Energy Security Package: Natural Gas Markets in Focus

March 23, 2016 | 00:00
Energy Security Package: Natural Gas Markets in Focus
Energy Security Package: Natural Gas Markets in Focus
Last week the European Commission’s proposal of the Energy Security Package [1] was presented at the European Council in the framework of the co-decision procedure involving the EC and the European Parliament.

The Energy Security Package (or the Winter Package) comprises of four documents: two legislative proposals (Proposal for a review of the Regulation on Security of Gas Supply (SoS); Proposal for a Decision on Intergovernmental Agreements (IGAs) and two non-legislative strategic documents (Communication on the LNG and Storage Strategy; Communication on the Heating and Cooling Strategy).

Notably, the review of the Regulation on Security of Electricity Supply was postponed until December 2016, which makes the Energy Security Package indeed very much natural gas – focused. This approach supports the common view that security of gas supplies is central to EU’s definition of its energy security as such, not least given the inherent characteristics of the gas network in Europe (especially EU’s Southeast), the fact that gas accounts for a quarter of EU’s overall energy consumption and the volumes of imports are set to rise given the decline of indigenous production.

Presented just about a year after the launch of EU’s flagship Energy Union initiative, this Package is designed to be the milestone along the pathway of the Energy Union strategy delivery and going hand in hand with EU’s commitments in the framework of the COP21 Agreement.

Maroš Šefčovič, Commission Vice-President for Energy Union characterized the Package as follows: "The Energy Union Strategy, launched one year ago, promised to provide all Europeans with energy which is secure, sustainable, and competitive. Today’s package focuses on the security of our supply, but touches upon all three overarching goals. By reducing our energy demand, and better managing our supply from external sources we are delivering on our promise and enhancing the stability of Europe’s energy market.”

The Energy Security Package is indeed in line with the Roadmap for the Energy Union translating most of the Energy Union’s Action Points (15 in total were identified in the Energy Union Package published in February 2015) into the two legislative proposals and two strategic documents correspondingly: solidarity and regional coordination are at the core of the SoS Regulation proposal, Proposal for a Decision on Intergovernmental Agreements (IGAs) tackles the much debated gas contracts transparency issue; LNG and Storage Strategy - closely linked to SoS regulation – focuses on diversification of gas supply sources and routes and integrating additional gas storage in the market. The Heating and Cooling Strategy, in turn, has a strong consumer-oriented approach aiming at boosting energy efficiency and smart energy solutions in the sector.

However, the acknowledgement of the need for security of demand seems to be out of the picture, although the EC takes note in the Working Document complementing the LNG and Storage Strategy Proposal that stakeholders in the natural gas and LNG industry believe that “the EU should develop an understanding or vision on the future role of gas. This should be coherent across policy areas and clearly communicated to the market, and is a pre-requisite for a stable investment environment.” [2]

There are some positive messages from the Commission on the role of natural gas in EU’s energy transition coming through (particularly in the LNG and Storage strategy proposal highlighting sustainability and the use of LNG as an alternative fuel in transport, heat and power, as well as the symbiotic relationship between gas and renewables). At the same time, the Communication on the Heating and Cooling Strategy puts the emphasis on increasing energy efficiency in the sector, while prioritising the transition to alternative fuels (i.e. electrification of district heating and heat pumps) and omitting explicit reference to the role of natural gas in providing base load for seasonal demand fluctuations and potential cost effectiveness of the latter.

The Commission evidently tried to find a balance between giving some positive signals to the investors in natural gas and LNG projects (not least by prioritising market-based mechanisms in identifying and securing the necessary infrastructure projects in Europe) and reiterating the explicit commitment to increasing energy efficiency, as well as the share of renewables in EU’s energy mix.


The Legislative Proposals

Review of the Regulation on Security of Gas Supply (SoS) – the Review manifests EC’s determination to address the energy security issue by committing the Member States to greater cooperation and coordination on the regional level. The shift towards the regional approach to energy security measures is proposed on the basis of results of the stress tests carried out by the EC in 2014, [3] revealing the weak elements and vulnerabilities of the regional gas networks.

Boosting Regional Energy Security – what would that mean in practice? It will be mandatory for the National Regulatory Authorities (NRA’s) of EU Member States to develop (and update on a four-year basis) regional risk assessments, preventive action plans and emergency plans in cooperation with the Agency for Cooperation of Energy Regulators (ACER) and the European Network of Transmission System Operators for Gas (ENTSOG).

In the proposal most of the countries are grouped into clusters according to the supply pattern of Russian gas (i.e. Southern Gas Corridor, Central-East, South-East, Baltic Energy Market I and II), while the North-South Western Europe region is kept relatively broad due to the level of market maturity (Belgium, France, Luxembourg, Spain, the Netherlands and Portugal). Most of the regional Gas Connectivity Working Groups are already in place; therefore the present legislation mostly reinforces the obligations of the existing regional cooperation structures, instead of introducing new cooperation frameworks for the Member States.

