1

FIRST RESULTS OF THE INTEGRATED EUROPEAN GAS MARKET: ONE FOR ALL OR FAR FROM ONE

Nico Keyaerts

1, Leonardo Meeus

2, William D’haeseleer

1,*

1. University of Leuven (K.U.Leuven) Energy Institute – branch Applied Mechanics and Energy Conversion (TME),

Celestijnenlaan 300A P.OBox 2421 B-3001 Heverlee Belgium Name 2. University of Leuven (K.U.Leuven) Energy Institute – branch ESAT - ELECTA, Kasteelpark 10 P.O.Box 2445 B-3001

Heverlee Belgium * Corresponding author: Tel: +32 16 32 25 10; Fax: +32 16 32 29 85

Nico.Keyaerts@mech.kuleuven.be, Leonardo.Meeus@eui.eu, William.Dhaeseleer@mech.kuleuven.be

Keywords: 1. European gas markets; 2. market liberalisation; 3. market integration. 1 Background of European gas market integration

After a full decade of market integration of the EU natural gas markets, a concise but thorough review of the current state of the EU gas market(s) is needed. Although several aspects of the liberalisation process have been studied separately in mainly consultant reports commissioned by the European Commission or reports from national regulators, a condense overview of the EU gas market does not yet exist. The main question dealt with in this paper is what the current state of the EU natural gas market is and what the results of the market liberalisation and integration efforts have been so far. The paper is structured as follows: this first section sketches the background of the market reforms. Section 2 briefly summarises the aims and research questions of the paper, whereas section 3 covers the answers to the questions laid out in section 2. Section 4 takes a brief look at the on-going initiatives to complete the internal market. The conclusions/results are summarised in the final section of this paper.

It has been more than 20 years since the Member States of the European Union (EU) decided to formally create an integrated EU common market for goods and services [1]-[2]. In the early nineties, the European Commission expressed its intentions to include the traditionally monopolistic energy markets that had been dominated by vertically integrated energy companies into this ambitious market integration programme, resulting in directives governing the creation of the internal electricity market and the internal gas market [3]-[4]. Although the Commission claimed early successes were already achieved, a second legislative package, which fully replaced the first package, was adopted in 2003 (directive) [5] and 2005 (regulation) [6]. This second package was developed in the slipstream of the Lisbon targets that suggest a strategy to make the EU the most competitive economy in the world [27],[31]. In 2006 a Green Paper for a European energy strategy was presented [7]. This energy strategy was built on three cornerstones: besides competitiveness of energy markets (cfr. Lisbon targets), sustainability of energy and security of supply were added as focal points of the EU energy policy. Sustainability and security are not specific subjects of this paper, which focuses on the creation of an integrated gas market. Nevertheless, a fully competitive gas market supports the two other policy goals (e.g. unreliable partners are penalised by the market and unsustainable business models are killed by the market).

In response to the observations of the Commission’s DG Competition Energy Sector Inquiry [8], the Commission proposed a third energy package [9]-[10] in September 2007. This package will amend the second package upon its complete adoption by the European Parliament and the Council. So, three legislative packages were proposed by the Commission in less than a decade. This frequent patching by the European Commission raises the question what the current state of the integration process of the EU gas markets is. In other words, how close is the European Commission to getting the holy grail of the competitive EU single gas market? In this paper the authors give a comprehensive overview of the current state of the European gas market based on the publicly available literature (national market studies, progress reports, academic reports, etc.) and own market observations. In other words, where does Europe stand with the gas market reforms, where does it come from, and where is it going?

2 Aims of the paper

This paper summarises the first achievements of the integrated European gas market, based on publicly available evidence gathered from sources such as the European Commission’s Directorate General for Transport and Energy (DG TREN), the European Regulator’s Group for Electricity and Gas (ERGEG), Gas Infrastructure Europe

1 (GIE). Hereto the authors look at the current state of the European gas market(s)

from different perspectives. A first point of view discussed in this paper is the legal state of the integrated gas market: to what

extent are the directives (differently) implemented in the different Member States. The second directive [5]

1 GIE consists of three subdivisions: Gas Transmission Europe (GTE), Gas Storage Europe (GSE) and Gas LNG

Europe (GLE)

2

discusses a wide array of gas market matters, with a number of choices available to the Member States. The differences in implementation between the Member States provide a first measure of the progress made towards an integrated single market for natural gas.

Secondly, the market structure(s) of the European gas market(s) is looked at. Who are the market players? Is there still concentration in the competitive parts of the gas market? What is the role of storage and LNG (liquid natural gas)? Are the markets interconnected? In other words, is there a physical backbone to support market integration, and eventually the creation of a single European gas market?

A third element to be discussed is the market architecture. In this part of the paper the main characteristics of European gas markets are explained. What are the sources of gas, where does consumption take place, and to what extent is local flexibility available. Many national markets have rather limited amounts of flexibility available. Therefore, flexibility needs to be imported from neighbouring markets. However, bluntly stated, the majority of production is situated at large distances from the consumption areas (outside the European Union), which complicates the gas market. So, in this part of the paper the typical relationships between the market participants are explored and explained using flow chart logic.

A next part of the paper deals with market functioning. How does the reformed gas market perform? What is the level of national liquidity of European gas markets? What are the trade volumes? Are the markets transparent? Do market players have access to good price indices? Does entry occur in the national markets? Are incumbents entering each others markets, or are there effectively new participants in the markets.

Finally, the authors take a look at on-going market initiatives, especially the Gas Regional Initiative. As the single gas market is not in sight for the moment, maybe creating regional or coupled markets might prove a valuable step on the way to the holy grail of an integrated European gas market.

