The EU Commission’s probe into Gazprom

The EU Commission’s probe into Gazprom

The European Commission’s Investigation against Gazprom for Abuse of Dominance

1. The EU energy market liberalisation and antitrust enforcement

The European Union (“EU”) has indicated that competition within the energy market is one of its key priorities. Historically, the EU energy industry has been developed by national and State-owned monopolies. In an effort to introduce effective competition, the EU has issued three legislative packages aiming at market liberalisation. Industry-specific regulations now apply alongside antitrust enforcement to ensure a competitive, secure and sustainable EU gas and electricity market. Although paradoxically the energy market is open to new entrants, it has remained concentrated with few suppliers, buyer and sellers and thus creating a wide scope for potential antitrust abuses.

In order to investigate the energy market for anti-competitive behaviour, the Commission launched a sector inquiry into the gas and electricity market. Following its conclusion in 2007, it opened a number of formal investigations against key Central and Eastern European (“CEE”) energy companies for abuse of dominance under Article 102 of the Treaty of the Functioning of the European Union.

Within the wholesale electricity market in CEE, the Commission has recently accepted commitments by ČEZ, the Czech electricity incumbent. It has also fined the Romanian power exchange, OPCOM, for abusing its dominant position in the national market by creating barriers to entry for EU electricity traders. Additionally, the Commission is currently investigating the state-owned Bulgarian Energy Holding (“BEH”) against alleged abuse of dominance by placing territorial restrictions in relation to electricity trading operations.

In separate ongoing proceedings, the Commission is also investigating the Bulgarian Energy Holding and its subsidiaries, Bulgargas and Bulgartransgaz, against potential abuse of their dominant positions in the gas market by hindering new entrance. Most prominently, in September 2012, the Commission opened formal proceedings against Gazprom for a number of potential abuses of dominant position in relation to the supply of upstream gas in the Central and Eastern European region.

2. Introduction to the Commission’s investigation against Gazprom

The Gazprom case could bring fundamental changes to the current EU gas market. However, as a high-profile case involving a foreign government, it is also a very diplomatically sensitive matter. Gazprom is the world’s largest gas producer, and is also State-controlled through a 50.1 per cent stake held by the Russian State. Therefore, an investigation into the company’s practices has a geopolitical undertone, making the investigation more complex. The DG Competition Commissioner, Joacquin Almunia, has explicitly stressed that, like other high-profile antitrust investigations, the current proceedings are not politically motivated. Initially, the Russian government refused to cooperate with the Commission. However, negotiations talks are now ongoing and a “mutually acceptable solution” is expected to be reached in Spring 2014.

A settlement would be a more favourable outcome of the investigation for Gazprom as it could otherwise face fines of up to 10 per cent of its annual worldwide turnover in addition to stemming civil litigation and independent investigations by national competition authorities.

The gas market has been inherently oligopolistic due to the geographical advantages of certain regions in Europe and its development alongside monopolistic state-owned companies. With plenty of gas reserves in Russian, Gazprom has been supplying around 20-30 per cent of Europe’s gas. In 2013 alone, the company transported 160 billion cubic meters of natural gas to Europe. Gazprom’s market share varies in different parts of Europe. Western Europe has access to other gas sources, such as LNG stations, and therefore supplies only a portion of its gas from Gazprom. However, most CEE countries are heavily reliant on gas supplies from the company. Lithuania, as an extreme example, buys a 100 per cent of its gas from Gazprom. The company’s large market share and its market power make the company a dominant gas supplier in the CEE region which, as such, is subject to EU competition laws.

The Commission is currently examining three potential anticompetitive practices by Gazprom which could amount to an abuse of the company’s dominant position as an upstream gas supplier in CEE pursuant to Article 102 TFEU:

(1) Imposing unfair prices on its customers by linking gas and oil prices
(2) Dividing gas markets by preventing the free flow of gas
(3) Preventing the diversification of gas supplies

3. Unfair Pricing: long-term contracts with pay-or-take clauses and oil-indexation

One of the most controversial trading practices investigated by the Commission is Gazprom’s long-term contracts linking gas prices to a product basket of oils and incorporating pay-or-take conditions.

Historically, oil was considered as a substitute fuel to gas in energy generation, therefore justifying the existence of a price link in the contracts. Today, as Almunia, notes, there is a concern that the gas-oil indexation formula is no longer based on any economic fundamentals. The Commission will investigate whether Gazprom imposes unfair gas prices on its customers by using the oil-indexation pricing mechanism.

