Gas security proposal undercuts European gas market

The powers conferred upon the European Commission by its proposed “Regulation to safeguard security of gas supply” represent an unprecedented violation of the principles of free markets and of equal burden-sharing which are supposed to apply in the European Union. Moreover, in the long term, the Proposed Regulation will have the opposite of the intended effect: it will make European gas supply more vulnerable, not less.

Gas shortages lead to protests in Sofia, Bulgaria, in January 2009

Article highlights
- The European Commission has proposed a new Regulation to deal with gas crisis situations like the Ukranian gas crisis of 2009.
- The authors argue that this proposal is misconceived and even dangerous.
- Under the new Regulation, the Commission would ultimately get the power to divert gas flows from countries that have sufficient gas to countries that are hit by a crisis.
- This, say the authors, represents a harmful and in effect illegal intervention in the functioning of the free market by the European Commission.
- The main problem is that the proposed Regulation sends the wrong signals to market parties: Member States that reduce their risks will be punished, whereas Member States that take no preventive action, will be awarded.

- Thus, the proposed Regulation will make Europe more rather than less vulnerable to gas shortages.

The European Commission has sent the European Parliament and the Council of Ministers a proposal for a “Regulation concerning measures to safeguard security of gas supply”. This Proposed Regulation, which is meant to prevent and deal with gas crises, is ill-conceived for many reasons.

The Proposed Regulation ultimately gives the Commission powers to direct the National Authorities to divert gas flows from countries with ample supplies to countries that find themselves short of gas. This represents a far-reaching, indeed unprecedented, form of interference in the internal market.

The main danger of this is that it sends the wrong signals to the national and international markets. Countries that are now heavily dependent on external gas supplies will not be stimulated to invest in infrastructure, storage, and diversification, since they know they will be able to count on assistance in times of need. Although the Proposed Regulation requires Member States to prepare Preventive Action Plans, which must include measures to enhance security of supply, market partici¬pants cannot be compelled to invest in preventive measures, for example in extra storage or in long-term supply contracts or  other, usually higher-priced energy sources.

Market participants in countries with a weak supply security may even be encouraged to make unreasonable demands in contract negotiations with external suppliers, on the assumption that they will be backed by the powers of the Commission should the negotiations fail. In effect, with this Proposed Regulation the Commission is setting up an import cartel.

At the same time, countries that have invested heavily in diversification and sourcing of new supplies, will find themselves punished in case of a crisis. They will have to pay the price of the crisis – and may even literally find their gas supplies taken from them by the Commission.

Member State solidarityThe reason the Commission is proposing new measures to safeguard gas supplies is of course to be found in the Russian-Ukrainian gas supply crises, in particular the most recent crisis of January 2009, in which large parts of Eastern Europe faced the danger of being  without gas in the middle of winter. At the time the Commission found that it could do very little to help solve this conflict. If the Commission had analysed this crisis correctly, it would have found out that its effects varied considerably among the Member States, depending directly on whether States had domestic gas sources or long-term gas supply contracts in place with reliable partners. The Commission would then have stressed the importance of good long-term relations based on well-earned mutual respect. Instead, what the Commission did was to look merely at the symptoms and to prescribe extensive bureaucratic regulations as a remedy.

Hence, it has come up with a far-reaching new Proposed Regulation, which is to replace the current Directive 2004/67/EC concerning measures to safeguard security of gas supply. The Proposed Regulation includes a multitude of detailed requirements and procedures. For example, the Member States must impose EU-approved Preventive Action Plans enhancing infrastructure to a so called “N-1 level” (which means preparing for full compensation of the loss of the largest gas infra¬structure). Market participants are burdened with the obligation to prepare tools to facilitate supply security and to prepare Emergency Plans including three stages of “Alert”, “Early Warning” and “Emergency”. Most importantly, if a crisis occurs (this is defined as the declaration of a crisis by more than one Member State or the loss of 10% of the “natural volume” of a Member State’s supplies) the Commission will convene the Gas Coordination Group and after consultations it will order the Member States to take “appropriate measures”. What these measures will be, is left unspecified. The basic idea is for the Commission to engage in a redistribution of resources based on “Member State solidarity”. How this redistribution will take place – whose gas will be used, in what volumes, on what time scales – is not clear, but will be decided case-by-case.

It is true that some form of “Member state solidarity” may be appropriate in emergencies, such as a gas crisis. But we already have instruments to deal with such a situation. Under the current Security of Gas Supply Directive, based on Article 100 of the European Community Treaty (ECT), the Council of Ministers may act to alleviate a crisis in a Member State. But this would be a political decision, based on a qualified majority in the Council. What the Commission is now proposing to do, however, is something entirely different. Its Proposed Regulation is based on Article 95 of the ECT. This article is designed to align Member State laws that have an immediate effect on the creation or the functioning of the EU internal market – laws intended to make the internal market work free of national barriers and distortions of competition. In other words, the Commission’s proposed Regulation is applying regulatory measures to emergency situations.

This amounts to an inappropriate usurpation of competencies. While the EU has the responsibility to create a framework for the operation of the internal market, it has no general responsibility for the availability of goods on the market (see also Article 194 of the Lisbon Treaty). The responsibility to ensure a functioning public service lies with the Member States according to their constitutions. In case of a possible failure of the internal market due to a supply crisis in a Member State, the Commission is restricted to decree under which circumstances the needy Member State may or must opt out of the internal market until the crisis is over (see Art. 46 of the Gas Market Directive 2009/73/EC). Article 100 of the ECT and the Directive based on it cannot be used to open the door to a subsequent harmonisation of member state emergency laws under Article 95 ECT.

