spain)64 or Tunisia (to Italy).
Nevertheless, recent plans for export pipelines avoid these transit countries by opting
for direct sub-sea routes.
64
A brief interruption recently was caused by mechanical failure of compressors.
- 115-
The Medgaz pipeline which is already under construction with a capacity of 8 bcm
per year is expected to start flowing gas in 2006. This pipeline will have an onshore
section from the Hassi RMel field to the port of Arzew and then continue on the
Mediterranean seabed to Almeria in Spain. The pipeline could be upgraded to 16 bcm
per year at a later stage with an extension through Spain to France. There are also
plans for the Galsi pipeline from Algeria to Italy via Sardinia with a capacity of 8 to
10 bcm per year.
These two projects together with planned investment to increase capacity of the two
existing pipelines could result in total capacity of 60 bcm per year by the end of the
decade compared to 24 bcm per year current capacity.
Although foreign companies are allowed to participate in exploration and production
they may only do so in partnership with the state company Sonatrach.
The In-Saleh project is the first such joint venture between Sonatrach and foreign
companies. The consortium currently comprises Sonatrach (35%), BP (33%) and
Statoil (32%). The project should produce 9 bcm per year of gas which has been sold
under long term contracts to Spain and Italy. The gas will be linked by a new 48 inch
pipeline to the coast from where it will be exported by pipeline and LNG.
A joint venture of RYPF (60%) and Gas Natural (40%) has won the Gassi Touil
integrated gas project in Algeria. The expected capital cost of the project is $2.1
billion. Operation is expected to start in 2008/9. The project was originally due to
come on stream in December 2003 but development has been delayed due to technical
problems.
The project includes an upstream production sharing agreement. Sonatrach will own
all pipelines used. Gas Natural - RYPF has an 80% stake in the LNG export terminal
(5.2 bcm/yr) associated with the project. A joint venture marketing company has been
set up between the project partners and Sonatrach. Upstream oil and gas reform is
being undertaken in Algeria through a proposed hydrocarbon law, the so called
Khelil bill which is being re-activated after the government was re-elected. The
government had shelved the law during elections due to opposition to reforms. If all
goes well it could be adopted by November 2005. The law aims to create an energy
regulator and a separate agency for the awarding of exploration contracts.
Algerias gas contracts with Europe are shown in Table 21.
- 116-
Table 21 Algerian Gas Contracts

PIPELINE /
LNG
IMPORTER
IMPORTER
COUNTRY
BCM/yr
From
To
LNG
Distrigas
Belgium
4.6
1982
2013
LNG
GdF
France
5.3
1976
2013
LNG
GdF
France
3.6
1972
2013
LNG
GdF
France
1.1
1992
2013
LNG
Depa
Greece
0.7
1998
2021
LNG
Snam
Italy
1.1
1997
2014
LNG
Enel
Italy
0.9
1999
2022
LNG
Enagas
Spain
3.9
1978
2013
LNG
Iberdrola
Spain
1.0
2002
2018
LNG
Enagas
Spain
5.0
2004
2021
LNG
Botas
Turkey
4.0
1998
2014
Pipeline
Ina
Croatia
2.2
2003/4
2023/4*
Pipeline
Snam
Italy
21.0
1983
2016
Pipeline
Enel
Italy
6.0**
1992
2012
Pipeline
Mogest
Italy
0.5
2007/8
2018/9
Pipeline
Edison
Italy
4.0
2007/8
2026/7
Pipeline
Transgas
Portugal
2.5
1994
2019
Pipeline
Sozd Petrol
Slovenia
1.0
1992
2007/8
Pipeline
Enagas
Spain
6.0
1997/8
2017/8
Pipeline
Iberdrola
Spain
1.5***
2002/3
2017/8
Pipeline
Iberdrola
Spain
1.0
2007/8
2027/8
Pipeline
Cepsa
Spain
1.0
2007/8
2027/8
Pipeline
Total
Spain
1.0
2007/8
2027/8
Pipeline
Distrigas
Belgium
1.0
2007/8
2027/8
Pipeline
Gas Natural
Spain
3.0
2007/8
2027/8
*Assumed 20 year long-term contract

**Contract originally for supply for 4 bcm/yr
*** Build up to plateau level by 2007/8
The allocation of exploration licenses will also be changed to encourage foreign

investment. The recent Gassi Touili project highlights an opening up of the market.
Sonatrachs share in production sharing agreements will fall from 50% to 20-30%.
- 117-
Prior to the recent elections the focus had been on reducing Sonatrach involvement in
production sharing agreements to zero. The aim is to convert Sonatrach eventually
into a purely commercial company.
Libya
Libyan gas has started flow to Europe in the Green Stream pipeline which delivers gas
under the Mediterranean to Italy. The pipeline has been completed and started to flow
gas but there have been problems due to contamination. The pipeline will have a total
capacity of 11 bcm per year for which a gas contract already exists for 8 bcm.
Libyas gas contracts with Europe are shown in Table 22
Table 22 Libyan Gas Contracts
IMPORTER
IMPORTER
COUNTRY
BCM/yr
From
To
Enagas
Spain
2.0
2001
2008
Edison
Italy
4.0
2003
2023*
GdF
Italy
2.0
2003
2023*
Energia SpA
Italy
2.0
2003
2023*
4.4.4. Norway
Although Norway does not have a significant domestic gas market, it is a major
supplier of gas to other European countries. There are offshore pipelines from the
Norwegian gas producing areas to Germany, Belgium, France and the UK with
combined capacity of 92 bcm per year. As well as supplying those countries,
Norwegian gas also goes to the Netherlands, Austria, Spain, Czech Republic, Italy
and Poland through onshore pipelines.
Petroleum operations in the Norwegian sector of the North Sea date back over 40
years. Most of the largest fields are considered to have been discovered and many are
already in the decline phase or are expected to be so during the course of this decade.
Prospects for maintaining production at the current level hinge on smaller discoveries,
especially near to existing gas fields and pipelines, and on improving recovery rates
from existing fields. A new aspect of this area is the emergence of new companies
who specialise in maximising production from fields in the later phases of production.
Further north, the Norwegian Sea is a much less mature exploration and production
area. Production has grown steadily since 1996 to the point where the 20 bcm Asgard
pipeline, which transports most of the gas from the area is now fully utilised. The
most significant new development planned for this area is the Ormen Lange field
which is planned to be developed after 2007 with the gas sold to UK using a new
pipeline, the Langeled pipeline to Teeside. A number of smaller discoveries have been
- 118-
made which can be developed as satellites to existing infrastructure. Individually

these discoveries would have only marginal profitability if they had to be developed
on a stand alone basis. If further large discoveries are made they may form the basis
for new pipeline capacity in the future.
The third and least developed province of the Norwegian Continental Shelf is the
Barents Sea. Gas transport from this area by pipeline is not profitable because of the
long distances involved. Instead the Snhvit field is being developed as part of an
LNG scheme with output sold to USA and Spain. The area has not yet been fully
explored and further reserves are expected to be found.
Market Structure
The initial phases of exploration and the develoment of the first oil and gas fields was
led by foreign oil companies before the creation of Statoil in 1972. Statoil was created
as a state-owned oil company, and the principle of 50 per cent state participation in
each production licence was established. This was later relaxed so that the level of
state participation could be higher or lower than 50 per cent, depending on
circumstances.
State participation in petroleum operations was reorganised on 1 January 1985.
Statoils interest in many licences was split into two components, one linked to the
companys commercial participation and the other becoming part of the States Direct
Financial Interest (SDFI) in petroleum operations. Under the SDFI arrangement the
state pays a share of capital and operating costs and receives a share of the revenues in
proportion to its equity interest as any other partner in the licence.
An SDFI interest is incorporated in most licences awared after 1985. As a result, the
State now has a direct interest in most oil and gas fields and transport systems on the
NCS. In connection with Statoils partial privatisation, the government sold SDFI
assets corresponding to 15 per cent of the portfolios value to the company. A further
6.5 per cent was sold to other companies in the spring of 2002.
Statoil was partially privatised in 2001 with the Norwegian State retaining 70.9% of
the shares and the remainder floated on the Oslo and New York stock exchanges. The
floated shares are widely distributed with only one investor having more than 2 per
cent of Statoil shares.65 The Storting has approved further sales of shares to reduce
the state holding to two thirds.
In 2004 the Norwegian state controlled 58.9 per cent of gas production including 32.7
per cent direct intertests operated by Petero and 26.2 per cent through Statoil in which
it retains a controlling interest despite the partial privatisation of the company. Norsk
Hydro has the next largest share with 11.2 per cent followed by a group of foreign oil
and gas companies with shares ranging from 2.8 per cent to 9.5 per cent.
65
Statoil Website shows that as of 4th March 2005, State Street bank and Trust Co of USA was the
second largest share owner after the Norwegian states with 2.12 per cent.
- 119-
We have computed the Herfindahl-Hirschman Index (HHI) for this market in two
ways. Firstly we treat the market shares of Petero and Statoil seperately with the HHI
being 2,069. Alternatively if the states interests in Petero and Statoil are considered
jointly the index is increased to 4,049. Economists generally consider a market with
an HHI of greater than 1,000 to be concentrated and greater than 1,80066 as highly
concentrated.
Figure 9 Structure of Norwegian Gas Production

Company
Norwegian State
Petero/SDFI
Norwegian State -Statoil
Norsk Hydro
Total
ExxonMobil
ConocoPhillips
Shell
ENI
Others
Total
HHI with Petero and
Statoil treated separately
HHI with State interest in
Petero and Statoil
combined
Share %
32.7
26.2
11.2
9.5
8
4.3
3.2
2.8
2.1
100
State (Petero)
State (Statoil)
Norsk Hydro
Total
ExxonMobil
ConocoPhillips
Shell
ENI
Others
2,069
4,049
Source: EML analysis based on the Norwegian Petroleum Directorate Facts 2005 publication
Gas Sales Arrangements

From 1986 to 2001, all gas sales by Norway were negotiated exclusively by the Gas
Negotiating Committee (GFU), which comprised Statoil (chair), Norsk Hydro and
Saga Petroleum (until Hydro aquired Saga).
Gas from Frigg was sold under a contract with British Gas signed in 1973. Four
different agreements for gas deliveries from the Ekofisk area were concluded in 1973
and 1975 with a buyer group comprising Ruhrgas, Gasunie, Distrigaz and Gaz de
France.
The gas in Statfjord, Heimdal and Gullfaks phase I was also sold to European buyers
in 1981. The sales agreement for gas from the Troll field was signed in 1986 with
Germanys Ruhrgas, Thyssengas and BEB as well as Distrigaz, Gasunie and Gaz de
66
See for example OFT Mergers substantive assessment guidance, May 2003. The US Department
of Justice uses the same threshold.
- 120-
France. Gas sales agreements have later been concluded with buyers in Austria, Spain,
Italy, the Czech Republic, Poland and Denmark.
The largest Norwegian buyer is the methanol plant at Tjeldbergodden.
In 2001, the first gas sales contract was signed with a country outside Europe, and part
of the output from Snhvit is due to be delivered to the USA.
Only a small proportion of Norwegian offshore gas is delivered under contracts
lasting less than year. Most is supplied on long-term agreements.
Following action by the European Commission67, Norwegian gas producers have now
committed themselves to market their gas individually in future. In addition two major
gas producers, Statoil and Norsk Hydro, committed themselves to sell in the coming
five years approximately 15 billion cubic metres of gas to customers who previously
did not have access to Norwegian gas.
In June and July 2001 the European Commission initiated formal proceedings against
approximately 30 Norwegian gas companies arguing that the GFU scheme was
incompatible with European competition law. Both the gas companies and the
Norwegian Government claimed, at a hearing in December 2001, that European
competition law should not be applied, since the GFU scheme had been discontinued
for sales to the EEA as of June 2001 following the issuance of a Royal decree by the
Norwegian Government. They also argued that European competition law could not
be applied, since the Norwegian gas producers had been compelled by the Norwegian
Government to sell gas through the GFU system established by the Norwegian
Government.
The final settlement68 included a distinction between three different groups of
producers (1) the permanent members of the GFU (Statoil and Norsk Hydro), (2) six
groups of companies actually selling Norwegian gas through contracts negotiated by
the GFU (ExxonMobil, Shell, TotalFinaElf, Conoco, Fortum and Agip) and (3) all
other Norwegian gas producers, for which formal proceedings had been opened.
As regards Statoil and Norsk Hydro, the settlement consists of two main elements,
namely (1) the discontinuation of all joint marketing and sales activities unless these
are compatible with European competition law (for existing supply relationships this
requires individual negotiations when contracts come up for review) and (2) the
reservation of certain gas volumes for new customers, who in the past have not bought
gas from Norwegian gas producers. In the latter respect Statoil has undertaken to
make available 13 BCM of gas to new customers on commercially competitive terms
and Norsk Hydro has undertaken the same for 2.2 BCM. This gas has to be offered for
sale during the commitment period running from June 2001 to September 2005.
67
Although Norway is no a member of the EU it is a member of the European Free Trade Area and
complies which EU legislation in many instances.
68
European Commission. IP/02/1084 17 July 2002
- 121-
Taking into account that the commitment period already started in 2001 and that
certain volumes have already been sold during the last year, the volumes which are
still available to new customers are lower than the total volume of 15.2 BCM.
External auditors will monitor whether Statoil and Norsk Hydro respect their
commitment to the Commission.
Although not being part of the GFU case, Statoil and Norsk Hydro also confirmed that
they would not introduce territorial sales restrictions and/or use restrictions in their
gas supply contracts. Both types of clauses are considered incompatible with
European competition law as they prevent the creation of a single market.
As regards the other Norwegian companies concerned by the GFU case, the
Commission received commitments from six groups of Norwegian gas companies,
which were sellers of Norwegian gas negotiated under the GFU scheme, namely
ExxonMobil, Shell, TotalFinaElf, Conoco, Fortum and Agip. For these companies the
settlement consists of written commitments to discontinue all joint marketing and
sales activities similar to those given by Statoil and Norsk Hydro. For the remaining
Norwegian gas producers the Commission decided to close the case under the
assumption that they will sell Norwegian gas individually in the future.
Norways gas contracts with the rest of Europe are shown in Table 23.
Gas Transportation
Since 1997, Norway has built up an extensive network of export pipelines with
landing points in UK, Belgium, France and Germany. The main export pipelines are
described below.
Norpipe was Norways first export pipeline system which was constructed between
1973 and 1997 following discovery of vast oil and gas reserves by Phillips Petroleum
in 1969. The Norpipe system comprises an oil pipeline from Ekofisk to Teeside, UK
and a gas pipeline from Ekofisk to Emden, Germany. The 36 inch gas pipeline runs
440 kilometers to the Emden shore facilities which include a conditioning plant that
prepares gas for onward transit to markets in Germany, Belgium, France and the
Netherlands.
The Phillips-led consortium of Ekofisk producers were originally allowed to export
gas independently via Norpipe, but the Norwegian government subsequently vested
this task first in Statoil and then in 1986 in the Gas Negotiating Committee (GFU).
- 122-
Table 23 Norwegian Gas Contracts

IMPORTER
IMPORTER
COUNTRY
BCM/yr
From
To
Iberdrola
Spain
1.6
2006
2026
GdF
France
1.6
2006
2026*
OMV
Austria
0.5
1993/4
2023/3
Distrigas
Belgium
4.0
1997/8
2017/8
Czech Republic
3.0
1996/7
2017/8
GdF
France
4.0
1996/7
2014/5
GdF
France
2.0
2001/2
2027/8
GdF
France
8.0
1993/4
2023/4
EdF
France
1.0
2005/6
E.On Ruhrgas
Germany
16.8
1996/7
2026/7
BEB
Germany
5.4
1995/6
2017/8
Thyssengas
Germany
2.5
1995/6
2017/8
VNG
Germany
2.5
1993/4
2018/9
Mobil
Germany
0.6
1996/7
2014/5
E.On Ruhrgas/MOL
Hungary
0.5
1995
2005/6
E.On Ruhrgas/MOL
Hungary
0.5
2005/6
E.On Ruhrgas/MOL
Hungary
0.95
1998
2012/3
Statoil/Synergen**
Ireland
0.6
2002/3
2017/18
Snam
Italy
1.4
2001
2012
Snam
Italy
6.0
2001
2025
Gasunie
Netherlands
3.0
1994/5
2023/4
SEP
Netherlands
2.0
1990/1
2010/11
Essent
Netherlands
1.4
2004/5
2009/10
PGNiG
Poland
0.5
2006/7
Enagas
Spain
2.0
1993/4
2028/9
Gottenberg
Sweden
0.15
Alliance
UK
0.6
2001/2
2016/7
National Power
UK
2.2
2001/2
2016/7
Centrica
UK
5.0
2005/6
2015/6
BP
UK
1.5
2001/2
2016/7
BP
UK
5.0
2005/6
2015/6
Centrica
UK
2.0
- 123-
The completion of the Statpipe gas gathering system effectively ended Norpipes
dependence on Ekofisk supplies and led to a restructuring and consolidation of
contracts. Statpipe is not an export line in its own right but links fields in the northern
North Sea to the continental European gas market via Norpipe. A 15.8-kilometre
bypass line laid in the summer of 1998 now carries Statpipe around Ekofisk to tie
directly into Norpipe. First gas through this bypass reached Emden on 23 August
1998.
The Zeepipe trunkline system has been developed in several phases to carry
Norwegian gas sold under the Troll gas sales agreements to continental Europe.
Starting contractual deliveries on 1 October 1993, Phase I includes a line from the
Sleipner area in the Norwegian North Sea to a receiving station in the Belgian port of
Zeebrugge. It also embraces a line from the Sleipner area to the Draupner S riser
platform, providing Zeepipe with links to the Statpipe and Europipe trunklines.
The line to Zeebrugge can carry about 13 billion cubic metres of gas per year.
Possible residual liquids and particles are removed from the gas stream at the
receiving station. After metering and pressure adjustment, the gas is delivered on
through the Belgian pipeline system.
Phase II of the development includes two lines. Zeepipe IIA runs from the Troll gas
treatment plant at Kollsnes near Bergen to the Sleipner area. Zeepipe IIB has been laid
from Kollsnes to Draupner E in the Europipe I system. Gas deliveries from Troll
through Zeepipe IIA began on 1 October 1996, with Zeepipe IIB following a year
later. Daily capacity for Phase IIA has been increased by 40 per cent in relation to the
original plan, to 55 million cubic metres, by increasing pressure in the line.
Europipe I comprises a 670-kilometre gas trunkline with diameters of 40 and 42
inches. It runs from the Draupner E riser platform in the Norwegian North Sea to a
receiving station at Dornum on the German coast. Statoil started regular deliveries to
Germany through this system on 1 October 1995.
The Dornum station reduces the gas pressure. A 48-kilometre land line links it with
the metering station in Emden, which carries out quality checks and volume metering
before the gas is delivered to customers in Germany, Austria, the Netherlands and the
Czech Republic.
Long and complicated negotiations were pursued by Statoil with the German
authorities over the Europipe I landfall through the protected Wattenmeer coastal
wetlands. Political and ecological interests had to be balanced against each other
before a decision was reached. A high-tech boring machine was designed to drive a
2,531-metre tunnel for the pipeline under the wetlands.
The 42-inch Europipe II gas trunkline runs for 660 kilometres from Krst north of
Stavanger to Dornum on the German coast. Deliveries through the line began on 1
October 1999. Most of the gas carried through this system comes from Statoil's
sgard, Sleipner East/West, Gullfaks and Statfjord fields. The bulk of deliveries
through Europipe II at Dornum go directly into the 341-kilometre Netra transport
- 124-
system, which runs to Salzwedel further east. This line is owned jointly by Ruhrgas,
BEB Erdgas und Erdl, Norsk Hydro and Statoil Deutschland.
The Franpipe (previously called NorFra) gas trunkline, runs for 840 kilometres
from the Norwegian North Sea to France. Comprising 70,000 lengths of 42-inch line
pipe, this facility is able to carry up to 40 million cubic metres of gas per day from
Draupner E to Port Ouest in Dunkerque. The line comes ashore in an industrial zone
which becomes the first direct point of delivery for Norwegian gas to French
customers. First gas arrived on 1 July 1998 at the Franpipe receiving station, which
was built in cooperation with Gaz de France.
The Frigg Transport System comprises two 32 inch pipelines from the Frigg field to
St Fergus in Scotland. The Frigg field straddles UK and Norwegian territorial waters
and there are separate pipes for transporting UK and Norwegian gas. The UK pipe
was commissioned in 1997 and the Norwegian counterpart in 1978. Although the
pipelines were originally set up by competing consortia, both pipelines are now
operated by the same company TotalFinaElf as a result of the merger of these
companies. The pipeline stopped supplying gas to the UK at the end of 2004.
The Vesterled project involves the installation of a new 32 inch pipeline from the
Heimdal Riser platform to the Frigg system. Ownership of the Frigg line will then
transfer to the Vesterled project partners ( Hydro 13.86%, Statoil/SDFI 72.28%, TFE
11.48%, Exxon Mobil 2.38%). Vesterled will be capable of delivering some 11
BCM/year.
Table 24 Norwegian Export Pipelines
Pipeline
Length
Dia.
Km
Inches
880/440
42
21.6
1977
Emden
Zeepipe I
814
40
13.0
1993
Zeebrugge
Europipe I
670
40/42
18.0
1995
Dornum
Europipe II
660
42
24.0
Franpipe (earlier NorFra)
840
42
22.0
1998
Dunkirk
Frigg/Vesterled
350
32
13.0
1978
St Fergus
Statpipe/Norpipe
Capacity
Start
Destination
BCM/yr
Dornam
Source: Statoil/Energy Intelligence Research
The Langeled pipeline has received approval from the Norwegian parliament in
March 2004. The pipeline will bring gas from the Ormen Lange field in Norway to
the Easington terminal in the UK. The Langeled system will transport gas from the
land facilities for Ormen Lange at Nyhamna in mid-Norway via a tie-in at the
Sleipner Riser platform in the North Sea to a new receiving terminal at Easington on
the UK east coast. This system will comprise a 42-inch thick-walled pipeline from
Nyhamna to Sleipner Riser (the northern leg) and a 44-inch line from Sleipner Riser
to Easington (southern leg). Capacity will be just over 80 mill scm/d in the northern
- 125-
leg and about 70 mill scm/d in the southern. The system will have an overall length of
roughly 1 200 km. While the southern leg is due to become operational in October
2006, the northern will follow in October 2007.
Table 25 Investment Interests in Langeled
Company
Langeled Overall
Northern Leg
Southern Leg
Petoro AS
13.95
37.48
28.36
Norsk Hydro
17.61
18.07
17.14
Shell
16.50
17.04
17.96
Statoil
14.99
9.84
20.21
Dong
10.22
10.34
10.10
ExxonMobil
6.95
7.23
6.66
ConocoPhillips
0.80
0.00
1.57
NB Dong acquired its share from BP. Interests in the overall Langeled project will be finalised before
the line becomes operational on the basis of updated cost estimates for the two legs
Source: Ministry of Petroleum and Energy. Facts 2004.
Norsk Hydro will be the operator for the development phase. When the development
phase is completed the new pipeline will be incoporated into the Gassled system and
Gassco AS will take over operation of the pipeline.
As part of the partial privatisation of Statoil, the Norwegian government created a
new company for the transport of natural gas on the Norwegian Continental Shelf
(NCS). Gassco was created in 2001 and took over operation of the leading pipelines
and most important terminal facilities in 2002. The pipelines and facilities have been
organised as a unified transport system called Gassled with Gassco as operator.
The state holds 38.293% of Gassled through Petero AS which is the operating
company for the States Direct Financial Interest (SDFI). This will increase to
47.928% in 2010. When the States interest through Norsea Gas AS are taken into
account, the State has an interest of 39.5% in Gassled during 2003-10 and 49% from
2011. Other interests in Gassled include Statoil (20.379%), Norsk Hydro (11.134%),
Total (9.038%) and seven other companies with shares of between less than 1% to
5%. Gassco is wholly state-owned. The governments intention in creating Gassco
was to :
Open access to the pipelines and treatment facilities to all producers and
contribute to efficient development of the NCS.
Act neutrally towards all users of the gas transport system
Play a key role in further development of the transport system.
Introduce TPA to Gassled on an Entry Exit basis.