With the US shale gas revolution and the subsequent increase in liquefied natural gas supplies to Europe, some companies in Western Europe have chosen to diversify their gas supplies and to renegotiate prices with Gazprom. In addition, some have sought arbitration in order review their contracted gas price. As a result, Gazprom has agreed to lower prices to companies operating in countries with access to LNG stations thus creating a divergence in gas prices across Europe. Furthermore, Gazprom has paid rebates, to RWE, by applying contracts retroactively. The company has allegedly introduced hybrid pricing in some of its contracts thus taking into account both the oil price and the spot gas price. However, companies operating in CEE have had little success in renegotiating lower gas prices due to their dependence on gas coming from Russia.

In addressing the potential imposition of unfair prices, the Commission could request that the oil-indexation is replaced by a spot pricing mechanism. Some of Europe’s gas is traded on hubs based on supply and demand market conditions similar to those of the financial markets. With an increased supply of LNG to Europe traded on hubs, the spot price is now lower than the oil-indexed gas price.

A spot pricing mechanism in gas contracts however has some significant setbacks. First, without the emergence of another major gas supplier, Gazprom could still be the marginal supplier of gas traded on EU hubs. Therefore, the spot price could be easily manipulated by dominant companies, such as Gazprom, by managing the volumes on the market. Second, in the long-term, spot pricing mechanisms cannot guarantee lower gas prices than oil-linked ones. Finally, spot pricing could potentially introduce great price volatility in the energy sector where the security of supply is of paramount importance.

The Commission would need to find a balance between the latter considerations and the effective means of creating a competitive EU gas market through fair gas pricing. If the Commission proposes spot gas pricing instead of oil-indexation, Gazprom could face a dramatic shift its business model.

4. Market portioning through sale restriction clauses

The Commission is also investigating whether Gazprom has been hindering the free flow of gas in Europe through territorial restriction clauses in its contracts. For instance, a buyer, who has a surplus of gas supply, cannot resell its gas to a third party. Such restrictions, or destination clauses, de facto allow Gazprom to charge its customers different prices for the gas it sells at the same delivery point. Additionally, those clauses have the effect of dividing the single European market into smaller national markets and therefore are not eligible under any block exemptions in EU competition law.

Destination clauses have been considered as anti-competitive by the Commission in Gazprom’s agreements with ENI (Italy), OMV (Austria) and E.ON Ruhrgas (Germany). The cases were settled and an exclusion of the destination clause was agreed. The Commission has also examined destination clauses relating to other major gas suppliers, such as Sonatrach (Algeria) and GDF (Europe). If the Commission establishes the existence of territorial restrictions in the current proceedings, it is likely it will seek the deletion of those clauses in the company’s contracts.

5. Preventing diversification of the gas market

In order to determine whether Gazprom’s practices have been preventing diversification of the gas market, the Commission will be looking into the cumulative effect of various contracts and clauses and any evidence of denied access to infrastructure to third parties.

Gazprom’s long-term pay-or-take contracts are usually agreed for a period of 20-30 years. Contracts, incorporating duration and volumes, are considered essential to the gas market as they ensure the financial viability of large-scale investment projects, from gas field explorations to pipeline construction, as well as the long to medium-term energy security to the purchaser. Although long-term pay-or-take contacts usually include a legitimate risk sharing mechanisms, the Commission will be closely examining provisions and business practices potentially hindering competition. More specifically, it will be examining the economic effects of both the duration and minimum volume of gas purchases in the agreements. Minimum purchase volumes could be regarded as de facto anti-competitive exclusion provisions if they, for instance, amount the total historic gas demand by the purchaser and are agreed for a long duration.

Another aspect that the Commission will be examining is whether Gazprom has prevented the diversification of the market by denying access to essential infrastructure such as pipelines. Under EU energy law, dominant market participants are required to allow unhindered access to pipeline infrastructure to third parties. Gazprom, as a producer and supplier of gas, also owns transit infrastructure and equity interest in some distribution companies. Therefore, the Commission will be examining the company’s conduct in relation to its competitors and their access to Gazprom-owned essential infrastructure. Similarly, the Commission has investigated other major gas companies in the past, including Distrigas (Belgium), E.ON (Germany) and EDF (France), for prevention of diversification of the market through refusal of access.

Finally, the Commission will be looking at various practices which could have impeded the diversification of the market. Such practice could include, but are not limited to, requiring existing customers to support specific gas infrastructure projects as oppose to others not relating to Russian gas.

6. Conclusion

As a part of the European Commission’s goal to create a competitive and liberalised energy market, the antitrust proceedings against Gazprom have important implications to various stakeholders. First, the Commission has the difficult task of balancing out the interplay between competition law, energy policy and regulations, and foreign politics in the negotiation talks with Gazprom which are expected to end in Spring 2014. Second, given Gazprom’s large market share in the CEE gas market, any changes to the pricing mechanism and the overall competitiveness of the market, would have a significant impact on consumers. Finally, a settlement decision could require Gazprom to alter its core business model and practices. Thus, the Commission’s proceedings against Gazprom have the potential to radically change the shape of today’s gas and energy market both in the CEE region and throughout the European Union.

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