ORIGINAL COMMISSIE VOOR DE REGULERING VAN DE ELEKTRICITEIT STRUCTURE AND FUNCTIONING OF THE NATURAL GAS. March Final Report

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1 COMMISSIE VOOR DE REGULERING VAN DE ELEKTRICITEIT EN HET GAS / COMMISSION DE RÉGULATION DE L'ELECTRICITÉ ET DU GAZ: STRUCTURE AND FUNCTIONING OF THE NATURAL GAS MARKET IN BELGIUM IN A EUROPEAN CONTEXT March 2008 Final Report ORIGINAL Prepared by: Cambridge Economic Policy Associates Ltd. 1

2 CONTENTS SUMMARY REPORT...9 Purpose of the study...9 Scope...9 Approach and methodology Analytical approach...11 Sources of Information Suez Gaz de France Merger Belgian gas market definition The Belgian H-Gas market Barriers to entry Barriers to competition in the product markets...22 Barriers to competition in the product markets arising from transport network access issues...23 Barriers to competition created by limited availability of flexibility services...24 The L-Gas market Recommendations and remedies H Gas Remedies L Gas remedies Introduction Study aims Scope of work Background and context Report structure Approach and methodology Introduction

3 2.2. Structure, Conduct and Performance analyses Sources of evidence Approach to evaluating barriers Approach to evaluating remedies Deliverables Key definitions and concepts Introduction Market definition Supply chain Barriers to entry Vertical integration, entry barriers, and market foreclosure Remedies Summary Wholesale gas Introduction Market definition Belgium s role in international wholesale gas markets Market structure and conduct Conclusions Secondary trading (including supporting services at the Zeebrugge hub) Introduction Market definition The Zeebrugge Hub Market structure Contractual arrangements Recent developments and ongoing performance Conclusions

4 6. Retail supply Introduction Market definition Liberalisation progress to date The impact of liberalisation on market structure, conduct and performance Market entry Conclusions Transport services Introduction Market definition International transit Transmission Distribution Conclusions about the transport services markets Storage Introduction Market definition Characteristics of the available storage in Belgium Market structure Conduct Conclusions Liquefied Natural Gas Terminal Services Introduction Market definition Nature of LNG terminal services in Belgium Conclusions Overview of barriers operating within the H Gas market

5 10.1. Introduction Nature of the evidence H Gas product market Key intermediate service market problems Potential remedies Detailed assessment Barriers preventing new entrants from purchasing base-load (including forecast peak) gas in the wholesale markets and secondary trading markets and selling in retail markets Introduction Barriers to the primary wholesale market, including base-load LNG Barriers to international secondary trading markets Barriers to retail markets Summary of barriers in the product markets Barriers arising from the new entrants being unable to access gas transportation services Introduction Barriers to the use of international transit pipes Barriers to the use of domestic transmission lines (congestion, failure to release capacity, balancing requirements, etc) Capacity matching and allocation Summary Barriers which arise from new entrants being unable to access flexibility services Introduction Quantity of capacity Allocation of capacity Barriers to storage markets

6 13.5. Barriers to Zeebrugge hub short term markets, including peak shaving LNG Conclusions regarding indirect barriers created by the limited availability of flexibility services The L-Gas Market Introduction Common barriers to the H-Gas market Overview of the barriers to competition in the L-Gas market Conclusions and summary Introduction to the consideration of remedies Introduction The causes of barriers Evolving the remedies Approach Introduction Summary of the main barriers Potential causes of the artificial barriers The nature of potential remedies Issues in developing an appropriate remedial strategy Conclusions Proposed remedies for H-Gas barriers Introduction Proposed remedies Summary and conclusions L-Gas remedies Introduction Scenarios for the development of the L-Gas market Steady state

7 18.4. Growing the market Ending L-Gas Conclusions Conclusions and next steps Introduction The impact of liberalisation Why has the development of competition been so limited? Barriers to entry The causes of the barriers Developing remedies L-Gas market Next steps Appendix A - Views of the European Commission The European Commission and the First and Second Gas Directives Appendix B First Shipper questionnaire Appendix C - Stakeholder feedback Introduction Appendix D Second Survey of Shippers Views Belgian Natural Gas Market Shipper s Questionnaire Introduction Activities within the Belgian natural gas market Factors affecting the attractiveness of entering the Belgian natural gas market Barriers to entry Additional comments Appendix E Second Survey of Customers Views Belgian Natural Gas Market Customer s Questionnaire Introduction

