Seminar"INSTITUTIONAL AND ORGANIZATIONAL DESIGNS OF THE GAS HUBS IN EUROPE: AN INTRODUCTION TO THE IBERIAN GAS HUB“Bilbao, 24th June 2014

LEGAL ASPECTS FOR THE DEVELOPMENT OF IBERIAN GAS HUB

Vicente López-Ibor MayorPresident of Estudio Jurídico InternacionalFormer Commissioner of the National Energy Commission (CNE)José María Martínez ValverdeLawyer- PartnerLawyer PartnerEstudio Jurídico InternacionalVice-Secretary Iberian Gas Hub Board

1

Index

• 1.- Towards an integrated EU Gas Market• 2 - The European Gas Target Model• 2. The European Gas Target Model• 3.- A Wholesale Natural Gas Market• 4.- Spanish Gas Market• 5.- An Iberian Gas Hub• 6.- Iberian Gas Hub Legal Framework

2

TOWARDS AN INTEGRATED GAS MARKET

Th hi t f i t t d E k t i b d EU l ti th t h b• The achievement of an integrated European gas market is based on EU regulations that have beenprogressively introduced through different “packages”:

• DIRECTIVE 1998/30/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 22 June8 i l f h i l k i l1998 concerning common rules for the internal market in natural gas

• Directive 2003/55/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 26 June 2003concerning common rules for the internal market in natural gas and repealing Directive 98/30/EC

• “Third package”

• The Third Package for gas markets is composed of three measures:

a. Regulation (EC) 715/2009 on conditions for access to the natural gas transmission networks anda. Regulation (EC) 715/2009 on conditions for access to the natural gas transmission networks andrepealing Regulation (EC) No 1775/2005,

b. Regulation 713/2009 establishing an Agency for the Cooperation of Energy Regulators,c. Directive 2009/73/EC concerning common rules for the internal market in natural gas and repealing

Directive 2003/55/ECDirective 2003/55/EC

• On Regulation 715/2009 is stated: “To enhance competition through liquid wholesale markets for gas, it isvital that gas can be traded independently of its location in the system. The only way to do this isto give network users the freedom to book entry and exit capacity independently therebyto give network users the freedom to book entry and exit capacity independently, therebycreating gas transport through zones instead of along contractual paths”.

3

TOWARDS AN INTEGRATED GAS MARKET (2)

• 1.- CREATING AN EUROPEAN GAS TARGET MODEL AND EUROPEAN NET WORK CODES

The implementation of the Third Package launched a process for the creation of a target model for aEuropean gas market including pan-European Network Codes (NC) In particular Regulation 715/2009European gas market, including pan-European Network Codes (NC). In particular, Regulation 715/2009indicates that Member States have to implement “entry-exit gas systems”. National system operators(through ENTSOG) and national regulators (ACER - CEER) have to co-operate to create network codes thatfacilitate cross-border exchanges and integration among “entry-exit systems”.

• 2.- DEVELOPING WHOLESALE NATURAL GAS MARKETS

Third Package of legislation leads all countries to develop a daily balancing market which will require bothimproved third party network access and increased trading. A ‘full’ entry-exit system needs to be equipped

ith “ i t l t di i t” h b t d d i d d tl f it l ti Th i t l t diwith a “virtual trading point” where gas can be traded independently of its location. The virtual tradingpoint offers the users the possibility to bilaterally transfer title of gas and/or swap imbalances betweennetwork users.

• 3 - PROMOTING GAS REGIONAL INITIATIVES3. PROMOTING GAS REGIONAL INITIATIVES

Third Package promotes Gas Regional Initiatives for regional co-operation among private and public actors.The first three regions had been identified (North West, South, South-East). Afterwards, other specificcompositions have been created, (Spanish Enagas, Portugese REN).p p g g

4

THE EUROPEAN GAS TARGET MODEL

• On the basis of the regulatory commitments, the Council of European Energy Regulators (CEER)delivered a Target Model for an European gas market to the European Commission (CEER Visionfor a Gas Target Model, Conclusions Paper 1 December 2011).

• The Gas Target Model (GTM) provides a vision for 2014 and beyond, and contains a suite ofrecommended steps to achieve a single EU Gas Market by 2014, deadline set by the EuropeanCouncil, based on following premises:

a. Enable functioning Wholesale Gas Marketsb. Promoting a limited number of “entry-exit” systems with the horizon scope of one European

entry-exit system.c. Promoting Market Connections.d. Enable secure supply patterns.

