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Energy union. Time for delivery

If the European Union’s ambition is to attain secure, sustainable, competitive and affordable energy for every European, member states should agree on how, when, and to what extent they would be ready to ensure energy solidarity and transparency among them. In the case of natural gas, this could well require strengthening the European Commission’s supervisory powers, at least for some time, in order to accelerate completion of the internal energy market and improving coordination of interactions with third countries, such as LNG exporters.

July 18, 2016 - Jarosław Ćwiek-Karpowicz - Articles and Commentary

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The Commission’s proposals

At the end of April, the first commercial LNG cargo from the United States to Europe docked at the port in Sines, Portugal. As the world gas market became glutted due to the slowdown of Chinese demand, the cargo was expected to be the first of many to Europe, where the average gas price is still higher than in North America. But regular LNG trade flow from the US to the EU has not yet happened, as the EU’s market import capabilities cannot be used to their full extent thus far. Some member states are still not well-connected to the European gas transmission network and are often bound by, not always transparent, contracts with one dominant supplier, which significantly decreases their energy security.

Developing the Energy Union concept through the last year, the EU has aimed first of all at improving security of gas supply for all member states. The concept begins a new stage of legislation delivery with the Energy Security of Supply Package, presented by the European Commission (EC) on 16th February 2016. The Commission’s  winter package consists of two revised legislative acts — the Regulation on Security of Supply (SoS Regulation) and the Decision on Inter-Governmental Agreements (IGAs Decision) — and two non-binding Communications on the LNG and Storage Strategy and the Heating and Cooling Strategy. The real test of the Energy Union is drawing nearer, as Brussels’ intention to impose a comprehensive European gas policy will now be confronted with member states’ own interests.

Regional cooperation and solidarity

At the heart of the EC’s winter proposal is a call for mandatory regional risk assessments, preventive action plans, and emergency plans in the events of a gas supply cut off. The logics of a new security of supply system goes from national to the regional and supraregional level of cooperation, which provides member states with a new set of instruments to enhance their gas security. EU stress tests carried out in 2014 in response to the Russia-Ukraine crisis demonstrated the EU’s alarming vulnerability. The tests revealed the EU’s overreliance on Russian gas and confirmed that mitigation efforts would be limited to national markets and interventionist measures, which would intensify the impact of the crisis, making it more acute.    

According to the Commission’s plan, the solidarity principle would manifest itself not only through the closer cooperation of member states within permanent regional groups supervised by the EC, but also through better ensuring gas supply to households, essential social services and district heating. If these rules are fully accepted by the EU member states, gas supply to non-protected customers in one country, for example, Germany, would not be continued if supply to above mentioned categories customers in a neighbouring state, for example, the Czech Republic or Poland, is not satisfied, although all market-based measures had been used. But such regional solidarity requires mutual trust and concrete commitments, which could be easily weakened by a “more flexible approach” demanded by some member states.

To enhance EU resilience to external gas disruptions and complete the internal gas market, member states should be better equipped with interconnectors and physical reverse flow capability. So far, bi-directional gas transmission is not constructed at many critical points, such as the French-German border or the underwater pipeline between the UK and the Netherlands, mostly due to the high costs of reverse flow investment. The Commission proposed mandatory reverse flow capability as a rule and, in parallel, it tabled stricter exemption procedures in scenarios where the relevant transmission gas system operators (TSOs) are not willing to enable permanent physical capacities. These procedures envisage the engagement of all TSOs and other stakeholders along the whole supply chain and not only two neighbouring member states, in order to ensure that all options are considered before granting an exemption. These proposals are also important for those who want to build an LNG terminal and to calculate its cost.  

Competition and transparency

To support free competition in the EU gas markets, the Commission is set to ensure that all external energy agreements comply with EU law. The Commission’s right to scrutinise intergovernmental agreements (IGAs) before they are signed would be a milestone in completing the internal market for gas, as such assessment was rejected by member states a few years ago and still seems quite controversial to many of them.