8 1. Requirements for natural gas in Belgium Market experiences Barriers to entry Additional comments Appendix F Shippers and Customers Responses to our Second Survey Introduction Appendix G Gas Quality Issues Differing gas quality specifications across Europe Lowering the heating value of gas Raising the heating value of gas Doing nothing Appendix H - Network capacity planning Introduction Network planning under negotiated access and regulated access regimes The Belgian network planning system Elements of the network planning process Demand forecasts Supply / demand matching Long term investment signals in Belgium

9 SUMMARY REPORT PURPOSE OF THE STUDY This study is intended to: Provide a complete and in-depth understanding of the structure and functioning of the Belgian gas market from a domestic and European context. Help the Commission de Regulation de Electricite et du Gaz (CREG) identify any artificial 1 barriers which are hindering the efficient functioning of Belgian gas markets. Substantiate the existence of any barriers with reference to the available evidence. Make recommendations as to how the identified barriers might be addressed. As we understand it, provide a starting point for discussions with industry participants as to how the functioning of the Belgian gas market can be improved. At the highest level, we understand that the practical purpose of the study is to assist CREG in ensuring that the potential benefits of liberalising the Belgian natural gas market materialise and that Belgian consumers, both domestic and industrial, obtain those benefits. Benefits are likely to be maximised by ensuring that markets work efficiently and effectively. The study s remit is, however, limited to addressing the barriers to market entry that exist and the impact on competition and market entry of addressing those barriers, rather than considering the political or social consequences of such decisions. SCOPE The study considers all aspects of the Belgian gas market. This includes the activities directly regulated by CREG, such as the prices charged by and the behaviour of Fluxys, the market rules developed by CREG and other market participants in the Code of Conduct, which affect the operation of sectors of the market such as wholesale trading, and the regional retail supply activities, which are regulated by the three regional regulators. The study also considers the H and L-Gas parts of the market. H-Gas accounts for about two-thirds of consumption in the Belgian market, while L-Gas accounts for about one-third of largely domestic consumption. H-Gas has a higher calorific value than L-Gas and is similar in specification to the gas used in most of Europe (although there are a wide range of 1 In this context the use of the term artificial is intended to recognise that new entrants will face some barriers to entering a market that are consistent with most competitive markets, e.g. set-up costs, establishing a brand name, etc, but this study is focused on barriers that do not arise normally from the functioning of competitive markets, i.e. artificial barriers. 9

10 differences in gas quality specifications for gas found across Europe). L-Gas is mainly found in gas fields in the Netherlands, which is the sole supply source for Belgium. The study covers primarily entry barriers which originate in Belgium, but also the impact of rules and behaviour in other countries that could lead to the creation of entry barriers in Belgium. This recognises that Belgium s geographic location means that it is a key route for gas to transit to other countries in Europe. It is also particularly important for L-Gas as the sole source of natural L-Gas is the Netherlands. In considering barriers to entry, we consider it is also important to recognise certain characteristics of the Belgian market. While Belgium is an important country for transiting gas across Europe, with flows totalling twice domestic consumption, it has a relatively smaller domestic market than most of its neighbours. According to European Commission published information 2, in 2003 Belgium had 16 bcm of gas consumption (now 17.15bcm) compared to 106 bcm in the UK, 86 bcm in Germany, 76 bcm in Italy and 46 bcm in France, which are the four biggest gas markets by consumption in the European Union. The study also considers the potential impact of Belgium s market size and role as a key transit country for natural gas on the attractiveness of market entry. APPROACH AND METHODOLOGY The starting point for our assessment involved defining and analysing the various relevant product markets, both for (high calorific) H-Gas and (low calorific) L-Gas. These market sectors are: The market for the wholesale purchase of natural gas the primary wholesale market for gas. The market for the trading of natural gas - the secondary market 3 for gas. 4 The market for the supply/ sale of natural gas to end customers - the retail market for gas. To the extent to which they impact upon competition within identified product markets, we also consider intermediate service markets, specifically: The market for the transport of natural gas (which we take to include both internal 2 Table 6.3 of the Commission Staff Working Document, Technical Annexes to the Report from the Commission on the Implementation of the Gas and Electricity Internal Market, May We have not been able to identify comparable information for a more recent year. 3 In this report we have used the term secondary market to describe the trading of commodities (such as gas or pipeline capacity) after the initial or primary sale of the commodity. When we use the term secondary market we have attempted as far as possible to explain the commodity to which we are referring in that particular case. 4 Within this report we make references to secondary markets in the context of the secondary trading of the commodity of natural gas (as in this case) and the secondary trading of capacity in pipelines. 10

