Gas Industry Regulatory Models Gas Industry Regulatory Models

AgendaAgenda

Status of the European gas Status of the European gas transportation regulationtransportation regulation

A case study of regulation in ArgentinaA case study of regulation in Argentina

Lessons learned that can be applicable Lessons learned that can be applicable in Indiain India

Acceleration of the Process in EuropeAcceleration of the Process in Europe

Second Directive Adopted in June 2003Second Directive Adopted in June 2003

Directive Electricity (December 1996) 1999 2000 2003

Minimum Opening 26% 28% 33%Minimum Threshold 40 GWh/y 20 GWh/y 9 GWh/y

July 2004

Opening to non domestic clients

Directive Gas(June 1998) 2000 2003

20% 28%Minimum Threshold 25 Mm3/y 15 Mm3/y

July 2004

July 2007

Opening to all clients

July 2007

First Directives adopted:First Directives adopted:• in December 1996 : electricity• in June 1998 : gas

Minimum Opening Opening to non domestic clients

Opening to all clients

1st Gas Directive: general principles1st Gas Directive: general principles

Conditions for third party access must be transparent and non-Conditions for third party access must be transparent and non-discriminatorydiscriminatory

Tariffs for third party access will be negotiated or regulatedTariffs for third party access will be negotiated or regulated

Mandatory accounting separation of transport – distribution – Mandatory accounting separation of transport – distribution – storage – non-gas activitiesstorage – non-gas activities

Creation of independent Regulators to:Creation of independent Regulators to:• guarantee non discrimination• Oversee complaints and penalize abusive behaviour

2nd Gas Directive : a push to open markets2nd Gas Directive : a push to open markets

Acceleration of the market opening : Acceleration of the market opening : • 01/07/2004: Open to all non-residential clients (50% of French market)

• 01/07/2007 : Complete opening

Legal separation of activities :Legal separation of activities :• Legal separation of transportation and distribution from other activities

• Possible to operate a combined network of LNG, storage, transportation and distribution

Reinforcement of Regulator roleReinforcement of Regulator role

Third party access to storage Third party access to storage

Finance Law of 2001 : end of transport concessionsFinance Law of 2001 : end of transport concessions

Law of January 3 2003 transposing the 1998 EU Directive :Law of January 3 2003 transposing the 1998 EU Directive : Role of Public Entities

Tariffs : the CRE (regulator) proposes, le Ministry decidesTariffs : the CRE (regulator) proposes, le Ministry decides La CRE controls the separation of accountsLa CRE controls the separation of accounts

Waiver for international transit of gas End of GdF import/export monopolies

A draft energy law with a chapter dedicated to third party access A draft energy law with a chapter dedicated to third party access to storage is circulatingto storage is circulating

A future law is anticipated regarding the legal status of EDF-GDF A future law is anticipated regarding the legal status of EDF-GDF

Regulation in FranceRegulation in France

Accounting Separation

Exemption

Legal Separation

A slow evolution of separation of activitiesA slow evolution of separation of activities

Separation of Ownership

UK: total separation

Italy: participation of Eni in SNAM Should be reduced to 10% in 2004

Spain: 41%participation of Gas Natural in Enagas should fall to 35% in 2004

France: proposed law for EDF and GDF in 2004 ??

Netherlands: abandoned the proposed restructuring of Gasunie

Germany ?Belgium: legal separation complete

Tariff structures – many modelsTariff structures – many models

Entry / Exit

Exemption (up to 2008)

Distance

Postage stamp

Entry / Exit system under consideration in Germany

UK: long term reservation of capacity through bidding system

Modes of RegulationModes of Regulation

COST PLUSCOST PLUS PRICE CAPPRICE CAP

Cost plus return on investmentCost plus return on investment Regulated maximum priceRegulated maximum price

+ Reduced risk for transportersReduced risk for transporters

+ Lower rate of return necessaryLower rate of return necessary+ Productivity gains promoted Productivity gains promoted

