Q1: Which further key design criteria should be reflected in cross-quality market areas?

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1 Attachment to ExxonMobil letter dated Sept. 21, 2010 Please find below our responses to the FNA public consultation with regard to a cross-quality creation of market areas. Our responses are indicated by italics letter type. I. Questions related to the Model Design From the current point of view of the ruling chamber, a cross-quality market area would constitute a single market area in which different grids are operated with different gas qualities. All entry- and exit points of that market area can be combined with each other irrespective of the corresponding gas quality. This means that e.g. shippers can supply demand at L-gas exit points with supply from H-gas entry points and vice versa. All transported or traded gas volumes will be accounted for in one cross-quality balancing account. The virtual point will be designed in such manner, that the gas volumes can be traded in the entire market area. The TSOs of a market area are responsible, that the gas at the exit points reflects the corresponding quality specifications. To ensure the physical balancing of the grid, the TSOs can apply technical measures (e.g. technical gas conversion) or commercial measures (e.g. use of control energy or minimumflow agreements). Thereby the ruling chamber has the following questions: Q1: Which further key design criteria should be reflected in cross-quality market areas? A1: We agree with the aforementioned design criteria. In addition, the in-take of indigenous production into the grid must be ensured at any time. This includes gas production from existing fields in Germany but also production from future fields including 'unconventional' resources. Furthermore, the commercial measures to balance the MACs portfolios shall not be limited to sales / purchases at the market for control energy. Bilateral, market based agreements between the MACs and shippers about the supply with control energy must be possible. Q2: Which measures should be used by TSOs to ensure the physical balancing of the grids in the case of cross-quality transports? Which relation should exist especially between the use of technical measures (e.g. construction and operation of blending- and conversion plants or expanded allocation of storage capacities to the grid operations) and commercial measures (e.g. swaps, minimum-flow agreements, control energy)? Does this relationship between technical and commercial measures shift if these commercial products are purely offered capacity price based? A2: The FNA has a role in ensuring that the most economic measure is taken first and after consultation with the stakeholders. As physical supply and demand will not fundamentally change through a cross-quality integration of transport market areas, commercial measures should initially be sufficient. Commercial measures to balance the grid should include: minimum-flow commitments by shippers at specific locations in the grid, the supply or purchase of control energy at the virtual point and potentially at specific points in the grid, blending service agreements with third parties, and commodity swaps with shippers and neighboring TSOs, 1

2 agreements with bivalent end-consumers. Such agreements shall be market reflective and hence can amongst others -include fees for capacity to the extent shippers need to reserve such capacity for the MAC on a firm basis. At a later stage, technical measures can be considered. Such measures should include: the blending / mixing of L- and H-gas flows at pipeline intersections, blending of H-gas with Nitrogen, the use of storage services, and the expansion of entry capacity into the grid (e.g. additional L-gas import capacity from the Netherlands as currently envisaged as part of Gasunie s integrated open season). A conversion of grids from L-gas to H-gas quality has significant cost implications and should only be the measure of last resort as such a decision would essentially not be reversible. Such a decision should not be taken without a thorough assessment of the potential L-gas supply from existing and future sources. L-gas suppliers must be consulted in such a process and have a decisive voice. As described in the KEMA study and by E.ON Gastransport, the MAC will need to enter into commercial agreements to enable cross-quality integration. As long as the MAC can not rely on a deep, liquid control energy market, he will need to enter into bilateral agreements with shippers to ensure the required supplies to balance its system. In such agreements shippers typically commit to provide flows on a firm basis, i.e. flows which the MAC can use at any time to balance its system. For such commitments of firm capacities, capacity charges are typically required to provide a commercial incentive to shippers to reserve capacity for control energy supply purposes. The need for capacity charges may change over time with the development of a liquid control energy market. Q3: How much time is required to establish a cross-quality market area in total? a. Based on commercial measures. b. Based on technical measures (esp., if new investments are required)? A3: The needed commercial measures and potentially related adjustments to existing IT infrastructure should be possible to implement within one year after the full development of the implementation concept and its measures. The lead times for technical measures typically require investments, depend on the individual measure and are generally longer than commercial measures. Initially, technical measures should not be required to enable cross-quality integration. In the Netherlands the integration of L-gas and H-gas transport market areas was implemented on 1st of July 2009, within one year after GTS made commercial arrangements to swap gas (as reported by NMa/Energiekamer in November 2009). Q4: How should the virtual trading point be designed to enable liquid trading? 2