11 domestic and international transmission), both in terms of primary market allocation and secondary market trading of gas pipeline capacity. The market for the storage of natural gas. The market for terminal services relating to Liquified Natural Gas (LNG). The market for trading services as offered on the hub and the gas exchange. We also consider issues such as the balancing arrangements. ANALYTICAL APPROACH The report starts from a Structure/ Conduct/ Performance approach which is supplemented by more detailed analysis undertaken from a competition policy perspective. The issues that arise within each of the relevant subsections of the market identified above can be summarised as follows: Structure Who owns which assets or is party to a given number of contracts? For example, what proportion of companies operating in the gas markets are owned by the Suez Group? Under this heading we include both the economic effects that can be achieved by ownership control of assets and/ or those that arise through control of the use of assets through contracts. This recognises that the same or similar economic effects can be achieved by ownership and contractual rights. Conduct How do the markets operate in terms of the various actions of the participants? For example, how does third party access operate in theory and practice? In considering conduct issues, part of the consideration is about how effective the market rules are in promoting appropriate market conduct. The nature and impact of the incentives provided by the regulatory framework are also an important consideration when assessing conduct issues. Performance What are the implications of market structure and conduct on market outcomes, such as prices and quality of service? Performance can be considered both relative to appropriate benchmarks; for example in absolute terms and also relative to the experience of other countries and what one might expect to find in a well-functioning, liberalised gas market. Performance is generally going to be determined using observable facts, such as price levels and trends, as well as factors such as the way in which key stakeholders perceive the market is working. 11

12 SOURCES OF INFORMATION In carrying out this analysis, we draw on various types of information. These include: Data or primary data analysis to the extent that the relevant information exists within the public domain. Throughout the study we indicate the key points where we consider that the lack of access to data limits our analysis of potential barriers. The observations and views of independent third party commentators. We have referenced these in our study where we have drawn on these sources. The use of rational economic argument or counter-factuals (for instance whether market outcomes and/ or the behaviour of market participants appear to be materially different from what might be reasonably expected in an effectively functioning competitive market). In particular, we have sought to consider what lessons can be learnt from gas markets that have undertaken relatively effective processes of liberalisation and introducing competition. Case studies, which demonstrate differences or similarities (for instance, the nature of liberalisation required for success in the UK or US). We have also sought where possible to consider what lessons can be learnt from countries with gas markets that have similar characteristics to Belgium, such as market size, proportion of transit gas to domestic consumption, etc. Surveys of shippers operating in Belgium, including shippers who supply final consumers and those who transit gas through Belgium. We have carried out two surveys. The first involved detailed discussions with a small number of shippers. The second survey was sent to all the shippers that CREG was aware were operating in the Belgian natural gas market. When interpreting the results of the surveys we have sought to consider the perspectives of the companies concerned, recognising that their views will be influenced by the market position they currently hold. Surveys of natural gas customers in Belgium. We had some in depth discussions with a small number of customers and sent a survey to a list of transmission and distribution connected customers in Belgium, which was given to us by CREG. CREG has provided us with a large amount of documentary evidence about the regulatory framework in Belgium and detailed reports about particular aspects of the market. In addition the three regional regulators have also been helpful in providing information about the operation of retail supply markets in their respective areas. The other major source of information has been the recent EU Commission Enquiry Report by DGIV 5 into the energy 5 DGIV is the directorate of the European Commission responsible for energy and transport issues. 12

13 sector and its review of the Suez Gaz de France merger. We have also reviewed other public sources of information about the operation of the Belgian and European gas markets. As set out above, we have also undertaken two surveys of shippers and customers in the Belgian gas market. Although we have had access to a wide range of information we have not had access to information about the contracts for wholesale gas and transit capacity held by companies operating in Belgium or detailed information about the costs and revenues of company s operating in the Belgian market. It is only with such information, which typically can only be gathered from companies as part of a wider investigation or a specific competition law investigation, which is clearly outside the scope and mandate of a study such as this, that a number of detailed questions can be answered. (Note, for instance, that a number of the most important conclusions reached by the European Commission came from its analysis of information about gas supply contracts and international transit capacity.) We indicate in the study where the data access issues limited our assessment. It is also important to note that the Belgian gas market, including its regulatory framework and market rules, are evolving and changing on a continuous basis. We have sought, with the assistance of CREG, to ensure that the report and study reflects as far as possible the latest developments. However, it is important to recognise that in some cases it is too early to assess the actual impact of recently introduced changes, and therefore, the ongoing significance of any identified barriers. We have noted where we consider that recent or ongoing changes to the regulatory framework could change our view about the barriers depending on the impact of the changes to the regulatory framework and market rules. This is particularly an issue regarding the remedies to be implemented as part of the Suez Gaz de France merger. We note that the precise way in which the remedies will be implemented is still being determined. SUEZ GAZ DE FRANCE MERGER When we began our study the merger of Suez and Gaz de France had not been finalised, and indeed has only been confirmed towards the end of our study. To ensure that our conclusions are robust to the current and known future market developments, we have considered again our conclusions in the light of the merger and the remedies that the parties have agreed to implement. The merger remedies, if effectively implemented, appear to have the potential to address some of the concerns we have identified about the structure of the Belgian gas market. In particular, the requirement for the merged entity to reduce its ownership and control of Fluxys have the potential to improve the prospects for competition in the Belgian gas market. However, the actual effect of the merger remedies will depend on their effective introduction and ongoing monitoring to ensure that they continue to be adhered to. The merger remedies do not directly address the concerns we have identified about capacity availability and market rules, such as the balancing rules. However, the structural changes have the potential to change the incentives of some key 13