4.4.5. Caspian Area
Gas from the Caspian area could be supplied to Europe via the Baku to Erzurum
(BTE) pipeline. This pipeline will pump gas from the large Shah Deniz field in
- 126-
Azerbaijan which has proven reserves of 460 bcm to Georgia and then Turkey. Gas
could start to flow within two to three years depending on the development of the
Azeri field and construction of the pipeline.
Iranian gas already supplies Turkey which is unlikely to be able to consume all of the
gas it has contracted from Russia and these newer sources. In all likelihood gas from
Iran and Azerbaijan will flow on to Europe through new pipelines to Greece and to
Austria via the Balkans.
In the Caspian Sea area distinction should be made between the west side (principally
Azerbaijan) and the east side (Turkmenistan and Kazakhstan). While gas from
Azerbaijan will soon be entering the European markets, the real problem lies with gas
from Turkmenistan and Kazakhstan. In order to be able to add to the Russian system a
pipeline across the Caspian sea would be required. The Caspian is not governed by the
United Nations Law of the Sea Convention (UNLOSC) which could give rise to
claims by Russia and Iran, as the original bordering states, to veto any pipeline, even
without opposition from the Azeris, whose territory the pipeline would have to go
through.
The Caspian Areas gas contracts with Europe are shown in Table 26.
Table 26 Caspian Area Gas Contracts

EXPORT
COUNTRY
IMPORTER
IMPORT
COUNTRY
BCM/yr
From
To
Turkmenistan
Botas
Turkey
16*
2010/11
2030/31
Turkmenistan
PGNiG
Poland
2.0
2005/6
Azerbaijan
Botas
Turkey
6.6**
2010/11
2025/6
*Build up to plateau level, reached 2020/1

** Build up to plateau level, reached 2013/4
4.4.6. Energy Charter Treaty

The Energy Charter Treaty provides the broadest multilateral framework of rules in
existence under international law governing energy cooperation. It is relevant in the
context of considering current conditions in the Pipeline Supply Area because of its
provisions on the transit of gas, which provide for the freedom of energy transit
through pipelines and grids.
The ECT transit provisions:
i) require transit traffic to be treated no less favourably than goods originating in or
destined for the transit country itself (National Treatment);
- 127-
ii) require Governments not to impede the creation of new capacity (subject to any
national legislation which is consistent with the principles of freedom of transit and
non-discrimination);
iii) notes that if a transit country seeks to prevent the construction of new capacity or
additional use of existing capacity on grounds that it would endanger the security or
efficiency of its energy systems, it has to demonstrate that to the other parties
concerned (not just assert it).
iv) states that in order to protect security of supply to consumers and security of outlet
to producers, the ECT prevents a transit country for up to 16 months from interrupting
transit in order to enforce its claim in a dispute so that the conciliation for which ECT
provides can proceed.
Russia signed the ECT in 1994, but has yet to ratify it pending drawn out negotiations
on the Transit Protocol. Gazprom has put forward three main arguments against
ratifying the ECT:
it would undercut Gazprom's position on European markets by forcing Russia to

open up its network for cheaper gas from Central Asia;
it would require that Central Asian states be given access to the Russian pipeline
system at subsidized internal tariff levels, and;
it would place in jeopardy the system of long-term contracts for supplies of

Russian gas to Europe.
The ECT secretariat refutes all three of these arguments69.

Appendix 7 includes a more complete description of the Energy Charter Treaty.
4.4.7. Summary
supplies in 2003. Russia accounted for half of the import, Norway 25% and Algeria
20%. Russia and Algeria will increase their exports to Europe in the next 10 years but
new pipeline supplies are expected from Libya, Iran and the Former Soviet Union
Uzbekistan). Europe will remain highly dependent on gas flowing from Russia
through the Ukraine to Slovakia. However, alternative routes through Belarus and
Poland (Yamal) and direct to Turkey under the Black Sea (Bluestream) are now
flowing gas with volumes expected to increase over the next few years. A third route
to Germany under the Baltic Sea (North European Gas Pipeline) is also planned
although the timing of this project remains subject to uncertainty.
69
Dr. Andrei Knonoplianik, Energy Charter: Counter-acting through Inaction, Oil Gas and Energy,
March 2003.
- 128-
Gazprom dominates Russian production at the moment but a decline from existing
fields is forecast and Gazprom will need to develop other deposits mainly in Western
Siberia. Independent production has doubled between 1994 and 2004 to just under
100 bcm per year. Gazprom has been trying to buy up some of the independent
producers and exercises effective control over all exports of gas. Most of the exported
gas is routed through Ukraine but Yamal has diversified some of the gas and Blue
Stream into Turkey some more. The proposed Baltic pipeline will result in more
diversification away from Ukraine. Gazprom is effectively blocking any reforms of
the gas sector in Russia.
Algerian exports to Europe were 55 bcm in 2003 30 bcm by pipeline and 25 bcm by
LNG. Pipeline routes are to Italy and Spain (via Morocco) but the Medgaz pipeline,
which is under construction, will delvier gas directly to Almeria. Sonatrach dominates
the gas industry and although foreign companies area allowed to participate they may
do so only in partnertship with Sonatrach. However, Sonatrachs share is planned to
fall as part of the reform to encourage more foreign investment.
Norway is the second largest importer into the EU market and recent reforms have led
to the break up of the GFU and producers selling their gas directly. The offshore
transportation regime has also been reformed by the creation Gassco (operator) and
Gassled (owner) with open access and an entry exit methodology.
Azerbaijan will begin to supply gas to Turkey from Shah Deniz and Iran already
supplies gas.
The Energy Charter Treaty includes key transit provisions ensuring freedom and nondiscrimination of energy transit, but Russia has yet to ratify it because of Gazprom
opposition.
- 129-
Final Report November 2005
Table 27 Current Status of Production and Wholesale Markets in the Pipeline Supply Area
Characteristic
Institutional
Market
Power
Access
Essential
Facilities
to
Status
Open and non-discriminatory licensing regime
Some movement in Algeria
Tax regime which encourages investment
Regime in Russia provides disincentive to investment
Limited foreign investment in Russia so far. Algeria now open to foreign investment but Sonatrach must participate in all projects
Proactive regulatory authorities
Regulators not independent. An arm of government if they exist
Multitude of Producers
Dominance of Gazprom over all aspects of the Russia gas market over exports of gas by pipeline to Europe
No dominant national production company
Almost all producer countries have a dominant production company. Merger of Gazprom and Rosneft would create an even bigger
company and increase state control
Equity partners sell own shares of gas on shorter contracts
True now in Norway following reform of GFU. Increasing in Algeria for example sales through the new Medgaz pipeline.
Only true in NW Europe
Customer pressure
Customers could stand to lose from market reform because of existing subsidies estimated to be $8 billion in Russia in 2002 (World
Bank)
Multitude of customers
Effective monopolies exist in most producer countries domestic markets so customer power is not a factor at present
Effective unbundling
Most countries continue to have integrated gas companies
Anti competitive wholesale contracts
EU activity in this area. Main success was break up of Norwegian GFU and possibly Russian contract with Italy.
Regulated TPA to transmission and storage networks
Required by Energy Charter but little progress so far in Russia and the transit countries.
Regulated transmission network and storage charges
Gas prices in Russia are set by the Federal Energy Commission (FEC) and these include regional variations which implicitly reflect
distance related transportation charges. There is external pressure for cost reflective and non-discriminatory transport tariffs e.g. from
World Bank
Largely tied to new field development. Little independent infrastructure development.
- 130-
4.5. LNG Supply Area

4.5.1. Overview
The Global LNG market is smaller and much more diversified than the pipeline
supply area. Total World trade in LNG amounted to 169 BCM in 2003 compared with
613 BCM for pipeline exports. Twelve countries exported LNG in 2003 (see Figure
102). The largest exporter was Indonesia with 31.9 BCM followed by Algeria with
27.4 BCM, Qatar (19 BCM) and Trinidad and Tobago (12.3 bcm).
Figure 10 World LNG Exports 2003
Indonesia
Algeria
Malaysia
Qatar
Trinidad and Tobago
Nigeria
Australia
Brunei
Oman
Other
UAE
USA
Libya
1.7
0.7
0.0
12.2
11.5
10.8
9.6
8.2
8.0
7.8
10.0
20.4
19.0
20.0
31.9
27.4
30.0
40.0
BCM
Source: IEA
Algeria was by far the biggest source of LNG for the European market in 2003. With
25.7 BCM with Nigeria supplying 10.1 BCM. (See Table 28).
Table 28 LNG Imports to Europe by Origin
BCM
Belgium
France
Greece
Italy
Algeria
3.4
9.0
0.6
2.1
Portugal
Spain
Turkey
Total
7.1
3.5
25.7
Nigeria
Qatar
Other
Total
3.4
9.0
0.6
6.7
4.6
0.6
3.9
1.0
10.1
1.9
1.8
1.9
1.8
0.6
14.7
4.5
39.5
Sonatrach is responsible for the entire exports of Algeria and therefore controls 65%
of all LNG exports to Europe in 2003. The partners in the Nigerian LNG export plant
- 131-
and Qatar Petroleum also had significant shares of LNG supply to Europe as can be
seen in Table 29 below.
Table 29 LNG Supplies to Europe Market Shares
Company
Sonatrach
NNPC (Nigeria)
Shell
Total
Qatar Petroleum
Eni
Other
HHI
Share (%)
65.0
12.4
6.6
3.7
3.0
2.8
6.5
4,496
4.5.2. LNG Spot Market

LNG spot and swap transactions amounted to about 7.6 BCM in 2002, or 7.6% of
total LNG trade. The trend has been growing fairly rapidly in recent years. In 1997
spot trade was around 1.6 BCM or only 1.5% of total LNG trade. Nevertheless, most
observers believe that long term contracts will continue to be the mainstay of the LNG
market for many years to come and spot trading is not likely to exceed 15-30% of
total LNG trade. Large scale trading of LNG on the scale of crude with markets in
derivatives as well as physical commodity is not seen as very likely in the industry.
The factors which have led to increased spot trading in recent years fall into two
groups. Firstly short term contracts, swaps and spot deals have emerged in response to
unexpected changes in either the supply or demand side of the market. For example:
The Asian financial crisis in 1997/8 which caused supply surpluses in the
Middle East.
The temporary shut down of Arun liquefaction plant in Indonesia in 2001

resulted in production being replaced on short term contracts from other
Asian sources.
In 2002 the delay in bringing the Dabhol plant on stream in India meant
shipments intended for Dabhol became available for spot sales.
The shut down of 17 nuclear power plants in Japan in 2003 led to a surge in
demand for LNG for gas-fired power plant
Some countries, including Korea and Spain in particular, have shifted from
importing LNG as base load towards using it for seasonal load, by buying
spot cargoes in winter.
The second driver of spot trade has been the re-emergence of the US LNG market, in
response to high prices, and the creation of arbitrage opportunities as a consequence.
- 132-
In 2002, Middle East and Algerian cargoes destined for USA were diverted to Europe
where prices were higher and in 2003 that situation was reversed with cargoes
diverted from Europe to USA.
This winter, Spanish LNG buyers, including Union Fenosa complain that they are
caught between Henry hub price and regulated tariffs in Spain. The going rate for a
spot cargo of LNG is the Henry Hub price less $1/mmbtu for transport and nondelivery costs. This makes the LNG more expensive than the regulated tariff rate of
$4/mmbtu.
A number of companies are building up assets on both sides of the Atlantic to take
advantage of the arbitrage opportunities:
Tractabel owns Cabot LNG North America as well as the Zeebrugge

terminal in Belgium. . Tractabel is also a partner in Atlantic LNG (Trinidad
and Tobago) and is building a regasification terminal in the Bahamas.
BG has LNG liquefaction assets in Egypt, Nigeria, Equatorial Guinea and

Trinidad. It owns Lake Charles terminal in the USA and is involved in
Brindisi in Italy and a new terminal project in the US (Keyspan LNG).
Repsol is a partner in Atlantic LNG (Trinidad and Tobago) and a

shareholder in Gas Natural which has LNG regasification facilities in Spain.
Gaz de France and Sonatrach have a joint venture Med LNG and Gas
which was set up specifically to market LNG on both sides of the Atlantic.
Statoil has marketed LNG on both sides of the Atlantic from its Snohvit
terminal in Norway and has bought long term entry capacity at the US Cove
Point Terminal.
BP is a partner in Atlantic LNG and in regasification terminals in Spain and

Italy.
Shell which is one the worlds biggest LNG producers owns capacity at
Cove Point and Elba Island regasification plants in USA and recently
announced plans for a new plant in Italy.
For an LNG spot market to flourish requires spare capacity in infrastructure. As we

have seen, spare capacity at liquefaction plant often arises as a result of unforeseen
circumstances such as the unexpected delay to import facilities. There is also often
spare liquefaction capacity in the early years of a contract when contracted offtake
volumes build-up less quickly than liquefaction plant capacity is built. In both cases
these are temporary phenomena but with a continuous programme of new projects
coming on stream this could create a ready supply of spare capacity.
Shipping capacity has been more of a bottleneck in recent years. In June 2003 only
6% of the shipping fleet could be allocated to spot trading. However, there has been a
big increase in the LNG fleet in the last two years with 26 new tankers delivered.
- 133-
Several ships were built with no dedicated route in mind either by the companies
building up a portfolio approach to LNG or purely speculatively to cash in on the
arbitrage opportunities.
Furthermore, several older tankers are going to be freed from their current trade routes
in coming years. These tankers have been fully depreciated and are therefore more
profitable for use in the spot trade because only operating costs need to be considered.
4.5.3. Contract Development
A more flexible approach to pricing is emerging in the LNG industry:
Qatar has linked LNG prices to oil prices in Asia, Henry Hub in USA and
NBP in UK.
Japanese buyers require more flexibility in pricing because sales to power

sector are less sensitive to oil than they were in the past.
The Australian NW Shelf (NWS) project is continuing to sell gas with oil
indexation but using an S-curve which gives greater protection to the buyer
in the event of high oil prices. The formula used for the recent sale to China
is about 15% less than the older Japanese formula for an oil price of $25/bbl.
The NWS/China deal is thought likely to set a new benchmark for price renegotiations in Asia. A decrease in prices is expected, greater flexibility
(lower minimum bill) is being sought and more pricing flexibility is
expected to feature in renewed contracts.
European contracts are still predominantly linked to fuel oil and gas oil
prices (apart from UK as mentioned above). However, European contracts
are subject to re-negotiation every three years and there are some signs of
more flexibly contract terms. In some countries other indices are starting to
be included to reflect competition in the power sector. One example is the
contract between Trinidad and Tobago and Gas Natural of Spain which
includes the electricity pool price.
Excluding Algeria, the LNG gas contracts to Europe are shown in Table 30
below.
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Table 30 LNG Gas Contracts to Europe

EXPORT
COUNTRY
IMPORTER
IMPORT
COUNTRY
BCM/yr
From
To
Abu Dhabi
BP
Spain
0.9
2002
2005
Egypt
GdF
France
5.0
2004/5
2025/6
Egypt
Union Fenosa
Spain
2.9, 3.6
2020
Egypt
BG Gas
Marketing
Spain
1.1
2005,
2009
2005
Egypt
BG Gas
Marketing
Italy
2.4
2008
2028
Egypt
Enel
Italy
3.2
2008
2028
Qatar
Edison
Italy
3.6
2007
2033
Qatar
Gas Natural
Spain
1.7
2001
2012
Qatar
BP
Spain
0.9
2001
2005
Qatar
ENI
Spain
1.0
2004
2024
Qatar
Endesa
Spain
1.1
2007/8
2027/8
Qatar
Gas Natural
Spain
2.0
2006/7
2026/7
Qatar
Exxonmobil
UK
2.8
2007/8
Nigeria
GdF
France
0.5
1999
2032/3
3
2021
Nigeria
Enel
France
3.5
1999
2021
Nigeria
ENI
Italy
1.5
2005/6
2025
Nigeria
Total
Italy
1.2
2007/8
2027
Nigeria
Transgas
Portugal
1.4
1999
2019
Nigeria
Transgas
Portugal
2.0
2005/6
2025/6
Nigeria
Gas Natural
Spain
1.6
1999
2021
Nigeria
Gas Natural
Spain
2.7
2002/3
2022/3
Nigeria
Iberdrola
Spain
0.5
2005/6
2025/6
Nigeria
Botas
Turkey
1.3
1999
2021
Trinidad and
Tobago
Enagas
Spain
1.6
1999
2019
Trinidad and
Tobago
Enagas
Spain
2.8
2003
2023
Trinidad and
Tobago
Union Fenosa
Spain
2.8
2004
2024
Oman
Shell
Spain
0.5
2002
2006
Oman
Union Fenosa
Spain
1.0
2003
2006
Oman
Union Fenosa
Spain
2.2
2006
2026
- 135-
2025
4.5.4. Cost Reductions

The growing interest in LNG is partly due to decreasing costs driven by technological
developments and economies of scale.
Technological development over the last four decades has led to a decrease in average
unit capital cost from $550/tonne of capacity in the 1960s to $350/tonne in the 1970s
and 1980s and $250/tonne in the late 1990s. For a project starting operation today, the
price is slightly less than $200/tonne (all at todays prices).
Significant cost reductions have been made in the cost of tankers due to economies of
scale. Tankers have increased from 40,000 cm for the first generation of ships to
140,000 cm. Costs for LNG tankers dropped significantly following the Asian
financial crisis.
Table 31 Cost Reductions in the LNG Chain
$/mmbtu
Upstream development
Liquefaction
Shipping (LNG Tanker)
Regasification
Total
Early 1990s
0.5-0.8
1.3-1.4
1.2-1.3
0.5-0.6
3.5-4.1
Early 2000s
0.5-0.8
1.0-1.1
0.9-1.0
0.4-0.5
2.8-3.4
Source: IEA
4.5.5. Summary
The global LNG business is smaller but much more diversified than the pipeline
supply area. Spot trade in LNG has been growing fairly rapidly and accounted for
7.6% of all LNG trade in 2002. We expect spot trade to continue to grow as a result of
spare capacity in infrastructure, more flexible contractual terms and a desire to benefit
from arbitrage opportunities in the Atlantic Basin in particular. Spot trade is not
expected to emulate the market for crude with a paper market as well as a physical
market and we do not expect spot trade to exceed 15-30% of total LNG trade.
Contractual terms are changing. In the Far East LNG prices are becoming less
strongly tied to oil prices, indexation is switching to gas spot prices in UK and USA,
and in Europe power prices are beginning to be included in the basket. Contract terms
are becoming more flexible with less rigid take or pay terms. Shipping capacity was a
bottleneck until very recently but new tanker deliveries will add to the number of
tankers available for spot trades
LNG capital costs have been coming down markedly as a result of technological
development and economies of scale.
- 136-
Table 32 Current Status of Production Market in the LNG Supply Area

Characteristic
Institutional
Market Power
Status
Major companies are heavily involved in most markets
Tax regime which encourages investment
Major companies are heavily involved in most markets
Algeria is now open to foreign investment but Sonatrach must participate in all projects. Generally welcomed elsewhere.
Multitude of Producers
Growing number of LNG producers worldwide with intense competition for new projects
No dominant national production company
Most countries in the LNG producing area have dominant production companies although western oil companies are also widely
represented
Equity partners sell own shares of gas on shorter contracts
Sales of equity LNG developing (notably in Trinidad)
Producers generally remote from existing markets and hubs though this will change in UK and possibly Spain and Italy as new
LNG plant come on stream
There has been an increase in spot trade and shorter term contracts. Price indexation has move away from oil linkage especially in
UK and USA markets. European contracts are still linked to gas oil and fuel oil. However electricity pool price is included in
natural gas contract with Trinidad and Tobago contract.
- 137-
- 138-
5. BARRIERS TO COMPETITION AND CHANGES REQUIRED

The terms of reference asked the following question:
What will be the most important drivers/factors, between now and 2010-15, which
will determine whether these conditions (for a competitive market) will be met?
Whether these conditions will be met will depend on whether the identified barriers to
competition can be removed. In this section we draw upon the preceding sections
discussion of conditions in the current markets to draw out the main barriers to
competition which need to be addressed. The changes required in each of the key
markets will then be directly linked to the removal of the barriers to competition.
5.1. Barriers to Competition
The following sections list the barriers that we have identified for each market and
geographical area.
5.1.1. EU Production Market
Production within the EU is declining, as discussed above in Section 4 so that by 2015
only the Netherlands is likely to be a significant producer. Indigenous production will
be much less important than imports for the development of competition in the gas
market. The UKs production decline is projected to be fairly rapid, although there is
a lot of uncertainty over the projections. However, the UK is still likely to be an
important producer for the next 5 years at least
Despite the lower importance of indigenous EU production we identify two possible
barriers to competition in the Netherlands and the UK:
Dutch Small Fields Policy
The Dutch gas industry structure and small fields policy means that gas production
in the Netherlands operates as a partnership between the state and private industry.
The Government operates a cap on production to conserve reserves in Groningen and
encourages development of small fields by requiring Gasunie to buy gas from all
fields on offer at prices which are consistent with import prices.
UK Offshore Regulation
In the UK, the upstream gas industry is not subject to regulation by Ofgem in the
same way as the downstream industry as it is a fully competitive market.
It is the remit of the DTI to ensure that the UKs oil and gas reserves are fully
exploited if economically possible. As UK gas production declines it will continue to
be important that new fields coming onstream are provided with access to UK
upstream gas and oil pipelines and process infrastructure at fair and reasonable prices.
- 139-
The recently updated Infrastructure Code of Practice and DTIs Dispute Resolution
process provide the basis for new fields obtaining fair and open access terms.
In the past, there have been concerns about limitations on the flow of information
from upstream to downstream and within the downstream market which, it has been
alleged, have led to price volatility, market distortions and competition issues. This
was a recurring theme in some of the evidence given to the recent Trade and Industry
Committee Inquiry into Fuel prices.
Under a recent Voluntary Agreement with the DTI the production industry has,
through NGT, released more information to the market concerning gas flows into the
National Transmission System and the effect of planned maintenance in a prescribed
form and time. One final category of information under this Agreement, near to real
time flows, has just been released. It is too soon to have an opinion as to the
effectiveness of the changes in providing useful and timely information.
5.1.2. EU Wholesale Market
Development of completive gas wholesale markets, since the first Gas Directive came
into force in 2000, has been patchy and very disappointing in some countries. We list
below the main barriers to developing truly competitive gas wholesale markets in
Europe.
Availability of Transmission Capacity
The long term reservation of transmission capacity makes it difficult for new entrants
to obtain capacity. Many TSOs allocate capacity on a first come first served basis so
that all or a substantial proportion is booked out to incumbents on long term contracts
leaving little if any firm capacity available for new competitors. This should not be
necessary because when a new entrant wins a customer from the incumbent it does
not create a need for additional capacity but rather for the required capacity to be
transferred from the incumbent to the new shipper.
There is also a perceived lack of capacity particularly in cross border pipelines. In
many cases, it is not clear whether this is a physical constraint or purely a practical
constraint resulting from long term booking of capacity by incumbents. There are
seemingly some physical capacity constraints, notably most routes into Italy and some
into Spain70, but contractual constraints appear to be the main issue. Contractual
constraints work against the development of competition in two ways. First, they deny
capacity which is physically available to the market. Secondly, if a contractual
constraint is falsely perceived as a physical constraint it may lead to pressure for
unnecessary and inefficient investment to increase the physical capacity.
70
Real physical constraints can lead to solutions which are not conducive to, and may hinder, the
development of competition. For example, Italy using subsidies from TENS for new pipelines across
the Mediterranean and Spain limiting dependence on piped gas from Algeria.
- 140-
Diverse Tariff and TPA Structures

Diverse tariff and TPA structures across Europe make transmission of gas across
Europe difficult. To move gas long distances through Europe requires making
arrangements for transportation with a series of different operators. For example, to
route gas from the NBP in the UK to the PSV in Italy requires transit to be arranged
with six different operators. Each has different tariff structures and TPA rules making
the administration and transaction costs along the entire route prohibitive.
Separate Transit Regimes
Transit systems are often operated separately from domestic transportation systems
with different charging regimes and cross subsidy of the domestic market by higher
priced transit charges. Capacity in transit lines is frequently reserved for the pipelines
owners making cross-border gas trade difficult for third parties.
Lack of Regulated Storage TPA and Inappropriate Balancing
There is a lack of regulated TPA to storage and inappropriate balancing regimes. The
second Gas Directive allows for negotiated rather than regulated access to storage
systems. Furthermore, many balancing regimes fail to comply with the requirement
of being cost reflective. Lack of access to storage on regulated terms and overcomplex and over-priced balancing regimes leave shippers with higher costs than the
incumbent company. Uncertainty over the magnitude of balancing charges represents
a significant risk for any shipper contemplating entering the market.
The key problem in relation to the lack of regulated TPA to storage is that in most EU
countries storage remains in the control of the incumbent pipeline and supply
monopoly or dominant player. If this was not the case and there were real competition
between multiple storage facilities then regulated TPA might not be necessary.
High Import Dependency and Local Monopolies
There is high import dependency coupled with dominance of a single import company
in many EU countries. For competition to develop there needs to be a multitude of
companies offering gas to the wholesale market. This is not possible where a single
company controls all imports or there is lack of effective competition between a small
group of importers. The dominance of a single import company creates a local
monopoly. In terms of the conventional assessment of market power none of these
companies would be large enough to have market power over the whole of Europe.
However they are in a position to influence their own local market. The evidence
from the OFT analysis (see section 2) is that companies can exert undue influence on
the market by the ability to control very local events that have a disproportionate
impact. Our conclusion is that we should remain concerned about local monopolies in
Europe until there is clear evidence that they are having no adverse effect on the
market. This is particularly the case where the local supply monopoly, or dominant
player, is also the TSO and is refusing to make capacity available.
- 141-
Lack of Liquid Spot Markets and Hubs