Triple disadvantagesSo what will happen under the Proposed Regulation in the event of a crisis? Essentially, the Commission will order a Member State authority to divert gas flows from a Member State to another Member State. It is to be expected that in such an event, upcoming gas scarcity will raise prices throughout the market. The protected customers of the Member State in a supply crisis will not, however, have to pay higher prices. According to the Regulation, protected consumers (e.g. households, small businesses and public institutions) have preferential rights to receive gas at the prices they are used to. The parties from whom the gas is taken may draw additional volumes from flexible supply contracts, for which they have paid, or may not be able to fulfil their delivery contracts, which may lead to damage claims from their customers in consequence. As the Commission induces the national authorities of the Member State to take the gas, the Member State will face compensation claims for the taking. There is no automatic recourse to the Member State that is a beneficiary of the gas.

Thus, there are triple disadvantages for the Member State contributing gas at the request of the Commission: its market participants are having gas volumes taken from them; its population has to cope with price spikes due to scarcity, and it is faced with extra costs in the form of damage claims.

This situation may be aggravated as at the time of crisis nobody can really foresee its duration and what the impact will be of weather conditions and the like. The Commission will determine the gas volumes for redistribution, which means that – with the advice of the Gas Coordination Group – the Commission

rather than the Member State will assess the expected duration and scope of the crisis, suspending the  national prerogative of Member States to determine their  energy mix and security of supply policy. This could  lead to shortages of supply for the customers in a Member State from which gas has been taken for early redistribution and whose security of supply efforts are thereby frustrated. Yet the Commission will not be liable, and damages will be incurred exclusively by the Member State. 

The Regulation, then, leads to all sorts of interference in the market. In general, Member States that have done less to reduce risks, having made fewer investments and taken fewer crisis prevention measures and having burdened their market participants to a lesser extent with security of supply requirements, will be better off. To give some examples:

  • Member States with good interconnectivity will be called upon sooner and more often to supply gas in a crisis than Member States with more rudimentary infrastructure.
  • The same goes for Member States that have diversified their imports and stimulated  domestic gas production.
  • Member States that have long-term import contracts and importers of outstanding reliability, which have created mutual investments and dependencies with gas suppliers, are compelled to share the fruits of their investments; not only its gas market participants but also its general industry will be deprived of well-earned  advantages.
  • Gas for cogeneration plants and central heating plants does not qualify for emergency reassignment. In Germany and other countries, however, many households are being supplied with heat from such plants. Will they be left out in the cold if a crisis hits another Member State?

Member States that are vulnerable to gas supply disruptions, should be stimulated to invest in diversification of supplies, new gas infrastructure, the development of alternative fuels, and so on. Market participants should be stimulated to offer cheaper, flexible (interruptible) supply contracts or more expensive, non-interruptible supply contracts. Consumers should be induced to save energy. The Regulation, however, counteracts such incentives. Vulnerable states can refrain from taking appropriate measures to regulate their market participants into compulsory investments and rely on the other Member States to bail them out if they get hit by a crisis.

CartelAnother effect of the Regulation is that – as it cannot be ruled out that the enforced solidarity will also work in case of prolonged or failed negotiations with producers – it has the characteristics of an import cartel. If one Member State does not get what it wants, it can lead to burden sharing by all the other Member States. The cartel effect is even strengthened by the rules on Early Action included in the Proposed Regulation.

These rules stipulate that the Member States shall cooperate with each other to prevent supply disruptions.

The cartel which is thus created may have two malicious effects. First, as it consists of political entities and is administered and represented under the auspices of the Commission, a political component enters into the negotiations and the pricing of gas imports, at least for the new import contracts. Second, it may induce the exporting nations to answer in kind, i.e. by creating some sort of Gas-OPEC.

To sum up, we can say that the EU has the responsibility to create a framework for the operation of an internal market under Article 95 of the ECT. The Commission should restrict itself to this task of organising the internal market. It may decree the necessity of preventive measures to mitigate potential gas supply crises and leave the Member States with the choice of implementing these requirements, in order to put all participants of the internal market on an equal footing. However, the design of the framework for the market is not the cause for a gas shortage, and the case of market failure should be dealt with separately. In case of regional or total market failure, Article 100 of the ECT comes into play. It

allows for sectoral measures to be taken by the Member States with a qualified majority and – taking into account the principles of subsidiarity and proportionality – for specified measures to ensure the distribution of scarce goods. In view of a possible failure of the internal market due to a supply crisis in a member state, all the Commission should do is decree under which circumstances the Member State hit by a supply crisis may or must opt out of the internal market until the crisis is over. This will allow the Member State to take appropriate national actions to solve the crisis. The Council of Minister may then decide to help the troubled Member State, but this should be a political rather than a mechanical decision. Member State solidarity has to meet Member State responsibility.

 

Dr. Achim-Ruediger Börner is Rechtsanwalt in Cologne  (www.boernerlaw.de).
Peter Hohaus, who is now working for E.ON Ruhrgas AG as Head of German and International Energy Law, European Law, Gas Associations EU, wrote this article as Senior Manager Legal and Regulatory Affairs at Eurogas (the European Union of the Natural Gas Industry). The views expressed in this article are personal and do not necessarily reflect the positions of Eurogas or of its Members.

* This article is based on a legal opinion by Mr. Börner, “A critical evaluation of the new proposal for an EC Gas Supply Security Regulation”, published in Oil Gas and Energy Law Intelligence as pre-publication in September 2009, and will be included in one of the next issues (see www.ogel.org).