14 market participants with regard to their approach to addressing these issues, particularly if a truly independent Fluxys is created. When proposing the remedies to address the barriers to entry that we have identified, we have particularly considered whether we need to propose remedies beyond those being implemented as a condition of the merger proceeding, where the merger remedies relate to barriers to entry that we have identified. BELGIAN GAS MARKET DEFINITION From a competition policy perspective, we consider the relevant markets in the gas supply chain as defined by (a) the products in that market; (b) the geographic extent of the market and (c) temporal dimensions (for example, over current and future capacity or gas availability). A critical issue is to consider both demand-side and supply side substitutability (that is, the extent to which purchasers can satisfy their demand with alternative products and suppliers can move production to other markets). Within this framework, we focus primarily on issues of entry barriers and potential market foreclosure. These were discussed extensively as market impediments in the European Commission Competition Study on the energy sector and its review of the Suez/ Gaz de France merger. Like that study, we explore the role of vertical integration in the presence of a monopoly network through which all gas bought and sold in Belgium must travel. We use this analytic framework to establish potential barriers to entry. This then allows the later identification of potential remedies which can be targeted onto the specific remedy, depending on how the barrier arises for example, whether it arises from readily remediable information or market operation conduct or from underlying structural causes. We characterise the relevant Belgian gas markets and their inter-relationships in the following diagram: Figure S1: Economic markets to consider (H-Gas) Primary Wholesale Secondary Trading Retail Product Markets Russia, Norway, etc LNG Zeebrugge Hub Industry / Commerce Consumers Flexibility Services Storage Transport Distribution Intermediate Service Markets Outside Belgium Belgium Line Pack International Domestic Transport Services Although this diagram focuses on the H-Gas supply chain, many of the components would 14

15 also be appropriate for the L-Gas supply chain, with the exception of some of the H-Gas specific components such as LNG imports and the Zeebrugge hub, which do not have an L- Gas equivalent. As the diagram makes clear, the definition of flexibility services cuts across the intermediate service and to some extent, product markets. Taking the supply chain for H- Gas as an example, Figure S1, highlights in red, blue and green the factors which we see as being the main markets to consider from an economic perspective, showing in red the market for flexibility services. In terms of barriers to competition, for potential new entrants the key issue is the ability to have reliable and predictable access to flexibility services at an economic price. To some extent, there is potential substitution between the flexibility services. THE BELGIAN H-GAS MARKET From our review of the H-Gas market we have drawn the following overall conclusions: There are few new active entrants in the market. This conclusion applies for the industrial and commercial as well as the household sector of the market. Most of the active new entrants are incumbents from neighbouring gas markets to Belgium, such as Gaz de France and Wingas. As the merger remedies require the disposal of Distrigas, the competitive position in the market is unlikely to worsen. The disposal of Gaz de France s share of SPE could possibly increase the effective level of competition in the market as there would be a fully independent supplier with a growing market position, although SPE would no longer have direct access to any services from Gaz de France. Until the remedies are actually implemented, however, the precise impact on competition in the retail markets is difficult to assess. 15

16 Table S1: Market progress since liberalisation for H-Gas for wholesale purchase Players and market share (per cent) 6 Before liberalisation (January 2004) After liberalisation (2005) Distrigas (legal monopoly 100) Distrigas 84 Gaz de France 10 Wingas 6 Source: CREG 2006, Different components of natural gas prices in Belgium and possibilities for lowering them, p. 10 and CREG 2006, Predicted concentration between Gaz de France and Suez, p. 11. There is extensive market concentration resulting from the lack of active entrants and the continued strong vertical integration in the Belgian gas market. Subsidiaries of the Suez Group of companies have extensive interests in all stages of the supply chain, including ownership and contractual interests. Some of the remedies resulting from the Suez Gaz de France merger should improve this position, such as the disposal of Distrigas and the reduced role of Suez in the ownership and control of Fluxys. However, as noted above, we will need to wait to see precisely how the merger remedies are implemented before reaching firm conclusions about the impact on competition. The perceptions of market participants about the independence of Fluxys after the merger remedies are implemented will be an important test of their effectiveness. 6 It should be borne in mind that the market shares shown for H-Gas and L-Gas wholesale purchases mainly relate to the primary market, they will contain some data created through secondary trading, either before gas is supplied to final customers or for shippers transporting gas through Belgium to other countries. 16