The present lack of liquid and transparent spot markets and hubs is often seen as a
barrier to competition in the wholesale market. However, we believe that market
liquidity and hubs develop naturally as a result of competition rather than the reverse.
Once developed they will, however, greatly assist in ensuring diverse sources of
supply can get to the market and promote discovery of market prices.
Anti-Competitive Gas Purchase C ontracts
Long term contracts continue to serve a purpose in the European gas business because
they help manage the risks of gas field development and long distance transportation.
However as competition develops, it is appropriate to rebase price terms to include a
gas index rather than oil product prices. Clauses which restrict resale of gas or place
limitations on where the gas can be sold are anti-competitive and create a barrier to
development of wholesale competition. Considerable progress has been made already
in excluding these clauses from both new and existing contracts.
5.1.3. EU Retail Market
The retail markets (defined here to include small industrial and commercial customers
as well as residential customers) are being opened to competition at different speeds
in different member states. The second Gas Directive requires full market opening in
all member states by 2007. However, experience shows that simply changing the law
to allow customers to change supplier does not itself create a competitive markets.
For truly competitive retail markets to develop the following barriers will need to be
overcome:
Lack of TPA Access to Distribution
There is a lack of TPA access to Distribution systems. TPA to Distribution systems on
a fair, non-discriminatory and cost reflective basis will be essential for competition to
develop in the retail sector.
Restrictive Wholesale Sales Contracts
In some countries Local Distribution Companies are locked into restrictive long term
contracts with National or Regional companies for the supply of all or most of their
gas. Typically, LDCs are forced to buy all or most of their gas from a single supplier.
Minimal Supplier Switching
Customer inertia is a problem in competitive energy markets. The saving from
switching supplier is often exceeded by the cost of information required by the gas
consumer before they can make a decision. This problem is particularly true for small
residential consumers. Regulators can help by ensuring that the consumer transfer
process is as simple as possible and also by publishing information about competing
energy suppliers. This inertia does favour incumbent monopoly suppliers.
- 142-
Inadequate administrative structures can also inhibit the ability of customers to change
suppliers. The process of switching supplier can be complex from the point of view of
the customer and often leads to administrative difficulties such as late and/or
inaccurate bills which are seen as a disincentive to switching.
Lack of Unbundling and Cross Subsidies
The integrated nature of gas distribution utilities means that scope exists for
companies to subsidise retail operations from other parts of the business such as gas
distribution or activities in non-gas related areas such as electricity or water supply.
State ownership can also be an issue here. Appendix 8 discusses the issue of state or
public ownership in more detail but it would seem that continued public ownership of
gas utilities could be a barrier to the development of truly competitive gas markets.
Firstly public companies may not respond to market incentives in the same way that a
private company would. There is not the same drive to maximise profits. Secondly
its decisions may be subject to political interference and not just based upon rational
economics.
The existence of public companies in gas supply might not matter if they were small
in number and they only had a marginal effect in market liquidity. This does not
appear to be the position at the moment.
Non Controllable Upstream Costs
The structure of costs along the gas chain can mean that a large proportion of the price
paid by end-users, covering gas costs, transportation, storage and distribution charges,
is beyond the control of the supplier leaving reduced scope for competition in price
terms.
5.1.4. Pipeline Supply Area Production
We have identified the following barriers to competition in the Pipeline Supply Area.
Pipeline supplies to Europe are dominated by just three producing companies giving
rise to fears that producer countries could decide to control the gas market on similar
lines to OPEC control of the crude oil market. Gazprom dominates production in
Russia and is in a powerful position as a buyer of gas from other FSU states because it
can block access by those countries to the European market.
Restrictions on Independent Producers
Restrictions are placed on exports by independent gas producers. Independent Gas
Producers in Russia are currently denied access to export markets and are limited to
selling to the domestic Russian market at regulated prices, leading Gazprom a free
hand in the more lucrative export market.
- 143-
Lack of Foreign Investment

Whilst there has been some investment by western countries in Russia and Algeria,
more is needed in order to finance development of reserves and to generate
competition. Foreign investors cite inappropriate legal and tax regimes and inadequate
third party access to the pipeline system as the main obstacles to increased volumes.
5.1.5. Pipeline Area Wholesale
Reform of the gas market in Russia has long been discussed and there is a fairly broad
consensus on want needs to changed from commentators both within and outside
Russia. However, Gazprom has been very successful in resisting change despite
pressure from World Bank, OECD, WTO and other agencies.
The following are the main barriers which need to be overcome.
Lack of TPA to infrastructure in producer and transit countries
This is a barrier particularly in Russia where TPA exists in theory but not on an open
and non-discriminatory basis. Gazprom can in effect choose which producers are
granted access and which are not and which routes are used (which affects the tariffs
charged). Whilst Gazprom acknowledges that independent production is vital to the
future development of gas reserves in Russia, independent producers have to be
mindful of their reliance on Gazproms co-operation. By denying transit rights to
other FSU countries Gazprom keeps potential competitors out of the European market
and captures economic rent by buying gas from them at low prices to maintain its own
export potential.
Gazprom can in particular use its access to information to dominate the entire
wholesale market. In fact gas is rationed in Russia rather than there being a market.
Rationing of gas supplies at regulated prices to domestic customers is nominally
performed jointly by the state and Gazprom but in practice Gazprom has sole access
to all the information needed and can therefore determine the outcome. The process is
entirely opaque and Gazprom can in effect choose which businesses receive gas at the
subsidised price and which will have to pay more for gas in excess of their quotas.
There is a lack of spare capacity in export pipelines in some of the transit countries
such as Ukraine and most capacity is booked to Gazprom under long term contracts.
Lack of Pipeline Connections
There is a lack of pipeline connections to countries in FSU (particularly the Central
Asian Republics), and the Middle East with abundant reserves. This currently inhibits
supply diversity into the EU. Apart from LNG gas coming from outside the EU is
dominated by 3 countries Algeria, Norway and Russia. Gazprom is also currently
- 144-
purchasing gas from Kazakhstan and Turkmenistan to supplement their own resources
and maintain their control over the export markets.
5.1.6. LNG Supply Area
Although the LNG supply market is much less concentrated than the pipeline supply
area, with a relatively large and growing number of export countries involved. Many
of these countries production is still dominated by large national oil and gas
companies such as Sonatrach.
5.1.7. LNG Wholesale Area
Dedicated LNG Facilities
Despite a rapidly growing spot market most LNG infrastructure (liquefaction,
shipping and re-gasification plant) are still dedicated to specific import export
schemes and dedicated routes. Spare shipping capacity is starting to be available and
not tied to specific routes but nevertheless there are limits to the extent to which LNG
can be traded outside the traditional long term contract structure and we would not
expect to see spot trade exceed 15-30% of total LNG trade.
Lack of Terminal and Shipping Capacity
Lack of spare capacity at terminals and more specific in shipping has been a barrier to
competitive LNG trade in the near past though that situation is easing particularly in
reference to ships. However, spare capacity will need to be maintained as the size of
the LNG industry increases over the coming years.
5.1.8. Summary
We have identified some 24 barriers to competitive markets. Fourteen of these
barriers relate to the EU market itself and the remaining ten barriers relate to the
production and transit of gas by pipeline and LNG from the EU borders.
The following section goes on to discuss how these barriers may be removed.
- 145-
Table 33 Barriers to Competition

Geographical
Area
Market Sector
Production
EU
Market Power:
Pipeline
Supply
LNG Supply
Historically there have been limitations on

the flow of information from the UK
offshore industry although steps are being
taken to address this
Dominant national producers, largely state

owned
Restrictions on exports by independent
producers
Market Power:
Dominant national producers in some

countries
Retail
Access to Essential Facilities:
Indigenous production is declining but the

small fields policy in the Netherlands
ensures that Gasunie dominates a major EU
production area
Market Power:
Wholesale
Perceived lack of transmission capacity and problems with capacity booking
Diverse tariff and TPA structures make transmission of gas, particularly

transit, over long distance difficult
Market Power:
Lack of true competition or regulated TPA in storage and inappropriate

balancing regimes
Dominance of pipeline companies in relation to sales to

LDCs
Minimal supplier switching: customer inertia and

administrative difficulties
Market Power:
High import dependency coupled with dominance of single import company

in many countries or insignificant competition between multiple suppliers.
Creates local monopolies
Lack of unbundling. Incumbents can subsidise the

supply business.
Lack of liquid and transparent spot markets and hubs
Oil price escalation and anti competitive clauses in gas purchase contracts
A large proportion of the retail gas bill is outside the

suppliers control, including gas cost, transport fees and
taxes, making it difficult to undercut the incumbents
prices.
Lack of TPA access to infrastructure in producer and transit countries.
Lack of spare capacity in export pipelines
No transmission connections directly with specific (FSU in particular) countries

with abundant gas reserves
Market Power:
Gazprom in particular can exploit its exclusive access to information in order to

control the entire wholesale market.
Dedication of facilities to specific import/export schemes
Lack of TPA access to Distribution systems
N/A
N/A
Hitherto shortage of spare capacity in terminals and ships
- 146-
5.2. Changes Required in Key Markets

In this section we address how these barriers can be removed and what factors will
determine whether these changes can be made. This analysis will concentrate on the 4
key markets identified as being of High or Medium to High importance EU
Wholesale, EU Retail, Pipeline Supply Production and Pipeline Supply Wholesale.
5.2.1. EU Wholesale
Introducing full competition into the EU Wholesale market is seen as a key priority
and an area where there are significant barriers to entry. In the table below, the
barriers are summarised together with the changes required and the main
drivers/factors determining whether these changes can be made. The sections below
describe the changes in more detail
Market Carriage TPA and Capacity Availability
Regulated TPA under the Market Carriage model, as was originally in place on the
Transco system in the UK and in Victoria, Australia, works easily under the entry
exit type TPA systems being adopted around Europe. At the exit points on the
transmission systems, capacity is effectively allocated on a daily basis to each shipper
depending on their customer portfolio in the local distribution zone (LDZ) or local
distribution company (LDC). For an integrated transmission and distribution company
(as Transco was and for example like GDF) the allocation of capacity is undertaken
by that company and the shippers are informed daily how much capacity they are
responsible for, and, therefore, will be billed. Where there are separate transmission
companies and LDCs, the responsibility for allocation would rest with the
downstream LDC who would inform the transmission company of the daily allocation
of capacity for the transmission companys shippers71.
At the entry points to the transmission system there would be no limit on the amount
of capacity that a shipper could book, if they were willing to pay for it. If, on any
given day, the amount of nominated capacity exceeded the available capacity there
would be a pro-rata reduction. Also any unused capacity on a day could be resold by
the transmission operator on an interruptible basis or use-it-or-lose-it (UIOLI) basis.
There would need to be safeguards in this system to prevent any shipper, particularly
the transmission operators affiliate from overbooking capacity to ensure a higher
share of any pro rata allocation. The affiliate could, for example, be required to
provide proof of the amount of capacity that they are booking is actually required for
customers or transit gas. If the capacity was never used over a period of time then that
capacity would be lost (UIOLI). If capacity at any particular entry point has to be
regularly pro rated then that would be a signal to the transmission operator of the need
to expand capacity on their system.
71
An independent agent can also be used but they would be relying on information provided by the
LDC.
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Table 34 EU Wholesale: Changes Required

Changes Required
Introduce market carriage TPA

model to provide more flexibility in
capacity booking including UIOLI,
and allow rolled in treatment,
where appropriate, for capacity
expansions
Some resistance from incumbents

on freeing up capacity and will need
market signals or incentives from
regulatory authorities to make
unused capacity available and
encourage investment where/if
needed
Diverse tariff and TPA structures

make
transmission
of
gas,
particularly transit, over long
distance difficult
Harmonisation of TPA structures

across the EU but need to avoid the
The widespread adoption of entry

exit
is
a
move
towards
harmonisation of regimes but needs
to be modified to incorporate
transit

domestic transmission systems.
Increase importance of UK as a
transit country.
Many transit contracts will be long

term legacy contracts with very
different terms and conditions. Will
be difficult to incorporate
Lack of true competition or

regulated TPA in storage and
inappropriate balancing regimes
Presumption that all storage should

be regulated TPA, unless it can be
shown that there is true competition.
Simplified, non-punitive, balancing
regimes, with daily being the
There has already been resistance

from incumbents and some
governments. Strong pressure from
European Commission needed

dominance of single import
company in many countries or
insignificant competition between
multiple suppliers. Creates local
monopolies

programmes
Release at the gas purchase end

needs to be accompanied by release
at the sales end as well. Current
schemes are arguably not ambitious
enough.

markets and hubs
Spot markets and hubs will develop

once the conditions for effective
Will follow other changes

contracts
Removal
of
anti-competitive
clauses
from
contracts
and
encouragement of shorter term
contracts
European Commission making

good progress on anti competitive
clauses

capacity and problems with
capacity booking
Many of the incumbent transmission companies are seen as resisting the release of
capacity to third parties since they argue that it is required for their own supply
companies to meet their obligations. The introduction of a market carriage regime
would go a long way towards removing this argument but in the meantime pressure
could be placed on the incumbents by requiring them to prove that their systems are
capacity constrained and to show evidence of the amount of capacity required to
supply their customers.
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In respect of expanding capacity, it is important that the regulatory authorities in each

country understand that the risks involved in having too much or too little capacity are
not symmetrical. Natural gas, unlike electricity, is a product which fails to danger
so it is imperative that there is sufficient capacity available to meet all reasonable
demands at the peak (however that is defined), taking account of the potential for
demand-side management. The costs and safety risks incurred in having to cut off and
reconnect firm customers in the event of a failure to supply would suggest that, on
balance and taking due regard to the costs, having slightly too much capacity is better
than having slightly too little. The availability of excess capacity would also be
helpful in encouraging competition in wholesale supply since if there were no real
transmission capacity constraints then gas should be able to get access to capacity
relatively easy. Any slight rise in transportation tariffs because of over capacity could
be more than offset by lower gas prices resulting from the encouragement given to
gas-on-gas competition. This is not to argue that pipelines should goldplate their
systems and make totally unnecessary investments but that some excess capacity can
be beneficial in promoting competition elsewhere in the gas chain.
In order to provide the right incentives to invest in additional capacity, the regulatory
authorities need to ensure that the rate of return on investment is fair and reasonable
(not excessive). In addition, in principle all capacity expansions should be rolled-in
to the existing asset base so that all users of the system pay for them, unless there are
compelling reasons as to why the expansion should be paid for on an incremental
basis. This does not necessarily rule out joint ventures or open seasons to build new
pipelines (or even TPA exemptions where necessary), but creating the climate in
which all prudent investments would effectively be guaranteed a reasonable rate of
return will aid the planning of capacity and encourage necessary investment.
Pricing additional capacity on an incremental basis has merit from a purist economic
perspective, and in competitive markets, or markets where the investments themselves
are relatively small, incremental pricing may well be preferred. However, the addition
of pipeline capacity is generally a discrete and lumpy investment. When capacity is
added, either by looping or compression, the increase can easily be of the order of
30% to 50% and it would be impossible to charge the incremental customer(s) for
such an increase. In addition, the load to fill the capacity may only build up over a
number of years and the actual incremental customers may not be known at the time
the investment is made. For practical purposes, therefore, rolled-in treatment of
additional investment is generally preferred. Its big advantage is that it encourages
investment, allowing new customers and shippers onto the system, thereby promoting
competition at the supply level through a level playing field for new entrants. In
contrast pure incremental pricing tends to discourage investment, since new entrants
are likely to be unwilling to pay the higher costs since it puts them at a competitive
disadvantage to existing participants in the market72.
72
The general approach adopted in the UK has been to distinguish between shallow and deep
reinforcement. Shallow is considered to be the full incremental cost of supplying the individual
customer, typically a short length of pipe from the main to the customers premises, and the cost of
that is generally charged to the customer. Deep reinforcement is where the transportation network
needs additional investment, but where the cost only partly relates to an individual customer. The cost
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Harmonisation of TPA in the EU

As noted in section 4, the entry-exit TPA regime is being widely adopted in the EU.
However, there are some significant differences between the regimes being adopted.
In Germany, Austria and France there are multiple nodes and balancing
zones for example.
Some systems have hourly balancing, others daily balancing.
The Dutch Entry Exit system is complicated by the three gas quality
regimes. That also affects the German and French Systems.
Gassco has an Entry Exit system for capacity booking but the entry and exit
charges are all the same so its really a postalised tariff system.
SPP (Slovakia) and Botas (Turkey) have both recently introduced entry
exit tariffs. Both tariffs structures have multiple entry and exit points and
include a virtual national balancing point prior to the exit points to
distribution systems and storage facilities.
Entry-exit can work well for specific types of systems where there are multiple entry
points and the gas is flowing from different directions. However, where gas is
expected to flow through a number of different entry-exit systems, the layering or
pancaking of entry and exit charges can lead to excessive charges for transportation
and considerable complexity for the shipper. This will be particularly true of transit
gas from, for example, Russia going to the UK, which will have to transit several
different systems, accumulating multiple charges along the way. The problem with
entry-exit is that at the exit point of one system and the entry point of another system
2 charges will be paid and it is unclear that the cumulative charge will reflect the true
economic cost of providing that capacity73. For gas which is moving long distances
generally in one direction, a zonal pricing regime, as is common on most US
pipelines, is a simpler system. As the gas moves through each zone it effectively picks
up one charge and changing systems within a zone would not, in principle, result in
any charge being levied. One way around the layering of charges under entry-exit
maybe for transit gas to be levied a zero exit charge when transferring between
systems at country borders typically the only gas exiting at that point would be
transit gas. However, this may require some reconfiguration of entry-exit charges on a
particular system.
Transit Regimes
At the moment in some countries the transit pipelines are totally separate from the
pipelines carrying gas for domestic consumption (e.g. Belgium), or are subject to
of that is generally rolled in to the asset base and the transportation charges which are applied to
everyone.
73
In some cases the true economic exit charge could well be negative if the exit of the gas actually
alleviates a capacity constraint elsewhere in the system
- 150-
different terms and conditions and charges. In the former case this is likely to lead to
an under utilisation of capacity and in the latter to price discrimination either in
favour of or, more likely, against transit gas.
Ideally separate transit pipelines and/or separate transit arrangements should be
incorporated into the main domestic system within each country. However, the
different contractual arrangements could cause issues for one or both parties leaving a
legacy to deal with.
The UK is currently expanding import capacity both by pipeline and by LNG
terminals. The LNG terminal capacity expansion could be particularly important in
terms of bringing new gas supplies to the EU in that the gas is being imported
essentially from new supply sources Trinidad, Qatar, Nigeria, Malaysia. This in
contrast to the pipeline gas from the Netherlands and Norway is essentially gas that
would have ended up in the EU market anyway. The import of the LNG gas is
effectively shifting the supply curve for EU gas to the right, is being priced against
the NBP index and will lead to downward pressure on prices. In a few years time the
UK will have over 100 bcm of import capacity which together with the indigenous
production could mean that we will be re-exporting much of the imported gas, with
the Transco system essentially acting as a transit route for LNG into continental
Europe and the Interconnector in export mode. In terms of putting downward pressure
on UK prices and overall EU prices, the more LNG import schemes that are approved
and built in the UK the better. The UK could again become a net exporter of gas,
when account is taken of indigenous UK production plus LNG imports, which should
lead to UK wholesale prices being at a discount again to prices at Zeebrugge.
The second EU gas directive provides for a choice of regulated or negotiated access to
gas storage facilities. In a competitive wholesale market, gas storage is a key element
in balancing gas flows and providing market flexibility. If it is concentrated in too few
entities, who can also set charges which are penal to potential competitors on the
supply side, then market flexibility is going to be denied to new entrants and the
development of competition inhibited. The starting point in the EU, therefore, should
be the presumption that all storage facilities should be subject to regulated TPA,
unless an exemption can be argued for on the grounds that there is sufficient
competition in storage and other forms of flexibility to make regulated TPA
unnecessary74. In addition, storage is an ideal asset where ownership could be
unbundled from operation. The incumbent gas company could still retain ownership
of the storage asset but the operation of it would be handed over to an independent
third party who would then sell the capacity, at a regulated tariff, to users. These users
would then have complete freedom to provide storage services in the secondary
market to other interested parties. Restrictions could also be placed on the amount of
capacity a primary user could book in any one storage facility.
74
For example, in the UK, there is no requirement for formal regulated TPA to storage since
competition is generally deemed sufficient in the market overall, when combined with the undertakings
required from Centrica as owner of the Rough storage facility.
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The lack of proper access to storage facilities is compounded by penal and onerous
balancing regimes, particularly ones where hourly balancing is used. On a gas
pipeline system, no matter how small, there is really no need for a balancing regime
that is shorter than daily. The pipeline operator potentially has other mechanisms
available to ensure that the system does not, on a real time basis, have too much or too
little gas, including arrangements with neighbouring pipelines through operational
balancing agreements and the adoption of rules that ensure that shippers schedule
their flows of gas as the operator requests.
Many EU countries are reliant on imported gas from Russia and Algeria for the bulk
of their gas supplies. This can lead to concerns about security of supply with the
argument that powerful national companies are required to contract with the large
producer countries. With the EU diversifying its sources of supply, whether by
pipeline or LNG, the argument for powerful national companies carries much less
weight. Gas release programmes are being, or have been, instituted in many EU
countries with mixed success. Gas release is primarily seen as being a release of gas
from specific gas purchase contracts or from the portfolio of gas that the incumbent
supplier has. As we have seen from the example of the US and the state of Victoria in
Australia, effective gas release also involves release of sales gas as well as purchased
gas, whether it be sales directly to end users or to intermediates such as LDCs. The
release of gas sales at the same time as gas purchases quickly creates the conditions
where a multitude of buyers can choose from a variety of sellers.
The effective release of sales gas can also be encouraged by setting the incumbent
market share reduction targets with severe penalties if they fail to achieve them.
Additionally, the loss of sales in the industrial and commercial market in the UK by
British Gas was greatly enhanced by the requirement that British Gas had to publish
price schedules so that their competitors could see the prices they had to beat. These
are both effective methods of tilting the playing field against the incumbent.
The lack of liquid and transparent spot markets and hubs are seen, by some, as a
barrier to a competitive gas market. It is true that active spot markets and hubs are
associated with competitive gas markets but they are much less a driver, or cause, of
the competitive market, than a consequence of the fact that the conditions are right for
competitive markets to develop. Spot markets and hubs certainly help the functioning
of a competitive market, by ensuring that diverse sources of supply can reach the
market, but they should be seen more as a symptom than a cause.
The importance of developing spot markets lies in their provision of a liquid forward
market for gas purchases and sales. The availability of a number of willing buyers and
sellers of gas, coming together at a convenient point, or hub, allows parties to enter
into forward physical trades for days, months or years ahead. The liquid forward
market then provides confidence that the prices at which trades are completed are
truly representative of the underlying fundamentals in the market, in turn giving rise
to the development of gas price indices which can be used as the benchmarks for
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index pricing in longer term contracts, replacing other forms of indexation such as oil
price escalation.
The liquid forward physical market is usually soon followed by the introduction of a
futures market, over an exchange such as the IPE, and other forms of over-the-counter
derivatives such as options and swaps. These enable participants in the market to
hedge price risk if they require.
Escalation of prices in long term gas purchase contracts remains, at least outside the
UK, largely in line with oil prices. Until there are reliable alternative indices which
reflect gas-on-gas competition this is likely to remain the case. However, some of the
contracts contained so-called destination clauses, which limited the resale of gas by
the purchaser outside their own country. These are gradually being removed because
of European Commission action and a move to shorter term contracts, and a more
diverse choice of supplies, would render such clauses a relic of the past.
5.2.2. EU Retail
Introducing full retail competition is seen as a Medium to High priority. As was
discussed earlier, we do not consider that it is essential for competition to develop at
the retail level in order for the benefits of competition at the wholesale level to filter
down to retail customers. However, the extension of competition to the retail sector
has the following benefits:
It exposes supply operating costs to market forces, although these are typically
less than 10% of the total gas bill;
Regardless of any effect on the price, it allows gas consumers to chose their
supplier and therefore should promote better service standards;
It reduces the ability of the incumbent gas supplier to cross-subsidise between its
competitive and monopoly customers;
It overcomes the problem of defining where the boundary between the competitive
and monopoly markets should lie; and
Accompanied by effective unbundling of transportation and supply, the regulatory
authorities can ensure that the distribution network charges are set at an efficient
level which would limit the ability of the incumbent to cross-subsidise between
transportation and supply.
The changes required for retail competition in the EU are summarised in Table 35 and
described in more detail in the following sub-sections:
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Table 35 EU Retail: Changes Required