+ Sharing of risks Sharing of risks

+ Less intervention by regulatorLess intervention by regulator

- Little incentive to reduce costsLittle incentive to reduce costs

- Incentive to over-investIncentive to over-invest

- Regulator must exercise strict controlRegulator must exercise strict control

- Higher risk for transportersHigher risk for transporters

- Possibility that quality will suffer in Possibility that quality will suffer in favour of cost reductionfavour of cost reduction

FranceFrance Great Britain, Italy, Spain Great Britain, Italy, Spain

Remuneration of TransportersRemuneration of Transporters

CALCULULATION OF CALCULULATION OF REVENUE TARGETREVENUE TARGET ModalitiesModalities

Asset ValueAsset ValueHistoric costs (France, Italy)Historic costs (France, Italy)Replacement value (UK)Replacement value (UK)

Basis for Return Basis for Return On amortized asset base (France, Italy)On amortized asset base (France, Italy)On asset base before amortization (Spain)On asset base before amortization (Spain)

Duration of ContractDuration of ContractFrance : 50 yearsFrance : 50 yearsItaly : 40 yearsItaly : 40 yearsSpain : 30 yearsSpain : 30 years

New InvestmentsNew Investments Special treatment in some cases (France, Special treatment in some cases (France, Italy, Spain)Italy, Spain)

Rates of ReturnRates of Return

EXISTING EXISTING ASSETSASSETS

NEW NEW INVESTMENTSINVESTMENTS

HYPOTHETICAL HYPOTHETICAL NEW INVEST.*NEW INVEST.*

FRANCEFRANCE7.75% applied to the 7.75% applied to the

amortized assetamortized assetUp to 12% for 5-10 Up to 12% for 5-10

yearsyears 9% average9% average

9.0%9.0%

ITALYITALY

7.94% applied to the 7.94% applied to the amortized assetamortized asset

Remuneration after Remuneration after accounting life of accounting life of assetasset

12.45% for 6 years12.45% for 6 years 10.0%10.0%

SPAINSPAIN

6.7% applied to non-6.7% applied to non-amortized asset amortized asset valuevalue

Remuneration after Remuneration after accounting life of accounting life of assetasset

Specific Specific

remuneration based remuneration based

on case by caseon case by case

9.5% – 12.8%9.5% – 12.8%

* Based on a 60 year project life – before tax and * Based on a 60 year project life – before tax and financingfinancing

Argentina – a case studyArgentina – a case study

Norte Pipeline: 22 / 0.8

Centro Oeste Pipeline: 31 / 1.1

Neuba I Pipeline: 12 / 0.4

Neuba II Pipeline: 29 / 1.0

San Martín Pipeline: 19 / 0.7

Transportation Capacity 2002 Transportation Capacity 2002 (MMm3/d / Bcf/d)(MMm3/d / Bcf/d)

TGN: TGN:

TGS:TGS:

Total System:Total System:

TGSTGS(Petrobras/Enron)(Petrobras/Enron)

53 / 1.953 / 1.9

60 / 2.160 / 2.1

113 / 4.0113 / 4.0

TGNTGN(Total/ Techint/Petronas/CMS/CGC)(Total/ Techint/Petronas/CMS/CGC)

Prior to Dec 92Prior to Dec 92 Since Dec 92Since Dec 92

YPFYPFPRODUCTIONPRODUCTION PRODUCERSPRODUCERS

TRANSPORTATIONTRANSPORTATION

DISTRIBUTIONDISTRIBUTION

REGULATORY REGULATORY AUTHORITYAUTHORITY

GAS DEL ESTADOGAS DEL ESTADO

ENERGY SECRETARIATENERGY SECRETARIAT

TGN and TGSTGN and TGS

9 Distribution Companies9 Distribution Companies

ENERGY SECRETARIATENERGY SECRETARIATAnd ENARGASAnd ENARGAS

Industry Structure Pre 1992Industry Structure Pre 1992

The Privatization GoalsThe Privatization Goals

Government Objectives for PrivatizationGovernment Objectives for Privatization Generate cash through sale of assetsGenerate cash through sale of assets Assure stable and reasonably priced gas supplyAssure stable and reasonably priced gas supply Foster future investmentFoster future investment Create a competitive natural gas marketCreate a competitive natural gas market