17 Table S2: Estimated equity participation of Suez group in various supply chain activities before the merger remedies Supply chain activity Suez group companies Total Suez group ownership (%) Wholesale H-Gas Distrigas 84 L-Gas Distrigas 88 Trading (spot market operator) Huberator SA 42 Supply Distrigas 81 Transport Distrigas and Fluxys Distribution Flanders Electrabel 30 Wallonia Electrabel 49 capital Brussels Electrabel 30 Storage Fluxys 100 LNG Fluxys, Tractebel 99 Hub services Huberator SA 90 There are no major observable price benefits for customers, as yet, from liberalisation. While Belgian retail supply prices compare reasonably well with those of other EU countries, and there has been some improvement in those parts of the market liberalised earliest, this would not appear as significant as occurred either following Belgian electricity liberalisation or in the UK, following liberalisation of the gas sector, where post-liberalisation, there was evidence of relatively significant price benefits for customers. The difference is likely to reflect the much greater degree of effective wholesale and retail supply competition in the UK market. 7 There is also 7 When competition was introduced into the gas market in Great Britain it was at a time when British Gas had 17

18 recent evidence that prices have been increasing, such as recent price increases by Electrabel. While some of this might be accounted for by increases in input costs, it might also be indicative of the limited nature of entry into the market to date. The graphs below compare prices in Flanders, following the liberalisation of its markets in 2003, with those in Wallonia, which were not liberalised until later (2007). The first graph shows prices for electricity in Wallonia (brown line) and those in Flanders (all other coloured lines), while the second shows prices for gas in Wallonia (brown line) and those in Flanders (all other coloured lines). The price level in 2003 is shown as a red line to provide a benchmark for all subsequent price movements. The relative price fall is shown by the distance between the brown line and all other coloured lines in December 2006, especially the blue line, which represents the average lowest price in Flanders. Together, these graphs indicate that although prices for gas fell in Flanders relative to those in Wallonia following liberalisation, this fall was not as dramatic as that experienced for electricity. There may be reasons for the differences in experiences, but comparing the price trends for the two fuels provides some indicative evidence of comparative benefits for customers from liberalisation. a large number of out of the money long term contracts for gas, thereby allowing new entrants to source gas at substantially lower prices and obtain a competitive advantage. The relatively low prevailing wholesale price for gas was due to an excess supply of gas compared to demand. 18

19 Figure S3: Comparison of electricity prices in Flanders after market liberalisation with those in Wallonia for a family with an average usage (2,200 kwh by day, 1,300 kwh at night), , jan 04 jul 04 dec 04 jan 05 jul 05 dec 05 jan 06 feb 06 mrt 06 apr 06 mei 06 jun 06 jul 06 Price Level 1 July 2003 Wallonia Average Default Price Average Contract Price Average Green Contract Price Average Lowest Price aug 06 sep 06 okt 06 nov 06 Source: VREG 2007, Flemish experience of liberalisation, Presentation by Andre Pictoel on 6 February. dec 06 19

20 Figure S4: Comparison of natural gas prices in Flanders after market liberalisation with those in Wallonia for a family with an average usage (23,260 kwh), , , , , , , , jan 04 jul 04 dec 04 jan 05 jul 05 dec 05 jan 06 feb 06 mar 06 apr 06 may 06 jun 06 jul 06 aug 06 sep 06 oct 06 nov 06 dec 06 Price level July 2003 Average default price Average lowest price Wallonia Average contract price Source: VREG 2007, Flemish experience of liberalisation, Presentation by Andre Pictoel on 6 February. We now turn to a consideration of some of the main barriers to entry which are likely to have contributed to these observations. BARRIERS TO ENTRY From the evidence gathered and discussions with stakeholders, we conclude that there are significant barriers to competition in the Belgian gas market. We also conclude that the relatively small size of the Belgian market could be a factor deterring market entry, even if the barriers did not exist or were substantially lowered. We have found no major evidence to suggest that the lack of market entry is due to collusion between different shippers and/ or suppliers in Belgium, although it is important to note that the nature of the study is not one where it would be expected that such evidence would be found. In particular, for the study we have not had the power to formally require market participants to provide information to us. We do note however, that the European Commission is currently investigating potential collusion between Gaz de France and Eon for markets outside Belgium. From our surveys it is clear that there is no single barrier that is universally viewed as critical by a majority of shippers. Shippers identified several common barriers as being important, suggesting that there is broad commonality of view about important barriers, but also suggested a series of potential barriers which they perceived as important on an individual 20