3 A4: All volumes should be traded at the same market place / virtual point. A continued distinction between the trading of H-gas and L-gas control energy on a day ahead or within day basis as proposed by KEMA - should be avoided. Such a concept goes against the objective of creating one market place for both qualities. A continued distinction between the trading of H-gas and L-gas control energy complicates trading will create different prices for different gas qualities. Thereby it creates a market hurdle and potentially discriminates suppliers or customers of one quality versus those of the other quality. Furthermore, it would distort a level playing field and hamper the creation of trading and churn between shippers / traders in different qualities. Q5: Which abusive arbitrage possibilities are created through the creation of cross-quality market areas and with which measures could such arbitrage possibilities efficiently be avoided? If the market design will as proposed by KEMA require the MAC to balance its H- and L-gas systems via sales / purchases at separate markets for H- or L-gas control energy supplies, there will be an arbitrage possibility between these two markets for suppliers of (quality specific) control energy. Prices for H- and L-gas control energy will differ depending on whether these markets are short or long in the particular gas quality. Not establishing separate markets for H- and L-gas control energy would avoid this arbitrage potential. In such a case the MAC would need to procure his control energy requirements longer term via bilateral agreements from shippers. In the Netherlands, no separate markets for H- and L-gas control energy have been established and experience shows that no arbitrage possibilities have been created. Q6: Is a separate tariff required for cross-quality transports? If so, how should it be structured? Which cost should be covered by the tariff and under which system (entry/exit tariff regulation, socialized control energy fee, other socialized fees) should it be governed? We disagree with the proposed introduction of a conversion fee, which would have to be paid by shippers who transact between H- and L-gas portfolios. It complicates trading, creates an administrative layer, has a variable character and is not predictable; it creates a market hurdle and will contribute to the creation of different prices for different gas qualities. Thereby it discriminates suppliers or customers of one quality versus those of the other quality. Furthermore, it would distort a level playing field and hamper the creation of trading and churn between shippers / traders in different qualities (each transaction between the qualities would create a charge). The cost for quality conversion is likely to be limited compared to the overall transport system cost. Instead of an introduction of a conversion fee the potential cost for quality conversion should be smeared to those who benefit from the cross-quality market integration most. End-consumers of gas will be the main beneficiaries of an increased range of suppliers to choose from and of a deeper and more liquid and competitive market. Existing allocation mechanisms for control energy cost can be used. In the Netherlands, the (limited) costs for quality conversion are also smeared, thereby avoiding the above listed concerns. Q7: How can the balancing of the grids be ensured if the winter peak capacity demand of L- gas end-users can not be supplied any more by the indigenous production? Is it 3

