Cross-border Trade in Network-bound Energy Products:
Competition Related Issues
Brendan Oviedo
Centre of Energy Petroleum Mineral Law and Policy
University of Dundee
Scotland
Competition Provisions in Regional Trade Agreements
Istanbul, Turkey
31 July – 1 August
Table of Contents
1. Introduction …………………………………………………………………….. 3
2. The Liberalization of Electricity and Natural Gas Markets ………………… 3
3. Competition Related Issues in Electricity and Natural Gas Markets ………8
3.1 Market Structures and Market Concentration ………………………8
3.2 The Network ………………………………………………………….10
3.3 Long Term Contracts ………………………………………………. 11
4. Explicit Regulation or Competition? …………………………………………13
5. Competition Provisions in Regional Trade Agreements applicable to Crossborder Trade of Electricity and Natural Gas: The Way Forward? .................14
6. Conclusions …………………………………………………………………… 15
2
1. Introduction
Electricity and natural gas (NG) are network bound energy products. They
depend on their corresponding networks for their transportation. For electricity
and NG cross-border trade to take place domestic markets need to be
interconnected. Without interconnecting networks cross-border trade of these
products will be inexistent.
Anticompetitive practices by private undertakings in interconnected electricity
and NG markets could distort or restrict cross-border trade flows. The purpose
of this paper is to try to determine the platform from which these
anticompetitive practices could be effectively dealt with.
In order to try to answer this question, Chapter two below will review the
liberalization process of electricity and NG markets. Chapter three is destined
to identify potential anticompetitive practices that can negatively affect crossborder trade of electricity and NG. For that purpose such Chapter will review
market structures, ownership concentration of undertakings in the market, the
specific characteristics that networks have, and the long term contracts
entered by electricity and NG market undertakings in order to finance
upstream and downstream infrastructure projects.
The application of competition law and/or explicit regulation to the markets in
question will be addressed in Chapter four. Chapter five will lay out the
findings of all the previous chapters in order to identify the possible
supranational dimension of the competition issues that could affect crossborder trade of electricity and NG. Chapter six concludes.
2. The Liberalization of Electricity and Natural Gas Markets
There are three physical activities that can be identified in electricity markets.
These are generation (production), transmission and distribution. Electricity is
generated through the transformation of primary (sun, wind, water, etc.) and
secondary (oil, gas, coal, uranium, etc.) sources of energy. As electricity
3
cannot be stored once these primary and secondary sources are transformed
the produced electricity will have to be injected into the transmission network.
The electricity will then be transported on high voltage transmission lines until
it reaches the distribution network where the voltage will be reduced in order
to be delivered to final consumers.
NG is primordially composed by methane (CH4). However NG can usually be
found together with oil, water, and other gases in oil, gas and condensate
fields. The production of NG involves separating the methane from these
other elements.
After NG is produced to become “pipeline quality” gas it is injected into high
pressure pipelines and transported over long distances, as production sites
are not usually located near the markets where NG is consumed. After the
high pressure transmission, the NG pressure is reduced and pumped into low
pressure distribution networks for its delivery to consumers. However, NG can
be stored for an indefinite period of time and storage facilities can usually be
found at different points of the pipeline network. This largely depends on the
consumption intensity pattern of certain locations.
Now then, before electricity and NG markets were liberalized, their structure
generally consisted on the existence of vertically integrated utilities
responsible of all physical activities within national borders. These companies
held monopolistic rights over the production, transmission and distribution
(and storage in the case of NG) of electricity and NG. They owned their entire
market infrastructure and rendered all the services required to deliver
electricity and NG to consumers. There was relatively no cross-border trade in
electricity and if it did take place it would occur, as in the case of NG, among
vertically integrated companies.
In most cases, these vertically integrated companies were state owned. The
state ownership of these companies was sustained on the idea that the
industry’s potential monopolistic behaviour would most likely be prevented if
4
the ownership of the infrastructure was held by the State1 since electricity and
NG markets as a whole were considered to be natural monopolies2.
The monopolistic perception of electricity markets responded to the natural
monopoly characteristics of transmission and distribution networks, the
required synchronization between generation and transmission activities and
the costs arising thereof, the long term planning of generation and
transmission projects and the economy of scale nature that generation
activities have3.