Changes Required

systems
Introduction of consistent and

coherent
Network
Codes,
specifically for distribution if
separate from transmission
Overcoming
resistance
from
incumbents and concern about the
possible high cost of introducing
retail competition
Dominance of pipeline companies

in relation to sales to LDCs
Removal
of
exclusive
arrangements, shorten duration of
contracts and institute gas sales
release programmes.
Strong incumbent resistance falling

back on the security of supply
argument. Strong regulatory and
competition
authorities
action
required
Minimal supplier switching as a

result of customer inertia and
inadequate administrative structures
to enable customers to change
suppliers

benefits of switching. Introduce
cost effective and efficient supply
point administration
Fear of the high cost of introducing

necessary systems but there are
lower cost alternatives which can be
utilised
Lack of unbundling. Incumbents

can subsidise the supply business
Proper
legal
unbundling
of
Privatisation of state owned
businesses.
Reduction
of
distribution charges to eliminate
Incumbent and possible government

resistance. Strong action required
from regulatory authorities, backed
by governments.
A large proportion of the retail gas

bill is outside the suppliers control,
including gas cost, transport fees
and taxes, making it difficult to
undercut the incumbents prices.
Introduction of full competition in

the EU Wholesale market and the
Wholesale markets and firm
regulatory
oversight
on
Refer to sections on EU Wholesale,

Wholesale
Distribution TPA
For competing suppliers to enter a particular distribution market requires the rules for
transportation of gas on the distribution system to be clearly laid out and present at
least a level playing field to compete against the incumbent. In the UK, Transco was,
until recently, an integrated transmission and distribution system so the Network Code
covered all the required transmission and distribution aspects. In the last few months,
4 distribution networks (DNs) have been sold to third parties, but the intention is that
the single integrated Network Code will remain in place. However, in other EU
countries transmission is often split from distribution and many of the smaller LDCs
are struggling to put in place a coherent distribution Network Code and are fearful of
the cost of introducing competition. A separate distribution Network Code need not be
that complicated. It has to deal mainly with supply point administration (see below)
and with the nomination and allocation of gas flows between shippers or users of the
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system. Unlike a transmission network code it does not, and should not, require a
balancing regime, where much of the complexity of a network code is involved75.
Gas Sales to LDCs
Pipeline companies, in their role as wholesalers, can dominate the sales of gas to
LDCs and enter into very long term exclusive agreements. This can affect the
development of wholesale competition in much the same way that the minimum bill
in the US prevented LDCs purchasing gas from alternative sources. As noted in
section 4, the German cartel office, the Bundeskartellamt, has recently completed an
investigation of 750 contracts and has judged 75% of them as anti-competitive
because they make it impossible for new entrants to gain access to the customers.
All contracts are judged anti-competitive if
they have a duration of more than two years and oblige the buyer to buy more than
80% from the supplier; or
they have a duration of more than four years and oblige the buyer to buy more
than 50% from the supplier.
One argument is that the exclusive long term sales agreements with the LDCs are
necessary to allow wholesale pipeline companies to enter into long term gas purchase
agreements with the producers76. However, this misses the fundamental point of the
gas chain that someone, somewhere has to buy long and sell short, thereby bearing
the risk both on price and volume. With the traditional non-competitive approach of
back-to-back contracts from producer to the LDCs, most of the risk is left with the
end users and, to a lesser extent, on the volume side the LDC. There is some price risk
with the producer related to the oil price. In a competitive, flexible trading market the
risk is shared more evenly along the gas chain and the cost of that risk can be priced
into the specific contracts. Volume risk largely disappears since contracts become
shorter term and gas can be bought and sold easily between all participants and is
replaced by price risk77. In turn price risk can be hedged by all participants in the
market if they so desire.
Breaking the contractual link between the wholesaling pipeline companies and the
LDCs should be seen as part of an effective gas release package dealing with the sales
side as well as the more usual gas purchase side.
Administrative Structures
75
The balancing of gas flows on a daily basis requires that inputs to and offtakes from a system are
metered on a daily basis. While the inputs to a distribution system will be measured daily or more
frequently almost all end user offtakes will measured infrequently. In a distribution system, therefore,
one of the main daily activities will be the allocation of gas flows coming into the system between
shippers or users, with the simplifying assumption that whatever quantity of gas comes into the system
is effectively consumed (allowing for shrinkage).
76
However, most of the gas purchase contracts have regular price and volume re-opener provisions in
them, which largely mitigates any risk they may have of any significant take-or-pay liabilities
77
There is almost 100% certainty that gas can be bought and sold for any given period, it is just that the
price is very uncertain.
- 155-
As part of the Distribution Network Code efficient supply point administration (SPA)
is a key element. The essence of a SPA system is a database of which supplier is
supplying which end user and the tracking of any changes. Most LDCs will already
have a meters database which can be used as the basis for this and with some
amendments can serve as the SPA system. It should also be relatively inexpensive to
add on a simple load forecasting model which would deal with the nominations,
allocation and reconciliation process. In Northern Ireland, Phoenix Natural Gas (with
80,000 customers) have put in place all the necessary administrative structures
including a network code, a SPA system and load forecasting model to deal with retail
competition for less than 1 million.
Unbundling Transportation and Supply
New entrants can be put at a significant competitive disadvantage where the
incumbent distribution company remains not only the owner and operator of the
distribution pipes but also a large competing supplier of gas. As operator of the
distribution pipes the tariffs for transportation of gas can be set at a level which allows
the incumbents supply business to be cross subsidised and effectively operated at zero
profit or even be loss-making, against which new entrants would be unable to
compete.
The first step to dealing with the possibility of cross subsidies is to require the
complete legal unbundling of transportation and supply and to ensure that the supply
business operates on a commercial basis. It would be preferable for the supply
business to be broken up or sold off in each distribution area but this may not be
possible. Whatever is the process of unbundling, the regulatory authorities should
ensure that the distribution tariffs are set at an efficient level and do not contain any
costs that were not incurred in the delivery of the gas nor allow for excessive profits
to be made. If they are set at an efficient level then the possibility of any cross
subsidies would be removed.
Upstream Costs
A large proportion of the retail gas bill is outside the suppliers control, including gas
costs, transport fees and taxes, making it difficult to undercut the incumbents prices.
In reality, competition at the retail level comes down to efficiency selling and billing,
but also, if the opportunity is there, of more efficient gas buying. That is why it is
important that competition is fair, and there are no cross subsidies, and also why the
introduction of full wholesale competition, together with firm regulatory oversight on
transmission tariffs, is the key factor.
5.2.3. Pipeline Supply Production
Because of the dominance of supplies to the EU by a few countries and largely state
owned companies introducing more competition in this area is seen as a High Priority.
The changes required are summarised in Table 36:
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Table 36 Pipeline Supply Production: Changes Required

Dominant
national
largely state owned
producers,
Restrictions
on
exports
independent producers
by
Changes Required

producers
Expect some resistance from

governments but generally these
countries are in need of foreign
investment
Allow independent producers to sell

Introduction of foreign investment

combined with opening the
wholesale market through regulated
TPA should help independent
producers to sell their gas directly
Put in place legal and tax structure

to encourage foreign investment
Many countries do not have well

developed legal and tax structures
which respect property rights and
corruption can still be rife
The changes required are described in more detail in the following sub sections:
Although the GFU has now been broken up in Norway, the other key suppliers to the
EU Russia and Algeria have dominant national producers in Gazprom and
Sonatrach, basically under state control. In addition, the potential pipeline suppliers
from the Middle East and the FSU also largely comprise dominant state owned
national producers. Privatisation of these companies, and placing them on an equal
footing with foreign investors, would be preferable but resistance from their
governments would almost certainly be strong.
Restrictions on Independent Producers
In each of the pipeline supply countries there are independent producers. In Russia,
Gazprom controls the supply network tightly and does not allow independent
producers to supply gas outside Russia. In Algeria, where there are a number of
foreign multinationals involved, Sonatrach maintains control over exports and gas
tends to be sold under national contracts. Ideally independent producers would be
allowed to sell their gas directly but the prospect of that in the near future seems
unlikely unless major reforms of the wholesale market are undertaken.
Foreign Investment
In order to develop the reserves and maintain and/or increase production, most of the
pipeline supply countries will require significant amounts of foreign investment. This
is particularly true of Russia if they are to develop the remote reserves for the Yamal
pipeline and the planned Baltic pipeline. While it will be necessary for the appropriate
legal and tax structures to be developed, the requirement for foreign investment
provides an opportunity for the EU to seek the changes required in terms of reducing
the power of the national producers and removing the restrictions on independent
producers.
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5.2.4. Pipeline Supply Wholesale

The wholesale markets in the Pipeline Supply area are also seen as a High Priority for
competition because of the importance of diversifying supplies to the EU. The
changes required are summarised in Table 37:
Table 37 Pipeline Supply Wholesale: Changes Required
Changes Required


consistent with EU
Some countries are still resistant to

the introduction of regulated TPA

pipelines
Promote privatisation of pipeline

systems and introduction of foreign
investment
Infrastructure is generally in poor

condition and there is still resistance
to privatisation and foreign
investment in key infrastructure
No
transmission
connections
directly with specific (FSU in
particular) countries with abundant
gas reserves. Inhibits diversification
of EU supplies
Promote the construction of new

pipeline links and try and reduce the
influence
of
the
incumbent
producers such as Gazprom and
Sonatrach
The incumbents may try and keep

control of any new pipeline links or
try and prevent them. Investment
funds could also be an issue in some
countries
Gazprom in particular can exploit

its exclusive access to information
in order to control the entire
wholesale market.
Preferably unbundling of Gazprom,

separating
transportation
and
supply, but may have to settle for
strict enforcement of regulated TPA
regime
Could
encounter
powerful
resistance from Gazprom and
Russian Government
The changes required are described in more detail in the following sub sections:
Regulated TPA
In both the producer and transit countries there is a lack of true TPA to the pipelines.
The principal concern here is with the gas flowing from Russia where the pipeline
systems are largely under the control, direct or indirect, of Gazprom, even through
Ukraine and Belorussia. From Algeria the pipelines are controlled more by the buyers
such as Eni in Italy and Enagas in Spain. Ukraine is particularly important in this
respect since currently over 25% or 77 bcm of gas imported into the EU flows through
Ukraine and by 2015/16 the volume of gas will have increased to between 120 and
170 bcm. In the past few years there has been constant discussions on reform of the
Ukraine transit system with control passing to a consortium of companies, of which
Gazprom is usually included but Ruhrgas are also often involved.
The pipeline exporting gas from Russia and on through Ukraine as well as from
Algeria and into Spain and Italy are running close to capacity. In Russia in particular
the pipeline system is reportedly not in good condition. Because of the need to
increase capacity as EU demand grows, while EU supply falls, there are opportunities
for foreign investment to fund the expansion. This could involve equity investments
by EU pipeline companies as well as bank lending.
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The Middle East and the FSU countries have little or no capacity to export gas to the
EU. Gazprom have been entering into gas purchase agreements with Kazakhstan and
Turkmenistan to supplement their own reserves to supply both domestic and export
markets. This also has the added effect of reducing gas from Kazakhstan and
Turkmenistan competing against Gazproms own gas in EU markets.
A key route for both Middle East and FSU gas which would by pass Russia would be
through Turkey. Gas from Turkmenistan would get to Turkey through Azerbaijan and
Georgia, if the Trans-Caspian pipeline (TCP) were constructed. The TCP has been
planned for a number of years but was put back by the development of the Shah Deniz
field in Azerbaijan. The Azeris didnt want Turkmen gas competing with their gas in
the Turkish market and beyond. However, as EU requirements grow there should be
room for both Azeri and Turkmen gas in the EU market. With Middle East gas from
Iran and potentially Iraq also transiting Turkey, the BOTAS pipeline system will be a
main route for gas into the EU. BOTAS are moving towards the introduction of
regulated TPA and also the introduction of wholesale competition at least in their own
market. It is very important, however, that they incorporate the appropriate regulated
TPA transit rules as well. Georgia could also be a key country for transit gas from
Turkmenistan. Shah Deniz gas is already planned to transit Georgia using the under
construction South Caucasus pipeline. However, the existing Georgian system, which
runs north to south and carries gas from Russia to both Georgia and Armenia, is in a
poor state of repair and is in urgent need of rehabilitation. Reportedly the Georgians
are in discussion with Gazprom concerning a possible sale of the system. If Gazprom
took control of the Georgian system this could inhibit the east west route for transit
gas.
The other major new pipeline connection, the Baltic or North European gas pipeline,
will be largely controlled by Gazprom but they will require other equity investors as
well to be involved in the financing, which might dilute their influence.
Control of the pipeline system in Russia gives Gazprom exclusive access to
information on all the gas flows at the wholesale market level. Ideally the unbundling
of Gazprom, separating supply and transportation, could be a way to reduce the
control over the wholesale market.
5.2.5. Institutional Drivers for Change
Implementation of EU Legislation
To date implementation of the second gas Directive (2003/55/EC) has been
incomplete and the Commission wrote to eighteen Member States warning that they
had still not fully notified to the Commission the legal measures taken to transpose the
latest Directives. After five years of competition for electricity and over three years
for gas, fewer than 50% of customers have switched supplier in most Member States
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according to the Benchmarking report published last year78. In addition, many

customers are reported to be unsatisfied with the range of services being offered.
Progress by Member States in transposing the Directive will be critical to achieving
the objective of fully opening the gas market for all consumers by 2007. Adoption of
the proposed Regulation for access conditions to the gas transmission network would
represent an important addition to the legal framework and is sometimes referred to as
the third gas Directive. This Regulation would formalize and make legally binding
the Guidelines for Good Practice 2 (GGP2) document which was agreed at the 7th
Madrid Forum. Compliance with GGP2 has hitherto been voluntary and the first
Monitoring Report noted a certain lack of compliance with respect to some key
elements.
An important aspect of the proposed Regulation is that it contains a procedure to
amend and improve the requirements for access conditions over time under the
comitology procedure. This process for tightening up on Third Party Access
conditions could prove to be an important driver towards introducing effective
competition.
Competition Law
The application of competition law may prove to be an important driver for
developing the conditions needed for a competitive market. A recent example is the so
called Marathon Case which has resulted in concessions being made by several TSOs
including Gasunie and Ruhrgas. Most recently E.ON Ruhrgas has implemented a
form of entry exit for its pipelines as a result of the Marathon Case settlement having
previously been to the fore in attempts by GTE to resist pressure for entry exit by the
Commission, CEER and end users. Another aspect in this area is the move to modify
long term gas supply contracts to remove the destination clauses on the grounds that
they are anticompetitive. The German cartel office has also declared 75% of the
contracts between the TSOs and distribution companies anti-competitive and has
demanded reforms.
Madrid Forum
We also note the current work of the Madrid Forum in developing Guidelines for
Good Practice for storage which we regard as equal importance to the conditions for
access to pipelines. Similar work may be needed in the future to cover access to LNG
terminals and distribution systems. The whole Madrid approach, however, is
operating slowly because of the committee approach and the differing viewpoints
and commitment. The involvement of the trade associations who defend the status
quo can be part of the problem and not the solution.
78
Annual Report on the Implementation of the Gas and Electricity Internal Market {SEC(2004) 1720}
- 160-
Interoperability is a key issue for achieving a truly competitive market and the work
of EASEE-Gas will be instrumental in developing Common Business Practices in
areas including harmonisation of business rules, communications standards and units
of measurement and addressing differing gas quality specifications.
Performance of National Energy Regulators
Proactive regulation at the national level by the regulatory authorities is seen as a key
institutional driver for change. In terms of the international experience this was a
common theme in the US, UK and Victoria. Few countries would seem to have
proactive regulatory authorities. If some regulators are less active than others that
could lead to some member States lagging behind in liberalising their own gas
markets and that could hinder the development of the EU wide competitive gas
market.
Views have been expressed on the need for a Europe-wide energy regulator, along the
lines of FERC in the US. Whilst this has not been taken forward, the creation of the
European Energy Regulators Group for Electricity and Gas goes some way towards
achieving a more harmonised approach to energy regulation in the EU, which should
assist in the development of a competitive market.
5.2.6. Risks and Costs of Changes
The opponents of moving towards a competitive gas market often point out that there
are significant risks and costs involved in liberalising the market. They argue that risk
will increase because supplies will no longer be secure without long term contracts,
that the large producers such as Gazprom will be able to dominate even more
European utilties if the power of the utilities is reduced in their home markets and that
the necessary infrastructure will not be built. Upon closer inspection, none of these
arguments hold up and are not supported by the experience in the US and UK
markets, nor in the State of Victoria in Australia.
In respect of security of supply, the general effect of liberalisation will be to introduce
alternative supplies into the market and encourage diversification. Buyers of gas, such
as utilities, will not be locked into one supplier and will seek alternative supplies.
Sellers of gas will also seek a wider variety of buyers so that their risk is diversified.
While it is true that there may be fewer long term contracts to underpin the
construction of new pipeline infrastructure the combination of mechanisms such as
open seasons and rolled-in tariff treatment is usually sufficient to ensure that the
pipelines get built. The US has enjoyed the construction of more capacity from
Canada, new pipelines within the US to take gas from the Rockies to California and
other markets, more interconnections with Mexico and, more recently, a plethora of
plans for new LNG regasifcation terminals. The UK similarly is seeing the
construction of 2 new import pipelines, expansion of Interconnector import capacity
and at least 3 LNG regasification terminals. In the State of Victoria an interconnection
with New South Wales was built and also one with South Australia.
- 161-
As was pointed out earlier in this section, it is not the overall risk in the gas market
that changes, but the parties who bear the risk changes. Instead of the end user and, to
a lesser extent, the producer in monopolistic markets who bear almost all the risk, in a
competitive market the risks are spread more evenly along the gas chain.
There are costs involved, however, in introducing competition. These can include
costs of restructuring companies, investment in new systems and practices and the
requirement to restructure contracts, particularly long term gas purchase contracts. In
the US and, to a lesser extent, in the UK there were large take or pay liabilities which
had to be bought out. In the UK these were borne by the shareholders of British Gas,
while in the US there was a sharing of these costs between producers, pipelines and
end users. In the EU, contract restructuring costs should be less of an issue since most
of the long term contracts are thought to contain provisions for price and volume reopeners on a reuglar basis. In addition, the introduction of properly structured and
effective gas release schemes would go along way towards alleviating any potential
liabilities. The regulators also have recognised that the introduction of TPA, in
particular, requires investments in new systems and business practices and have
generally allowed properly incurred costs to be recovered through transmission and
distribution tariffs.
It has also been shown above that the costs of introducing retail competition need not
be nearly as great nor complex as is generally thought.
- 162-
6. TIMING OF THE TRANSITION

In this section we answer the following question:
What are the likely outcomes on these key factors, and, on balance, how competitive is
the European/global gas market likely to be around 2010-15?
In considering the timing of the transition to competitive markets in the key sectors
identified three scenarios have been considered and these are described below. The
three scenarios were then tested using Energy Markets European Gas Model (EGM)
and the scenario results for wholesale prices, supply-demand matches and gas flows,
for 2015/16, are discussed in Section 7. A description of the EGM is provided in
Appendix 9.
6.1. Overview of Scenarios
6.1.1. The Fully Competitive Case
The Fully Competitive Case represents the best possible world from the point of view
of competition in the gas market, fulfilling all of the criteria described in Section 4.2
above. It depicts a fully competitive gas market in EU and globally by 2015/16.
Within the EU the liberalisation process has been completed and there has been
substantial reform in the gas market in Russia and other gas producing countries. The
LNG market becomes fully commoditised with extensive spot trade.
The Fully Competitive case is included as a benchmark against which to measure
the other scenarios and is not considered to be a realistic picture of the market in
2015/6.
6.1.2. The Most Competitive Case
This case represents the most positive outcome from the point of view competition in
the gas market that can reasonably expected to be achieved over the next ten years.
Long term contracts continue to play an important part in the market but pricing terms
move away from oil price indexation to market related pricing. Liberalisation within
the EU itself is substantially completed but there remain problems beyond the EU
borders. Whilst some reform has been attempted in Russia and Russia has signed the
Energy Charter Treaty Gazprom remains dominant over Russian production and
effectively manages to exclude gas from the Caspian area from direct access to the
European market.
6.1.3. The Constrained Case
This case represents a fairly pessimistic view of competition in the gas market by
2015. Whilst the second gas Directive has been transposed into national law by all
member states there has been little real enthusiasm for competition and the European
gas market continues to be characterised as a series of national markets. Trade
continues to be dominated by long term contacts with price escalation clauses linked
to oil prices. Gas prices, therefore remain sensitive to oil price outcomes. We have
- 163-
used the DTI reference case forecast for oil price of $30/bbl (real 2004 prices) and
tested the sensitivity of the constrained case (the only case with gas prices linked to
oil) to $20/bbl and $40/bbl (real 2004 prices).
6.1.4. Probability of Scenarios
The scenarios are not intended as predictions of the future. They are a device for
understanding the impact on the UK in terms of gas costs and security of supply
resulting from different levels of competition in Europe and the wider global gas
markets.
As mentioned above the Fully Competitive case is not a realistic view of the position
in 2015/6. As its name implies it is a somewhat idealistic view of how the market
would function if all of the changes we have identified are implemented. Whilst all
these changes may eventually be made, we do not consider it achievable within a
timeframe of 10 years or so. However, by comparing more realistic scenarios with the
ideal world created in Fully Competitive we have endeavoured to provide insight into
the importance of what is at stake for the UK in terms of European liberalisation.
The Constrained and Most Competitive cases are intended to cover the range of
outcomes that could be reasonably expected to arise in the period to 2015/6. The Most
Competitive case is achievable if the actions described in Section 4.5 are pursued
energetically. The Constrained case is only likely to arise if liberalisation is not
pursued vigorously beyond mere compliance with the Gas Directives.
6.1.5. Quantification of Scenarios
In Section 6.2 below we provide a narrative summary of the scenarios which is based
on the foregoing discussion of characteristics of competitive markets and the changes
needed to bring them about in the European gas industry and beyond.
Each of the scenarios has to be interpreted for purposes of modelling. Some of the soft
issues in the scenarios such as market dominance and the level of pressure brought to
bear by regulators are not directly represented by parameters in the model. However,
they can be represented by their resultant impact on quantifiable measure such as the
extent to which gas is freely traded, gas on gas competition develops and economic
rent is squeezed out of the gas chain.
The main variables which can be flexed in the model to reflect the scenarios are
Gas Demands
Oil prices
Exchange rates
Availability and Cost of Gas Supply from various sources
Infrastructure Development (pipelines and LNG)
- 164-
Transportation tariffs
Gas contracts, spot trading and gas to gas competition,
Demand
We have used a conventional view of gas demand in Europe, for 2015/16, which is
broadly consistent with forecasts by IEA. The UK demand forecast of 103.3 bcm is
based on forecasts supplied by the DTI (taking a 30%/70% weighted average of the
projections for 2015 and 2016). For the Most Competitive scenario a sensitivity case
has been added, with slightly higher demand, assuming greater demand for gas in the
power sector in Germany, Italy and other countries. We have also increased UK
demand to 118.2 bcm based on NGT assumptions.
Table 38 Gas Demand in Europe by Scenario (Net of Producers Own Use)
BCM
2002
Base
Austria
Belgium
Bulgaria
Croatia
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Luxembourg
Netherlands
Poland
Portugal
Romania
Slovakia
Slovenia
Spain
Sweden
Switzerland
Turkey
UK
Grand Total
7.5
15.9
3.8
2.8
9.6
4.4
4.5
41.7
90.2
1.6
13.4
4.3
70.0
1.2
48.9
13.0
3.1
18.8
7.4
1.1
20.5
0.9
3.0
17.6
92.8
498.2
13.4
18.4
5.7
4.3
13.4
5.0
9.5
71.1
109.1
6.8
15.2
6.6
100.6
1.5
55.8
16.5
6.4
29.3
12.1
1.6
46.4
1.3
3.6
58.9
103.3
715,9
Most Competitive
Sensitivity
13.4
18.4
5.7
4.3
13.4
5.0
9.5
71.2
120.0
6.8
15.2
6.6
103.0
1.5
55.8
18.0
6.4
29.3
12.1
1.6
47.6
1.3
3.6
58.9
118.2
746,8
All forecasts summarised in Table 38 are net of producers own use. Also shown are
actual demand figures for 2002 the last year for which net figures are available from
IEA.
- 165-
Oil prices
We have used the DTI assumption for oil prices of $30/bbl (real 2004 prices) and
tested the sensitivity of the constrained case (the only case with gas prices linked to
oil) to $20/bbl and $40/bbl (real 2004 prices).
Exchange Rates
The exchange rates used to convert $ figures to and equivalents were the average
of the 5 years 1999 to 2004. The :$ rate therefore is $1.585 and the :$ rate is
$1.033. These do, of course, represent a significantly stronger $ than is currently the
case. However, we would not expect a materially weaker $ to result in lower p/therm
or /MWh prices, since a sustained period of $ weakness would result in resource
costs being higher in real $ terms than we have assumed in our production supply
costs and pipeline tariffs, leaving and prices little changed.
Supply and Infrastructure
The Fully Competitive and Most Competitive cases both assume plentiful supplies and
infrastructure. In the Fully Competitive case the pipeline supply area is extended by
new pipelines from Egypt to Turkey and from Nigeria to Algerian and on to southern
Europe. Supplies from the Caspian can transit Russia using TPA in this case as well
via Turkey and the Nabucco pipeline. In both the Most Competitive and Constrained,
Russia does not introduce TPA. Caspian gas can be routed via Turkey and, in the case
of Most Competitive, in the Nabucco pipeline to Austria. Russia is able to continue to
buy supplies from Caspian area producers to supply its own exports to Europe. Table
39 summarises the new pipeline infrastructure by scenario, whilst Table 40 and Table
41 summarise the LNG liquefaction plant and regasification plant included in the
model respectively.
Transportation Charges
As discussed in section 4.3.3 there is currently a wide variation between tariffs in
Europe when compared on the basis of charge per 1000 cm per 100km for the same
volume of load and load factor. Future tariff levels will depend among other things on
the effectiveness of regulators and we have made the following assumptions in the
three scenarios
In Fully Competitive European tariffs are reduced to levels which are

comparable with UK tariffs by 2015/16.
In Most Competitive European tariffs are reduced on the basis of an RPI-X

formula where X varies between 2 and 4 with higher values applied to
countries where the 2005 tariffs are highest in comparison to UK (including
France, Germany and Spain.
In Constrained all tariffs are reduced by RPI-2.
- 166-
Table 39 Pipeline Infrastructure Assumptions by Scenario