4 appropriate, in this case, to integrated storages into the grid operations? If so, by which means and to what extent? Please address alternative solutions if possible. A7: The risk that winter peak capacity demand can not be supplied any more by the indigenous production is limited; already today, the peak capacity demand is mainly supplied through imports from the Netherlands and additional import capacity is expected to be built if regulatory approval can be obtained by Gasunie. Storages should not be integrated into TSO operations. Instead the MAC should take winter peak demand into account when procuring control energy and blending services. Storage users can offer services to the MAC which should be evaluated against alternative commercial and technical measures. Q8: How will the creation of cross-quality market areas impact the European market integration? A8: The potential creation of two cross-quality market areas in Germany will be a further major step in the development of a liquid North-West European gas market. Trading at the virtual trading points in these cross-quality market areas will likely increase further and have a catalyst effects on trading in neighboring markets. The integration of the market areas GasPool and Aequamos would establish a market area which potentially could further integrate with the entry / exit system in the Netherlands. Also, neighboring markets to the east of Germany should increasingly be able to tap into a liquid gas market at their doorstep, thereby increasing their security of supply. II. Cost-Benefit Analysis Q1: Which advantages would result from the creation of cross-quality market areas for traders, shippers, TSOs and end-consumers, especially as opposed to a quality reflective market area integration, which cements the differences in quality? A1: Market area integrations increase the number of suppliers and customers which compete with their offers and their demand at one single trading point. This typically increases trading activity and thereby market depth and liquidity. The price will act as a corrective element between supply and demand as in many other commodity markets. Financial traders generally benefit from increasing liquidity as there are more volumes to be traded. Physical shippers benefit from market area integration through better market access; fewer transport bookings are required and fewer transport bottlenecks can occur. End-consumers will benefit from a larger pool of suppliers offering gas supplies. Market area integrations shift the responsibility to ensure the transport of gas to end-consumers and to balance the system further to the TSOs. This increases their scope in the value chain. TSOs may be tempted to shift new potential transport risks resulting from the more complex operations back to the shippers through the reduction of firm capacity and increase of interruptible capacity. This must be avoided; TSOs need to find measures to maintain firm capacity levels. The above observations also apply to cross-quality integrations. In addition, a crossquality integration of market areas will have following advantages over a quality specific integration: 4

5 it improves the access for customers at L-gas exit points to a broader pool of suppliers and vice versa, it avoids the potential reduction of available capacity at entry- and exit points (see our answer to the next question), it enables existing TSOs such as Gasunie Germany and E.ON Gas Transport to integrate market areas already (partially) operated by them; a quality specific integration may likely delay the integration process further, a cross-quality integration with the step-wise application of commercial and then technical measures to balance H- and L-gas systems enables a step-wise and tailor made grid conversion which follows a decline in L-gas supplies as opposed to a potential risk of early conversion of grids, Q2: Will the creation of cross-quality market areas impact the firm available capacity at entry- and exit points at the market area borders? If so, what are these impacts and how can negative impacts be mitigated? The impact on available firm capacity should be low, if any. The past integrations of market areas of the same quality have caused an increased number of possible entryexit combinations of nominations. The TSOs claim that they are not able to physically transport gas in all theoretically possible new flow scenarios. This has caused firm capacity to be partially reduced and/or the introduction of a so called statistically firm capacity concept. In a cross-quality integration of the formerly separately managed H- and L-gas grids (e.g. GasPool and Aequamos) such an effect should not occur as no new physical flow combinations can occur; higher or lower flows at e.g. a H-gas entry point should not have any impact on the capacity of an L-gas entry point. Q3: Which cost are caused through the creation and operation of a cross-quality market area (e.g. investment cost, operating cost) as a one-off item and continuously? How do these cost compare with cost of quality reflective market area integration scenarios, which cement the differences in quality? The physical supply and demand in a grid will not fundamentally change through crossquality integration. Initially integration should be possible based on commercial measures only. These may incur continuous cost. One-off cost should initially be limited to adjustments to IT systems and processes. Longer term, the cost will reflect cost for the procurement of blending services or corresponding technical measures, which can include one-off investments into e.g. Nitrogen blending facilities and rather continuous cost for e.g. power supplies. Q4: How should additional cost related to the operation of a cross-quality market area be allocated appropriately and non-discriminatorily? Please refer to our answer to question I.6 above. III. Permanent conversion from L-gas to H-gas The long term decline of the indigenous and international L-gas production will likely mean, that parts of the grid in the current L-gas market area can not or only with significant cost be supplied with L-gas longer term and, hence must be converted to H-gas at some point. 5