3 Current state of the market reforms

In this section the current state of the market reforms is evaluated and the first attained results of the market integration are discussed.

a. Legal implementation This section discusses the straightforward legal state of the integrated gas market. In other words,

have the Member States complied with the rules laid out in the second package and how different are the national gas market legislations?

Due to the nature of the used legal instruments (regulations2 and directives

3) the time schedule

concerning the opening of the gas market was determined by the deadline for transposition of the second directive into national law: July 1, 2004. However, DG TREN’s 2005 benchmarking report notes that many Member States had been late with the full implementation of the directive [11]. In 2006 the European Commission initiated infringement procedures against 17 Member States that had failed to respect the transposition deadline in order to ensure full energy market opening by 2007. By July 1, 2007, all Member States who had not received derogations

4 had formally opened their gas markets.

Yet, the DG TREN benchmarking report of 2008 noted that some aspects of the directive were not properly implemented in national law: e.g. the authority of the regulator or the unbundling of competitive (e.g. gas supply) and non-competitive (e.g. gas transport) activities [12]. Moreover, the ERGEG monitoring report of 2007 [13] concluded that in general the transparency requirements of the gas Regulation had not been properly implemented in the field. The problems identified in the different benchmarking and monitoring reports, and the conclusions of the Energy Sector Inquiry [8] inspired the Commission to propose a third legislative package.

Below two major aspects of the European energy legislation are subject of a closer examination: “unbundling” and “third party access”. The former is an example of a legislative rule which is implemented in the Member States, but does not produce the expected results as far as market liberalisation is concerned; whereas the latter is an illustration of divergent national choices, directly following from the fact that European directives only serve as a general framework in which the national authorities can still make own choices.

i. Unbundling Unbundling in the gas directive means that the transport and distribution functions, which are

monopolistic by nature, cannot be controlled by market players who are active in the competitive parts of the gas business. Otherwise the controlling party could hinder access to the networks, or charge excessive

2 A regulation lays down Community law that is directly applicable in all Member States without any national approval

procedures. 3 A directive needs to be transposed into national law before the agreed rules become applicable in a particular Member

State; a directive usually provides framework for national legislation with a lot of ‘room to maneuver’ for the Member

States. 4 Latvia, Lithuania and Portugal received derogation until 2010. Finland has derogation because its gas grid is not

interconnected with the main European grid. Cyprus and Malta currently have no gas market.

3

tariffs for the use of the network, which would just result in a transfer of profits within the controlling integrated company, but put the competitors at a serious disadvantage.

Art. 9 of the second directive stipulates: “it [transmission system operator] shall be independent at least in terms of its legal form, organisation and decision making from other activities not relating to transmission”. So, the system operator should be a separate legal entity with separate business logic. According to the same article the ownership could stay with the vertically integrated company. Table 1 lists the evolution of TSO unbundling in the different Member States between 2004 and 2008. Four degrees of unbundling are distinguished: unbundling of accounts (the business unit responsible for transport services keeps its own accounting books), management unbundling (a separate management team is responsible for transportation services), legal unbundling (a separate legal company is created for delivering transportation services), and ownership unbundling (the former vertically integrated company divests its transportation activities). A fifth category lists the countries that have either received derogation (Finland) or have no gas market (Cyprus and Malta).

Table 1 TSO Unbundling: country status [14]-[16], [18]

TSO unbundling

2004 [14] 2008 [15][16][18]

Accounts Germany, Sweden, Estonia, Latvia, Lithuania, Bulgaria

Latvia

Management Ireland, Luxembourg, Slovakia Luxembourg, Lithuania

Legal Austria, Belgium, France, Italy, Netherlands, Spain, Poland, Hungary, Slovenia, Romania

Austria, Belgiuma, France, Germany, Greece,

Ireland, Italy, Estonia, Czech Rep., Slovakia, Hungary, Slovenia, Bulgaria

Ownership Denmark, United Kingdom Denmark, Germany

b, Italy

c, Netherlands,

Portugal, Spain, United Kingdom, Poland, Romania

Derogation/No gas market

Finland, Malta, Cyprus

aDue to the divestments demanded by the Commission as part of the merger between Gaz de France and Suez,

the Belgian TSO Fluxys will become ownership unbundled bGermany has 20 TSO, of which one is ownership unbundled

cSocietà Gasdotti SpA (owns ca. 5% of the national network)

dLuxembourg received a derogation until 2009

From Table 1 it is clear that legal unbundling, which is the minimum required by the directive, was

not yet common practice in the European gas markets in 2004. By 2008 the majority of TSOs complied with legal unbundling; ownership unbundling remained the exception, though.

ii. Third party access (for storage facilities)

Besides the unbundling of the regulated network activities, non-discriminatory third party access (TPA) is also required by the second directive. TPA is an absolute prerequisite for creating a truly competitive gas market: if an unbundled TSO arbitrarily gives preferential treatment to one party and refuses access to another party, the market is seriously distorted. Therefore, the directive foresees regulated third party access for transport and distribution networks and LNG terminals, thus requiring the tariffs to be published. Storage and linepack services, on the other hand, are subject to either “negotiated-TPA” or “regulated-TPA”, depending on the choice by the Member State. Negotiated-TPA means that the service provider negotiates the terms of access with each party, only requiring publication of the main conditions of use of the service. It is curious that the option of negotiated-TPA has remained available for such important flexibility instruments in the gas markets, especially since negotiated access is neither available elsewhere in the gas directive, nor is it available in the electricity directive. Moreover, only storage facilities that are technically or economically necessary to supply customers are subject to TPA. Since flexibility is an essential part of a gas market player portfolio, one could easily argue that all storage is important to guarantee supply.