Pipeline
Capacity
(bcm)
25.0
Yes
Yes
No
10.0
10.0
Yes
Yes
No
No
No
No
Nigeria to
Algeria and
MGE Pipeline
15.0
Yes
No
No
Caspian direct
access to Europe
61.0
Yes
No, only Turkey
No, only Turkey
Nabucco
Medgaz
Extension to
France
15.7
15.0
Yes
Yes
Yes
Yes
No
No
Yes
Yes
No
North European
Gas Pipeline
Galsi Pipeline
Egypt to Turkey
Pipeline
Increase FRASPA and reverse
Fully Competitive
Most Competitive
Constrained
TAG Pipeline
Upgrade
34.0
Yes
Yes
No
Turkey to
Greece to Italy
Pipeline and
Reverse
11.0
Yes
Yes
No
Langaled
pipeline Norway
to UK
49.4
Yes
Yes
Yes
BBL pipeline
Netherlands to
UK
17.2
Yes
Yes
Yes
Belgium to UK
Interconnector
Upgrade
24.1
Yes
Yes
Yes
Total Capacity
287.4
- 167-
Table 40 LNG Liquefaction Plant Assumptions By Scenario

Country
Algeria
Algeria
Algeria
Angola
Equatorial
Guinea
Egypt
Egypt
Iran
Libya
Capacity
(bcm)
24.0
11.2
5.2
5.6
4.8
Plant
ARZEW
SKIKDA
Gassi Touil
SOYO
BIOKO
Fully
Competitive
Yes
Yes
Yes
Yes
Yes
Most
Competitive
Yes
Yes
Yes
Yes
No, USA only
Constrained
Yes
Yes
Yes
No, USA only
No, USA only
10.6
9.8
10.0
2.8
ELNG
SEGAS
?
MARSA EL
BREGA
Yes
Yes
Yes
Yes
Yes
Yes
No, Asia only
Yes
Yes
Yes
No, Asia only
Yes
Nigeria
30.0
Yes
Yes
Yes
Nigeria
Nigeria
6.8
6.8
Yes
Yes
Yes
Not go ahead
Yes
Not go ahead
Nigeria
Norway
Oman
14.3
5.6
4.8
Yes
Yes
Yes
Yes
Yes
Yes
Not go ahead
Yes
Yes
Qatar
Qatar
22.0
31.3
BONNY
ISLAND
BRASS RIVER
NNWA
FLOATING
LNG
OK LNG
SNOHVIT
MINA AL
FAHAL
RAS LAFFAN
QATARGAS
Yes
Yes
Yes
Yes
Yes
Yes
Trinidad
and
Tobago
UAE
22.4
ATLANTIC
LNG
Yes
Yes
Yes
1.7
DAS ISLAND
Yes
Yes
Yes
YEMEN
9.4
Yemen LNG
Yes
No, supplies
Asia only
No, supplies
Asia only
Venezuela
6.7
VENEZUELA
Yes
No, USA only
No, USA only
Total
Capacity
245.8
- 168-
Table 41 LNG Regasification Plant Assumptions by Scenario

Country
Belgium
France
France
Capacity
(bcm)
10.0
13.0
11.4
Plant
Fully
Competitive
Yes
Yes
Yes
Most
Competitive
Yes
Yes
Yes
Constrained
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
France
Greece
7.1
2.2
ZEEBRUGGE
FOS SUR MER
MONTOIR DE
BRETAGNE
Fos Cavou
REVITHOUSSA
Italy
Italy
8.3
6.0
BRINDISI
MARINA DI ROVIGO
Yes
Yes
Yes
Yes
Yes
Yes
Italy
3.5
Yes
Yes
Yes
Italy
3.0
LA SPEZIA
(PANIGAGLA)
ROSIGNARIO
Yes
Yes
Yes
Italy
Italy
Italy
Italy
7.0
4.0
8.0
8.0
GIOIA TAURO
MONFALCONE
TRIESTE
TARANTO
Yes
Yes
Yes
Yes
Yes
Yes
Not go ahead
Not go ahead
Not go ahead
Not go ahead
Not go ahead
Not go ahead
Italy
Netherlands
8.0
9.0
SYRACUSE
ROTTERDAM
Yes
Yes
Not go ahead
Not go ahead
Not go ahead
Not go ahead
Portugal
5.8
GdP
Yes
Yes
Yes
Spain
Spain
Spain
Spain
10.5
10.5
9.2
9.2
BARCELONA
BILBAO
CARTAGENA
CASTELLON
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Spain
Spain
Spain
3.9
5.3
10.6
FERROL
HUELVA
PUERTO
SAGUNTO,VALENCIA
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Sweden
2.0
BALTIC LNG
Yes
Not go ahead
Not go ahead
Turkey
Turkey
UK
UK
6.2
5.5
13.9
6.0
ALIAGA (IZMIR)
MARMARA
ISLE OF GRAIN
DRAGON LNG
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
Yes
UK
UK
9.9
10.0
SOUTH HOOK
CALOR GAS
Yes
Yes
Yes
Not go ahead
Yes
Not go ahead
Total
Capacity
227.0
- 169-
Gas Contracts and Spot Trading

Within the model we have a number of switches which can set to simulate the future
structure of gas contacting ranging from long term contracts to spot trading. The
following describes the assumptions for each scenario:
In Fully Competitive all long term contracts are removed and there is full gas to
gas competition.
In Most Competitive the existing long term contracts are extended for Russia
but other suppliers move to shorter contracting and spot. Although contract
volumes remain in force pricing is assumed to move to market related basis
with no linkage to oil prices.
In Constrained gas contracts are extended after their existing terms for all
contracts and the link between gas and oil prices is retained.
US Gas Prices
The European Gas Model includes scope to simulate the impact of arbitrage in the
Atlantic Basin LNG market. This requires assumptions to be entered for LNG
terminal capacity in USA and for US wellhead prices.
We have based our assumption for US gas prices on a recent report by the US
Department of Energy79. For our Fully Competitive and Most Competitive cases we
have taken the US gas price from the DOE reference case whereas as for our
Constrained case we have taken the DOE Restricted Supply case as this is includes
restrictions on LNG imports which is consistent with our Constrained Case.
As European gas prices are set by pipeline gas imports in Fully Competitive and Most
Competitive scenarios, LNG imports and hence the US gas price does not influence
European prices in these two scenarios. Consequently, the DOE Reference case is of
less relevance to this study than the DOE Restricted Supply case. Nevertheless we
give a brief a brief synopsis of the Reference Case below.
DOE Reference Case
The DOE Reference case projects that lower 48 wellhead gas prices will decline from
the 2003 level of $4.90 per 1000 cu ft to $3.60 per 1000 cu ft (2003 prices) by 2010
and thereafter will rise to $4.16 per 1000 cu ft by 2015 and $4.79 per 1000 cu ft by
2025. This assumption was used for both the Fully Competitive case and the Most
Competitive case.
79
Department of Energy, Energy Information Agency, Energy Outlook, February 2005
- 170-
Growth in consumption is led by the electric power sector based on the assumption
that all new-build plant will be gas-fired80.
Total production grows by about 9% over the period to 2015. Growth in gas
production comes mainly from unconventional sources including tight sands, shale,
and coalbed methane. An important assumption in this regard is that technological
progress will continue at historical levels so that the projected wellhead price is
sufficient to make production from these unconventional sources economic.
The Reference Case assumes that gas from North Slope will come on stream from
2016. Consequently the contribution of Alaskan gas in 2015 is minimal.
Canadian imports are projected to decline from 110 BCM in 2003 to 88 BCM in 2009
and then increase back to 105 BCM by 2015. USA continues to be a net exporter to
Mexico, even though the case includes an LNG import terminal in Baja California
which exports gas from western Mexico to the USA from 2006.
The Reference Case assumes that, with the exception of the facility at Everett,
Massachusetts, three of the four existing U.S. LNG terminals (Cove Point, Maryland;
Elba Island, Georgia; and Lake Charles, Louisiana) are expected to expand by 2007;
and additional facilities are expected to be built in New England and elsewhere in the
lower 48 States, serving the Gulf, Mid-Atlantic, and South Atlantic States, including a
new facility in the Bahamas serving Florida via a pipeline. Another facility is
projected to be built in Baja California, Mexico, serving a portion of the California
market. Total net LNG imports to the United States and the Bahamas are projected to
increase from 16 BCM in 2003 to 153 BCM in 2015.
Table 42 Key Outcome of DOE Reference Case
BCM
Total Consumption
Of which electric power
Production
Imports
Of Which Canada
Mexico
LNG
Average Lower 48
Wellhead Price $/mcm
(2003 dollars)
2003
769
175
675
114
110
-12
16
176
2015
986
296
736
248
105
-10
153
147
80
The DOE considers that coal plant will become competitive for new build towards the end of the
outlook period, i.e. later than 2015.
- 171-
Restricted Supply Case

In the restricted natural gas supply case, the availability of future domestic gas
production is constrained by rates of technological progress that are 50 percent lower
than those observed historically. Natural gas imports are constrained by the
assumption that only the currently scheduled proposed expansions of existing U.S.
terminals are permitted to go into operation, along with new LNG terminals already
under construction.
Net LNG imports in 2015 are projected to be 83 BCM in the restricted supply case,
compared with 153 BCM in the Reference Case. Currently planned expansions at the
four existing LNG terminals and the construction and operation of the Excelerate
Energy Bridge terminal are responsible for the increase in future LNG imports
projected in the restricted supply case, relative to the 16 BCM net LNG imports in
2003.
The higher natural gas prices projected in the restricted supply case have a mixed
impact on net imports of natural gas from Canada. In the near term, the higher prices
are projected to stimulate Canadas production, and in 2015 U.S. imports of natural
gas from Canada are projected to be 112 BCM compared with 105 BCM in the
Reference Case.
Projected natural gas production is not significantly different in the restricted supply
and reference cases, because the higher prices projected in the restricted supply case
largely offset the lower assumed rate of technological progress. The Restricted Supply
case projects total US gas production of 722 BCM in 2015, 2 percent less than
projected in the Reference Case.
Table 43 Key Outcome of DOE Restricted Supply Case
BCM
Total Consumption
Of which electric power
Production
Imports
Of Which Canada
Mexico
LNG
Average Lower 48 Wellhead
Price $/mcm
(2003 dollars)
2003
769
175
675
114
110
-12
16
176
2015
916
247
722
188
112
-7
83
181
Other Cases
The DOE Report also considered sensitivities to the pace of technological
development.
In the slow oil and gas technology case, advances in exploration and production
technologies are assumed to be 50 percent slower than those assumed in the reference
- 172-
case, which are based on historical rates. (Note the same assumption regarding
technology is made in the Restricted Supply Case). Wellhead gas prices are about 7%
higher in this case compared with the reference case.
The rapid technology case assumes 50 percent faster technology progress than in the
reference case, resulting in lower development costs. Wellhead prices are 9% lower
than the Reference Case.
The study also considered a range of assumptions for world oil prices. However, the
impact of varying the oil price on gas wellhead prices is minimal.
- 173-
Table 44 High Level Overview
Demand
Supply
Infrastructure
and
Oil Price
Fully Competitive Case
Most Competitive
Constrained
Conventional EC/IEA view
As Fully Competitive case but sensitivty also

produced for higher demand resulting in particular
from more gas use in power generation
As Fully Competitive case
Plentiful supply and infrastructure so that there is

strong competition to supply gas to Europe
Adequate supply and infrastructure so that there is

supply competition but some routes may be
constrained
Adequate gas to supply demand but not enough

spare capacity to stimulate effective competition
DTI Fully Competitive case $30/bbl real
DTI Fully Competitive case
DTI Fully Competitive case

Plus sensitivities of $40/bbl real and $20/bbl
EU Liberalisation
Fully competitive gas market in EU with

widespread development of hubs and de-linkage of
gas price from oil in contracts
EU Liberalisation is well developed but continues

to operate on national markets basis
EU directives are implemented but that does not

lead to a fully competitive gas market
Reform in pipeline supply

area
Fully reformed
Only partial reform.
Little change from 2005 position.
Russian export policy give high priority to

maximising volume sales to Europe
Russia takes a global approach to gas exports

including China and world LNG market
Spot market increases to around 15% of total LNG

sales
Spot market continues to represent about 5% of

LNG trade
Development of the LNG

market
Fully commoditised LNG market with development

of an LNG exchange
- 174-
6.2. Market Characteristics by Scenario

Table 45 Market Characteristics by Scenario - EU Production
Most Competitive
Constrained
Open licensing procedures
Yes
Yes
Yes
Tax regime which encourages

investment, both foreign and
domestic
Yes
Yes
Yes
Multitude of producers; equity

partners sell gas individually
on short term contracts
The norm for all new field developments
The norm for all new field developments
Only in UK
Producers have access to

liquid wholesale gas markets
Widespread development of spot markets and hubs with

good liquidity
Widespread development of spot markets and hubs with

good liquidity
Virtual hubs continue to develop but few physical hubs

outside NW Europe
Lack
of
anti-competitive
contracts between producers
and buyers
Yes
Yes
Yes
Removal of special purchase

arrangements
Yes
Yes
No
- 175-
Table 46 Market Characteristics by Scenario - EU Wholesale (Part 1)

Proactive Regulation by both
energy
regulators
and
competition authorities

Regulators have succeeded in advancing liberalisation
within EU
Governments energy policy
Energy mix left to market to determine
Multitude of wholesalers and

suppliers
Multitude of Customers
Multiple suppliers with no dominant supplier
Most Competitive
Regulators have succeed in advancing liberalisation within
most countries
Laggard countries under pressure because of reciprocity
issues
Energy mix left to market to determine
Customer pressure
Widespread interest in buying gas on competitive terms by

LDCs, power generators and large industrials
Development of transparent spot prices and multitude of
suppliers encourages customers to demand low price and
high service
Complete unbundling of all TSOs
Release gas widely used to pump prime the market but no

longer needed by 2015
Completely removed. Contract mainly short term
Multiple supplier but one company still retains .25% of

market share
LDCs, power generators and large industrial customers
Development of transparent spot prices and multitude of
suppliers encourages customers to demand low price and
high service
Power gen customers seek changes in the structure of gas
contracts with links to power price
Only legal unbundling in some countries but effective
regulation and Chinese walls
Release gas still seen as necessary to enable new entrants
to obtain gas supplies
Completely removed. Contract mainly short term
Widespread all over EU
Widespread all over EU
Anti Competitive contracts

between TSO and LDCs
Development of liquid spot
markets and hubs
Constrained
Regulatory efforts continue to be frustrated in some
countries which adopt lax regulation
Some government intervention such as German policy in

favour of coal. Special taxes of gas continue to apply
Incumbent company retains large market share in some
countries
Customers more wary of competition
Customers wary of impact of competition fearing price
volatility and reduced security of supply
Only legal unbundling in some countries. TSOs continue to

favour supply affiliates
Release gas has been tried but with limited success due to
difficulties in obtaining transmission capacity
Mostly removed but still some left
Limited to UK and NW Europe
- 176-
Table 47 Market Characteristics by Scenario - EU Wholesale (Part2)

Open access to infrastructure
Ownership of Networks
Regulated
TPA
to
transmission
networks,
storage and LNG
Regulated
Transmission,
storage and LNG charges
Balancing regimes
Gas Quality
Investment
interconnectors
pipelines
in
and
new
transit

Shippers can move gas long distances efficiently and at
cost reflective tariffs
Some concentration in ownership of networks but this does
not inhibit competition in supply since networks are
effectively regulated and unbundled from suppliers.
Implemented as result on second and third gas directive
Most Competitive
TSOs operate on national basis. Gas can be shipped across
boundaries but not easily as in Fully Competitive case
Some concentration in ownership of networks but this does
not inhibit competition in supply since networks are
effectively regulated and unbundled from suppliers
Constrained
Difficult to arrange transport over several countries.
Some TSO still operate unreasonable balancing systems
TSOs remain powerful local monopolies with ability to
influence governments and are able to protect their supply
affiliates
Implemented but not always enthusiastically by some
member states

Regulators ensure real price decreases

Daily is minimum period

Harmonisation of gas quality or regional differences with
treatment services at hubs so all gas is tradable
Daily is minimum period

Harmonisation of gas quality or regional differences with
treatment services at hubs so all gas is tradable
Market Driven
Market driven

Regulators fail to ensure real price decreases or TSOs are
allowed to over charge for ancillary services such as
balancing
Mixture of daily and hourly
Regional differences without sufficient treatment resulting
in constraints on gas trading and separation of transit from
national networks
Some pre-emptive investments allowed
- 177-
Table 48 Market Characteristics by Scenario - EU Retail

Regulators have succeeded in advancing liberalisation
within distribution
Most Competitive
Regulators have succeed in advancing liberalisation in the
distribution sector
Constrained
Regulatory efforts continue to be frustrated in some
countries which adopt lax regulation
All over EU
All over EU
Limited to UK and NW Europe
Multiple suppliers with no dominant supplier
Multiple supplier but one company still retains >30% of

market share
Customer pressure
All customers are keen to switch supplier for competitive

terms including residential customers
Complete unbundling of all DSOs
Industrial and commercial customers are keep to switch

supplier but residential customers prefer to stay with the
traditional supplier
Only legal unbundling in some countries but effective
regulation and Chinese walls
Active in industrial and commercial market but not as
much in retail
LDC remains the dominant local supplier especially in the

residential market
Some industrial and commercial firms buy gas on
wholesale market.
Only relatively large customers willing to switch supplier
for competitive terms
Proactive Regulation by both

energy
regulators
and
competition authorities
Access to liquid wholesale
market
Multitude of Suppliers
Development
of
public
awareness on ability to switch
suppliers
Widespread at all customer levels
Only legal unbundling in some countries. DSOs continue

to favour supply affiliates
Limited to large customers
Procedures in place
Procedures in place
Procedures technically in place but administratively

difficult
Standards of Service, PSO and

security of supply
Standards of service are retained as required by the gas

directive and this is not an issue for competition
Standards of service are retained as required by the gas

directive this is not an issue for competition
Regulated TPA to distribution

networks
Regulated distribution network
charges
Incentives to invest and make
capacity available
Implemented as result of the second gas directive

GGP drawn up for distribution access
Implemented as result on second gas directive
Market Driven
Implemented as result of the second gas directive

GGP drawn up for distribution access
Implemented as result on second gas directive
Market driven
Concern of standards of service used as excuse to go slow

on liberalisation and
reinforce customers unwillingness to switch supplier
No effective access to distribution networks
Smooth
procedures
suppliers
administrative
for
switching
- 178-
Implemented as result on second gas directive but

regulators fail to ensure real price decreases
Restricted
Table 49 Market Characteristics by Scenario Pipeline Area Production

Foreign
investment
encouraged through tax regime
and open licensing
Multiple producers
Dominant national production

company
Equity
partners
sell
individually on shorter term
contracts
liquid wholesale markets

Foreign investment is encouraged in all pipeline producer
countries
Most Competitive
Foreign investment is encouraged in all pipeline producer
countries
Constrained
Foreign involvement limited especially Russia
Producer numbers increase as new countries supply Europe

(FSU, Iran, Egypt, Iraq, Nigeria)
Producer numbers increase but fewer new supply countries

than in ref case
Market continues to be characterised by small number of

large producers including Gazprom, Sonatrach etc
Proliferation of independent producers
Some growth in independent producers
Broken up
Not broken up but independents can compete to some

extent
Gazprom continues to sell on long term contracts. Norway
and Algerian gas sold on short term contracts
Production continues to be dominated by national

producers such as Gazprom and Sonatrach.
Gazprom continues to sell on long term contracts. Norway
and Algerian gas sold on short term contracts
Hubs from but limited liquidity especially in respect of

Russian gas.
Trading of gas from Algeria and Caspian area is more
liquid as pipelines are extended into central Europe
(Medgaz and Nabucco )
Few physical hubs develop outside NW Europe
Occurs as result of break up of dominant national

producers
Hubs form around EU borders and liquidity develops
- 179-
Table 50 Market Characteristics by Scenario Pipeline Area Wholesale

Constrained
Regulation remains a government function
Multitude of Customers
Transportation and supply legally unbundled

Multiple suppliers but one company retains 25% market
share
Most Competitive
Regulators are set up but real reform is hampered by
political problems such as cross subsidy of domestic
markets
Largely accounting separation only
Multiple supplier but one company still retains 50% of
market share
Customer Pressure

LDCs, power generators and large industrials

LDCs, power generators and large industrial customers
Customers more wary of competition (as above)
The pipelines in Russia and transit countries are opened up

under pressure from World Bank, EU and other western
agencies
As above
Limited access on a long term contractual basis for partners

in new infrastructure projects
Gazprom continues to control export pipelines
Negotiated tariffs only
Gazprom continues to control export pipelines
Market Driven
Market driven
Restricted
Proactive regulation
Effective unbundling
Regulated
TPA
to
transmission networks and
storage
Regulated transmission and
network storage charges
Incentives to invest and make
capacity available

Independent regulators set up producer and transit
countries with active roles
- 180-
Very little progress on separation

Incumbent company retains large market share in most
countries
Table 51 Market Characteristics by Scenario LNG Area Production

Foreign
investment
encouraged through tax regime
and open licensing
Multiple producers
Dominant national production

company
Equity
partners
sell
individually on shorter term
contracts
liquid wholesale markets

Foreign investment is encouraged in all LNG producer
countries
Most Competitive
Foreign investment is encouraged in all LNG producer
countries
Constrained
Foreign involvement limited
Producer numbers increase as new countries supply Europe