According to the Commission’s proposal, each member state would have to notify its intention to enter into an intergovernmental agreement with a non-EU country, which would have to be assessed and approved by the EC before being signed (ex ante assessment). Furthermore, non-legally binding instruments, like memoranda of understanding, would be included in the Commission’s assessment, however ex post. This means that if a member state decides to sign an agreement with an outside country after the EC has identified non-compliance, this state might be liable for infringement procedures.

As Brussels also intends to tighten control over the most sensitive commercial contracts signed with a dominant gas supplier, many European gas companies and Member States have resisted; they are reluctant to share contracts granting  privileged position in relation with major suppliers. They are expected to try and soften the EC’s proposal in this regard and limit the number of sensitive contracts that must be submitted to the Commission, as this rule would allow the EC to enter too deeply into their domain. The crucial point is that the ultimate goal of the proposed transparency mechanism is to detect and properly address, by the Commission and competent authorities of member states, all the abusive clauses in the contracts as well as other provisions that are not in line with EU laws. As such all the commercial data, as well as contracts, will be kept secret and not released to the public. Thus, it can be said that those companies which do not have illegal provisions in their contracts should not be afraid of the new mechanism.  

Some member states criticise proposed transparency and compliance mechanisms as an administrative burden. They claim that market forces should regulate the energy market on their own. The point is that the market will not work properly if illegal clauses are enforced and if the abuse of dominant position is not detected and properly addressed. In June EU energy ministers clarified their positions and reached preliminary agreement on IGAs. They dropped the mandatory ex ante assessment for non-gas IGAs and exempt all non-binding agreements, e.g. Memoranda of Understanding, from any kind of notification to the Commission. These changes put the Council on a collision track with the Parliament, which supports the idea to give more power to the Commission.

LNG and common purchases

Although a common gas purchasing agency (as originally proposed in Donald Tusk’s Energy Union concept) will be not established in the foreseeable future, Brussels plans to use the EU’s sizable gas demand to Europe’s benefit.In the LNG strategy included in the winter package, the EU is set to ensure that every member state has access to LNG supply while continuing their dialogue with global LNG suppliers. This engagement, along with voluntary joint LNG purchases, may improve European gas consumers position and better utilize existing LNG infrastructure in the EU, especially when the new export infrastructure in Australia and the United States is anticipated to boost the global potential of LNG exports by 2020.

Meanwhile, as the gas demand in Asia has slowed, Europe, with its many receiving terminals, is a growing LNG outlet. This offers an opportunity to improve the diversification of supplies and reduce gas prices in the EU. Therefore, the Commission’s intention to more effectively use LNG capacities and gas storage should be welcomed not only by European gas businesses but also gas-reliant manufacturing sectors such as plastics, petrochemicals and fertilisers.

Next steps

Security of supply is the first of the five dimensions identified by Brussels in order to establish a coherent Energy Union, while the winter package is expected to be the first from several upcoming legislative packages focusing on the internal energy market, energy efficiency, decarbonisation and research. However the Commission’s future follow-up proposals will depend on when and especially how the European Parliament and the Council will adopt the first package. Negotiations between them should start in October with many expecting a deal by the end of this year.

Some energy companies, including external suppliers, may be afraid of bowing to Brussels and member states’ administration supervisory powers, as well as shifting balance from national to supranational level of cooperation (in particular through regional risk assessments, preventive and emergency measures and solidarity clauses). However, this package gives a clear signal that the EU is interested in enhancing the use of natural gas as a transitional fossil fuel and continuing to be a reliable LNG consumer. Moreover the proposed mechanisms deliver more transparency to the market and encourage member states and companies to cooperate. This increased cooperation will contribute to the optimisation of use of the current infrastructure as well as market oriented distribution of gas (removing illegal clauses from contracts and governmental binding and non-binding agreement is crucial to fulfil this task). In the presence of low global energy prices and high investment costs in new gas fields, this message may at least help keep stable volumes of gas production in currently exploited fields and launch new LNG projects at a time of uncertain global gas demand.

Jarosław Ćwiek-Karpowicz is Research Director at the Polish Institute of International Affairs and an Associate Professor of Political Science at the University of Warsaw.

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