The above perception was not entirely different for NG markets. The NG
market was, and in some markets still is, vertically integrated. Producers
owned transmission and distribution infrastructure, transmission companies
owned
distribution
and
production
facilities
and
distributors
owned
transmission and distribution assets4.
In Western Europe the market was controlled by “gatekeepers” at national
borders (transmission firms) and at local areas (distribution firms)5. These
companies usually held monopoly rights for NG imports, exports, transmission
and distribution and were partially or fully state owned.
During the 1970’s oil crisis it was discovered that independent power
producers in the United States (US) could operate in a manner that would not
endanger the reliability of the network. This implied that electricity production
was not a natural monopoly6 per se. This was not the case for NG. The
production of NG has and still is dominated by large oil companies.
1
IEA, Electricity Market Reform 21 (Paris, France: Head of Publications Service, OECD/IEA,
1999)
2 See Id, at 20
3 Hunt, Sally, Making Competition Work in Electricity 25-26 (New York: Wiley, 2002).
4 De Vany, A., and Walls, W.D., The Emerging New Order in Natural Gas: Markets versus
Regulation 5 (Westport, Conn. : Quorum Books, 1995)
5 Stern, J., Competition and Liberalization in European Gas Markets: A Diversity of Models 10
(London : Royal Institute of International Affairs, 1998)
6 See IEA, supra note 4, at 22-23.
5
This non-monopolistic perception of electricity production directed efforts
towards liberalizing electricity markets so as to introduce competition where
competitive activities could be identified.
The principle behind liberalizing electricity and NG markets is to ensure
competition7. In order to achieve this, some electricity and NG markets have
been restructured to enable competition where it is believed that this is
possible.
The modification of electricity and NG market structures has characterized
their liberalization. This means breaking up the existing vertically integrated
state company, privatizing its infrastructure, enabling potential competitors to
enter the markets where competition is deemed possible, unbundling the
activities that are potentially competitive from those that have natural
monopoly characteristics and creating independent regulators to foresee the
competitive performance of the markets8.
Electricity generation (wholesale market) and retailing are considered to be
competitive. In the case of NG these activities are production, storage and
retailing.
To enable competition in the wholesale electricity market, new undertakings
were allowed to enter such market by unbundling the incumbent vertically
integrated monopoly, privatizing its upstream assets and withdrawing its
monopoly rights9. However, not only electricity producers take part in the
wholesale market. Retailers that seek to procure electricity for their customers
and financial traders also participate.
7
Lee, M., and Morand, C., Competition policy in the WTO and the FTAA: A Trojan Horse for
International Trade Negotiations 5 (Ottawa: Canadian Centre for Policy Alternatives, 2003)
8 For further information on the sequencing of the liberalization measures introduced in a
given electricity market see Zhang, Y., Parker, D., and Kirkpatrick, C., Competition,
Regulation, and Privatization of Electricity Generation in Developing Countries: Does the
Sequencing of the Reforms Matter? Available at: http://www.competitionregulation.org.uk/publications/working_papers/WP62.pdf
9 Albers, M., Competition Law Issues Arising from the Liberalization Process in The
Liberalization of Electricity and Natural Gas in the European Union 3-4 (Geradin, D., Ed.,The
Hague; London : Kluwer Law International 2001 )
6
Introducing competition into electricity and NG retailing implied that the
transport component of the distribution activity was susceptible of being
unbundled from the commercial activity of supplying electricity to consumers.
This means that there would be a defined number of competing retailers
which provide customers with the possibility to decide what retailers they wish
to purchase their electricity from. It has been a gradual process of granting
consumers with the right to decide who their supplier will be. The first
consumers that have been granted this right were industrial consumers.
Usually the have been residential consumers. This process has occurred both
in the US and European Union (EU).
Transmission and distribution activities are still considered to be natural
monopolies as a consequence of their economies of scale and their network
characteristics10. Moreover the high maintenance costs of the electricity grid
and the impracticality of constructing unlimited power lines reflect the high
degree in which electricity undertakings have to rely on transmission and
distribution infrastructure11.
Electricity and NG depend exclusively on transmission grids and pipeline
networks respectively in order to trade. Furthermore, the possibility to engage
in cross-border trade of these products will depend on the interconnectors that
link exporting and importing countries’ domestic networks.