21 basis. While there are common themes to the barriers identified by shippers, it is also notable that some of the barriers identified related to the portfolios held by those shippers. For example, shippers with access to L-Gas contracts do not regard access to L-Gas as an issue, and vice versa. It appears therefore that there are a significant number of potential artificial barriers to entry in Belgium, but a company s ability to overcome the barriers depends on their existing market position, and the assets and contracts they hold. One interpretation of this conclusion could be that some of these potential barriers are not real barriers, but instead just factors that new market entrants would need to overcome to be effective competitors to the incumbents. However, as we discuss further in the body of this report we consider there are reasons to believe that some of the legacy arrangements and existing market rules are creating real barriers to entry rather than merely being factors that any new entrant would need to overcome to compete effectively. In our view, the relatively small size of the Belgian market increases the importance of the market rules being relatively simple compared to neighbouring and larger markets, so that new entrants do not perceive the fixed entry costs to Belgium to be very high compared to other markets. The fragmented licensing regime in Belgium and the split between H and L Gas increases the potential that small market size is deterring entry because of the associated higher proportionate fixed costs of entry. However, shippers did not consider these to be major issues compared to other barriers, although any factor that makes entry to a relatively small market more difficult needs to be considered. In addition to the specific barriers which we discuss below, two overall themes emerge across the specific markets. These are: The dominance and role of Suez group and its subsidiaries in the Belgian gas market. Given the inherent conflicts of interest between network operators and shippers in competitive gas markets, the role of Suez across the markets which comprise the H-Gas supply chain creates risk of actual and perceived discriminatory behaviour, and potential concerns about the incentives for Suez group companies to treat all other market participants on equal terms. It will be important to see whether the reduction in ownership and control of Fluxys by the Suez group following the merger remedies effectively addresses some of these concerns. The disposal of Distrigas may also help to address some of the concerns about market structure. The lack of transparent information about various aspects of the operation of the Belgian gas market. In particular, there is a marked lack of information on capacities on transit pipelines and at key entry points, information about secondary trading markets, etc. Although Fluxys has requirements to make such information public, the same degree of transparency for this information does not exist as in other comparable markets, such as Great Britain. We recognise, however, that some improvements in this regard are occurring. 21

22 Barriers to competition in the product markets While we have identified some barriers to competition in the product markets in the Belgian gas market, we do not consider that these are of primary importance or as significant as those arising from the intermediate service markets. Nevertheless, the barriers in the wholesale markets and secondary markets are described below, before the more important competition barriers in relation to flexibility services and network access are discussed in detail. In the primary wholesale markets for H-Gas there are some potential concerns about the ability of new entrants to acquire wholesale gas on the same terms as incumbents, but this was not highlighted as a major concern by shippers who responded to our surveys. Shippers were more concerned about the ability to access transport capacity to ship gas to and through Belgium, which is crucial for serving customers in Belgium. However, our conclusions in this area are limited since we have not been given access to the details of the long term supply contracts held by Distrigas and other companies. For the secondary trading markets, while there are no significant direct barriers to trading at the Zeebrugge hub, there do seem to be some other important indirect barriers. In particular, problems arising from capacity availability for would-be traders seem to be significant. Although we note later in the report the potential impact of the recent creation of the Zee Platform service. Our understanding is that trading at the hub for gas which is to be delivered, needs prior pipeline access and this is not readily or predictably available. Other barriers to trading development include the differences in gas quality specifications between the UK and continental Europe and the absence of a National Balancing Point in Belgium. The combination of the capacity availability and other issues implies lower trading volumes than the relatively liquid NBP market in Great Britain, but higher volumes than at other continental European hubs. Within retail supply markets there are no obvious direct barriers to entry. For instance, there does not appear to be any particular difficulty in getting licences to supply customers. However, the limited number and activity of competitors means that customers are not, in general, receiving competitive offers compared to the prices charged by the incumbent. It is important to note that the impact of any limitations on competition in the wholesale and secondary trading markets will have a significant impact on the potential for competition in the retail supply markets. There are some issues to be monitored as competition develops in the retail supply market, but they do not appear to constitute significant barriers to competition, unlike barriers in other segments of the supply chain. As competition develops it will be important to consider whether competitive pressures throughout the supply chain are sufficient to constrain pricing behaviour by the incumbents, or whether further measures need to be considered. 22

