A TARGET MODEL FOR THE EUROPEAN NATURAL GAS MARKET *** Preliminary Outline

1. European Energy Regulators' 2nd Workshop on Target Model for the European Gas Market Bonn, 22 February 2011 A TARGET MODEL FOR THE EUROPEAN NATURAL GAS MARKET***Preliminary Outline Jean-Michel Glachant & Sergio Ascari Florence School of Regulation

2. THE EUROPEAN GAS TARGET MODEL • A research project developed by • Florence School of Regulation • Clingendael International Energy Programme • Wagner, Elbling & Co. • with support from: • E-Control, Gmbh • Bundesnetzagentur • Net4Gas

3. PART 1GAS TARGET MODEL ARCHITECTURE

4. MARKET ARCHITECTURE: OVERVIEW • Multiple market zones • TM will not define how many / which zones • Mergers to be encouraged as larger zones would increase market competition and supply security • Zones may merge if economically reasonable • Too large zones (like a single EU zone) would entail unacceptable cross subsidies • Zones must be market capable • Architecture fully consistent with regional approach recommended by Security of Supply Regulation (No. 994/2010)

5. THE MECO MODEL (1) • The MECO model is a proposal for the European Gas Target Model • MECO is an acronym for: • Market Enabling and Connecting • The model focuses primarily on issues that can be addressed in framework guidelines and the ENTSOG network code • The status of the model is preliminary

6. MECO Model Pillar 1:Enable functioning wholesale markets Pillar 2: Tightly connect functioning wholesale markets OVERVIEW OF THE MECO MODEL FOR EUROPEAN GAS MARKET INTEGRATION Pillar 1: Structuring of the European gas grid in a way that enables functioning wholesale markets, so that every European end-user is served by such a market. Pillar 2: Connection of the resulting functioning wholesale markets by significantly facilitating cross-market trading especially in the forward markets and implementing market coupling of day ahead markets to align market prices as closely as the given infrastructure allows.

7. DEFINITION OF “FUNCTIONING WHOLESALE MARKETS” • A functioning wholesale gas market is: • a single price zone • accessible to incumbents and new entrants on equal terms • where trading is liquid - vivid and resilient at the same time • it creates reliable price signals in the forward and spot markets • no trade - even if substantial - shall distort the market price

8. MECO PILLAR 1: ENABLE FUNCTIONING WHOLESALE MARKETS • Functioning wholesale markets are essential for: • Fostering retail competition • Efficient use of gas assets (procurement contracts, storage, etc.) • Functioning wholesale markets can not be replaced by tightly connected non-functioning markets. The effects on retail competition and market efficiency would never by the same. • The MECO model creates structural conditions that enable the emergence of functioning markets by arranging price (entry/exit) zones that are: • Large enough to be interesting for a substantial number of wholesalers • Well connected to other markets

9. ARCHITECTURES TO ENABLE FUNCTIONING MARKETS • In order to create the structural conditions for the emergence of functioning markets, the following alternative architectures are foreseen in the MECO model: • Market Areas • i.e. a single price (entry/exit) and balancing zone from the import points to the end-users, either structured as: • National market areas (if functioning wholesale markets can be achieved stand alone); or • Cross-border market areas (if cross-border cooperation is required to achieve functioning markets) • Trading Regions • i.e. a single cross-border price (entry/exit) and balancing zone for wholesale markets with congestion-free interconnection to national end-user zones.