Moreover long distance transmission of electricity is not economically feasible
due to electricity loss, thus remaining regionally bound. NG transportation is
also regional in nature. However this regional dimension has been overcome
by the use of liquefied natural gas (LNG). LNG becomes a competitive option
10
See Id., 25
Pfrang, E, Towards Liberalisation of the European Electricity Markets: The Directive
Concerning Common Rules for an Internal Market in Electricity in the Frame of the
Competition and Internal Market Rules of the EC-treaty 19 (Frankfurt am Mein : Peter
Lang, 1999)
11
7
as a means for NG transport over distances of around 4800 kilometres12.
However, after the LNG is regasified it has be stored as NG or injected into
pipelines for its transport and distribution to consumers.
3. Competition Related Issues in Electricity and Natural Gas Markets
Although this is not an exhaustive assessment of all competition issues that
may arise in electricity and NG markets which could affect cross-border trade,
this paper intends to demonstrate that there are sufficient reasons to suggest
that cross-border trade of electricity and NG could be subject to competition
law.
Private market barriers that can hamper cross-border trade of electricity and
NG can depend among other things on the way markets are structured, the
degree of concentration these markets have, the technical characteristics of
the networks and the agreements commonly used to finance upstream and
downstream infrastructure projects.
3.1 Market Structures and Concentration
The liberalization of electricity and NG markets has been welcomed in a
variety of countries. The most enthusiastic have restructured their entire
markets, privatized its infrastructure, created an independent regulator, and
unbundled the ownership of the network infrastructure from its operation to
enable wholesale and retail competition.
However not all countries have passionately embraced this liberalization
movement. Countries electricity and NG market structures can vary
depending on the degree of liberalization they were willing to undertake.
12
Stevens, P., Cross-border Oil and Gas Pipelines: Problems and Prospects 3 (Washington
D.C., ESMAP, 2003)
8
These structures can range from having enabled wholesale competition,
unbundled ownership from the operation of the network and allowing retail
competition to solely privatizing the entire incumbent vertically integrated
company. Some countries have not introduced competition at all and have left
the vertically integrated structure of their markets unaltered and in public
ownership.
The differences between interconnected market structures engaged in trade
could well circumscribe this trade to bilateral dealings between a dominant
undertaking and a vertically integrated company. As mentioned above,
bilateral cross-border exchanges of network bound energy products between
vertically integrated firms was the rule before electricity and NG markets
began to be liberalized.
The post-liberalization of European electricity and NG markets has shown that
undertakings that had previously acquired state owned infrastructure are
prone to increase their market share by means of local and cross-border
mergers and acquisitions13 (M&A) These M&A appear destined to create what
are currently know as “national champions”.
Cross industry M&A between electricity and NG firms can also have
anticompetitive effects if access to NG for electricity generation is restricted to
competitors of the merged or acquiring firm.
These situations will evidently increase the possibilities for anticompetitive
cross-border effects, through the abuse of a newly attained dominant position
in one or more interconnected markets, the celebration of agreements
between related firms located in different ends of interconnected markets, etc.
However it has to be bared in mind that these M&A could also produce
13
Jamasb, T., and Pollitt, M, Electricity Market Reform in the European Union: Review of the
Progress toward Liberalization and Integration, p. 15 Available at:
http://mit.edu/ceepr/www/2005-003.pdf
9
efficiency gains by increasing the scope of the products and/or their
geographical markets14.
The issue of collective market dominance should also be carefully considered.
Concentrated or not, wholesale markets can tend to yield towards collective
dominance as it briefly occurred in the English wholesale electricity market
after 199815.
3.2 The Network
As has been mentioned above, transmission and distribution networks are
considered to be natural monopolies. Restructuring the markets to allow
wholesale and retail competition would be pointless without a competitive
minded operation of the network.
No matter how many undertakings are competing between each other in the
wholesale market, as long as they cannot access the network on nondiscriminatory and transparent basis, trade will be restricted. Therefore
electricity and NG trade depends on the access undertakings have to their
corresponding networks.