Proliferation of independent producers within the supply
countries
Producer numbers increase but less so than in Fully

Competitive case
LNG supply to Europe limited to current planned projects
Occurs as result of break up of dominant national

producers
Some growth in independent producers

Not broken up but independents can compete to some
extent
Current trend to shorter contracts continues with more
contracts linked to power prices
The LNG spot market continues to grow in importance
Broken up
Production continues to be dominated by national

producers such as Sonatrach.
Long term contracts continue to prevail in the LNG market
with prices linked to oil in Europe
Spot LNG remains a marginal market compared with long
term contracts
Table 52 Market Characteristics by Scenario LNG Area Wholesale

Development of spot market in
LNG
Spare capacity in ships and
terminals
LNG
operators
develop
Portfolio approach

Most Competitive
Considerable spare capacity which allows for flexible

trading and diversion of cargoes
Producers continue to move downstream by taking
capacity in regas plant in Europe and build ships not
dedicated to fixed supply routes
Considerable spare capacity which allows for flexible

trading and diversion of cargoes
As Fully Competitive
- 181-
Constrained
Spot LNG remains a marginal market compared with long
term contracts
Lack of spare capacity chokes off development of spot
trading
With some exceptions the traditional buyer/seller model for
LNG sales continues to apply in Europe
- 182-
7. IMPLICATIONS OF A COMPETITIVE GAS MARKET

In this section we address the question:
What are the implications of this level of of competititiveness for UKs energy
markets, especially the prices and security of supply issues we might face
To do so we draw on the results and outputs from the EGM model for various
scenarios and sensitivities, as outlined in section 6, and consider gas price
implications, gas supply patterns and security of supply and market dominance in
Europe generally and UK in particular. Detailed supply-demand balances for key
countries in 2015/16 are included in Appendix 10.
7.1. Gas Price Implications
The EGM model calculates the spot price in each quarter in each country as the
marginal cost of supply including gas costs, transportation costs and storage costs.
The marginal cost is the increase in total costs in the entire model that result from
increasing the demand for a particular country in a particular quarter by a small
increment (1 million cubic metres), whilst holding all other assumptions and
constraints unchanged. As there are 25 countries in the model and four quarters, there
are 100 spot prices to be calculated.
Fortunately it is not necessary to rerun the model 100 times to extract all the spot
prices. This is because the mathematics of linear programming allows the marginal
prices to be calculated during the optimisation process. The disadvantage of this
mathematical device is that it can be less than straightforward to interpret the resulting
spot price. For example an increase in demand in Germany could result in increased
import to Germany from Russia. The marginal cost would be the marginal production
cost in Russia plus transportation costs for the additional flow. However, there may be
second order effects which impinge on the spot price calculation as the model is free
to adjust any of the variables to obtain the optimum solution. So, to simplify the
explanation of marginal prices in the following discussion we concentrate on the
primary factors which determine the spot price and ignore second order effects.
Gas prices in the three scenarios (Constrained, Most Competitive and Fully
Competitive) are summarised in Table 53 for each of the 25 countries included in
EMLs European Gas Model. For the Constrained case we show both the spot price
and WACOG (weighted average cost of gas) which is the cost of gas for all import
contracts (long term and spot) and indigenous production weighted by volume. In all
cases other than the Constrained Case the WACOG is the same as the spot price
because in the case of the Most Competitive Case all contract prices are set to market
related prices and in the Fully Competitive Case there are no long term contracts. The
Constrained Case contract prices are based on an oil price of $30/bbl. Sensitivities to
different oil prices are discussed below.
Generally, price (or basis) differentials between countries, including those between
the UK and other Member States, should reflect the transportation tariffs on the
- 183-
connecting pipeline systems. In the Constrained and Most Competitive Cases,

contractual and physical constraints on the pipeline systems result in basis
differentials diverging from the transportation tariffs. In the Fully Competitive case,
where almost all constraints have effectively been removed, basis differentials
generally do reflect the tariffs. Also, in the Most Competitive and Fully Competitive
cases, the general pattern is for prices to get higher the further west in Europe the
country is. However, in the Most Competitive cases it is noticeable that prices in
Central Europe (Austria, Hungary and Romania) are relatively higher than in
neighbouring countries, which is likely to be a result of capacity constraints
preventing these countries accessing cheaper Russian gas. This would signal the need
to build more capacity and over time these large differentials could be expected to be
reduced.
Table 53 Gas Prices by Scenario
P/Therm Real 2004 Prices
Constrained Case
Most
Competitive
MC
Sensitivity
Fully
Competitive
WACOG
Spot Price
21.3
27.1
23.1
21.7
18.9
31.0
17.1
19.9
21.1
19.5
10.8
12.3
21.1
20.8
10.8
12.5
14.6
15.3
11.6
16.3
22.0
17.7
17.6
31.7
23.0
20.3
17.7
11.6
37.4
22.8
10.9
13.8
8.2
20.6
14.6
11.7
13.8
8.2
21.7
15.5
14.0
13.8
9.1
16.1
14.2
Hungary
Ireland
Italy
Luxembourg
20.1
18.2
36.6
22.4
24.3
18.6
18.0
36.6
19.7
24.6
11.9
21.1
24.6
10.0
16.9
11.9
21.4
26.1
11.8
17.2
12.9
12.1
18.2
14.1
17.4
Netherlands
Poland
Portugal
Romania
Slovak Republic
23.7
19.0
21.7
18.8
19.8
26.1
11.5
12.7
16.5
15.8
16.1
9.8
20.5
20.0
8.6
16.5
10.7
21.5
20.0
8.8
12.7
9.2
17.6
11.2
11.7
Slovenia
Spain
Sweden
Switzerland
Turkey
22.8
18.3
18.8
28.0
20.5
30.6
18.8
32.8
13.2
13.6
14.1
20.5
13.3
16.0
14.4
21.1
16.2
15.0
12.7
15.2
23.5
31.4
34.9
31.5
14.1
20.4
14.1
22.0
11.2
16.6
Austria
Belgium
Bulgaria
Croatia
Czech Rep
Denmark
Finland
France
Germany
Greece
UK
- 184-
Constrained Case
The key features of this scenario are:
Contracts remain in place and are extended beyond their current contract
periods;
Gas contract prices remain linked to oil;
Progress with liberalisation in Europe is disappointing
Gazprom remains dominant both in terms of Russian production and in

excluding Caspian are gas from the European market
The US wellhead price based on the DOEs Restricted Supply Case which
includes limited LNG import capacity in the USA and heavy reliance on US
production from unconventional sources resulting in a wellhead price of
31.6 p/therm.
In general the spot price is higher than WACOG that is marginal costs are higher
than the long term gas contract price based on a $30/bbl oil price. In this case gas
costs are being driven by LNG and many European countries are competing with
America for supplies. The UK spot price is around 31.5 p/therm reflecting the
effective role of the USA, as the marginal supplier, with an opportunity cost of 31.6
p/therm. The resulting spot price in UK in the summer is 30.1 p/therm which is the
wellhead price in the USA less a saving in LNG shipping costs of 1.3 p/therm.
Table 54 Constrained Case Sensitivities to US Wellhead Price
P/Therm Real 2004
Prices
DOE Reference
Restricted Supply/
Faster Technical
Development
Restricted Supply
High US Wellhead
UK Spot Price
Q3
Q4
US
Wellhead
Q1
Q2
25.8
28.9
28.0
30.5
29.0
32.1
25.5
28.6
25.5
28.6
27.0
29.9
31.6
36.5
32.0
37.0
33.6
38.6
30.1
35.1
30.1
35.1
31.5
36.4
Average
Table 54 shows the sensitivity of UK spot prices to US wellhead prices. The table
includes three cases in addition to the Restricted Supply case which is our base
assumption for the Constrained Case. The DOE Reference case includes significantly
higher LNG import capacity in the USA than in the Restricted Supply case with a
wellhead price of 28.8 p/therm. We have also considered a wellhead price of 28.9
p/therm which could arise from the Restricted Supply case combined with a faster
pace of technological development which would reduce the cost of production from
unconventional sources.
- 185-
Finally we have considered a wellhead price of 36.5 p/therm which is higher than any
of the DOE cases to cover a wider range of possible outcomes.
In all the cases considered the US wellhead price sets many of the European spot gas
prices in the summer months with storage costs further increasing winter spot prices.
Table 55 Sensitivity to Oil Prices (Real 2004 Prices)
P/Therm Real
2004 Prices
Spot
Price
$20/bbl
$30/bbl
$40/bbl
Belgium
Bulgaria
Croatia
Czech Rep
18.9
31.0
17.1
19.9
20.3
18.3
24.6
16.9
18.9
16.4
21.3
27.1
23.1
21.7
22.0
24.7
29.7
29.5
24.5
27.9
Denmark
Finland
France
Germany
Greece
17.7
11.6
37.4
22.8
18.6
17.7
12.6
29.4
19.3
17.8
17.7
17.6
31.7
23.0
20.1
17.7
23.1
34.2
27.0
22.7
Hungary
Ireland
Italy
Luxembourg
Netherlands
18.0
36.6
19.7
24.6
17.8
36.6
17.7
23.2
18.2
36.6
22.4
24.3
18.6
36.6
27.4
25.5
26.1
11.5
12.7
16.5
15.8
19.3
13.7
17.2
15.7
23.7
19.0
21.7
18.8
28.5
24.5
26.6
22.0
20.5
14.9
20.1
19.8
22.8
24.7
25.6
30.6
18.8
32.8
34.9
31.5
18.3
18.8
25.2
17.7
31.4
18.3
18.8
28.0
23.5
31.4
28.7
18.8
31.0
29.8
31.4
Austria
Poland
Portugal
Romania
Slovak
Republic
Slovenia
Spain
Sweden
Switzerland
Turkey
UK
Table 55 shows the sensitivity of WACOG to the oil price assumption of $20/bbl,
$30/bbl and $40/bbl. The oil price has a direct impact on contract prices because in
this scenario it is assumed that gas prices continue to be linked to oil product prices.
Spot prices, are not materially affected by the oil price since they are determined by
the cost of production and transportation as described above.
The low oil case ($20/bbl) reduces WACOG by between 1.2 and 6.4 p/therm
depending on the country. The variation arises partly because of differing oil
- 186-
escalators in different contracts but many from different weightings between

contracted and spot supply the more spot supply in the mix, the less variation there
is due to oil prices since spot prices do not change with the oil price.
The high oil case ($40/bbl) increases WACOG by between 1.2 and 6.3 p/therm.
In all cases UK WACOG is equal to the spot price in all oil price cases because we
assume in the model that input prices are pegged to the NBP price.
Most Competitive Case
The key features of this scenario are
Gas contracts are retained and the Russian contracts are extended beyond
their current contract terms
Contracted gas prices are rebased to market levels and the link with oil is
broken
EU liberalisation is well developed with more liquidity in the trading

markets and improved access to infrastructure within the EU. Tariffs have
been reduced from current high levels as a result of regulatory pressure but
remain high in Germany in particular compared to the UK benchmark.
There is some liberalisation of the Russian market with open access for
independent gas producers but Russia blocks gas from the Caspian except
along the route through Georgia, Turkey and the Nabucco pipeline.
There is sufficient flexibility in this scenario for pipeline supplies to set the gas price
in Europe. The marginal cost of production at the wellhead in Russia is $20/mcm (3.4
p/therm). There are four transportation routes for Russian gas to reach Germany:
The Brotherhood pipeline via Ukraine and Slovakia. and Czech Republic to
Waidhaus on the Czech/German border.
An alternative route for gas from the Brotherhood pipeline is from Slovakia to
Baumgarten on the Slovak/Austrian border and from there to Germany in the
WAG pipeline (Russian gas also flows to Italy via Baumgarten)
The newer Yamal Europe pipeline which transits Belarus and Poland to Frankfurt
Oder on the Polish/German border
The proposed North European Gas Pipeline (NEGP) which includes a sub-sea
crossing of the Baltic from Vyborg in Russia to Griefswald on the German coast.
Transportation charges along these routes are built up using the following
assumptions.
- 187-
Transportation costs of $1.00/mcm per 100 km on Russian terroritory from

Siberia to the borders with Belarus and Ukraine
Transportation tariff of $1.09/mcm per 100 km in Ukraine and Belarus
Transportation tariff of $0.75/mcm per 100 km in the EuroPolPipe section

of Yamal Europe in Poland
Transportation tariff of $1.50/mcm per 100km for the subsea section of

NEGP which yields 7% real pre-tax rate of return assuming a capital cost of
$2.4 billion for the offshore section.
Transportation tariffs in Germany and Austria are based on current

published prices and reductions between 2005 and 2015/16 based on PPI-2
formula.
This results in transportation costs for Russian gas to Germany as follows, based on a
3.4 p/therm wellhead cost:
Table 56 Most Competitive: Transport Tariffs From Russia to Germany

Brotherhood
via Waidhaus
$/mcm
P/therm
Delivered price for
Russian gas to
Germany
70.4
12.1
15.5
Brotherhood
via Baumgarten
and WAG
63.4
10.9
14.3
Yamal-Europe
55.9
9.6
13.0
NEGP
58.0
10.0
13.4
The summer spot price in Germany in this scenario is 14.0 p/therm set by Russian gas
delivered along the Brotherhood/WAG route the cheapest route with available
capacity - less some second order effects. The winter price is determined by Russian
supply with higher transportation charges along the Brotherhood/Waidhaus route.
The spot price in the UK is 18.7 p/therm in the summer and 22.2 p/therm in the
winter. The differential in the summer price is equivalent to the cost of transport from
Germany to the UK via Belgium and the interconnector.
The sensitivity case, which is based on higher demand (some 30 bcm higher than the
base case), has a German summer spot price of 15.2 p/therm set by Russian gas
delivered via Waidhaus while the winter price is set by Netherlands which provides
the required swing to meet winter demand. Spot prices also increase, maintaining
roughly the same differential with German prices as in the base case.
- 188-
The German and UK prices in the base case and sensitivity are summarised in the
following table.
Table 57 Most Competitive: UK and German Spot prices
P/Therm Real 2004
Prices
Germany Base
Case
Germany
Sensitivity
UK Base Case
UK Sensitivity
Spot Prices
Q1
15.2
Q2
15.2
Q3
14.0
Q4
14.0
Average
14.6
15.4
16.2
15.2
15.2
15.5
22.2
23.7
22.2
23.7
18.7
20.3
18.7
20.2
20.4
22.0

The Fully Competitive case represents the ideal world in which all conditions for a
truly competitive market are met. Although this is not considered to be a realistic
case, it is intended to provide the benchmark against which other cases can be
measured.
In this case the cost of Russian gas delivered to Germany is as indicated in the
following table, based on 3.4 p/therm wellhead cost.
Table 58 Fully Competitive: Gas Transportation Costs to Germany
Brotherhood
via Waidhaus
$/mcm
p/therm
Delivered price for
Russian gas to
Germany
66.2
11.4
14.8
Brotherhood via
Baumgarten and
WAG
55.6
9.6
13.1
Yamal-Europe
55.9
9.6
12.7
NEGP
53.1
9.1
12.6
The German summer spot price is 12.9 p/therm set by Russian gas delivered via
Baumgarten. The winter spot price of 16.2 p/therm which is seasonal differential of
3.3 p/therm set by storage.
The UK spot price 15.2 p/therm in the summer and 17.3 p/therm in the winter. The
differential between UK and German spot prices is 2.3 p/therm, compared with 5.8
- 189-
p/therm in the Most Competitive case because of lower assumed transportation

charges in Germany.
Table 59 Fully Competitive: UK and German Spot Prices

P/Therm Real 2004
Prices
UK Spot Price
Q1
14.9
17.3
Germany
UK
Q2
16.2
18.7
Q3
12.9
15.2
Q4
12.9
15.2
Average
14.2
16.6
7.2. European Gas Supplies

The breakdown of supplies to Europe is summarised in Table 60. In all scenarios
production within Europe is under half of the 2000 level. The UK Production figure of
18 BCM is consistent with the JESS report. Netherlands continues to operate within
the 80 BCM cap on total production.
Table 60 European Gas Supply by Scenario
BCM
2015/16
2003
Fully
Competitiv
e
Most
Competitive
Most Comp
Sensitivity
Constrained
Indigenous production
73
Netherlands
108
UK
75
Other
63
18
33
74
18
27
77
18
30
74
18
39
256
113
119
125
131
135
68
30
209
127
71
255
127
60
276
127
61
247
127
54
4
0
237
61
20
488
38
14
494
37
15
516
30
15
474
26
26
18
21
37
2
0
10
1
39
45
10
13
21
114
14
17
40
13
102
15
17
40
13
106
14
17
30
14
111
532
716
715
747
715
Total
Production
Pipeline Imports
Russia
Norway
Algeria
Caspian
Other
Total pipeline
LNG Imports
Algeria
Qatar
Egypt
Nigeria
Other
Total LNG
Total Supply
- 190-

Demand
NB LNG to
USA
532
716
716
747
716
14
100
77
89
62
There are significant new supplies from Caspian and other pipeline areas and
expanded LNG in all scenarios which helps to contain Russian dominance of the
import mix. Caspian and other supplies could reach 81 BCM in the Fully Competitive
case represesenting some 12% of European demand. The equivalent figure in Most
Competive is 52 BCM (for both the base and higher demand sensitivity) and 45 BCM
in the constrianed case as Caspian supplies are limited.
LNG imports could almost treble by 2015/16 to 114 BCM in the Fully Competitive
case and slightly less in other cases.
Russia continues to be the biggest source of supply in all scenarios. In Fully
Competitive some 29% of European demand is met from Russia, compared with 25%
in 2003, although in this case there would be a number of producers contributing to
the total, not just Gazprom. In the other scenarios the Russian contribution ranges
from 35% to 37% of demand.
Algerian pipeline supplies increase from 30 BCM in 2003 to 71 BCM in 2015/16 in
the Fully Competitive case supported by the Medgaz pipeline to Spain with an
extension into France and the Galsi pipeline to Italy. In the Most Competitive and
Constrained case we have excluded Galsi and in the Constrained case the Medgaz
pipeline is not extended into France. This results in Algerian imports by pipeline of 60
BCM in Most Competitive and 54 BCM in Constrained.
- 191-
Figure 11 European Gas Flows in 2015/6 Constrained $30 Oil Price Case
2 0 1 5 /1 6 C O N S T R A IN E D $ 3 0 C A S E E U R O P E A N G A S
FLO W S
LNG
5.4
N a tu ra l G a s M a in E x p o rte rs
A lg e ria
N e th e rla n d s
N o rw a y
R u ss ia
U n ite d K in g d o m
O th e r
LNG
4 .8
LN G
25.0
0 .6
IR E
4.6
14 .8
T e l: + 4 4 ( 0 ) 2 0 82 32 1 57 0
8 .9
LNG
S o u rc e : E u ro p e a n G a s M o d e l F lo w R e s u lts
U n its: S ta n d a rd B C M
C o p yrig h t E n e rg y M a rke ts L im ite d
3 3.0
NET
9 .1
26.0
0.5
BEL
G ER
10 .8
LNG
6 0.1
1.2
6.0
18 .0
1 .2
LNG
1 .8
42 .1
10 .0
AUS
10.0
SPA
2.4
2.1
9.9
6 .0
13 .0
9.9
MOR
ALG
34 .3
TU N
L IB
2.2
15 .3
0.5
CRO
C AS
BUL
5 .6
2.2
IT A
34 .3
44.1
2 3.9
2 6.1
LN G
10 .0
1 6.2
ROM
S LN
0.9
3 1.5
0.6
HUN
5 .0
8 .2
7.0
FR A
SLK
C ZE
0.5
1.2
1.4
SW I
3 0.3
1 14.2
3 .0
0.3
9 .1
3.4
RUS
49 .9
8 .9
LU X
48 .1
POL
3 0.5
2 .0
0.2
0.3
3.0
2.0
8.0
9 .2
1.3
9.5
DEN
6 .0
UK
21 .0
1 .3
44 .8
49 .4
w w w .e n e rg y m a rk e t s.e u .co m
POR
F IN
SWE
NOR
GRE
1 2.6
TU R
1 .4
1 2.8
LN G
LN G
2 0.7
1 .2
9.6
IR N
LN G
- 192-
Figure 12 European Gas Flows in 2015/6 Most Competitive Base Case
2015/16 M O ST
S E C AS E E U R O P E A N
S T C O M P E T IT IV E B A
AS
GA
S FLOW S
AS
35.0
LNG
5.6
N a tura l Gas M a in Exp orte rs

A lg eria

N eth erlan ds

N orw a y

R ussia

U nited Kingd om
O ther
L NG
4 .8
0 .6
IR E
LN G
44 .8
49 .4
3 3.7
8.0
9 .2
3 4.9
NET
2.9
14 .8
Tel: + 44 (0) 20 82 32 1570
1 2.8
26.0
0.2
BEL
G ER
5.4
4 3.0
1.2
9.8
1 .2
LN G
3 .0
10 .0
4 .9
10.0
SPA
8.4
1.6
13 .5
9.9
MOR
AL G
34 .4
TU N
2.7
IT A
34 .4
L IB
1 5.4
RO M
10.1
0.1
CRO
39.9
2 5.9
16 .0
C AS
BUL
6 .3
LN G
16 .0
2.6
2 6.1
6 .0
9.9
S LN
0.9
2 7.8
0.6
HUN
7 .8
AU S
7.0
FR A
1 .8
3.0
34 .1
1.4
SW I
3 0.4
S LK
C ZE
4.8
1.2
9 .9
18 .0
8 9.1
3 .0
0.3
LNG
RU S
32 .7
4 .4
LU X
50 .0
POL
3 7.5
4 .4
LNG
So urc e: Eu rope an Gas M od el Flow Results

U nits: Stand ard BC M
Co pyrig ht En erg y M a rke ts Lim ited
POR
9.5
DEN
6 .0
UK
21 .5
w w w .e n e rgym arke ts.eu.co m
3.4
F IN
1.3
SWE
N OR
G RE
1 4.0
TU R
0 .7
1 2.8
LN G
LN G
2 8.8
10.2
1 .2
9.6
IR N
LN G
- 193-
Figure 13 European Gas Flows in 2015/16 Fully Competitive Case
2015/16 FULLY COMPETITIVE CASE EUROPEAN GAS

FLOWS
25.0
Natural Gas Main Exporters
Algeria
Netherlands
Norway
Russia
United Kingdom
Other
LNG
25.0
5.3
IRE
LNG
49.4
13.0
UK
14.1
44.8
LNG
0.9
6.0
4.5
1.6
0.3
14.8
5.0
LNG
Source: European Gas Model Flow Results

Units: Standard BCM
Copyright Energy Markets Limited
33.0
0.3
2.5
1.5
25.0
0.9
SWI
34.2
FRA
13.7
AUS
0.8
31.5
2.9
9.9
9.4
35.0
15.0
9.9
ALG
35.0
10.0
LIB
1.2
1.3
CRO
34.6
CAS
1.0
LNG
6.5
5.4
3.7
11.8
34.4
5.5
BUL
GRE
1.4
ITA
ROM
4.3
LNG
TUN
1.4
15.3
1.2
SLN
SPA
16.0
12.3
HUN
32.1
SLK
3.6
18.0
10.7
MOR
41.8
17.6
7.2
CZE
0.9
LNG
3.2
4.3
7.2
LUX
LNG
RUS
GER
BEL
1.4
48.1
POL
4.2
7.2
POR
24.6
NET
Tel: +44 (0) 20 8232 1570
3.2
9.5
DEN
4.2
FIN
0.4
SWE
NOR
5.0
TUR
22.8
IRN
EGY
- 194-
In section 4.3.5 we showed that Russia and hence Gazprom supplied 49% of all
imports to Europe in 2003. In all scenarios we expect Russian exports to increase in
absolute terms but to decline as a percentage of total imports as new supplies come on
stream from other areas including the Caspian and global LNG. In the Constrained
case Gazproms share of total European imports is around 42% by 2015 assuming
Gazprom retains 100% interest in all exports to Europe.
Furthermore non-Gazprom production could reach as much as 37% of total Russian
production by 2015 and some of this gas could be exported to Europe in the Most
Competitive and Fully Competitive cases. In the following table we have assumed
that non-Gazprom exports account for 20% of Russian exports to Europe in the Most
Competitive case and 35% in the Fully Competitive case. This would result in
Gazprom market shares of 34% in the Most Competitive case and 23% in Fully
Competitive.
Table 61 Russia/Gazprom Market Share of European Imports by Scenario
BCM
Total Imports
Russian Imports
Of which
Gazprom
Gazprom Share
2003
Most Competitive
Constrained
276
135
135
Fully
Competitive
603
209
136
597
255
204
585
247
247
49%
23%
34%
42%
Similarly Sonatrachs market share is likely to decline markedly from 20% in 2003 to
13% to 16% depending on scenario (see Table 62).
Table 62 Algerian/Sonatrach Market Share by Scenario
BCM
Total Imports
Algerian
Pipeline
Algerian LNG
Total Algerian
Sonatrach Share
2003
Most Competitive
Constrained
276
30
Fully
Competitive
603
71
597
60
585
54
26
56
20%
26
97
16%
18
78
13%
31
85
15%
Norwegian exports to Europe are expected to increase in absolute terms but decline
slightly in percentage terms from 25% to 21% or 22% (see Table 63).
- 195-
Table 63 Norwegian Market share