10. Country A Legend and Symbols Ex Interconnection capacity between transmission and distribution systems in the market area (not bookable by shippers) IC Cross-border interconnection capacity in the market area (not bookable by shippers) Virtual point of the market area serving as the sole marketplace of the market area Market Area A Transmission systems Distribution systems THE MARKET AREA MODEL • Features: • One virtual point for trading • Fully integrated wholesale market • One balancing zone from import points to end-users • Single balancing entity • Single set of balancing rules VP National market area Ex Country A Country B Market Area AB VP Cross-border market area Transmission systems Transmission systems IC Ex Ex Distribution systems Distribution systems VP

11. Country A Country B Trading Region AB VP End-user zone A End-user zone B VP THE TRADING REGION MODEL • Features: • One virtual point for trading • Fully integrated wholesale market • End-users are balanced in national end-user zones that may reflect national specifics • End-user balancing may be done by national balancing entity • Congestion-free interconnection between trading region and end-user zones through the common virtual point Legend and Symbols Trading Region AB = Cross-border entry/exit system including all nominated points on the transmission systems of countries A and B End-user zone = National balancing zone for national end-users, no matter the system (distribution or transmission) they are connected to Virtual point of the trading region serving as the sole marketplace of the trading region and all attached end-user zones. Shifting of gas between trading region and end-user zone is done by nominating a virtual exit on the VP.

12. MECO PILLAR 2:TIGHTLY CONNECT FUNCTIONING WHOLESALE MARKETS • Tight connection between functioning wholesale markets is essential for: • price alignment between adjoining markets, thereby driving market efficiency and public welfare on a European scale • improving market liquidity and increase competition, reducing market dominance in each & joint markets • enhance interconnecting infrastructure where necessary and economically justified • The MECO model foresees a number of measures in order to connect markets, differentiated by time horizon

13. CONNECTING THE ZONES (1) • Sell long term capacity by rolling auction / open seasons • bundled across transmission systems • coordinated across adjacent transmission systems and along routes • invest to increase capacity if market willing to pay for it • Sell at least 10% of total capacity on short term basis by auctions • bundled, coordinated • yearly, monthly and intermediate products to be available • enforce commercial / physical reverse flows • cap LT (>5 years) capacity contracts to 75%

14. CONNECTING THE ZONES (2) • Implement strict congestion management procedure • process already under way • Any firm capacity available / released after the CM procedure is transferred to DA markets • DA capacity may be directly auctioned off or transferred to gas exchanges for an implicit auction (volume or price coupling, market splitting) • Any unused capacity left from DA may be allocated intra-day (1st come 1st serve)

15. METHODS FOR CONNECTING MARKETS IN THE MECO MODEL Connection by … Time horizon Open Seasons, Cross-market trading furthered by Enhanced Trading Conditions Long term market Mid term market Cross-market trading furthered by ETC Short term market Day ahead market Market Coupling Intra-day market 1st come 1st serve, furthered by ETC

16. ENHANCED TRADING CONDITIONS • Enhanced trading conditions (ETC) are a package of measures to be implemented foremost in the ENTSOG network code in the areas of • CAM/CMP (e.g. VP2VP-products, coordinated auctions for longer term capacities, FCFS for the intra-day market, harmonized contract start dates, standards for secondary capacity trading…) • Nomination and Balancing (e.g. common gas day, harmonized nomination schedules, limits on renomination, …) • Tariffs (e.g. harmonized date for change of tariffs, structure methodology, inter-TSO compensations within zones) • Gas quality (in order to enable bidirectional flow at all border points) • Gas year sessions (co-ordinated LT auctions / open seasons, short term capacity auctions, seasonal storage booking) • The details of the ETC package are still under development.

17. VP DAY AHEAD MARKET COUPLING Market 1 Market 2 VP VP IC Adjoining day ahead spot markets (organised as exchanges operating on the virtual point) are connected by an administrative process in the course of which gas is bought in the cheaper market and sold in the pricier market, with the goal of price alignment and within the capacity limits of the interconnection capacity available to the market coupling process. Market Coupling may involve several member states at once. Legend and Symbols IC Interconnection capacity between markets Virtual point of the market

18. THE ROLE OF MARKET COUPLING • Not a general model, but an option limited to daily capacity allocation • Most trading likely to remain based on long term contracts, with increasing role of short term • More benefits from MC expected in power markets, where congestion issues are common • Market coupling untested in natural gas • Generalised usage unlikely for several years, no meaningful target dates • MC usage a valuable goal, as it leads to optimal capacity allocation and price alignment whenever justified • MC to be allowed and encouraged