If a producer owns and operates the network it would be inclined to favour its
retail interest by providing its production unit access to available capacity
rather than granting it to its competitors. The unbundling of ownership and
operation of the network infrastructure is desirable to avoid situations like the
one just mentioned. Prohibiting ownership by generators/producers of network
assets or not allowing the owners of transport infrastructure to engage in
competitive activities of electricity and NG markets are other alternatives.
For cross-border trade of electricity and NG to take place, bordering markets
need to be interconnected. Interconnection may well be the most important
14
Cameron, P., Competition in Energy Markets 324 (Oxford, Oxford University Press, 2002)
Newberry, D., The Relationship between Regulation and Competition Policy for Network
Utilities p. 22 Available at:
http://www.dspace.cam.ac.uk/bitstream/1810/137385/1/eprg0611.pdf
15
10
barrier for electricity and NG cross-border trade competition16. Ownership of
production facilities and ownership/operation of interconnection infrastructure
can also provide incentives to restrict access to third parties from both
exporting and/or importing markets.
Notwithstanding the measures introduced in order to enhance competition in
electricity and NG markets (i.e. unbundling of ownership/operation), the firm
responsible for the network operation will sustain a dominant position which
could be easily abused without adequate regulation establishing nondiscriminatory third party access (TPA), cost reflective prices, equivalent
prices for similar services to different consumers, etc. Moreover there is also a
need to address the way in which capacity will be managed in highly
congested areas of the network.
Additionally, a harmonized approach for cost based transmission pricing will
be needed to avoid disruptions to potential trade between interconnected
markets.
It is clear that the main issue regarding the network is the granting of TPA on
a non-discriminatory and transparent basis. Without this access competitors
will have no market to trade. Therefore it is possible to affirm that TPA to the
network is “an essential condition for creating competitive cross-border energy
markets.”17
3.3 Long Term Contracts
Upstream and downstream electricity and NG infrastructure projects are
capital intensive. Financing electricity generation plants and NG production
facilities usually require long-term purchase agreements to guarantee the
project sponsor’s lenders certain amount of revenue flows to repay dept.
16
Celli, R., and Riis-Madsen, C., New developments in EU legislation and Application of
Competition Rules to Interconnectors 177 I.E.L.T.R. (2002)
17 Walde, T., and Gunst, A., International Energy Trade and Access to Networks: The Case of
Electricity in Electricity Trade in Europe: Review of the Economic and Regulatory Challenges
183 (Desta, M., and Bielecki, J., eds., The Hague: Kluwer Law International, 2004)
11
In electricity generation and NG production projects these contracts are called
power purchase agreements (PPA) and gas sales agreements (GSA)
respectively. The long-term nature of these contracts is linked to the financing
period which depends on the repayment of also long-term loans.
Both PPA and GSA contain take or pay clauses. Through these clauses the
purchaser of electricity or NG will assume the obligation to “take” a specific
volume of the product. This means that no matter if the purchaser “takes” or
not “takes” such volume it will have to pay the price agreed for it. These
clauses mitigate the supply risk of the producer by guaranteeing the purchase
of volume from the project. On the other hand, the purchaser will thus assume
the market risk of the purchased product.
Another type of clauses used, are destination clauses. These clauses have
been used in contracts for the supply of Russian Federation NG to the EU.
Destination clauses basically exclude the possibility of the purchaser of NG of
reselling the purchased product and restrict its use to specific areas.
The project financing of network infrastructure utilizes similar contracts to
guarantee revenue as those used in electricity generation and NG production
projects. The way in which this type of projects’ revenue is guaranteed is
through long-term capacity contracts (LTCC). These LTCC reserve the
capacity of new built network infrastructure to a particular market undertaking,
usually a producer. The logic consequence of this is that TPA to the network
will be limited or inexistent during the duration of the contract.
PPA and GSA (with take or pay and destination clauses) and LTCC can act
as market access barriers that would significantly reduce competition and
trade. In the case of the former two, these would have the effect of
discouraging new market entrants. Regarding the latter, available capacity will
be scarce or even inexistent and therefore there would not even be a market
to trade in. NG storage infrastructure finance would likely have in place LTCC
contracts.