BCM
Total Imports
Norwegian
Imports
Norwegian
Share
Statoil Share
2003
Most Competitive
Constrained
276
68
Fully
Competitive
603
127
597
127
585
127
25%
21%
21%
22%
15%
12%
12%
12%
7.3. UK Supplies
Shows the breakdown of gas supplies to UK by scenario. UK consumption increases
by 9 BCM between 2003 and 2015/16 (except in the sensitivity to the Most
Competitive case where the increase is 24 BCM). However the increase in UK
consumption is offset by decline in exports in the Interconnector and, in the Fully
Competitive case, in exports to Ireland (Ireland is supplied by a combination of
imports from Norway via the UK and indigenous gas).
In all cases Norway is the main contributor with volumes constrained by the capacity
of the Vesterled and Langeled pipelines. Netherlands is an important contributor both
via the BBL pipeline and, in the Most Competive sensitivity when UK demand is
higher, also via the Interconnector. In order to supply this amount of gas the
Netherlands imports increased quantities of gas from Russia.
In all scenarios LNG provides slighly less than a quarter of UK supplies, with the
origin of the LNG varying between scenarios.
The model shows that UK in 2015/16 could have a fairly diversified portfolio of
supplies. The breakdown of supplies in shown in Table 64 and Table 65 shows the
same information as percentage market shares
The largest single contributer is Norway, which despite being a non-EU country is for
all intents and pursposes subject to EU law. The reliance of Russia is between 4% and
14% depending on scenario. However, that simple statement understates the
importance of Russian supplies since it remains a major supplier to Europe as a whole
and security of supply for the UK cannot be considered in isolation from Europe.
- 196-
Table 64 UK Supplies by Scenario

BCM
2015/16
2003
Fully
Competiti
ve
Most
Comp
MC
Sensitivity
Constrained
101
18
4
18
9
18
14
18
14
44
13
1
10
4
49
11
0
3
19
49
20
0
3
20
49
8
4
3
14
10
104
Total supply
93
103
UK Consumption
4
0
Exports (Ireland)
12
0
Exports (via
Interconnector)
* Net of gas used in the petroleum industry
0
108
103
5
0
0
123
118
5
0
0
110
103
5
1
Production*
Russia
Norway
Netherlands
Algeria
Qatar
Nigeria
Egypt
Table 65 UK Supply Shares by Scenario

% Share
2015/16
2003
Fully
Competitive
Most
Comp
MC
Sensitivity
Constrained
Production
94
17
17
15
16
Russia
Norway
Netherlands
Algeria
Qatar
0
6
0
0
4
42
13
1
8
45
10
0
11
40
16
0
13
45
7
4
0
0
0
100
10
4
10
100
3
18
0
101
2
16
0
101
3
13
0
100
Nigeria
Egypt
Total supply
- 197-
7.4. Price Signals

In this section we address the following question:
What are the implications of a competitive gas market for responses to price signals
both in the short term and in the medium term?
The short term and medium term aspects are discussed separately below.
Short Term Issues
In a fully competitive market one would expect an efficient response to price signals.
This should result in price differentials between two locations which broadly reflect
the cost of transporting gas between them, since there is a clear opportunity to
arbitrage the difference by buying gas at the lower priced location and moving the gas
to the higher priced location, with a clear profit. Providing there is sufficient liquidity
and spare transport capacity between the two locations the potential to arbitrage
should result in increased demand in the first location and hence an increased price
and increased supply at the second location resulting in lower prices. The levelling of
prices should result in a price basis difference exactly equal to transportation cost
because then the profit to be made from arbitrage would vanish.
EML recently published a report on the Bacton Zeebrugge Interconnector which
included an analysis of how shippers had responded to price signals in the period
since start up of the Interconnector to August 2004. More precisely we looked at the
effect of prices on shippers short term decisions and to do so we first stripped out the
effects of long term contracts and concentrated the analysis on spot flows.
There are a number of long term contracts for forward flow in the Interconnector
amounting to some 10.5 bcm per annum. We believe around 4 bcm can be diverted to
UK under the contracts whenever UK prices are high enough for that to be
advantageous. Gas from Elgin and Franklyn fields can flow either into the UK NTS
for sale in Britain or into the Interconnector. The Conoco contract with Gasunie
includes a claw back term which allows the gas to be left in the UK. Discounted
these two contracts, leaves some 6.5 bcm per annum of firm commitment to deliver
gas in the forward direction.
On average, therefore, shippers would have to nominate approximately 0.54 bcm in
the reverse direction just to cancel out the firm contracted flows and reduce flows in
the interconnector to zero. Any reverse flow nominations in excess of 0.54 bcm in the
month would result in net imports.
In order to understand the effect of short term price movements on spot flow
nominations we have backed out the firm contracted volumes in Figure 14. The bars
in the figure are the net monthly flows reduced by 0.54 bcm.
The spot flows are then compared with the differential in the spot price between
Zeebrugge and NBP. As might be expected the level and direction of spot flows
- 198-
appears to respond fairly well to the price signal, showing strong export nominations
when the Zeebrugge price is higher than NBP and vice versa.
Figure 14 Comparison of Spot Flows With the Price Differential Between Zeebrugge Hub and
NBP
7.0
1.5
6.0
1
5.0
4.0
3.0
2.0
0
1.0
Pence/Therm
bcm (N) monthly
0.5
0.0
-0.5
-1.0
-2.0
-1
-3.0
-4.0
Ja
n01
Ap
r-0
1
Ju
l-0
1
O
ct
-0
1
Ja
n02
Ap
r-0
2
Ju
l-0
2
O
ct
-0
2
Ja
n03
Ap
r-0
3
Ju
l-0
3
O
ct
-0
3
Ja
n04
Ap
r-0
4
Ju
l-0
4
-1.5
Spot Monthly Flows
Zee Hub- NBP Basis p/th
The analysis presented above is on a monthly basis and so disguising some detail in
terms of the Interconnector shippers responses to changes to prices on a daily basis. It
does however, give a reasonably concise overview of how the Interconnector allows
shippers to respond to price signals.
However, as Ofgem indicated in its review of high gas prices in Britain, there have
been occasions when shippers response to price signals has not been as efficient as
one might expect and raised the question as to why gas supplies imported from
Europe had not increased more quickly when GB prices had increased above
European levels.
Ofgems analysis indicates that the main reasons for high gas prices are:
high oil prices feeding through to British prices, predominantly via the pipeline
link to the rest of Europe. Most gas contracts in Europe link prices to oil - this
happened in Britain before competition was established
- 199-
declining UK gas supplies. Winter gas supplies have fallen more quickly than
the market was expecting.
more expensive alternatives such as gas from other European markets to

replace UK supplies.
Ofgems further analysis into European gas supplies and the use of the interconnector
confirmed that the interconnector appeared to operate as would be expected in
response to relative prices in Belgium and Great Britain. Ofgems analysis concluded
that no company using the interconnector sought to manipulate the direction of flow.
The analysis identified a number of other factors that provide some explanation for
the time it took for the interconnector to begin importing gas. These include higher
demand due to cold weather in several European countries and an increased
requirement for gas to be placed into store in Europe ahead of winter because of
operational problems on the interconnector before the period covered by the probe.
However, Ofgem was not, on the basis of the information available to it, able to
answer a number of important questions.
The first is whether any of the European gas companies withheld surplus gas
supplies and prevented more gas flowing to the UK.
The second is whether European gas companies withheld transportation

capacity on the European pipeline networks and prevented more gas flowing
into the UK.
The third is whether their decision to continue to place gas in store, rather than
sell it to the UK, was reasonable given their forecast customer demand and
supply contracts for that winter.
Medium Term Issues

Traditionally European gas markets were centrally planned by national governments
and major gas utilities. For example in the UK the industry was closely managed by
British Gas which was solely responsible for forward planning and investment
required to meet the 1 in 20 peak day and 1 in 50 winter planning criteria. British Gas
was also responsible for building in planning margins to cater for mechanical
failures which could be reasonably anticipated. Although the detailed definitions vary,
most European gas markets operate to some form of security of supply criteria.
In a competitive market responsibilities are shared by different market participants.
The Transmission System operator has a responsibility to ensure there is adequate
transmission capacity available to meet expected demand growth but is not
responsible for securing adequate supplies of gas, other than possibly for safety and
balancing reasons. The provision of storage may be the responsibility of one or more
storage operator usually separate from the TSO.
In these circumstances security of supply depends heavily on the ability of price
signals to achieve the desired response to changing supply and demand conditions. In
the short term this may mean for example withdrawal of gas from storage in response
- 200-
to rising prices as a result of increased demand resulting from colder weather. In a

harmonised European market one would expect such responses to cross national
boundaries.
In the medium term price signals play a role in generating investment income. For
example a range of new import projects have come to the fore in the last year or two
in response to rising prices in the UK. Some of these projects were mooted some time
ago, for example the BBL pipeline idea was raised by Gasunie in the late 1990s but
has only become a firm project in the last year or two after prices in the UK had
already started to rise. Other projects have been proposed but failed to win support
such as Marathons proposed Symphony pipeline from Norway.
Because of the timescale involved in developing new capacity there is a risk that such
investment will not be timed to prevent a potentially tight supply and demand position
emerging for a year or two which can lead to volatile prices. Precisely this situation
has emerged in the UK market.
However, with all the capacity into the UK market coming on stream, a situation of
excess capacity is likely to arise, which could force UK prices down below levels in
other EU countries. In the medium term this may lead to reduced infrastructure
investment in the UK raising the spectre of possible capacity shortages again in the
future as UK production declines further.
The wholesale gas price forecasts in the 3 scenarios represent equilibrium prices
since the European Gas Model projects prices based on the fundamentals of supply
and demand. It is clearly possible that actual prices may overshoot or undershoot the
equilibrium levels which could obscure, or provide misleading, price signals to the
market. The experience of the UK, however, in recent years does suggest that the
price signals in a competitive market work, even if profit-maximising decisions lead
to more capacity being planned than might currently appear to be needed in the UK in
the immediate future.
7.5. Summary
Table 66 summarises the approximate breakdown of the UK gas price under each
scenario.
P/Therm Real 2004
Prices
Constrained Case
Most Competitive
Fully Competitive
UK Spot Price
Q1
32.0
22.2
23.7
17.3
Q2
33.6
22.2
23.7
18.7
- 201-
Q3
30.1
18.7
20.3
15.2
Q4
30.1
18.7
20.2
15.2
Average
31.5
20.4
22.0
16.6
The Constrained Case results in a UK spot price of 31.5 p/therm set by arbitrage with
USA in the LNG market. On a range of reasonable assumptions for US prices the UK
spot price could fall within a range of 27.0 to 36.4 p/therm. Under this scenario many
European countries prices are closely linked with US prices, since US prices are the
main driver of LNG spot prices, which in turn are the marginal supplier to much of
Europe. European contract gas prices would remain linked to oil prices in the
Constrained case. A +/- $10bbl change in oil prices could impact on contract prices,
and hence on the weighted average cost of gas in continental Europe, by up to +/- 6
p/therm.
other sources. The alternative is that potentially higher prices result from Europe
competing with the US for LNG supplies.The Most Competitive case would bring in
would be around 20.4 p/therm, or 11.1 p/therm less than in Constrained case. Supplies
from Russia are now the key in setting spot prices, with LNG supplies becoming a
price taker, as opposed to the price setter in the Constrained case.
Once access to adequate low cost gas is secured the greatest scope for containing gas
prices lies in reducing transportation charges. It is particularly important for the UK
placed almost at the end of the east-west supply chain that access to and the pricing of
transportation along the supply route is secured at an efficient cost. In the Fully
Competitive case, prices fall to 16.6 p/therm, partly because of access to lower cost
sources of gas but also due to this continued downward pressure on transportation
tariffs by the regulatory authorities across Europe.
The Fully Competitive Case, would not only help contain gas prices, through greater
pipeline capacity and increased liberalisation and competition, but also improve
security of supply to Europe because there is a much more diversified range of supply
countries contributing to supply. Russia will contribute a significant proportion of
European gas requirements under any scenario because of its reserve position.
However, in Fully Competitive, the Russian share is limited to less than 35% and
more importantly the gas is produced by a wider range of producers because of the
assumed break up of Gazprom and independent gas producers can market their gas
directly to Europe.
producers to decline to 69% in the Constrained case, 59% in Most Competive and
51% in Fully Competitive.
The UK would have a fairly well diversified supply portfolio in all scenarios with
Norway providing the greatest single source of supply providing between 42% and
45% of UK supply in 2015/16 compared with 6% in 2003. Reliance on Russian
supplies ranges from 4% in Fully Competitive to 14% in Constrained. However,
Russia is a major supplier to Europe in all scenarios and security of supply for Europe
as a whole will be highly dependent on Russian supply.
- 202-
8. ACTIONS FOR CONSIDERATION BY THE UK GOVERNMENT

In Section 5 the barriers to competition and a series of changes required in key
markets were described and discussed. This section considers the key changes in the
context of reviewing actions that might be considered by the UK Government.
Specifically two questions will be considered, as outlined in the Introduction:
Based on the above, what, if any, action (including influencing strategies) should
the UK Government consider in order to facilitate the development of competitive
gas markets?
What actions are needed by the EU and Regulatory Authorities in Member States?
In order to answer these questions this section will:
Outline a series of options and recommendations both for the UK Government and
the EU and Regulatory Authorities in Member States
Outline a strategy for the UK Government for the implementation of the agreed
recommendations
8.1. Options and Recommendations
The possible options and recommendations are linked directly to the barriers to
competition and the changes required in key markets as described in section 5. For
each barrier and change required, options for action by the UK Government will be
considered together with its priority or value and finally its achievability. These are all
summarised in Table 67, 68 and 69 below. Each barrier and change required has been
given a short title and a code.
The changes required in the key markets can be divided into the EU area and the
Pipeline Supply Area, since the actions that the UK Government can undertake will
differ between the two areas. Direct action that the UK Government can take is
relatively limited since almost all the changes required are outside the UK. Much of
the actions, therefore, will be limited to influence and persuasion, although under
certain circumstances it may be possible in the future for direct legal action to be
taken under EU Competition Law.
8.1.1. EU Markets
Key Changes
A number of the recommended changes required, especially at the EU Wholesale
market level, go well beyond the Second Gas Directive and further than has been
suggested at the Madrid Forum. If these changes are to be implemented, therefore,
most, if not all, of the other countries in the EU and the European Commission will
have to be persuaded of the merits of the changes. This is particularly true of the first
4 in the EU Wholesale list, which deal with access to essential facilities. These cover:
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Market Carriage TPA and Capacity Availability - Introduce market carriage TPA
model to provide more flexibility in capacity booking including UIOLI, and allow
rolled in treatment for capacity expansions
Harmonisation of TPA in the EU - Harmonisation of TPA structures across the

EU but need to avoid the pancaking of charges
Transit Regimes - Transit to be incorporated into main domestic transmission

systems. Increase importance of UK as a transit country.
Storage and Balancing - Presumption that all storage should be regulated TPA.
Simplified balancing regimes, with daily being the minimum balancing period
These are all considered to be a High priority with achievability being High or
Medium.
The only action which is in the direct control of the UK Government is the
recommendation to increase the importance of the UK as a transit country, since
planning permission can be granted for additional LNG terminals and developers can
be encouraged to seek sites in the UK. The clear intent of this, however, would be to
re-export any imports of gas to bring additional supplies to the EU market.
The remaining changes will all require a case to be made before the relevant parties
(EU governments and Commission).
The remaining 3 changes on the EU Wholesale deal with the issue of market power:
Effective Gas Release - Introduction of effective gas release programmes
Spot Market and Hubs - Spot markets and hubs will develop once the conditions
for effective competition are in place
Gas Purchase Contracts - Removal of anti-competitive clauses from contracts

and encouragement of shorter term contracts
Some progress is already being made in these 3 areas and the recommendations here
generally are in line with existing EU policy. The main thrust for here would be to
intensify the existing policy.
In respect of the changes required in the EU Retail market, we would suggest that
these are of slightly less importance than the reforms in the EU Wholesale market.
The changes cover both market power and access to essential facilities:
Distribution TPA - Introduction of consistent and coherent Network Codes,

specifically for distribution if separate from transmission
Gas Sales to LDCs - Removal of exclusive arrangements, shorten duration of

contracts and institute gas sales release programmes.
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Administrative Structures - Introduce cost effective and efficient supply point

administration
Unbundling of Transportation and Supply - Proper legal unbundling of

transportation, supply and storage. Reduction of distribution charges to eliminate
Upstream Costs - Introduction of full competition in the EU Wholesale market

and the Pipeline Supply Production and Wholesale market and firm regulatory
oversight on transportation tariffs
Information
While persuading the relevant parties of the case for some of these changes is
obviously important, the next steps, following agreement, would be to try and
implement the reforms. One of the major problems is the informational advantage
the incumbent gas companies have over the regulatory and competition authorities as
well as governments. There is also the presumption that the incumbents are innocent
until proven guilty. If progress is to be made the problem of informational advantage
and presumption of innocence need to be reversed.
As an example of this, the incumbents often argue that there is insufficient capacity
available on their systems to allow third parties to transport and hence supply gas, or
that there really is price competition but customers dont want to change supplier.
These issues need to be turned around so that the incumbents are required to prove
that all the capacity is being utilised and that there is real price competition. There is
at least, from our analysis, prima facie evidence of significant economic rent being
earned, particularly in the retail market. One method of getting the required
information would be to institute an EU wide benchmarking study for a number of
key areas:
Transmission and storage charges
Availability of transmission capacity
Separation and unbundling of transportation and supply;
Distribution network charges; and
Accounting for differences in end-user prices in EU countries.
However, our recommendation would be that this should be a benchmarking study

with a difference in that a full audit certificate would be required from each
companys auditors verifying the accuracy of all the information submitted.
The second way of removing the informational advantage would be to require the
publication and dissemination of considerably more information by participants in the
gas market. This could in part take the form of a 10 year statement prepared and
published by the transmission companies, just as Transco is required to do in the UK.
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Another area would be to require the publication of a much wider range of

information by all participants (subject to cost and commercial confidentiality)
including gas trades, storage flows, balances and pipeline flows.
EU Competition Law
The Competition Directorate of the EC recently announced an inquiry into the gas
sector. The competition authorities have an advantage over the DG Tren in that they
have more powers of investigation and can impose penalties if companies have been
found to abuse a dominant position. Thus the incentives to comply with competition
law are greater than with the Gas Directive for example. For EU competition law to
apply any the abuse has to affect trade between Member States rather than just trade
within a Member State.
Article 81 and 82 of the EU Treaty ban the abuse of a dominant position within the
common market insofar as it may affect trade between Member States. Abuse may
include the following:
Directly or indirectly imposing unfair purchase or selling prices or other unfair

trading conditions;
Limiting production, markets or technical development to the prejudice of
consumers;
Applying dissimilar conditions to equivalent transactions with other trading
partners, thereby placing them at a competitive disadvantage;
Making the conclusion of contracts subject to acceptance by the other party of
supplementary obligations which, by their nature according to commercial usage,
have no connection with the subject of the contract.
There are a number of features of the European gas market that may either
contravene the competition rules or be worth investigating. It would therefore be
useful to examine these issues in more detail.
Not Taking Gas Under Contract
Most gas in Europe is purchased under long term take-or-pay contracts. If the
contract volume is not taken in any period, the purchaser has to pay for the gas. These
payments are credited against future purchases when the gas is actually taken.
It is possible that not taking all the gas under a contract, when there a willing buyers
for it in the market be construed as limiting production.
Capacity Trading
One of the areas of concern is the difficulty of obtaining capacity rights to use EU
transmission systems. This is often because the existing gas suppliers have contracted
all of the existing capacity for themselves, leaving no capacity available to new
entrants. There are two key issues here. Firstly, were the arrangements for allocating
capacity fair and non-discriminatory? Secondly, is the lack of available unused
capacity on a secondary market an anti-competitive constraint?
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In a competitive market setting up arrangements that give priority to incumbent gas

suppliers might be considered to breach the competition laws in two respects. Firstly,
it could be argued that it places unfair trading conditions on the new entrants by
favouring the existing suppliers. Secondly it could be argued that dissimilar
conditions are being applied to equivalent transactions thereby placing new entrants
at a competitive disadvantage.
We know that demand is not constant throughout the year. Therefore on many days
there will be unused capacity in the system. One would expect a profit maximising
business to try to sell any spare capacity that it did not require. The lack of
willingness to sell any spare capacity indicates that these businesses are taking other
factors into account. Can it be argued that lack of willingness to sell unused capacity
constitutes an abuse by limiting production?
These concerns apply to both pipeline capacity and also to gas storage.
Transit Capacity
Competition rules place a constraint on applying dissimilar conditions on equivalent
transactions. Applying this to the gas sector suggests that capacity for gas transit
should be available on the same terms and conditions as capacity for internal market.
If one compares access to the gas network with access to the roads network two
features are clear:
There is no restriction on which roads transit vehicles can use, and transit vehicles
can use the same roads as the indigenous population;
Where there are charges for the use of roads, the same tolls apply to all similar
vehicles.
These same principles should apply to gas networks. Gas transit should be sold on the
same terms and conditions as internal transportation.
New Investments
Regulators should have in place rules to ensure that an appropriate return is made on
new investment in networks. Provided these rules are in place there should be an
incentive to ensure that all network operators make the necessary investments to meet
future requirements, whether these are for the national market or for transit gas.
Providing the necessary framework is in place, then if the network operators fail to
provide sufficient capacity, could it be argued that they are limiting production?
Different Returns in Different Markets
The Competition rules suggest that applying dissimilar conditions for equivalent
transactions may be evidence of abuse of a dominant position.
Many utilities are now operating either as suppliers or transporters in more than one
country. Terms and conditions often vary between countries. Can one use
- 207-
comparisons of these differences to show abuse of a dominant position? For example

if a company is charging relatively more in one country than another then they should
be able to explain the differences. A company might be charging too much in its home
(monopoly) market as evidenced by its willingness to charge less in other markets.
Alternatively it may be using monopoly profits to cross-subsidise entry into another
market.
8.1.2. Pipeline Supply Markets
Key Changes
While some of the issues in the Pipeline Supply markets are similar to those in the
EU, the solutions and recommended actions are somewhat different. The changes
required cover two areas. Firstly, changes required to deal with dominant players
exercising high degrees of market control:
Dominant National Producers - Encourage privatisation of national producers
Restrictions on Independent Producers - Allow independent producers to sell

Foreign Investment - Put in place legal and tax structure to encourage foreign
investment
Gazprom Market Control - Unbundling of Gazprom, separating transportation

and supply or enforcement of regulated TPA regime
The second set of changes required cover the area of access to infrastructure,
expanding capacity and diversification of sources of supply:
Regulated TPA - Introduce regulated TPA regimes consistent with EU
Export Pipeline Capacity - Promote privatisation of pipeline systems and

introduction of foreign investment
New Pipeline Connections - Promote the construction of new pipeline links and
try and reduce the influence of the incumbent producers
In respect of more direct action by the UK Government an important area would be

the encouragement of UK companies to invest in the Pipeline Supply area particularly
in the development of pipeline infrastructure. The key geographic areas to focus on
for investment would be the pipeline route through Ukraine and the potential for
transit gas through Turkey from the Caspian countries of Kazakhstan, Turkmenistan
and Azerbaijan via Georgia. A number of UK companies are already active in this
area, including BP in the Shah Deniz project, but their focus is more on the upstream
exploration and production side and less on the transmission side (except to the extent
that companies like BP need to be involved in constructing transmission pipelines to
get their gas to market).
- 208-
Geopolitical Issues
In respect of trying to deal with the dominant producers / suppliers in the Pipeline
Supply area, the actions are more related to influencing them and their governments
and also negotiating reforms and restructuring of their gas industries. Clearly,
Gazprom is seen as a major factor affecting alternative supplies coming to the market,
whether they are from independent producers within Russia, or from other FSU
countries. Promoting attempts to supplement Gazprom and Russia, as outlined above,
will assist in bringing alternative supplies to the EU but reform within Russia will still
be important. Gazprom and Russia do require a significant amount of external
investment to develop the reserves and infrastructure to supply the growing EU
market. The funding of this investment by EU investors, the commercial banks and
multilaterals, such as the EBRD, could be linked to appropriate reforms in respect of
regulated TPA and removal of restrictions on independent producers.
The Energy Charter Treaty (ECT) is important in this respect as well. The ECT is
very clear on the importance of freedom of transit and non-discrimination.
Unfortunately Russia has yet to ratify the ECT in its parliament.
- 209-
Table 67 Actions to Remove Barriers: EU Wholesale