Table 2 Access regimes storage facilities [17]

Storage TPA

Regulated-TPA Belgium, Italy, Hungary, Portugal, Spain, Latvia

Negotiated-TPA Austria, Czech Republic, Denmark, France, Germany, Netherlands, Slovakia, UK

Exclusion from TPAa

UK, Germany, Austria, Denmark

No storage/Other regime Lithuania, Estonia, Finland, Greece, Ireland, Latvia, Luxembourg, Malta, Sweden, Slovenia, Cyprus, Bulgaria, Poland, Romania

aStorage for production or network management purposes

4

Table 2 lists some Member State’s choices for negotiated- or regulated-TPA or another access regime. The choice for either negotiated or regulated access has lead to very different access regimes to storage facilities, even within the same country (e.g. UK and Hungary).

iii. Evaluation of legal implementation

Five years after the adoption of the second package, the different Member States have mostly transposed the rules in national law in the strict sense. However, the Commission assessed that several violations of the existing regulations are occurring throughout the EU. Consequently, the Commission has initiated infringement procedures in June 2009 by sending letters of formal notice for not complying with applicable gas and electricity regulations to all Member States (except Cyprus and Malta) [29]-[30]. Some of the mentioned violations are lack of information provided by TSOs to supply companies, inadequate network capacity allocation systems, and inadequate efforts by gas transmission companies to make maximum capacity available in order to create market entry opportunities.

Similarly, most monitoring reports conclude that the actual implementation in the field fails to reflect the true spirit of the legislation, e.g. resulting in different interpretations of “effective” unbundling and non-discriminatory TPA. Moreover, national authorities had eagerly been using the available room for national choices, resulting in diverging sets of rules across Europe. Although the complete harmonisation of gas market rules is neither attainable nor required, the diverging rules make cross border gas activities complex. Therefore, the rules should not be harmonised, but at least they should be compatible across borders.

So, it seems fair to state that the legal implementation by the Member States was carried out – not always effectively as is illustrated by the above mentioned infringement procedures; but that the content of the rules laid out had not always the projected effects on the liberalisation of the market. Therefore the third package is deemed an essential step forward on the path towards an integrated gas market. The proposed legislation tries to remedy the flaws in the second package and takes the legislation to the next level of regional cooperation: e.g. it foresees in a framework for regulatory cooperation (Agency for Cooperation of Energy Regulators, ACER) between national regulators. Although the first two energy packages did not suffice to create the integrated gas market, the Commission is learning on-the-job and if necessary she will propose a fourth and a fifth package to advance on the pathway towards a single gas market.

b. Market structure This section discusses what the current structure of the gas market is. Market structure is a concept

that can cover a variety of market aspects. In this paper the concept is used to describe who the market players are, what the degree of market concentration is, whether the (national) markets are interconnected and what the role of storage and LNG facilities is. In other words, is there a physical backbone to have an integrated gas market?

i. Market players Four types of market players can be distinguished in the European natural gas market. The first

group of market players are the natural gas producers and exporters. These players are usually located outside the single market (Russia, Qatar, Algeria), and as such they are not further discussed in this paper. Gas importers and traders form a second group that is active at the wholesale level of gas business. A third group consists of retail suppliers, and finally the providers of network services (transport and distribution) and supporting services (storage and other flexibility services). Besides the just mentioned market players, there are other supporting players like regulators, legal and competition authorities and financial services providers.

The competitive parts of the natural gas business consist of production, wholesale supply and retail supply. Transport and distribution are regulated activities. Storage and other flexibility are ambiguous services: belonging to the regulated part of the gas business when they are required to secure the supply of gas, and to the competitive part when they are used for commercial purposes.

With regard to the player dimension, the market structure is in general quite similar in the different national gas markets. Indeed, the majority of European national gas markets remain highly to very highly concentrated, with just one or two significant players and some fringe competition for the competitive levels of the gas market. This concentrated market structure is illustrated by Fig. 1 (wholesale) and Fig. 2 (retail), which consists of data taken from the benchmarking reports of 2005 [14] (reports numbers for 2004), 2008 [12] and 2009 [18] (report numbers for 2006 or 2007), and the national reports of the regulators [15].

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Number of wholesale companies with >5% available gas

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Figure 1 country comparison - wholesale companies with access to at least 5% of available gas (domestic

production + import): evolution between 2004 (left bar) and 2006-07 (right bar) [12],[14],[15],[18]

In Fig. 1 the number of wholesale companies with access to at least 5% of the available gas

(domestic production and imported gas) is compared for the Member States. The pairs of bars show the evolution between the situation in 2004 (left bar), just after the adoption of the second package, and the situation in 2006-2007 (right bar), when the market opening was to be completed. The main observation in this figure is the absence of an evolution towards substantially more wholesale players that have access to a significant part of the available gas. One can distinguish the West European countries from the East European countries, though. The former succeeded in breaking through the monopoly situation by having at least two companies with a 5% share, whereas in the latter countries there remains only one player with access to the majority of the available gas. Secondly, it should be noted that not all countries submitted data on their market structure to the authors of the used sources. Some Member States are exempted from complying with the gas market liberalisation: Malta and Cyprus (no gas market). Others received derogation from the time schedule for implementation. Hence, they did not provide numbers to all reports.

