Unified Gas Market in EU: Path to Liberalization - KAZENERGY Eurasian Forum 2012

1. Creating a Unified Gas Market in the European Union:The Long Path Toward Liberalization VII KAZENERGY Eurasian Forum 2 October 2012 Laurent Ruseckas Senior Associate, Global Gas

2. Terms of Use The accompanying materials were prepared by IHS CERA Inc. (IHS CERA) and are not to be redistributed or reused in any manner without prior written consent, with the exception of client internal distribution as described below. IHS CERA strives to be supportive of client internal distribution of IHS CERA content but requires that • IHS CERA content and information, including but not limited to graphs, charts, tables, figures, and data, are not to be disseminated outside of a client organization to any third party, including a client’s customers, financial institutions, consultants, or the public. • Content distributed within the client organization must display IHS CERA’s legal notices and attributions of authorship. Some information supplied by IHS CERA may be obtained from sources that IHS CERA believes to be reliable but are in no way warranted by IHS CERA as to accuracy or completeness. Absent a specific agreement to the contrary, IHS CERA has no obligation to update any content or information provided to a client.

3. Overview of the liberalization process • Since the mid-1990s the European Commission has been pushing for European energy markets to be opened up, liberalized, and unified • Policy has focused on gas and electric power • Markets for oil, oil products, and coal seen to be already sufficiently open and competitive so as not to require “special” measures • In legal terms this campaign began with the First Electricity Directive (1996) and the First Gas Directive (1998) • It has continued since that time through subsequent directives and through enforcement of EU competition (i.e. anti-trust or anti-monopoly) law • The driving goal of these reforms: To reduce electricity and gas prices paid by consumers

4. A unified market and a liberalized market:Two sides of the same coin • One key problem identified in the 1990s was the dominance of incumbent monopolies that controlled import and onward sales of gas as well as transmission assets, and were shielded from competition • Progress toward the overriding economic objective of the EU—creating a “single market” for goods and services—was clearly impossible without breaking up or unwinding these monopolies

5. 9 Timeline of EU gas regulatory change Second Directive: rTPA for national transmission network and LNG terminals nTPA or rTPA for storage Legal unbundling Implementation of the Network Code by national TSOs: At the latest, two years after the publication of the network code EU Third Package: Third Directive and Gas Regulation Ownership unbundling or Independent System Operator Creation of ACER Framework Guidelines on Capacity Allocation and Gas Balancing: To be released by ACER in July and September First Directive: Principle of the single European gas market and timetable for market opening nTPA or rTPA on the national transmission network 2011 1998 2003 2004 2006 2009 2013 Further Merger of German Hubs: 3 balancing areas First German hubs: BEB VP and E.ON VP Three French PEGs: Northand South (GRTgaz) PEG South-West (TIGF) New balancing regime In the Netherlands: GTS launching a full market based regime socialising imbalances Full opening of the Dutch market Five French PEGs Merged German Hubs: NCG and Gaspool with 6 balancing areas Full opening of major markets

6. Reforming the EU gas sector:The First Gas Directive (1998) • Immediate requirement to open 20% of retail gas market to competition • Exemptions (called “derogations”) were granted in practice in several cases • Third-party access (TPA) to gas transmission mandated; two options for implementation at the national level (regulated and negotiated TPA): • “Soft” unbundling of transmission and commercial functions • In practical terms, the achievements of the First Gas Directive were limited • Loopholes, exemptions, and weak enforcement of state-level regulation meant practical changes occurred only in those countries which were already intent on liberalization • But it very clearly pointed the way toward the future, and was a critical first step in convincing both EU member states and the gas industry that serious reforms were inevitable in the longer term

7. Reforming the EU gas sector:The Second Gas Directive (2003) • Required that all gas consumers would have a choice of supplier by 2004 (for industry and local distribution) or 2007 (for retail customers) • Requirement for negotiated third-party access to transmission, storage, and LNG regasification facilities, with tariff methodologies subject to approval by national regulators • Full legal unbundling between gas transmission and commercial functions • Although a transmission operator and gas wholesaler could still be owned by a single holding company • Minimum requirements defined for national gas regulators; establishment of European Regulators Group for Electricity and Gas (ERGEG) • The Second Gas Directive had a major practical impact • However, implementation was uneven; in mid-2005 the European Commission sent formal warnings for non-compliance to 10 member states

8. Reforming the EU gas sector:The Third Energy Package (2009) • Deeper requirements for transparent and fair third-party access to transmission, distribution, storage and LNG regas facilities • Stronger bias toward full ownership unbundling between transmission and commercial functions . . . • . . . although the Independent System Operator option continues to provide an alternative to full ownership unbundling • Major emphasis on cross-border integration • Formation of ACER—the Agency for Cooperation of Energy Regulators • By building on the Second Gas Directive, the Third Package has had additional impact on the gas sector, but mainly on the margins • Competition enforcement is now the center of the action

9. The Directorate-General for Competition:The sharp end of the stick • DG Competition is by a wide margin the most powerful body of the European Commission, with broad powers to investigate anti-competitive behavior and punish offenders • Right to raid offices within the EU to seize documents and gather evidence • Statutory right to impose fines of up to 10% of a company’s annual turnover • Targets of DG Competition actions have the right to appeal to the European Court of Justice—but no such appeal has ever succeeded • For the past decade, DG Competition has increasingly taken a more active role in enforcing energy regulations • Against joint selling of Norwegian and Danish gas • Against destination clauses in long-term gas sales contracts • Cases launched against anti-competitive behavior on the part of many incumbents who were shown to be blocking TPA in practice

10. DG Competition actions have already transformed the European gas market • Joint or coordinated sales of gas by multiple producers is now ruled out • Destination clauses are now defunct, meaning that buyers can resell purchased gas anywhere in Europe • Various tactics to block TPA are no longer practiced • One result has been huge pressure on incumbents locked into to long-term gas purchase agreements with suppliers such as Gazprom • Are oil-linked prices the next frontier for DG Competition disapproval? Results of current Gazprom investigation will tell

11. Gas volumes traded at continental European hubs have been growing steadily Estimate for full year 2012

12. Lessons for the Eurasian Economic Community • What factors have allowed the European Commission to transform the EU gas market despite the objections and resistance of powerful incumbent players—and in many cases, EU member states themselves? • Powerful centralized bureaucracy with considerable independence of action • Deep ideological commitment (at DG Competition and DG Energy in particular) to free markets and a single market • Can this model be replicated in Eurasia? Not any time soon • The European Commission was established in the 1950s and only began liberalizing energy markets in the 1990s • Strong norms developed during this period prevent even the most powerful member states from intervening directly in Commission activity • EU member states have been willing to give up some sovereign powers to EU institutions, most notably DG Competition • The conditions today in Eurasia are very different

13. Thanks for your attention! Laurent Ruseckas Senior Associate, Global Gas laurent.ruseckas@ihscera.com