23 Barriers to competition in the product markets arising from transport network access issues Transport network access issues appear to present an important market barrier to the development of effective competition in the Belgian gas market. On balance, we are minded to conclude that the single most important issue is how new and potential entrants can gain access to capacity so that they can bring gas into Belgium. This arises from the apparent transport congestion arising from the contractual and physical position of Distrigas, and some other holders of capacity, relative to other market participants. We consider that the transport services within the Belgian market continue to exhibit a number of concerns that hamper liberalisation. These are specifically: A lack of available capacity. At a number of important entry points there is little or no capacity available in the future. Also for a number of international transit pipelines there is no contractual capacity available. Shippers have identified the lack of available capacity as one of the most significant barriers to the development of competition in the product markets. While the primary responsibility for efficient and effective network development lies with Fluxys it is important that shippers provide clear signals about investment requirements, and where appropriate, are prepared to provide financial guarantees to support their requests. Discrimination in the effect of network access rules between incumbents and new entrants. This includes first come first served rules for the allocation of all entry capacity, which can make it very difficult for new entrants to access capacity, at least in the short term, at entry points that are already fully booked. New entrants might have to wait until additional capacity can be built, thereby restricting their options for market entry to those entry points with some spare capacity, or buying capacity on the secondary market (if any is available). 8 Poor capacity utilisation. There is evidence that the actual capacity utilisation at some points in the networks is at times substantially below available capacity. We note that, as elsewhere in the EU, there is very limited availability of capacity on secondary markets or on an interruptible basis. Overly complex market rules. In particular, the balancing rules are relatively complicated (compared to other EU member states and relative to the size of the market) with the potential for balancing on some days to be undertaken in four separate zones. In addition, for each day there are hourly constraints as well as an overall end of day balancing requirement. 8 It should be noted that in the UK examples of grandfathering of capacity rights following the introduction of competition has in some cases been considered to be an example of unduly discriminatory arrangements. 23

24 Barriers to competition created by limited availability of flexibility services Access to flexibility services in gas markets is in general very important to allow shippers to manage the risks associated with supply and demand fluctuations in the markets and is particularly important in Belgium because of the relatively complex balancing rules. While there may be some scope to access storage facilities in other countries under swap contracts, we have concluded that barriers to entry in these markets seem to be particularly important in impeding the development of competition in the Belgian gas market. As set out in Table S3, Belgium has very limited storage facilities for H-Gas and no storage facilities for L-Gas. The table shows the proportion of storage capacity available in each country compared to its gas demand. Table S3: A comparison of the ratio of countries weighted gas volume to storage capacity 9 Country WGV (bcm) WGV/ Consumption (%) Belgium Denmark France Germany Netherlands 5 11 UK All the countries Based on the evidence from our survey of shippers and other information, we identified three particularly important barriers related to this issue: All existing available capacity is allocated to shippers with distribution connected customers. This rule is likely strongly to favour incumbent suppliers and disadvantages transmission connected customers. It also impedes the efficient use of the storage capacity. However, we understand the social and political justifications for having the rule. The distortion of investment signals for new storage facilities. This arises for a variety of reasons including the issue that wholesale gas prices in Belgium (like much 9 Taken from a presentation by Wim Groenendijk of Gasunie entitled, Perspectives of Natural Gas Storage in Europe, which was presented at the Berlin CeSSA conference on 31 May

25 of continental Europe) are likely to be driven by primarily oil price indices rather than gas market movements. The lack of new investment in storage facilities. There is a lack of clarity in available information to enable market participants other than Fluxys to develop and invest in storage facilities. It is difficult to understand why it would not be beneficial for Belgian customers to allow other parties to develop storage facilities independently of Fluxys if they wanted to. There do not seem to be any major barriers to entry arising from the operation of LNG markets. However, to the extent that there are limitations on the availability of pipeline capacity or restrictions on who can develop LNG facilities there may be some indirect barriers to the operation of the LNG market. Overall, both the direct and indirect barriers identified across product markets and intermediate services are highly consistent with previous surveys carried out by CREG, as set out in Table S4. They are also consistent with the conclusions of the European Commission when it considered the Suez Gaz de France merger. Table S4: Market participants identification of barriers to competition in 2005 Suggested barrier Respondants agreeing (%) Lack of transport / transit capacity, including access to the Zeebrugge hub 44 Limited storage facilities 25 General lack of flexibility 19 Inflexibility of matching rule 6 Inflexibity of the balancing rule 44 Inadequate transparency 38 Illiquid and opaque secondary market 38 Gas quality 13 L-Gas market 19 25