The pairs of bars in Fig. 2 represent the evolution of the market share of the top three retail players. This market share gives an indication of the concentration of the retail market in the different countries. Again, data was not publicly available for every Member State, due to various reasons. For the Central and East European Member States almost no evolution is noticeable. A possible reason for this observation is historical: while Western Europe is already engaged in market liberalisation for more than 20 years, for the Central and Eastern European countries market liberalisation is relatively new. For West Europe some remarkable observations can be made as well. In France and Ireland the retail concentration, measured by the market share of the largest players has increased despite market liberalisation. Germany reported a doubling of the indicator, but the combined market share of the three largest retailers remains relatively low, due to the regionally scattered energy landscape in Germany.

6

Market share top 3 retailers

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Figure 2 country comparison - market share of three largest retailers: evolution between 2004 (left bar) and

2006-07 (right bar) [12],[14],[15],[18] The increase of the indicator might be a result from increased market restructuring and consolidation

through mergers and acquisitions. An effect that is typical for integrating markets [28] and that can be observed in the energy markets both at the retail and the wholesale level (e.g. ENI acquired Distrigas, GdF and Suez-Electrabel merged, Iberdrola took over Scottish power, E-on acquired MOL’s gas business, and RWE acquired Transgas). This market restructuring should be considered as a positive evolution as long as the general European competition rules are applied to prevent market power abuse

5. No player can have

territorial exclusivity, though. For instance, a scenario in which there remain a number of European champions (e.g. Gasunie (NL), ENI (I), RWE (D), GdF-Suez (F), E-on (D)) in the market and in every regional submarket at least three of them compete against each other for customers should be considered as a successful integration of the gas market. From a company perspective, European transnational companies adapted at a single market are created. However, the gas sector is bound to specific infrastructure, which has to be adapted to the single market as well.

ii. Gas infrastructure: pipelines, LNG and storage

Natural gas supply to consumers is dependent on the available pipeline infrastructure. So, to have a truly integrated gas market, the first requirement is to have an interconnected network throughout the Member States. Besides the presence of a well developed European gas grid, the sufficient availability of storage and LNG facilities become more and more important due to the increasing import dependence of the EU that is projected in the next decades.

The development of the European gas grid started modestly in the late sixties, early seventies, with the export of Dutch gas to the neighbouring countries. Since then the European gas grid has been and still is expanding continuously, resulting in a well developed mature network. Figure 3 shows the transport gas grid in 1970. Clearly, there was no interconnected European grid. On the contrary, three separate regional grids can be distinguished: a Benelux grid with extensions to France and Germany, an Italian grid, and a Central and East European grid.

5 An overview of DG Competition’s antitrust cases in the energy sector can be found at

http://ec.europa.eu/competition/antitrust/cases/index/by_nace_code_d.html

7

Figure 3 European gas grid 1970 [25]

Figure 4 European gas grid 2001 [25]

The current EU grid

6, illustrated in Fig. 4, contains over 155,000 km of pipelines [32] and is clearly

interconnected with major pipelines crossing Europe from north to south and from east to west. Particularly interesting are the pipelines that support bidirectional flow. Examples of pipelines that allow bidirectional flow are the Interconnector between Belgium and the UK, a major part of the Belgian grid and parts of the Czech network. The main advantage of bidirectional pipelines is that such pipelines allow reverse flows (opposite to the normal flow direction), thus raising the flexibility in the ‘rigid’ pipeline network and increasing the number of supply routes to a market area. The operation of the gas grid is usually handled by a single national TSO. However, some countries have multiple TSOs, and recently a first real cross border TSO was created when Dutch Gas Transport Services took over the German BEB network.

Technically gas can access Europe from the north (Norway), the east (e.g. Russia), the south (e.g. Algeria) and the west (North Sea) through pipelines. So, based on the present gas grid the markets seem to be physically connected. Besides the pipeline connections, other gas infrastructures are equally important parts of the physical backbone of the integrated gas market. Especially LNG reception facilities and gas storage facilities are crucial building blocks of a truly competitive market.

LNG regasification terminals play an important role in the diversification of supply sources (more producers become available) and supply routes (LNG routed gas is complementary to piped gas). Moreover, LNG serves as a flexibility instrument for the European gas market, as LNG links the European market with the North-American gas market, allowing LNG cargoes to be diverted according to the needs of both markets in the Atlantic basin. Recently, LNG has boomed. Several LNG terminals have been added or are planned in e.g. the Netherlands, France, Spain and Italy [26].

A solid physical backbone of an integrated market requires storage facilities as well. These facilities provide the necessary flexibility to the competitive gas players. Indeed, by injecting or withdrawing gas suppliers can better adapt the gas supply to the gas demand of customers, thus managing the volume risk. Besides providing flexibility to the market players, storages are also used to increase the security of supply. However, the availability of storages is dependent on geological conditions. Some countries are well endowed with potential gas storages (e.g. France, Germany, Italy and the Netherlands

7), whereas other

countries have almost no storage facilities (e.g. Belgium, Bulgaria and Portugal). In an integrated market with transnational companies the exact location of storage facilities should not be important, though. Pan-European gas suppliers should build a portfolio of regionally diversified storage contracts. That way, these players can internally optimise the management of their gas purchases and gas sales.

iii. Evaluation of EU gas market structure

Although the structure of the European gas market is not yet perfect, the market is certainly moving in the right way. The physical backbone of the integrated market is strong with many interconnections between regional markets, with increasing LNG facilities at the sea borders and storages spread over the EU. At the same time transnational energy (often electricity and gas together) companies have been created.

