July 2018 Building New Gas Transportation Infrastructure in the EU – what are the rules of the game? OIES PAPER: NG 134 Katja Yafimava The contents of this paper are the author’s sole responsibility. They do not necessarily represent the views of the Oxford Institute for Energy Studies or any of its members. Copyright © 2018 Oxford Institute for Energy Studies (Registered Charity, No. 286084) This publication may be reproduced in part for educational or non-profit purposes without special permission from the copyright holder, provided acknowledgment of the source is made. No use of this publication may be made for resale or for any other commercial purpose whatsoever without prior permission in writing from the Oxford Institute for Energy Studies. ISBN 978-1-78467-115-0 DOI: https://doi.org/10.26889/9781784671150 i Acknowledgements Researching and writing this paper has been a challenge on many fronts – the complexity of the subject of EU regulation, its rapidly evolving nature, and its ongoing politicization, particularly as far as Russian gas pipelines are concerned. I was privileged to count on support and advice from Professor Jonathan Stern, a Distinguished Research Fellow on the OIES Natural Gas Research Programme, to whom I am extremely grateful for the time he spent on reading and commenting on this (very long) paper. I also thank everyone else who has lent their time and expertise in various ways. Special thanks go to Catherine Riches for her excellent editing which made this paper significantly more readable. I also thank Kate Teasdale for her administrative support. Responsibility for all the views expressed and all the conclusions reached is solely mine. ii Preface In the late 2010s, European gas pipelines have again become a controversial political issue, with various governments and stakeholder groups either supporting, or fiercely opposing, different projects. Much of this debate is not well based on gas supply and demand analysis, or on how post-2014 developments have changed the picture for European gas import requirements in the 2020s. But potentially more importantly, there has been almost no detailed consideration of the evolution and importance of pipeline gas regulation, partly because it has become extremely complex, but also because it is continuing to evolve. Calls over the past decade for gas pipeline promoters to ‘respect EU rules’ have tended to ignore the fact that these rules had either not been established or were not clear, requiring forensic examination and interpretation of the language of, and potential contradictions between, EU Directives and Regulations. This paper provides an essential guide to the different regimes for incremental (new) pipeline capacity which have evolved over the past decade. By disaggregating this ‘messy’ evolution, the paper not only sets out the different regimes and the projects to which they apply, but also shows how this rather unsatisfactory situation became increasingly politicized post-2014 in respect of all Russian pipelines, but especially Nord Stream 2. The paper also discusses the impact of the new security and governance regulations, and the possible amendment of the Third Gas Directive to include offshore pipelines and specifically Nord Stream 2. Over a period of nearly 30 years, enormous effort has been expended in creating a regulatory regime for EU gas pipelines. The result seems likely to be that complexity and politicization will persuade those wishing to bring additional gas to EU countries to do so as LNG, rather than as pipeline gas. It is not clear whether this is a desirable outcome, and important that all stakeholders understand both the reasons why it has resulted and their potential consequences. Katja Yafimava’s paper provides a unique guide for those who need to understand the detail of the different regulatory frameworks, as well as for those who only need to grasp the essentials as a way of charting the likely future of European gas trade. Professor Jonathan Stern Oxford, July 2018 iii Executive Summary The process of developing a legally binding regulatory framework for the creation of incremental pipeline capacity in the EU and hence for the construction of new gas pipelines has been uneven and slow. Eight years after the TEP was adopted in March 2009, and more than five years after it entered into force in September 2011, the CAM NC was finally established in March 2017. However, it did not fully resolve all the problematic issues in respect of the regulatory treatment of incremental capacity. The passage of time meant that many new pipelines, which were initiated around the time of the TEP’s adoption and entry into force, developed under a patchwork of TEP exemptions, OS procedures, and IGAs. This meant that incremental capacity was allocated and contracted under different regulatory regimes which – while not dissimilar – were not identical to the regulatory framework established by the CAM NC. In addition, although the CAM NC established a legally binding regulatory framework for conducting an incremental capacity process, it left important regulatory specificities, particularly in respect of capacity allocation methods, for the TSOs and NRAs to decide. This meant that the latter have been able to develop capacity allocation methods which differ across the EU. As a result, there are differences in the regulatory treatment of incremental capacity both between the CAM NC and the previous frameworks (exemptions, OS procedures, and IGAs) as well as within the CAM NC itself. Thus, the problem of the regulatory treatment of incremental capacity – created under diverse frameworks with varying degrees of consistency – has not been fully resolved at the EU level and uncertainty remains in respect of its future treatment. These problems have been made more difficult by the ongoing politicization of EU gas regulation, particularly in respect of Russian gas, and this adds further uncertainty in respect of the regulatory treatment of new EU pipelines, connected with Russian export pipelines. Signs of such politicization started to appear even before the sharp deterioration in the EU–Russia political relationship in the aftermath of the 2014 Ukraine crisis. For example, the cap imposed in 2009 by the EC on the utilization by Gazprom of OPAL (and hence Nord Stream) capacity was not justifiable on regulatory grounds. Such signs became even more evident post-2014, when the EU started to develop its new policy initiatives, which aimed de facto at reducing EU dependence on Russian gas and placing artificial constraints on Russia’s Europe-bound export pipeline capacity, in order to inter alia preserve significant transit of Russian gas across Ukraine. As the EC exhausted its ability to control capacity in Nord Stream 2 on the basis of the existing acquis, it launched several legislative initiatives – most importantly, the proposal to amend the Third Gas Directive. If adopted, the amended Directive would enable the EC to control the degree of utilization of capacity in pipelines coming to the EU from third countries and hence the degree of utilization of capacity in the EU’s internal connected pipelines (irrespective of whether the latter are regulated). This would increase the (already significant) uncertainty in respect of regulatory treatment of incremental capacity in the EU (including the projects that have been initiated prior to adoption of the amended Directive). At the time of writing, lack of political agreement among member states means that it is uncertain whether such regulatory action will succeed. To the extent that it does succeed, it will politicize – and ultimately undermine – an EU regulatory framework that has been painstakingly constructed over several decades. This paper concludes that, given the uncertainty and complexity associated with the regulatory treatment of incremental capacity, the projects that have been initiated prior to the CAM NC’s entry into force should proceed under the rules which were in place at the time of their initiation. Although the EC and the regulatory authorities might be tempted to request some changes in respect of their regulatory treatment – particularly where this differs from what would have been required under the CAM NC – this temptation should be resisted, as further changes would unnecessarily increase uncertainty and complexity. Overall, the complexity and the lack of clarity associated with the regulatory framework for incremental capacity iv in the EU (resulting from the way in which regulation has developed, as well from its subsequent politicization) suggests that very few major new pipelines will be built in the EU in the future, apart from those under construction or foreseen in this paper (including TAP, EUGAL, and the Baltic Pipe) and possibly also those pipelines needed for connecting the second string of Turkish Stream with European markets. This is because it will be much easier for those wishing to bring additional gas to Europe to do so via LNG import terminals. v Contents Acknowledgements .............................................................................................................................. ii Preface .................................................................................................................................................. iii Executive Summary ............................................................................................................................. iv Contents ...............................................................................................................................................