Code
EUW1
EUW2
EUW3
EUW4
EUW5
Title
Market Carriage TPA

and Capacity
Availability
Barrier

capacity and problems with capacity
booking
Changes Required
Change
Priority
Achievability
Introduce market carriage TPA model to

provide more flexibility in capacity
booking including UIOLI and allow
rolled in treatment, where appropriate,
for capacity expansions
High
High
Competition Law
Initiate benchmarking study
Diverse tariff and TPA structures make

transmission of gas, particularly
Harmonisation of TPA structures across

the EU but need to avoid the
High
Transit Regimes

domestic transmission systems. Increase
importance of UK as a transit country.
High
Presumption that all storage should be

regulated TPA, unless it can be shown
there is true competiton. Simplified
balancing regimes, with daily being the
High

dominance of single import company
in many countries or insignificant
competition between multiple
suppliers. Creates local monopolies

programmes
High
Lack of regulated TPA in storage and

inappropriate balancing regimes
Influence through EC
Information Publication
Harmonisation of TPA
in the EU
UK Government Action
Plan
Medium
Initiate benchmarking study
Low (EU)
Competition Law
High (UK)
Medium
Promote LNG schemes in UK

Competition Law
High
Influence through EC, Price

Schedules, Market Share
targets
Competition Law
EUW6

markets and hubs
Spot markets and hubs will develop once

the conditions for effective competition
are in place
Low
High
EUW7

contracts
Removal of anti-competitive clauses

from contracts and encouragement of
shorter term contracts
High
High
Competition Law
- 210-
Table 68 Actions to Remove Barriers: EU Retail

Code
Title
Barrier
Changes Required
Plan
Change
Priority
Achievability
EUR1
Distribution TPA

systems
Introduction of consistent and coherent

Network Codes, specifically for
distribution if separate from transmission
Medium
High
EUR2
Gas Sales to LDCs
Dominance of pipeline companies in

relation to sales to LDCs
Removal of exclusive arrangements,

shorten duration of contracts and institute
gas sales release programmes.
High
High
Competition Law
EUR3
Supplier Switching
Minimal supplier switching as a result

of customer inertia and inadequate
administrative structures to enable
customers to change suppliers

benefits of switching. Introduce cost
effective and efficient supply point
administration
Medium
High
EUR4
Unbundling of
Transportation and
Supply
Lack of unbundling. Incumbents can

subsidise the supply business
Proper
legal
unbundling
of
Privatisation of state owned businesses.
Cost reflective distribution charges to
eliminate
excess
profits
and
inefficiencies
High
High
Upstream Costs
A large proportion of the retail gas bill

is outside the suppliers control,
including gas cost, transport fees and
taxes, making it difficult to undercut
the incumbents prices.
EUR5
Introduction of full competition in the

EU Wholesale market and the Pipeline
Supply Production and Wholesale
market and firm regulatory oversight on
- 211-
Initiate Benchmarking study
Competition Law
Medium
Medium
Table 69 Actions to Remove Barriers: Pipeline Supply

Code
Title
Barrier
Changes Required
Change
PSP1
Dominant National
Producers
Dominant national producers, largely

state owned

producers
PSP2
Restrictions on
Independent Producers

producers
Allow independent producers to sell their

own gas directly
Plan
Priority
Achievability
Medium
Low
EU to negotiate restructuring
in return for investment
High
Medium
Enforce ECT
PSP3
Foreign Investment
Put in place legal and tax structure to

encourage foreign investment
High
Medium
PSW1
Regulated TPA


consistent with EU
High
Medium
Enforce ECT
PSW2
Export Pipeline
Capacity

pipelines
Promote privatisation of pipeline systems

and introduction of foreign investment
High
Medium
PSW3
New Pipeline
Connections
No transmission connections directly

with specific (FSU in particular)
countries with abundant gas reserves.
Inhibits the diversification of EU
supplies
Promote the construction of new pipeline

links and try and reduce the influence of
the incumbent producers
High
High
Encourage UK companies to
invest
PSW4
Gazprom Market
Control
Gazprom in particular can exploit its

exclusive access to information in
order to control the entire wholesale
market.
Unbundling of Gazprom, separating

transportation and supply or strict
enforcement of regulated TPA regime
Medium
Low
Put pressure on Gazprom and

Russia to liberalise
- 212-
8.2. UK Government Strategy

Table 70 below categorises each change required in the context of its priority and then
its achievability. This categorisation is designed to help focus on the areas where the
priority is important and there is a high chance of success.
Table 70 Barriers and Achievability Matrix
ACHIEVABILITY OF REMOVAL OF BARRIERS
HIGH
LOW
PSW3, EUR4, EUW5,

EUW7, EUW3 (UK),
EUR2, EUW1
PSP3, PSP2, EUR3,

PSW1, EUW2, EUW4,
PSW2
EUW3 (EU)
MEDIUM
EUR1
EUR5
PSP1, PSW4
LOW
EUW6
HIGH
PRIORITY FOR REMOVAL OF BARRIERS
MEDIUM
The matrix is known as a GE9 matrix, which is described in more detail in Appendix
11. The appendix also uses a paired comparison analysis to rank each change required
to achieve an overall ranking of the importance and achievability of each change. This
is shown in Table 71.
- 213-

Rank
Code
Title
Change Required
EUW1

Introduce market carriage TPA model to provide more

flexibility in capacity booking including UIOLI and allow
rolled in treatment, where appropriate, for capacity
expansions
EUW5
PSW3
Promote the construction of new pipeline links and try and

reduce the influence of the incumbent producers
EUR4
Unbundling of Transportation
and Supply
Proper legal unbundling of transportation, supply and storage.

Privatisation of state owned businesses. Cost reflective
distribution charges to eliminate excess profits and
inefficiencies
EUW3(UK)
Transit Regimes
EUR2
Gas Sales to LDCs
Removal of exclusive arrangements, shorten duration of

EUW4
Presumption that all storage should be regulated TPA, unless it

can be shown there is true competition. Simplified balancing
regimes, with daily being the minimum balancing period
EUW2
Harmonisation of TPA in the

EU
Harmonisation of TPA structures across the EU but need to

avoid the pancaking of charges
PSW2
Promote privatisation of pipeline systems and introduction of

foreign investment
10
EUW7
Removal of anti-competitive clauses from contracts and

encouragement of shorter term contracts
11
PSP3
Foreign Investment
Put in place legal and tax structure to encourage foreign

investment
12
PSW1
Regulated TPA
13
PSW4
Preferably unbundling of Gazprom, separating transportation

and supply or enforcement of regulated TPA regime
14
EUW3(EU)
Transit Regimes
Transit to be incorporated into main domestic transmission

systems.
15
PSP2
Producers
16
EUR1
Distribution TPA
Introduction of consistent and coherent Network Codes,

17
PSP1
18
EUR3
Supplier Switching
Increase customer awareness of the benefits of switching.

Introduce cost effective and efficient supply point
administration
19
EUR5
Upstream Costs
Introduction of full competition in the EU Wholesale market

and the Pipeline Supply Production and Wholesale market and
firm regulatory oversight on transportation tariffs
20
EUW6
Spot markets and hubs will develop once the conditions for
effective competition are in place
- 214-
In trying to achieve these changes in the EU, where the UK Government cannot take
direct action, a key factor will be redressing the informational advantage the
incumbents have over regulators and governments, through a detailed and thorough
benchmarking study together with the aggressive use of EU competition law.
Alongside this a programme of influence and persuasion of the reforms required can
be undertaken at EU and national government level.
In the Pipeline Supply area, apart from promoting UK company involvement in
Charter Treaty.
- 215-
- 216-
9. CONCLUSIONS
Defining a Competitive Market
In terms of defining what a competitive gas market is, two key areas were identified.
The first was open access to the essential gas facilities and second the issue of market
power. For the purposes of the analysis the gas market was divided into three distinct
markets the producer market, the wholesale market and the retail market and three
distinct geographies the EU25, plus accession and candidate countries, the Pipeline
Supply Area and the LNG Supply Area.
The combination of three markets and three geographies produces nine possible submarkets. Not all of these, however, are important in the context of introducing full
competition into the EU gas market. Three markets initially were considered to be of
Low or Medium to Low importance the Pipeline Supply and LNG Supply retail
markets and the LNG Supply wholesale market. On further analysis, the EU
production market will assume much less importance as UK production in particular
declines, leaving the Netherlands as the only major EU producer. While some market
reforms would still be desirable, in terms of their importance, they would not be likely
to have a significant impact. Similarly the introduction of competition into each
individual LNG Supply production market was not considered to be critical since the
LNG suppliers are beginning to compete against each other for access to the EU
market and more spot trades are being undertaken, increasingly at spot market prices,
creating a competitive market for LNG supply as a whole. The four key sub-markets
where reforms would be more critical, therefore, were the EU wholesale and retail
markets and the Pipeline Supply production and wholesale markets.
International Experience
The US, UK and Victoria in Australia provided examples of how competitive markets
have developed. A common theme in all these markets was the development of the
underlying market structure. This involved effective gas release on both the purchase
side, from producers, and also on the sales to end users, easy access to and availability
of transportation capacity and the unbundling of transportation, supply and storage at
least at the legal (or physical) level and for the most part at the ownership level as
well. Market size and diversity was helpful in the context of the US and the UK, while
in the small Victoria market, diversity was created through privatisation and
restructuring. A strong commitment and fervour for the introduction of competition
was also a common theme for the regulatory and governmental authorities. It was also
concluded that in the US and the UK, the introduction of competition at the retail
level was not integral in the development of a competitive market, while in the much
smaller market in Victoria it was a key factor. In all three markets, however, the focus
was very much on getting the structure of the wholesale market correct.
Current Conditions in Key Markets
Market dominance continues to be a major issue in the EU wholesale markets. Many
national markets continue to be dominated by the incumbent gas company. We are
- 217-
also seeing the advent of powerful pan-European gas and power companies with high
profile strategies based on acquisition and investment programmes aimed at
controlling large sections of the physical infrastructure and access to end users via
ownership of distribution companies. The implementation of the 2nd Gas Directive
may go some way towards limiting any market dominance but on its own we do not
believe it goes far enough. Major producers are also trying to establish market
positions but they are somewhat behind the gas and power companies in terms of
sales. Whilst there are some banks trading, notably absent from the market are the
independent wholesalers such as Enron, Dynegy and other US companies who were
trying to enter the market a few years ago.
Legal unbundling of transportation, storage and supply has largely been implemented
but how effective this has been in creating a level playing field for new entrants is
uncertain. Gas release schemes have also been introduced, which represents some
progress, but their real effectivenes is uncertain. Better progress is being made in
respect of gas contracts with more flexibility being introduced, the removal of
destination clauses and the German cartel office declaring 75% of the 750 contracts
between the TSOs and LDCs as anti-competitive.
The main issues regarding third party access relate to the allocation of capacity. Many
contracts and there are cross-subsidies between transit and domestic charges. Analysis
suggests that cross-border capacity is generally under utilised, except maybe into
Italy, and that there are also large discrepancies between transmission tariffs within
EU countries for transportation of similar loads and distances. Whilst relatively high
tariffs may be justifiable in growth markets where there is an intensive capital
requirement, there is less justification for differences among more mature and well
established gas markets where costs should be broadly similar. It is certainly noticable
that tariffs are lower where regulators have taken an active role in forcing out
inefficiency and economic rent than in countries where independent regulators have
been less forceful in regulating tariffs.
Balancing regimes also differ between countries with hourly and daily balancing and
evidence of overly penal charges with considerable scope for network operators to
adopt a regime that implicitly favours their associated supply business. Progress is
being made on the publishing of conditions for access to both LNG terminals and
storage facilities with a mixture of regulated and negotiated TPA. The issue of
network development under a TPA regime is being dealt with largely on an ad hoc
basis. The UK and Italy have better developed systems based on rolled in rates but
joint ventures, open seasons and applications for TPA exemptions are all being used.
A more consistent, coherent approach across the EU could be useful.
At the institutional level the regulatory authorities in some countries would appear to
be more proactive than in other countries, particularly where state ownership is still
important. Germany has only recently established a regulator but the cartel office has
been active.
- 218-
The process of introducing competition to the retail sector is in its infancy in Europe,
outside the UK. Experience so far shows that just changing the law to allow
consumers to change supplier does not necessarily lead to effective competition.
Many companies are finding it difficult to enter certain markets and there has been a
low rate of customer switching overall. However in Spain there has been some
significant switching of industrial and commercial customers amid a situation of over
supply and a price war. In Italy the Letta decree is forcing down the market share of
Eni with Edison proving to be the main competitor.
Apart from access to infrastructure and gas supplies, adequate systems are also
required, at the LDC level, to ensure smooth switching process and to ensure that
information flows are maintained to support proper customer billing. In addition it
should be noted that a large proportion of customers bills are for components which
are beyond the control of the gas supplier (gas and transportation costs and taxes).
This makes it difficult for new entrants to undercut the prices offered by the
incumbent company and makes the financial advantage of switching questionable in
relation to the potential problems and worries that switching can bring.
Analysis by EML indicates prima facie evidence of a significant amount of
inefficiency and/or economic rent in the distribution and supply sector in particular,
making the cross subsidisation of the supply side by the incumbents pipes business
much easier to achieve. This would indicate that distribution is yet to come under
effective regulatory control and supply to small users (households and small
industrials) has not been subjected to competitive pressure.
supplies in 2003. Russia accounted for half of the imports, Norway 25% and Algeria
20%. Russia and Algeria will increase the imports in the next 10 years but new
pipeline supplies are expected from Libya, Iran and the Former Soviet Union
Uzbekistan). Europe will remain highly dependent on gas flowing from Russia
through the Ukraine to Slovakia although alternative routes through Belarus and
Poland (Yamal) and direct to Turkey under the Black Sea (Bluestream) are now
flowing gas with volumes expected to increase over the next few years. A third route
to Germany under the Baltic Sea (North European Gas Pipeline) is also planned
although the timing of this project remains subject to uncertainty.
Gazprom dominates Russian production at the moment but a decline is forecast and
Gazprom will need to develop other deposits mainly in Western Siberia. Independent
production has doubled between 1994 and 2004 to just under 100 bcm per year.
Gazprom has been trying to buy up some of the independent producers and exercises
effective control over all exports of gas.
Algerian exports to Europe were 55 bcm in 2003 30 bcm by pipeline and 25 bcm by
LNG. Pipeline routes are to Italy and Spain (via Morocco) but the Medgaz pipeline,
which is under construction, will deliver gas directly to Almeria in Spain. Sonatrach
dominates the gas industry and although foreign companies area allowed to participate
they may do so only in partnertship with Sonatrach. However, Sonatrachs share is
planned to fall as part of the reform to encourage more foreign investment.
- 219-
Norway is the second largest importer into the EU market and recent reforms have led
to the break up of the GFU and producers selling their gas directly. The offshore
transportation regime has also been reformed by the creation Gassco (operator) and
Gassled (owner) with open access and an entry exit methodology.
Some 24 barriers to competition in the key markets were identified as part of the
analysis. These are summarised in Table 72 below
- 220-
Table 72 Barriers to Competition

Geographical
Area
Market Sector
Production
EU
Market Power:
Wholesale
Market Power:
LNG Supply
Dominant national producers, largely state

owned
producers
Market Power:
Dominant national producers in some

countries
Perceived lack of transmission capacity and problems with capacity booking

Diverse tariff and TPA structures make transmission of gas, particularly
Lack of regulated TPA in storage and inappropriate balancing regimes
High import dependency coupled with dominance of single import company

in many countries or insignificant competition between multiple suppliers.
Creates local monopolies
Lack of liquid and transparent spot markets and hubs
Oil price escalation and anti competitive clauses in gas purchase contracts
Lack of TPA access to infrastructure in producer and transit countries.
Lack of spare capacity in export pipelines
No transmission connections directly with specific (FSU in particular) countries

with abundant gas reserves
Market Power:
Gazprom in particular can exploit its exclusive access to information in order to

control the wholesale market.
Lack of TPA access to Distribution systems
Market Power:
Dominance of pipeline companies in relation to sales to

LDCs
Minimal supplier switching: customer inertia and
administrative difficulties
Lack of unbundling. Incumbents can subsidise the
supply business.
A large proportion of the retail gas bill is outside the
suppliers control, including gas cost, transport fees and
taxes, making it difficult to undercut the incumbents
prices.
N/A
N/A
Market Power:
Pipeline
Supply
Indigenous production is declining but the

small fields policy in the Netherlands
ensures that Gasunie dominates a major EU
production area
Historically limitations on information from
UK offshore industry although steps are
being taken to address this
Retail
Dedication of facilities to specific import/export schemes

Hitherto shortage of spare capacity in terminals and ships
- 221-
Alternative Scenarios
Table 73 summarises the approximate breakdown of the UK gas price under each of
the alternative scenarios Constrained, Most Competitive and Fully Competitive.
P/Therm Real 2004
Prices
Constrained Case
Most Competitive
Fully Competitive
UK Spot Price
Q1
32.0
22.2
23.7
17.3
Q2
33.6
22.2
23.7
18.7
Q3
30.1
18.7
20.3
15.2
Q4
30.1
18.7
20.2
15.2
Average
31.5
20.4
22.0
16.6
The Constrained Case results in a UK spot price of 31.5 p/therm set by arbitrage with
USA in the LNG market. On a range of reasonable assumptions for US prices the UK
spot price could fall within a range of 27.0 to 36.4 p/therm. Under this scenario many
European countries spot prices are closely linked with US prices, since US prices are
the main driver of LNG spot prices, which in turn are the marginal supplier to much
of Europe. European contract gas prices would remain linked to oil prices in the
Constrained case. A +/- $10bbl change in oil prices could impact contract prices, and
hence weighted average cost of gas in continental Europe, by up to +/- 6 p/therm.
other sources. The alternative is that potentially higher prices will result from Europe
competing with the US for LNG supplies. The Most Competitive case would bring in
would be around 20.4 p/therm, or 11.1 p/therm less than in constrained case.
Once access to adequate low cost gas is secured the greatest scope for containing gas
prices lies in reducing transportation charges. It is particularly important for the UK
placed almost at the end of the east-west supply chain that access to and the pricing of
transportation along the supply route is secured at an efficient cost. In the Most
Competitive Case the general pattern is for prices to get higher the further west in
Europe the country is. Price differentials between countries in this scenario will in
considerable part be driven by transportation tariffs but will also be affected by
contractual and physical constraints on the pipeline systems.
The Fully Competitive Case would not only help contain gas prices, by greater
pipeline capacities and increased liberalisation and competition in Europe, but also
improve security of supply to Europe because there is a much more diversified range
of supply countries contributing to supply. Russia will contribute a significant
proportion of European gas requirements under any scenario because of its reserve
position. However, in Fully Competitive, the Russian share is limited to less than 35%
and more importantly the gas is produced by a wider range of producers because of
the assumed break up of Gazprom and independent gas producers can market their gas
directly to Europe.
- 222-

producers to decline to 69% in the constrained case, 59% in Most Competive and 51%
in Fully Competitive.
The UK would have a fairly well diversified supply portfolio in all scenarios with
Norway providing the greatest single source of supply providing between 42% and
45% of UK supply in 2015 compared with 6% in 2003. Reliance on Russian supplies
ranges from 4% in Fully Competitive to 14% in Constrained. However, Russia is a
major supplier to Europe in all scenarios and security of supply for Europe as a whole
will be highly dependent on Russian supply.
Changes Required in Key Markets
Each barrier to competition was linked with a required change for the 4 key markets
EU Wholesale and Retail and Pipeline Supply Production and Wholesale. These
changes were then ranked in terms of their relative priority and possible achievability
and also linked with potential actions by the UK Government. The ranking of the
changes is shown in Table 74.
UK Government Actions
In trying to achieve these changes in the EU, where the UK Government cannot take
direct action, a key factor will be redressing the informational advantage, for example
on capacity availability, that the incumbents have over customers and regulatory and
governmental authorities, through a detailed and thorough benchmarking study
together with the aggressive use of EU competition law. Alongside this a programme
of influence and persuasion of the reforms required can be undertaken at EU and
national government level.
In the Pipeline Supply area, apart from promoting UK company involvement in
Charter Treaty.
- 223-

Rank
Code
Title
Change Required
EUW1

Introduce market carriage TPA model to provide more

flexibility in capacity booking including UIOLI and allow
rolled in treatment, where appropriate, for capacity
expansions
EUW5
PSW3
Promote the construction of new pipeline links and try and

reduce the influence of the incumbent producers
EUR4
Unbundling of Transportation
and Supply
Proper legal unbundling of transportation, supply and storage.

Privatisation of state owned businesses. Cost reflective
distribution charges to eliminate excess profits and
inefficiencies
EUW3(UK)
Transit Regimes
EUR2
Gas Sales to LDCs
Removal of exclusive arrangements, shorten duration of

EUW4
Presumption that all storage should be regulated TPA, unless it

can be shown there is true competition. Simplified balancing
regimes, with daily being the minimum balancing period
EUW2
Harmonisation of TPA in the

EU
Harmonisation of TPA structures across the EU but need to

avoid the pancaking of charges
PSW2
Promote privatisation of pipeline systems and introduction of

foreign investment
10
EUW7
Removal of anti-competitive clauses from contracts and

encouragement of shorter term contracts
11
PSP3
Foreign Investment
Put in place legal and tax structure to encourage foreign

investment
12
PSW1
Regulated TPA
13
PSW4
Unbundling of Gazprom, separating transportation and supply

or enforcement of regulated TPA regime
14
EUW3(EU)
Transit Regimes
Transit to be incorporated into main domestic transmission

systems.
15
PSP2
Producers
16
EUR1
Distribution TPA
Introduction of consistent and coherent Network Codes,

17
PSP1
18
EUR3
Supplier Switching
Increase customer awareness of the benefits of switching.

Introduce cost effective and efficient supply point
administration
19
EUR5
Upstream Costs
Introduction of full competition in the EU Wholesale market

and the Pipeline Supply Production and Wholesale market and
firm regulatory oversight on transportation tariffs
20
EUW6
Spot markets and hubs will develop once the conditions for
effective competition are in place
- 224-

Conditions For Truly Competitive Gas

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DEPARTMENT OF TRADE AND INDUSTRY

Conditions for Truly Competitive Gas

Report Prepared By:

ENERGY MARKETS LIMITED

Energy Markets Limited

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

4.4. Pipeline Supply Area ......................................................................................102

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

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Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Table 25 Investment Interests in Langeled ................................................................126

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Table 50 Market Characteristics by Scenario Pipeline Area Wholesale ................180

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

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Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Effective Gas Release - If the existing market structure is one of a monopoly

Access to and Availability of Capacity - Fundamental changes in moving towards

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

release of capacity on the interstate pipelines as their merchant sales business

Unbundling - The unbundling of the pipeline services into transportation, supply

Other factors which were seen as important in the introduction of competition

Market dominance continues to be a major issue. Many national markets continue

Legal unbundling of transportation, storage and supply has largely been

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Retail Market in the EU

The process of introducing competition to the retail sector is in its infancy in

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Pipeline Supply Area

Gazprom dominates Russian production at the moment but a decline in volumes

Algerian exports to Europe were 55 bcm in 2003 30 bcm by pipeline and 25

Conditions for Truly Competitive Gas Markets in the EU

Final Report - November 2005

Barriers to Competition and Changes Required

Introduce market carriage TPA

Some resistance from incumbents

Diverse tariff and TPA structures

Harmonisation of TPA structures

The widespread adoption of entry

Separate transit regimes

Transit to be incorporated into main

Many transit contracts will be long

Lack of regulated TPA in storage

Presumption that all storage should

There has already been resistance

High import dependency and