6 More detailed up to date maps of the pipeline, LNG and storage infrastructures can be found on www.gie.eu

7 When depleted gas production fields are converted into gas storage fields.

8

Exactly the kind of players8 the integrated market needs. Nevertheless some major improvements are

required to achieve a truly integrated market. As the Energy Sector Inquiry and the different benchmark reports have noted, concentration is still a problem [11],[12],[14],[18],[20]. The competition authorities have the responsibility to control market power problems both ex-ante (e.g. merger notification procedure) and ex-post (antitrust cases).

The physical backbone of the integrated market should also be strengthened further. Indeed the current gas grid has been developed with a national market paradigm in mind. To attain a flexible network that can support the competitive gas market, new investments are needed. Entry capacity should be added, both at the EU borders to bring gas to the market, and at the national borders to strengthen the interconnectivity of the national markets and to prevent distortion of the market by constrained pipelines. Furthermore, storage facilities should be managed taking a European perspective into account: there is no reason why French storages cannot be used to supply the Belgian market. The current gas market is physically integrated, but the players need to develop an integrated market mindset as well. This claim is valid for competitive players and regulated players alike. Indeed, cross border cooperation of TSOs, and even transnational TSOs are important steps forward in order to create an integrated gas market. Examples from other network industries such as Eurocontrol (aviation), European System of Central Banks (finance) and many railway projects, show that a transnational approach does work in the field.

c. Market architecture

Market architecture in this paper covers the main characteristics of a typical European gas market. So, in this section the supply and demand positions of the national gas markets are discussed, as well as the relations between the different market players who have been introduced in the previous section.

i. Market architecture: characteristics The typical European gas market has a substantial amount of natural gas consumption and very

limited domestic gas production. Therefore, gas has to be imported from mainly outside the EU (e.g. Norway, Algeria, Qatar and Russia). Due to the increasing transport distances, and the high capital cost that is related to such transport infrastructure, production is relatively rigid (high and stable load factors). As the availability of storage is not evenly distributed over all Member states, the typical European gas market has to import flexibility from neighbouring markets.

Table 3 gives an overview of some gas numbers taken from the last Eurogas annual report [32]. Many national markets have no local production at all (e.g. Belgium and the Baltic states), whereas the Netherlands and the United Kingdom are almost self sufficient and even net exporters to neighbouring markets. At the same time, total net supplies, which roughly coincide with gas consumption, are substantial. Thus, imports make out the majority of the gas supplies in most national markets. The ratio of the storage maximal working volume over the total supplies illustrates the uneven spreading of this flexibility instruments. Countries like Belgium, Spain or the United Kingdom have rather weak ratios (less than 5% of total supply can be stored), whereas Austria, Czech Republic, France and Germany have more flexibility in their markets. The poor ratios of Spain and the United Kingdom have to be nuanced: Spain uses LNG terminals as a proxy for physical storage and the United Kingdom is a market with substantial domestic gas production. The storage/supplies ratio for the EU-27 approximates 15%, which seems a low number given the importance of natural gas for the EU economy (natural gas accounts for approximately 25 % of EU primary energy consumption).

Table 3 National gas market characteristics: data 2007 – all numbers are expressed in million cubic meters

(Mm3), except for the last column, which has percentages as units [32]

Indigenous production

[Mm3]

Total net im-port EU [Mm

3]

Total net im-port non EU

[Mm3]

Total net supplies [Mm

3]

Storage max wor-

king volume [Mm

3]

Storage volume/total

supplies [%]

Austria 1894.4 -1894.4 8934.4 8115.2 4100 50.52%

Belgium 0 7700.48 10007.04 17443.84 680 3.90%

Bulgaria 273.92 0 3248.64 3192.32 1000 31.33%

Czech Republic 94.72 0 8140.8 8407.04 3376 40.16%

Denmark 8860.16 -4339.2 0 4377.6 881 20.13%

Estonia 0 0 998.4 998.4 0 0.00%

Finland 0 0 4439.04 4441.6 0 0.00%

France 1100.8 7390.72 36812.8 45824 11700 25.53%

Germany 15334.4 5427.2 64691.2 85888 19918 23.19%

8 This is especially true for the Wholesale level; with regard to retail, there is potentially more room for many small

retailers.

9

Indigenous production

[Mm3]

Total net im-port EU [Mm

3]

Total net im-port non EU

[Mm3]

Total net supplies [Mm

3]

Storage max wor-

king volume [Mm

3]

Storage volume/total

supplies [%]

Greece 0 0 3970.56 3929.6 75 1.91%

Hungary 2147.84 599.04 8655.36 12733.44 3720 29.21%

Ireland 440.32 4631.04 0 5071.36 198 3.90%

Italy 9474.56 7838.72 64286.72 82813.44 13400 16.18%

Latvia 0 0 1587.2 1587.2 2325 146.48%

Lithuania 0 0 3425.28 3425.28 0 0.00%

Luxembourg 0 1484.8 0 1484.8 0 0.00%

Netherlands 65185.28 -42319.36 16832 39705.6 3000 7.56%

Poland 4349.44 796.16 8599.04 13854.72 1660 11.98%

Portugal 0 0 4247.04 4262.4 90 2.11%

Romania 11256.32 0 4579.84 15836.16 2850 18.00%

Slovakia 69.12 -97.28 5452.8 5457.92 1300 23.82%

Slovenia 0 -46.08 1103.36 1085.44 0 0.00%

Spain 74.24 -110.08 37696 37621.76 1659 4.41%

Sweden 0 1070.08 0 1090.56 10 0.92%

United Kingdom 77235.2 -4633.6 24422.4 97382.4 4364 4.48%

EU-27 197793.28 -16501.76 322129.92 506030.08 76306 15.08%

Original data (PJ) converted with factor 1 PJ = 25.6 million m3 (GCV = 39 MJ/m

3)