Apart from the strong regional component of the security of supply legislative architecture, the regulation proposal features the new solidarity principle: in an event of an emergency supply disruption the supply standard in one Member State should not impede the necessary levels of supply (or even help supplying the required gas volumes) in the neighbouring countries dependant on the former. This measure is designed to guarantee service to all protected customers in the event of a crisis, although one has to note that the definition of “protected consumers” varies across the Member States. Apart from that, the Regulation states that market mechanisms should be prioritised and deployed “for as long as possible when coping with disruptions”. [4]

Another interesting aspect of the SoS Regulation is Commission’s take on the long-term contracts monitoring. Although the Commission has been expressing its neutral stance vis-à-vis gas pricing structures, the suggested legislative document is marked by EC’s proposal that natural gas companies should automatically notify the EC once any contract “relevant for the security of supply” is signed or amended. The latter are defined as any long-term contracts “that provide, either individually or together with other contracts concluded with the same supplier or its affiliates, more than 40% of the yearly natural gas consumption in the Member State concerned to one natural gas company or its affiliates.” While contracts based on hub pricing are exempt from this ex post notification rule.

Finally, the long-debated joint purchasing mechanisms are referenced as an optional solution for tackling supply shortages, however by no means a mandatory one.

Proposal for a Decision on Intergovernmental Agreements (IGAs). At present, according to the IGA Decision dating back to 2012, EU Member States are obliged to notify the EC once they enter an IGA with a Third Country. This mechanism of Commission’s involvement post-factum did not help ensuring a consistent approach on the EU side in its dialogue with the Third Countries (not least in the case of the South Stream project), while the ex-post evaluation – as stated in the proposal – was not taken into account by the Member States and the non-compliant IGA were not modified accordingly.

Hence, the new legislation proposes to shift to ex ante approval of the IGAs by the EC (before they are signed between the parties) to check the compliance of IGAs with EU law and a number of EU priorities: ensuring the well functioning internal market, enhancing EU’s energy security, increasing the cost effectiveness of the EU's energy supply and solidarity between EU Member States. [5]

Although the IGA Decision excludes commercial contracts between commercial entities (energy companies), this questions is addressed in the review of the SoS regulation and the proposal that EU natural gas companies would need to notify the Commission before signing contracts “relevant for the security of supply” (as discussed above). [6]

The Non-Legislative Documents Proposals

Communication on an LNG and Storage Strategy

The prospects of LNG and Gas Storage role in supporting EU’s energy security objectives is of course at the heart of the strategy, and the role of LNG and natural gas in EU’s energy transition (particularly in the transportation sector and the heating and cooling sector) features quite prominently.

With the aim of capitalising on EU’s position as balancing market on the global LNG trade map, the EC structured this Strategy along two core dimensions. The first one is that of internal market coordination and integration. The Strategy recognises that improving interconnection and market liquidity is essential to attract new LNG supplies in a cost-efficient manner, hence it puts forward the regional approach to integration and coordination of EU gas and LNG markets in line with and closely linked to the review of the SoS Regulation (e.g. preventive actions and emergency plans should include storage-related measures and agreements on their use on a regional scale) and the TEN-E Regulation. The rationale of the EC’s strategy is therefore very explicit: it calls for optimising investments in LNG and storage infrastructure on the regional level, while ensuring greater market liquidity.

As for project financing, the strategy reads that “in principle, LNG terminals should be financed through tariffs but in some cases market participants bear the risk of the investment” [7] and EU funds could be available to compensate for lack of commercial viability of project relevant for energy security. The general emphasis of the strategy is on the development of interconnectors, rather than new storage or regasification capacity (which is considered to be sufficient).

The stronger EU external energy policy agenda constitute the second dimension of the strategy, as it spells out some key action points aimed at strengthening Commission’s’ profile in the context of EU energy diplomacy and building relations with external exporters, in particular, Australia, Qatar, African countries and the Middle East. Apart from developing the dialogues with some key LNG exporters, the Commission aims at working closely with such major LNG importers as Japan, particularly in the framework of Japan’s G7 presidency, as well as China, India and South Korea. The Commission also aims at over sighting the LNG IGAs in line with the SoS and IGA Decision provisions.

Communication on a Heating and Cooling Strategy
In the first EU-wide Heating and Cooling Strategy the EC formulates its vision of the sector, which accounts for half of EU’s energy consumption. The EC identifies some key priority areas of work in the heating and cooling sector to achieve the 2020 energy efficiency and RES targets: improving the energy performance of buildings, reuse of energy waste (including waste cold generated by the LNG terminals), promotion of energy systems integration (which would improve the flexibility of supply and demand response), promotion of renewable heating and cooling and deployment of smart energy systems (including smart grids, smart building solutions and appliances). All these priority actions listed in the strategy form an integral part of the Electricity Market Design, Renewable Energy Directive and EED reviews to follow in second half of 2016. Notably, the consumer-oriented nature of the strategy, which seeks to empower the citizens with smart energy management tools is another key feature of the document.

The immediate observation that comes across when comparing this strategy with the LNG and Storage one (as well as the related Working Document) is the shift of discourse and technological prioritisation of electricity-based heating and cooling systems. By the end of the day, the policy signals to the market participants (both on the natural gas, RES and energy efficiency side) seem to be ambiguous, and to an extent, vary in the context of different sectors of the energy market. However, the present Package presents a compromise between the need for securing the role of natural gas in EU’s energy mix and pushing for greater RES and energy efficiency solutions uptake.

1. The Energy Security Package proposal was initially published by the EC on 16 February 2016
2. SWD(2016) 23 final, p. 7
3. See COM(2014) 654 final
4. See COM(2016) 52 final, p. 18
5. COM(2016) 53 final, p. 2
6. COM(2016) 52 final, p. 11
7. COM(2016) 52 final, p. 4

Image: Maroš Šefčovič. By: European Commission.
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