26 THE L-GAS MARKET The market structure for L-Gas is not conducive to creating a vigorously competitive market. In addition to a duplication of a number of barriers seen in the H-Gas market, our investigation suggested that there are specific barriers to the L-gas market, deriving largely from the single supplier. Currently those suppliers who are supplying L-Gas in Belgium are tending to charge L-Gas customers the same prices as H-Gas customers, so L-Gas customers are not directly getting a worse outcome, although the level of competition appears to be much weaker. The principal barrier to competition developing in the L-Gas market appears to arise from the difficulty for anybody other than Distrigas and Gaz de France to buy L-Gas directly from GasTerra and to obtain transit capacity to bring gas into Belgium. Without the producers in the Netherlands selling L-Gas to other shippers it is difficult to see how any new entrant could make an offer to customers, which was competitive compared to the incumbents, as it would only be from the incumbents that they could acquire wholesale gas. We discuss in greater detail below this and the other L-Gas specific barriers that we have identified. RECOMMENDATIONS AND REMEDIES The remedies to be implemented as a condition of the Suez - Gaz de France merger have the potential to address some of the structural issues that we have identified as significant barriers to the further development of competition in the Belgian gas market. In particular, the disposal by the merged entity of Distrigas and the reduction in the ownership and control of Fluxys are potentially significant pro-competition developments. While, in principle, the developments have the potential to increase competition, their actual impact will not be known for some time. The merger remedies do not address some of the other barriers that we have identified including the concerns about the availability of transport capacity and some market rules, e.g. balancing. However, the structural remedies have the potential to change the incentives for Fluxys and other market participants with regard to these issues, which again might promote pro-competitive behaviour. We have developed the proposed remedies taking account of our understanding of the nature of the barriers. We have generally been cautious in the remedies that we have proposed, and have principally focused on identifying remedies where we are very confident that the likely benefits will exceed any implementation costs. Our caution reflects a number of factors including the difficulty for some barriers in identifying the primary cause, and the difficulty of evaluating the potential impact of some remedies given other changes that are happening in the market, including the implementation of the remedies required for the Suez- Gaz de France merger. We would broadly characterise our approach as one of recommending incremental change to the regime in Belgium. However, we recognise that in the longer term more radical changes 26

27 to the regime might be required, and therefore, alongside our recommended barriers we have also identified some further options that CREG could consider. We are not recommending that CREG implement these further remedies at this stage, but instead that CREG monitor the impact of our recommended remedies, and if competition is not developing as quickly as CREG would like, it could consider implementing these further and more radical remedies. By their very nature these more radical remedies are most costly to implement and somewhat less certain in their impacts. Our approach also reflects that if our proposed remedies were implemented shortly after the merger remedies, there would be a number of major changes to the Belgian market over a relatively short period of time. Therefore, it may be appropriate to allow some time for these changes to take effect and their impact to be assessed, before further more radical structural changes are considered. H GAS REMEDIES For each barrier identified as part of the study, we have sought to highlight its impact, considered whether CREG has the power to address the barrier, and then identified (where appropriate) informational, behavioural and structural remedies that could address the barrier. We would urge that the remedies we have proposed are carefully considered by all interested parties in the Belgian gas market. It is our view that the market rules and regime will be best developed through a process that allows all parties to input their views in an open and transparent process. Only if all market participants have an opportunity to participate in the design of detailed market rules is there likely to be widespread confidence in the market rules. We consider that overall the proposed remedies set out in the table below could represent a coherent incremental change strategy for the Belgian gas market that is likely to improve the degree of competition in the market over the coming years if fully implemented. To implement all the remedies proposed CREG would almost certainly need co-operation from Fluxys and other market participants, plus some changes to primary legislation. We recognise that the co-operation of these other parties cannot be guaranteed, but it will be for CREG to seek their co-operation. 27

28 Barrier Impact Potential for CREG to address PRODUCT MARKETS Wholesale: Differences in Inability to substitute one Could seek technical quality of kind of H-Gas with to mandate gas another, which might limit investment sources of gas for trading by Fluxys Distrigas market Distorts investment Not clear share of contracts incentives for new sources if CREG acts as price setter in of gas and flexibility can Belgium, which is services because wholesale overturn based on oil market gas prices are not set by gas the Potential Remedy Options Informational Behavioural Structural NA Investment by UK changes gas Fluxys to provide quality specifications additional blending facilities, subject to shipper support Investment in the UK to provide additional blending facilities Review by CREG of Forced gas release NA following the Distrigas contracts programme disposal of Distrigas to identify any by Suez adverse impacts Publication of Rationale for the recommended remedy Without a willingness in the UK to invest, Belgium will need to invest to address the issue. Shipper support ensures the investment is required Need to understand the contract provisions to evaluate their 28