Cyprus and Malta have been omitted (no gas market) From Table 3 it should be clear that flexibility (both LNG and storages) from neighbouring markets

becomes increasingly important. For instance, Latvia has a storage working volume exceeding its own total gas consumption, so it could sell flexibility to Estonia and Lithuania. Similarly Belgium can rely on French and German storages to compensate for the lacking local storage. Based on these market characteristics and the physical backbone of the market, a number of regional

9 hubs (gas trading place) have been created

(Fig. 5). At these hubs gas can be traded spot, which serves as an alternative for the typical long term bilateral producer-importer gas contracts. Moreover, spot markets “connect” neighbouring gas markets. The most important hubs are the British National Balancing Point (NBP), the Belgian Zeebrugge Hub (Zeehub) and the Dutch Title Transfer Facility (TTF). Hubs will be discussed in more detail in subsequent sections.

Figure 5 European hubs – taken from [www.gie.eu.com]

ii. Market architecture: relationships

Juris [23] states that the architecture of a gas market depends on the characteristics of that market. This means that factors such as the size of the gas consumption, the availability of gas supplies and the structure of the pipeline network determine to a large extent how the market is organised. Although the

9 Actually the gas hubs are nationally organized and currently there is a competition going on to become the reference

hub of continental Europe.

10

European gas markets can differ significantly from each other, some typical relations between the players can be distinguished. Figure 6 shows a simplified sketch of the European gas market architecture. Two types of ‘relationships’ should be distinguished: the physical relationships on the one hand, and the contractual relationships on the other hand.

Physically, gas flows from the production site to the consumption site, a relationship that is completely handled by the TSO (for the high pressure transportation) and the distribution system operators (DSO, low pressure transportation). The gas can flow directly to the end-user, or it can be stored some time in storage. Besides the physical flow, represented by the block arrow in Fig. 6, the contractual flows are less straightforward and can form complex webs of relationships.

Basically gas is imported under long term contracts (15-25 years) between producers and importers at the wholesale level. Although shorter term contracts are increasing in number as a consequence of the market liberalisation, long term contracts will continue to form the backbone of natural gas supply [24], [33]. These long term contracts usually are oil price indexed. Alternatively, wholesale suppliers can acquire and trade gas at the spot markets that have been developing recently. On these regional spot markets traders (e.g. financial institutions) are active as well, providing liquidity to the spot market. Some large industrial consumers and the power sector contract directly with wholesale suppliers. Other consumers are supplied by retailers. So, the retail suppliers sign contracts with wholesale players to acquire gas. For the transportation of the gas, wholesalers and/or retailers sign contracts with the TSO/DSO who physically carry out the transportation as explained above.

Besides the above mentioned core players, the typical European gas market has a number of supporting players as well. Examples of such supporting services are storage, LNG and hub operators. At certain hubs exchanges have developed as well. Next, there are players that provide the framework in which the gas market can function. The regulators, competition authorities, law makers and justice department are ‘back office’ functions that have to be in place to ensure the well functioning of the market.

If the presented market architecture in Fig. 6 is compared to the models discussed by Juris, current European gas markets show most similarity to Juris’ fourth and most developed model (unbundling and retail competition). According to Juris such market architecture suits large gas markets well. Certainly, the integrated gas market satisfies the conditions of a large gas market, where a bilateral trading pattern (producer – wholesalers and retailers – consumers) can sustain a liquid spot market. However, many national markets are rather small in size, thus lacking some of the prerequisites to make this kind of market architecture a success. Juris argues that for such small gas markets a market pool approach can increase the liquidity of the market. Such a gas market pool existed in the UK (Poolco), but has now been abandoned in favour of the market model described above. The combination of small markets with the bilateral trading model results in low liquidity of the market. Indeed, current gas market hubs are built on national markets, rather than taking a regional approach, even in such small markets as Belgium.

11

Figure 6 EU gas market architecture – simplified model

WHOLESALE MARKET

Importers

Traders

RETAIL MARKET

Supplier 1

CONSUMPTION

PRODUCTION/EXPORT

TRANSPORTATION NATURAL MONOPOLY

Supplier 2

Domestic EUProduction

TRANSPORT

DISTRIBUTION

SUPPORTING SERVICES

STORAGE

HUBS/EXCHANGES

*REGULATOR

*COMPETITION

AUTHORITY

* JUSTICE

EU GAS MARKET

S

P

O

T

Residential Commercial/

tertiary

Industry Power

generators

P

H

Y

S

I

C

A

L

LNG HANDLING

Residential

Commercial

Industry

Power sector

12

iii. Evaluation of market architecture The market architecture of the European gas markets seems to be adapted to the market

characteristics and the liberalisation. Indeed, the market has moved away from the vertically integrated architecture, where all functions are within the same company. However, in some ways the market architecture is even ahead of the effectively realised market integration, because differences exist between the national market characteristics and the characteristics of a fully integrated gas market.