Regulator Objectives and FunctionsRegulator Objectives and Functions To protect consumersTo protect consumers To regulate TariffsTo regulate Tariffs To resolve conflictsTo resolve conflicts To apply sanctionsTo apply sanctions To secure fair rates of returnTo secure fair rates of return To ensure non-discriminatory accessTo ensure non-discriminatory access

Pipeline

Free market Free market Deregulated pricesDeregulated prices Export/import allowedExport/import allowed

ProductionProduction

No geographic exclusivityNo geographic exclusivity Regulated rates Regulated rates (“Price cap”)(“Price cap”) Expansion are not mandatory Expansion are not mandatory Free access through “Open Season”Free access through “Open Season” Transporters do not buy or sell gasTransporters do not buy or sell gas Reselling MechanismReselling Mechanism

TransportationTransportation

Geographic exclusivityGeographic exclusivity Regulated rates Regulated rates (“Price cap”)(“Price cap”) Profits only from distribution serviceProfits only from distribution service Roll through commodity and transport costsRoll through commodity and transport costs By-pass by large users possibleBy-pass by large users possible

DistributionDistribution

Gas Basin

Market

Industry Structure Post PrivatisationIndustry Structure Post Privatisation

Free Market Free Market RegulatedRegulated

End-userEnd-user PricePrice

GasGas PricePrice

TransportationTransportationTariffTariff

DistributionDistribution TariffTariff+ +

Expense recovery + reasonable profit.Expense recovery + reasonable profit.

Lowest end-user cost.Lowest end-user cost.

Promote growth compatible with security of supplyPromote growth compatible with security of supply

Regulated Tariffs must allow:Regulated Tariffs must allow:

Natural Gas Price StructureNatural Gas Price Structure

Ten Years LaterTen Years Later

How has the Argentine Gas Industry performed against the original objectives?

1992-2002 Evolution1992-2002 Evolution

A HEALTHY BEGINNING…….A HEALTHY BEGINNING…….

More capacityMore capacity: 65.5 to 130 MMm3/day (2,3 to 4,6 Bcf/day): 65.5 to 130 MMm3/day (2,3 to 4,6 Bcf/day) Private investmentPrivate investment: over 3500 MMusd in transport & distribution : over 3500 MMusd in transport & distribution More direct customers of transportersMore direct customers of transporters::

initial customers in 1992: 8 (all of them distribution companies) present customers: 56

More new domestic usersMore new domestic users: : 1,000,000 more than 19921,000,000 more than 1992 More dynamic transactionsMore dynamic transactions::

Beginning of secondary capacity market and traders

……………………HOWEVER………….HOWEVER………….

2002 economic crisis has frozen all development of the industry 2002 economic crisis has frozen all development of the industry and forced all regulated companies to default on their loansand forced all regulated companies to default on their loans

Consequently, the industry has fallen into crisisConsequently, the industry has fallen into crisis

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Argentina 190 $/Mm3

($6.3 per MMBTU)

(net of sales tax)(net of sales tax)

Residential Gas Prices (End 2001)Residential Gas Prices (End 2001)

……as a result of the economic crisis, residential as a result of the economic crisis, residential gas prices are currently under 3 USD per gas prices are currently under 3 USD per

MMBTU – too low to sustain.MMBTU – too low to sustain.

Before 2001, Argentina had one of the lowest gas prices Before 2001, Argentina had one of the lowest gas prices in the world….in the world….

Conclusions and Lessons LearnedConclusions and Lessons Learned

General agreement on privatization of transportation and General agreement on privatization of transportation and distribution in a regulated environment guaranteeing distribution in a regulated environment guaranteeing transparency and equity.transparency and equity.

No consensus on regulatory model and many variations to No consensus on regulatory model and many variations to consider.consider.

In Europe, a fair return for a new investment in gas transportation In Europe, a fair return for a new investment in gas transportation is seen to be between 9% and 12%.is seen to be between 9% and 12%.

The Argentine model was effective and functional in generating The Argentine model was effective and functional in generating investment and industry growth at fair prices.investment and industry growth at fair prices.

The Argentine economic crisis clearly demonstrates the link The Argentine economic crisis clearly demonstrates the link between country risk and investment risk.between country risk and investment risk.