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Natural Gas Supply Security: Is there a Rational for EU-Wide, Unique Supply Security Standards?

January 23rd, 2011 by Sophia Ruester, Florence School of Regulation (European University Institute, Florence)

Obviously, no country wants to depend on ‘insecure’ foreign supplies of an important economic input such as natural gas. However, security of supply has a cost. Therefore, we question whether there is a rational for EU-wide, unique supply security standards as have been implemented recently via the Commission’s new regulation concerning measures to safeguards security of gas supply.

Is there an optimal level of supply security? Security of supply has mainly to do with concerns about (i) supply disruptions arising from risks associated with gas supply sources, transit and transportation as well as about (ii) affordable prices since short-term price elasticities in the energy sector typically are very low for the majority of customers. Short-term reliability (operational security) has to be distinguished from long-term adequacy of supply and infrastructure (strategic security). However, supply security is first and foremost a short-term phenomenon, with the long-term effects being much less dramatic.

The establishment of a functioning, well interconnected and competitive internal market is one major pre-condition for guaranteeing a high level of supply security and providing efficient incentives to invest in natural gas infrastructure. In order to be prepared for potential future supply disruptions, European policy makers support a range of additional measures aimed at reducing the risk of gas shortages (including the diversification of supply sources and routes, a better use of existing infrastructures via e.g. reverse flows, the elimination of (cross-border) bottlenecks, enhanced internal coordination between Member States, or external cooperation with supplying countries). Several funding sources supporting infrastructure investments are made available. For instance, € 1.39bn have recently been awarded to 31 natural gas infrastructure projects (of which 14 include reverse flow projects and two LNG import terminals) within the framework of the European Energy Programme for Recovery.

From an engineer’s point of view, the optimal level of supply security might probably be such ‘that never constrains operation’. This line of reasoning neglects the fact that supply security, beside its benefits, also has a cost. From an economic (i.e. social welfare) perspective, the optimal level of security equates marginal social benefits and marginal social cost. Where the security level is relatively low, the cost of providing more security may be quite low but rises steeply when remaining risks are expensive to deal with. Consumers, on the other hand, are willing to pay a large amount to eliminate major risks but much less for eliminating further risks.

Both consumers’ willingness to pay curves and the cost of providing extra security differ by region. Natural gas represents varying shares in the primary energy mix of Member States (e.g. 2% in Sweden but 37% in the Netherlands); it is employed in different shares in residential, industrial, and power sectors; and there are differences in the availability of potential substitutes and the actual level of supply security. Moreover, different instruments are available that can absorb supply disruption. These might include strategic storage, an increase in domestic production, the delivery of additional volumes under existing long-term supply agreements via alternative routes, access to flexible short-term volumes (pipeline and/or LNG), or demand response measures. Therefore, the optimal level of supply security should be evaluated on a disaggregated (i.e. Member State, or where appropriate regional) level.

From an economic perspective, EU-wide, unitary standards for supply security bear the hazard of providing a level of security which might be too high, i.e. too expensive, with the cost of providing it exceeding the consumers’ willingness to pay. Especially the introduced (N 1) rule is a very strong measure and it is highly disputed as to whether it reflects the true risk situation of every Member State. It is not always the largest infrastructure, which is subject to the risk of serious supply disruptions but alternative scenarios; e.g. a total disruption of deliveries of Russian gas via Belarus and/or Ukraine, might be much more relevant.

A detailed risk assessment in turn can provide an overall picture of the supply security situation of a Member State or region including the actual level of security, potential risks, a probability distribution of potential events of supply disruptions, as well as the resulting economic damage. Such an analysis should form a reasonable basis on which to evaluate the costs and benefits of providing extra security and makes EU-wide standards needless.

The topic of a centrally-defined, EU-wide standard is also from the legal perspective a complex topic. These might collide with the exclusive right of the Member States to decide about their national energy mix. This decision, being the prerogative of the Member States, led to date to a situation in EU gas security of supply policy making, in which the respective regulation occurs at national level.

National sovereignty in addition with the strict limitation of powers of the EU with regard to the determination of the energy mix ensures that it is up to the Member States to decide on energy saving measures, alternate energy sources and security of supply enhancing tools. The envisaged security of gas supply regime as incorporated in the proposed Regulation now touches upon this exclusive right. Containing a re-definition of standards of emergency, moreover specifying mitigation instruments, and also strengthening the supervisory rights and those for intervention of EU institutions, the new regime illustrates the shift of EU security of supply regulation towards an enhanced ‘European’ regulatory approach.