The organisational rules of the gas markets can be discussed in much more detail. One can think of the different transport capacity models (point-to-point vs. entry-exit), tariffs (distance based vs. entry-exit) the balancing rules (hourly vs. daily balancing), nomination rules and many other aspects. A detailed study of these organisational rules is not part of the scope of this paper, though. Only the result of the differences is important: divergent organisational rules complicate cross border gas trade and as such they hinder the further integration of the market. Therefore, organisational rules, like the legal rules that have been discussed in section 3.a, should at least be compatible.

d. Market functioning

In the previous sections the European gas market(s) have been described from different perspectives. The analysis above shows that substantial market reforms have occurred. In this section, some important parameters of market functioning and integration achievements in the field are discussed. However, it is not the aim of this paper to exhaustively discuss all elements of market performance. On the contrary, a selection of issues has been made. Firstly, a general overview of national market liquidity is provided. Next, spot markets and price indices are discussed, and finally the market response to the Russian gas supply disruption is briefly studied.

i. National market liquidity Moffat Associates prepared a report about EU energy market liquidity for DG TREN [19]. Their

analysis shows that most national markets have a degree of liquidity that is moderate at best, the only exception being the United Kingdom. This exception is easily explained when one takes into account the different market structure (presence of domestic production) and the fact that energy market liberalisation started much earlier than on the continent. Figure 7 shows the state of market liquidity for a number of West and Southwest European countries.

Figure 7 National market liquidity (wholesale) – overall assessment taking into account factors such as market

entry, influence of incumbent, number of traders and volumes of trade – taken from [19]

The overall assessment is based on the assessment of a number of market liquidity factors such as trading volumes, number of traders and number of entrants. Trading volumes in national markets are low and the influence of the dominant incumbent remains high. The representativeness of the spot market was qualified as weak as well.

On the retail level customer switching, i.e. changing gas supplier, is a measure of the well functioning of the liberalised gas market. Data on customer switching are not abundantly available. The numbers provided by the national regulators [15] indicate that customer switching rates are well below 1 % per year. It

13

should be noted that there is a learning effect in customer switching: once a customer has learnt how to switch, that customer is much more likely to switch again. This behaviour has been observed in the more advanced UK gas market.

The conclusions in [19] seem to confirm the observations that have been made in the Energy Sector Inquiry: overall liquidity in European gas markets is low. However, a closer look to spot markets is needed to see the steps forward that have been made during the past decade.

ii. Spot markets: hubs, OTC and exchanges

Indeed, one of the main achievements in the post-liberalisation gas market is the development of real spot markets for natural gas. These spot markets have developed at gas hubs, which are places with an abundant availability of natural gas. Figure 5 shows a map of the main regional hubs that have developed. The oldest hub is the British NBP. Furthermore, France has its Points d’échange de gaz (PEG), Belgium its Zeehub, and the Netherlands the TTF. In Central Europe the Central European Gas Hub (CEGH) in Baumgarten is a major trading place.

At some of these hubs exchanges have been created. In contrast with the bilateral or OTC (brokered) trade at plain hubs, exchanges allow natural gas to be traded anonymously. Moreover, some more developed exchanges list financial derivatives with the gas at the hub as the underlying commodity. Examples of exchanges are the Intercontinental Exchange (ICE

10), the APX

11 group and the German

European Energy Exchange (EEX12

). Table 4 lists some basic statistics about the major European gas hubs. The traded volume gives an

indication of the market size, whereas the churn is the ratio of traded volumes over physical throughput. The NBP is clearly the most developed hub, both in traded volumes and in liquidity (measured by the churn ratio). Trade volumes have risen from some 400 billion cubic metres in 2003-2004 to about 900 bcm in 2007-2008 [34]. The churn ratio doubled as well over the same time period. The TTF is smaller with about 65 bcm traded in 2008, but coming from 30 bcm in 2007, it is growing fast. The Belgian Zeehub is considered one of the most liquid hubs on the continent with a churn ratio between 3 and 6. The traded volumes have stabilised over the last years, though. This stabilisation is easily observed in Fig. 8 which shows the cumulative traded volumes and physical volumes of the main continental hubs.

Table 4 Major European hubs – statistics [20], [31] and [34]-[35]

Volumes traded [bcm] Churn estimates [-]

NBP ± 900 (Aug 2007- Jul 08)

8-13

TTF ± 65 (2008) 3-6

Zeehub ± 40 (2008) 3-6

NCG (former EGT) ± 10 (2007 1-2

CEGH ± 16-18 (2007) 3-4

PSV ± 12 (2007) 1-2

PEG ± 12 (2007) 1-2

Figure 8 Evolution of traded volumes at major continental hubs – taken from [31]

10 www.theice.com

11 www.apxgroup.com

12 www.eex.com

14

Although the continental hubs are not that well developed yet, they are improving rapidly both in terms of volumes and in terms of churn ratio. This evolution is well illustrated in Fig. 8. Hub trade (bilateral and OTC) is responsible for more than 80 % of all gas trade. This implies that exchanges take about 20 % of total trade. Table 5 lists the most important European exchanges.

Table 5 European gas exchanges [20], [31]

Type Associated hub

ICE Futures NBP

APX OCM Spot NBP

APX Zee Spot Zeehub

APX TTF Spot TTF

ENDEX TTF Futures TTF

EEX Spot + futures NCG

Exchanges are a relatively new phenomenon in the European gas markets, with most indices only

starting a few years ago. Due to this short life of exchanges, not much data on traded volumes and exchange performance is publicly available. What is known about gas exchanges, is that volumes are substantially (factor 3 – 10) smaller than OTC trade. Moreover, liquidity of forward contracts decreases rapidly with maturity further away. Gas market exchanges are in general much less developed than their electrical power equivalents.

iii. Price indices and price convergence

The exchanges that were discussed above all have price indices published on their websites. However, due to the problem of low liquidity, it remains a question to what extent the indices truly reflect the demand supply dynamics in the market. Hub price indices are drawn up by private parties and are available for sale. Therefore, transparent price indices are not always publicly available.