6 When commenting on the following questions, please specify whether different requirements need to be considered when converting L-gas exit points to H-gas in a cross-quality market area as opposed to a conversion of L-gas exit points to H-gas in an L-gas market area as existing now. Q1: Which conditions should be met, to convert an L-gas area to H-gas? Which price parameters should be relevant in this decision? Are other parameters relevant for the decision? If so, which ones? A1: Permanent conversion is a more or less irrevocable decision considering the organizational effort of the industry to organize the conversion and the involved cost. Early conversion of L-gas transport systems must be avoided: L-gas production from existing fields in Germany is declining only slowly and there is a potential for new indigenous L-gas production from future fields including unconventional resources. Early conversion of grids would take away an outlet for this gas. Furthermore, L-gas imports from the Netherlands compensate the decline from the existing fields in Germany. It should also be noted that a large share of the L-gas produced within the market area Aequamos is exported into other German L-gas market areas, thereby reducing the impact of a German production decline on the Aequamos market area further. From our perspective, decisions for grid conversions should largely be based on plans established by the TSOs in close cooperation with the relevant stakeholders. Such plans must analyze future industry demand and supply as e.g. also done for pipeline capacity expansion planning. We doubt that signals from e.g. prices for control energy are sufficiently reliable and provide a basis for investment decisions with longer term effects. For example, a spell of three years of relatively low control energy prices due to relatively warm winters may hide the need for technical measures to ensure L-gas peak winter supplies. Vice versa, a certain period of high control energy prices may not be a sufficiently reliable signal to justify grid conversion. In any case, TSOs should develop a seriatim (or priority list) of individual actions ranging from commercial measures to grid conversion decisions. Such a seriatim should reflect the cost of the individual actions and must be extensively and frequently consulted with the stakeholders. This process can be aligned with related processes for capacity expansion planning. When looking at grid conversion measures, L-gas production in the Netherlands and its potentials to supply the German market need to be considered too. No decision to convert grids in Germany should be taken without a thorough assessment of the potential L-gas supplies from existing and future sources and consultation of L-gas suppliers. A potential conversion may not preclude L-gas supplies from entering the transport system. Q2: How should a cost monitoring be structured to provide transparent and reliable signals for a decision to convert? Please refer to our answer to question III.1 above. 6

7 Q3: Who should take the decision to convert? Which procedure should be followed, e.g. with respect to lead times, or participation of impacted market parties? Should individual market parties (e.g. local distribution grid operators, shipper, end-consumer) receive a veto-right with respect to a decision to convert? If so, why and under what conditions? Each partial grid conversion should be proposed by TSOs to the FNA following an extensive consultation with the industry, including L-gas suppliers. The FNA should then conduct a consultation of the proposed plan. A conversion plan should include an analysis of future demand and supply, the cost of commercial, technical and conversion measures per convertible grid segment. The role of the FNA should predominantly be the approval of the conversion plans. We believe no individual market party should receive a veto-right with respect to a decision to convert. However, no decision to convert grids should be taken without a thorough assessment of the potential L-gas supply from existing and future production and consultation of L-gas supplies. Q4: Would it be appropriate, that the entity responsible for the decision to convert manages a priority list, listing the areas in the order of planned conversion? Could in this case the lead-time to convert a grid area be shortened? Yes. Please refer to our responses above. Q5: What cost are created when converting areas? How should they be allocated appropriately and non-discriminatorily? The conversion of areas requires adjustments to or replacement of the gas burners of end-consumers. This would require technicians to visit every single end-consumer in the respective area. The exact cost would have to be determined through tenders of corresponding services. Once a conversion is agreed, the associated cost, including relevant upstream cost, should be socialized or distributed over all shippers via TSO transportation tariff increases. Q6: Which measures ensure the absorption of the remaining indigenous L-gas production during the period of conversion? The off-take from indigenous production must be ensured at any time; partial shut-ins of German fields would seriously impact the commercial viability of these resources. The conversion of L-gas grids should follow a decline of L-gas supplies with a time-lag. I.e. commercial and technical measures must have enabled continued supply of L-gas areas over a longer period before an irreversible decision of grid conversion should be taken. It must be ensured that after a conversion, remaining L-gas production volumes can be blended / mixed into the H-gas flows at no additional cost 7