19. VP VP MECO MODEL: ARCHITECTURE AT LARGE Country C Country D Market Area CD VP Country A Market Area A VP Country E Country F Trading Region AB Country B End-user zone E End-user zone F Market Area B VP Legend and Symbols Virtual point Connection between markets (facilitated by enhanced trading conditions and day ahead market coupling)

20. PART 2GAS TARGET MODELVISION, GOALS, CONSTRAINTS, CRITERIA AND NEXT STEPS

21. WORKING METHOD • Top-down approach • Outlining: • political goals • legal constraints • problems to be solved • Criteria for success • Providing a target model vision (architecture) • Outlining its main consequences for integration areas (Capacity Allocation, Congestion Management, Balancing, Tariffs, Investment, Interoperability, Operational Procedures) • Exploring links and relationships between the areas

22. POLITICAL GOALS OF THE GTM • Sourced from legislation recitals, official documents: • to establish an internal market in natural gas • to remove restrictions on cross border trade • to ultimately achieve efficiency gains • to promote competitive prices • to contribute to security of supply and sustainability • to ensure that Europe remains an attractive outlet for external supplies • to foster market integration • to reach an appropriate level of cross-border gas interconnections capacity

23. LEGAL CONSTRAINTS • Entry-exit systems required • Cost-reflective tariffs providing incentives to invest or value-reflective auctions • Endeavour to harmonize balancing regimes, streamline structure & level of balancing charges • Promote coordinated allocation of cross border capacity • Mandatory market based CA/CM • Implicit auctioning explicitly allowed for short term allocation

24. OUTSTANDING PROBLEMS • Uneven, un-coordinated capacity access allocation • Ineffective congestion management • Low transparency and no harmonization of entry-exit tariff setting criteria • Limited coordination of operational procedures, lacking IPAs/OBAs • Lack of open season co-ordination and decision criteria • Uneven status of hubs, exchanges and their liquidity • Reduced market competition, as problems are solved by horizontal & vertical company integration • Reduced investment, security of supply

25. CRITERIA FOR SUCCESS • Price convergence, after allowing for marginal transmission costs • hitherto achieved only in NW Europe • Liquidity: ability to buy and sell at market prices, from exchanges or long term contracts • satisfactory only in British NBP • Ability to reserve capacity for valuable trade in the short term and to reserve / expand capacity in the long term, including new infrastructure development • uneven, fragmented, no level playing field

26. MECO MODEL: BENEFITS • Once the MECO Model is implemented: • All European end-users will be served by a functioning wholesale market. • These functioning wholesales markets will act as enablers and fertilizers for retail competition because they provide easy access to competitively priced gas and are the basis for proper risk management. • Prices between these wholesale markets will be aligned as much as possible • This will maximize efficiency and thereby public welfare in / from trading on a European scale by making sure that all gas assets (procurement contracts, storage, …) are used in the most economic manner.

27. MECO MODEL: OPEN ISSUES • The research team is still working on a number of open issues including: • Integrating security of supply considerations • New infrastructure • Within day markets • The role of storage in the model • The role of LNG in the model • Balancing requirements • Tariffs • Operational procedures • Interoperability

28. STORAGE & LNG TERMINALS: EVOLUTIONARY VIEW • Storage facilities and LNG terminals are no natural monopolies • Negotiated access and TPA exemptions common in EU Member States • Essential facility doctrine, factual monopoly led to regulated TPE in several MS • Market integration likely to reduce monopoly power of remaining regulated facilities • Phasing-out of regulation to be foreseen as criteria for markets integration are me

29. NEXT STEPS • Some more detailed description of the Target Model • Addressing the main harmonisation areas • Exploring links between areas • Outlining further monitoring requirement • Discuss implementation steps and requirements

30. THANKS FOR YOUR ATTENTION! COMMENTS WELCOME TO: Gas.TargetModel@eui.eu