One of the expected results of market integration is price convergence. In theory, if markets are integrated the price differential between hubs should be limited to the cost of transportation between these hubs (assuming that there is no congestion along the route). Neumann & al. [21] found evidence of price convergence between the Zeehub price and the NBP price. Convergence between other continental prices was not established. Robinson [22] has looked at retail prices. He found weak signs of increasing convergence between European gas markets over the period 1978-2003. However, market integration has advanced significantly after these studies. Today, gas prices do converge to a large extent which is visually confirmed in Fig. 9. And the NBP and Zeehub can be considered to be coupled markets most of the time.

Figure 9 Monthly average prices for European hubs – taken from [36]

15

To date Europe, especially continental Europe has no reference price index like the American NYMEX Henry Hub gas price. Such a reference index could serve as a price basis for derivatives and all other hubs could be priced according to the differential with that reference price. This would certainly increase gas-to-gas competition in Europe.

Although price integration is not yet perfect some important steps forward have been taken. Given time to develop the spot markets and to invest in the grid in order to remove existing pipeline congestion, price convergence can be attained and a reference price index can be determined. Today, only the NBP approaches the liquidity that is required to serve as a reference, but the German hub might stand a better chance to really become the reference due to its better relative location in the EU.

iv. Case: Russia - Ukraine gas disruption

To further illustrate the results of market integration, the market response to the Russian gas supply disruption is briefly discussed.

When Russia completely stopped the supply of gas to Europe mid January 2009, the European gas markets responded promptly, as is shown in Fig. 10. Gas flows were reversed on the Interconnector and reduced on the BBL (Balgzand Bacton Line) to substitute German and France gas supplies from Russia. Similarly, gas flows reversed in the Czech Republic and Greece to help Slovakia and Bulgaria, respectively.

Figure 10 Market responses to supply disruption January 2009 – taken from [37]

These joint responses show that some degree of actual integration has been attained and that gas

markets are connected and can deal with a sudden shock.

v. Evaluation of market functioning The Energy Sector Inquiry identified a number of malfunctions in the European gas markets. These

problems such as low entry, low customer switching and low cross border trade are real. However, some major steps forward have been made. Spot markets are developing, gas prices are converging and markets respond rapidly to unexpected shocks like the Russian gas supply disruption.

Yet, much improvement is required, but the EU gas market is not standing still. On the contrary, a lot of initiative have been worked out to make further progress in creating a single gas market.

4 On-going initiatives to advance on the pathway of market integration

The full integration of all Member States’ gas markets at once proved to be an impossible challenge. Therefore an intermediate step was proposed: regional integration of European submarkets. ERGEG has divided the European gas market into three regions: North-West (basically UK, Benelux, Germany and Scandinavia), South (Iberian market and France) and South-Southeast (Central and East European gas markets). Each of these Gas Regional Initiatives has established task forces and work programmes adapted to the specific market integration needs within the region.

16

Figure 11 Gas regional initiatives [www.energy-regulators.eu]

The regional approach seems to be the way forward for gas market integration as the GRI groups

are much more dynamic. Moreover, countries with similar market characteristics (e.g. gas provision from the Norway vs. from Russia) are now grouped together. These GRI groups are working on balancing rules, market interconnections, capacity issues, gas quality rules, hubs and many other topics. In other words, they continue working on the issues and problems that have been identified and discussed in this paper, but on a smaller scale. However, because these initiatives just started, it is too soon to evaluate their achievements.

5 Conclusions

Currently the market integration is not yet completed, and the market distortions identified in the Energy Sector Inquiry continue to exist. But by focussing on what is to be achieved, one tends to forget that major reforms have been realised over the past decade.

With reference to the legal state of market integration, the Member States might have failed to fully implement the spirit of the second energy package. However, by proposing a third amending package the Commission implicitly acknowledges that the legal framework laid out in the second package failed to create the required conditions for full market liberalisation and integration. There is nothing wrong with learning-by-doing and given time the right legal framework for the European gas market will be determined.

The market structures of the Member States are still characterised by concentration in the competitive parts of the gas chain. Yet, recent mergers and acquisitions in the energy sector should be welcomed as a big step forward in the market restructuring. Evidently, competition authorities should safeguard effective competition in the gas market, but the economics of market integration logically imply the survival of less bigger companies. At the same time the current strong physical backbone of the gas market should be further strengthened. Indeed, the gas infrastructure has always been developed in a pan-European spirit, but with national objectives in mind (e.g. security of supply for domestic consumption). Full market integration requires a transnational approach: the infrastructure should not just allow competition; it should enhance competition by allowing gas flows to respond quickly to supply and demand dynamics. The planned addition of LNG infrastructure and connections between e.g. France and Spain are major steps forward towards market integration.

The market architecture has already been adapted to market integration in such a way that the architecture might even be more advanced than the realised market integration. Concerning the functioning of the market, some major achievements have been realised. Gas market hubs are developing into real spot markets, with gas exchanges offering futures and other derivatives. Although the backbone of oil-indexed long term gas contracts will continue to dominate the spot market, volumes of spot trade have been increasing over the past years.

The market response to the Russian supply disruption in January 2009 is another hopeful sign of market integration. Therefore, one should not be blind for the shortcomings of the European gas market, but the realisations should not be marginalised either. By focusing on regional integration as a transitional step and by ensuring compatibility of the interfaces between neighbouring markets, further integration can proceed.

So, there is no one market for all EU Member States, but certainly the European gas markets have come a long way on the path towards market integration. They just need to transcend their national mindsets.

17

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