Obviously, the proven inefficiencies of the gas security of supply regulation currently in place, suffering from non-existent harmonization across the EU as well as a lack of cooperation and coordination, such ambition seems to be natural consequence. However, by doing so, the EU might go beyond its competences: the definition of a crisis in view of the role of natural gas is under the exclusive competence of the Member States. The imposition of a centralized minimum level of security undermines their right to “define how much insurance they should buy and how and when to buy it” (Noël, 2010).

Hence, in order to avoid any collisions of competences it seems preferable to emphasize national security assessments rather than imposing unique EU-wide standards top-down. National assessment allow for a tailor-made minimum level of supply security determined by the Member States taking into account national circumstances and county-specific measures on how to achieve it.

Nicole Ahner and Sophia Ruester, Florence School of Reguation

P.S. This blog contribution is based on: Challenges for European Natural Gas Supply Security Regulation. Network Industries Quarterly, Vol. 12, No. 3, pp. 6-8.

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5 Responses to “Natural Gas Supply Security: Is there a Rational for EU-Wide, Unique Supply Security Standards?”

  1. Pierre Noel Says:

    The real question that this article — and especially the longer one on which it is based — poses is: where does inspiration from other people’s work stop, and does plagiarism start. An important issue in the academic world these days.

  2. Nicole Ahner & Sophia Ruester Says:

    Dear Pierre Noel: You are clearly the main inspiration of our blog. We are very sorry not having made it is clear as you would like. We are on your side and we admire your reasoning. Again: very sorry. Nicole and Sophia

  3. Pierre Noel Says:

    You look like two children caught with their hands in the box of sweets. Essentially, what you did is a re-writing of my papers. You cannot do this and publish it under your name. There is nothing in your paper — not only the blog post but also the paper on which it is based (in Network Industries Quarterly) — that reflects your own thinking and research. This is a breach of the basic rules of scholarship — irrespective of how much you “admire my reasoning” (sic).

  4. Jean - Michel Glachant Says:

    Dear Pierre, I know personally both Nicole and Sophia and both Nicole and Sophia really admire your reasoning. You are the only name quoted in their blog. Do not over-react. They did apologize hurting you. Please be merciful. To forgive is as beautiful as to apologize.

  5. Paul Hunt Says:

    Perhaps it’s time to move on and address the next steps. I must admit I was disappointed that this blog post (and the supporting paper) merely re-presented very relevant analyses. But it has brought us here and there is an opportunity for some fruitful engagement. For me, the important point is that national – and sub-national – gas market authorities should have the freedom to set, and enforce, their own standards of security of supply in the context of these markets’ specific configurations of gas supplies and infrastructures – but subject to EU-wide norms. It is equally important that market participants have the freedom to select the most efficient combination of resources, mechanisms or infrastructure that will meet these standards.

    It also seems to be accepted that increasing diversification of supply and increased pipeline interconnection of currently under-connected regional, national and sub-national markets greatly enhance security of supply efficiently. It is dismaying that DG ENER, ERGEG and, the soon to be established, ACER seem intent on pursuing their complex, but flawed, approach to addressing the poory-defined pipeline property rights enjoyed by TSOs – some fully unbundled, some partially unbundled and others barely unbundled – and the associated capacity rights enjoyed by their formerly or still currently affiliated supply busineses (by virtue of long-term external supply contracts). Existing or prospective market participants who do not enjoy these property rights face risks that act as a barrier to efficient participation or entry, respectively. New entrants (or combinations of new and existing participants) seeking to construct pipeline interconnectors or LNG importation facilities invariably seek exemption from TPA provisions to protect the property rights they will establish and to secure recovery of investment.

    There is an urgent requirement to re-define the property rights on cross-internal border pipelines and on key internal market supply entry pipelines that were granted prior to the market liberalisation process and have simply been adopted under the current regulated access regime. Prevously an assurance of investment recovery was provided by fully integrated supply businesses enjoying exclusive rights to import, purchase and supply. The fully or partially separated supply businesses provide some assurance of investment recovery, but at the cost of hogging available capacity and causing contractual congestion. New entrant supply businesses have very short time horizons and are unwilling or unable to enter into the long contracts required to provide the necessary assurance of investment recovery, because traded markets lack the depth and liquidity for risk management purposes. But they lack depth and liquidity because there is insufficient market interconnection capacity. This is the ‘Catch 22’ that must be broken. The NRAs are taking up the slack by providing some assurance of investment recovery, but this exposes investors in long-lived, specific assets to additonal regulatory risk. The result is insufficient investment in interconnection capacity. DG ENER is now considering providing public funds to top-up the revenues provided by the market to provide assurances of investment recovery, but this simply provides opportunities for political interference, lobbying by special interests and for rent capture at the expense of final consumers.

    The current approach is flawed and unsustainable; it is time to think again.

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