12
4. Explicit Regulation or Competition?
As this paper has identified above, there are a few competition issues that can
arise from electricity and NG market structures, the degree of market share
private undertakings possess in these markets, the contracts usually entered
in order to project finance new infrastructure and the ownership and operation
of the network that could affect, distort and/or restrict cross-border trade of
electricity and NG.
As electricity and NG networks are considered to be natural monopolies there
is a common understanding that these should be subject to explicit regulation.
However nothing suggests that competition law should not be also applied in
parallel to such explicit network regulation18.
This raises two issues that need to be dealt with. The first refers to what
issues should this network specific regulation be applicable to. It seems likely
that this specific regulation should address the way in which TPA is granted,
congestion is managed and transmission and capacity charges are
determined.
This has been the approach undertaken by the EU through Regulation
1228/2003 on conditions for access to the network for cross-border
exchanges in electricity.
Access to NG networks is subject to Regulation
1775/2005 on conditions for the access to the NG transmission networks.
The second issue relates to what should be left to competition. Competition
law could be applicable to any abuse of the network operator’s dominant
position by treating competitors discriminatorily, charging unfair prices for
capacity and/or transmission services that restrict or distort cross-border
electricity and NG trade.
18
Van Der Woude M.H., Competing Gas Pipeline Infrastructure: Some Comments from a
Dutch Perspective in International Energy Law and Taxation Review 296 (December 2005)
13
The way to deal with anticompetitive practices at both ends of the network is
pretty strait forward. As in any other market where competition is feasible, no
explicit regulation should be required. All anticompetitive practices carried out
by undertakings taking part in the wholesale and retail electricity and NG
markets should be subject to competition law.
In the EU, for example, the electricity and NG sector specific regulations have
been applied in parallel with the general competition law provisions contained
in articles 81, 82 and 86 of the EC Treaty.
5. Competition Provisions in Regional Trade Agreements applicable to
Cross-border Trade of Electricity and Natural Gas: The Way Forward?
In the previous chapter, this paper has examined the possibilities of applying
competition law to the network and to the activities currently considered
competitive at both ends of the network.
In an interconnected market where cross-border trade of electricity and NG is
taking place, anticompetitive effects originating in one domestic market can be
felt in another. These anticompetitive effects may be difficult to be addressed
by the latter market competition authorities.
Furthermore, addressing cross-border anticompetitive practices, from a
national platform, may be difficult where countries do not apply competition
law to their markets or where there are differences in the chosen competition
law approach to address anticompetitive practices. These situations could
lead to differences in the way these laws would be enforced. Moreover, issues
of jurisdiction and nationalism19 could increase the possibilities of conflict
between competition law enforcement by national competition authorities.
19
Tarullo, D., Norms and Institutions in Global Competition Policy in The American Journal of
International Law 481 Vol. 94, No. 3., (July 2000)
14
Private market access barriers that could foreclose the entrance of new
competitions could arise from the abuse of the dominant position that an
undertaking has in one or more interconnected markets due to the structure of
the markets or by way M&A.
However the abuse of network operators’ de facto dominant position can pose
a fundamental market access barrier in electricity and NG markets.
Long-term contracts used in the electricity and NG industries to finance
upstream and downstream infrastructure projects can also have a market
foreclosure effect. These market access barriers will also be difficult to tackle
by national competition authorities.
Furthermore the liberalization process has suggested the need to create and
independent energy regulator to supervise the overall functioning of the
market. Coordination between competition authorities and independent
energy regulators could be beneficial in order to facilitate the identification of
anticompetitive behaviour in an interconnected market.
6. Conclusions
This paper has examined the liberalization process that has been undertaken
in electricity and NG markets, the measures that have been used to achieve
this, the existing dominant positions pre-liberalization and the markets reconcentration tendency post-liberalization.
It has also assessed the pivotal role that the network plays in enabling
competition in interconnected electricity and NG markets. The contractual
instruments to finance infrastructure projects in upstream and downstream
electricity and NG markets and their potential to foreclose entrants to new
undertakings has also been reviewed.
15
Furthermore the previous chapter has provided strong reasons to consider the
need to address cross-border competition related issues on a supranational
level.
Therefore these anticompetitive practices could be addressed by the
application
of
competition
provisions
contained
in
Regional
Trade
Agreements. If this were the way forward, one question remains answered.
What should these provisions look like?
16