The Gas Target Model aims at facilitating the creation of a well functioning EU Gas Market• The Gas Target Model aims at facilitating the creation of a well-functioning EU Gas Market,consisting of cross-border interconnected entry-exit zones with virtual trading points (so-called gas“hubs”)

5

THE EUROPEAN GAS TARGET MODEL (2)

• The Gas Target Model launches for a competitive European Gas Market asa combination of “entry-exit” zones with virtual hubs, based in thefollowing principles:

a) Market integration should be served by efficient use of infrastructures, allowingmarket players to freely ship gas between market areas and respond to price signalsto help gas flowing to where it is valued most”

b) A functional and transparent European Gas Market will contribute to solve theb) A functional and transparent European Gas Market will contribute to solve theproblem of diversification of supply (as more transparency should attract moreactors) and availability.

c) The development of competition should be based on the promotion of liquidc) The development of competition should be based on the promotion of liquidhubs across Europe in which gas can be traded (these may be national or cross-border).

d) The establishment of a gas exchange with a spot and forward market that provides areliable price signal is considered to be a key attribute of a competitive natural gasmarket.

6

THE EUROPEAN GAS TARGET MODEL (3):

Th t t d l f E k t i l d th i t d ti f E N t k C d• The target model for a European gas market includes the introduction of pan-European Network Codes(NC).

• COMMISSION REGULATION (EU) No 312/2014, of 26 March 2014, approved a Network Code on GasB l i f T i i N k iBalancing of Transmission Networks, stating:

a. Rules on Gas Balancing facilitate gas trading across balancing zones, thus contributing towards thedevelopment of market liquidity.

b. Network Users shall take primary responsibility to balance their Portfolios in order to minimize theneed for TSOs to undertake balancing actions.

c. Network Users bear the responsibility of balancing their inputs against their off-takes, with thebalancing rules designed to promote a short term wholesale gas market, with trading platforms tofacilitate gas trade between Network Users and the Transmission System Operators (TSO’s).

d. Transmission System Operators should aim to maximize the amount of their gas balancing needsthrough the purchase and sale of short term standardized products on the short termwholesale gas market.

e. National Regulatory Authorities and Transmission System Operators should harmonize processes forthe implementation of legal framework to support this Regulation.

7

A WHOSALE NATURAL GAS MARKET1. A Wholesale Natural Gas Market, can be defined as: “a single price zone accessible to incumbents and new entrants on equal

terms and where trading is liquid, so that it creates a reliable price signal in the forward and spot markets which are notterms and where trading is liquid, so that it creates a reliable price signal in the forward and spot markets which are notdistorted.” (Dengel, 2011).

2. To support competition in a Whole Natural Gas Market, previously some institutional requirements need to be met:

• A Hands-off government approach to natural gas markets,• Separation of transport and commercial activities,• Wholesale price deregulation,

3 The go ernmental role ill then shift from acti e participant to reg lator setting r les and monitoring the sector3. The governmental role will then shift from active participant to regulator, setting rules and monitoring the sector:

• Sufficient network capacity and non-discriminatory access to networks:• Competitive number of market participants:• Involvement of financial institutions: enabling a market to efficiently service supply and demand will requireInvolvement of financial institutions: enabling a market to efficiently service supply and demand will require

investments throughout the natural gas value chain (upstream development, transport, storage and distribution capacity).

4. Structural requirements (available capacity, third party access, a competitive number of market participants and a link withfinancials) are essential for a kick-start a Wholesale Natural Gas Market.

5. A transparent natural gas price that reflects the current and future state of the market will not be realized unless a platform forthe ownership exchange of natural gas is developed: a GAS HUB.

8

A WHOLESALE NATURAL GAS MARKET (2):A WHOLESALE NATURAL GAS MARKET (2):NATURAL GAS HUBS

A N l G H b i h h i l f l i h d b• A Natural Gas Hub is where the title for natural gas is exchanged between anumber of buyers and sellers.

• Natural Gas Hubs serve two main objectives:

a to be a delivery point of gas entering a systema. to be a delivery point of gas entering a system,b.to offer a place for balancing portfolios, as hubs serve companies to sell gas

in excess with respect to demand needs or to buy if they are “short” overthe balancing periodthe balancing period,

• Natural Gas Hubs offers a counterpart for transactions and give a price signalt k t ti i tto market participants.

9

A WHOLESALE NATURAL GAS MARKET ( )A WHOLESALE NATURAL GAS MARKET (3 )VIRTUAL TRADING POINTS

• Two types of Natural Gas Hubs have emerged: a physical and a virtual hub.

• A physical hub is a geographical point in the network where a price is set for natural gas• A physical hub is a geographical point in the network where a price is set for natural gasdelivered on such specific location. The best functioning and most liquid natural gasmarket in the world, which consists of a physical trading point (the Henry Hub inLousiana).

• Virtual hubs show the gradual disconnection between physical transport of gas andcommercial activity (eased by the unbundling process) and the construction ofreference markets”,

• Currently, the European Union prefers to continue to integrate its natural gas marketsth h th t bli h t f i t l ( i l) t di h bthrough the establishment of virtual (regional) trading hubs.

10

A WHOLESALE NATURAL GAS MARKET ( )A WHOLESALE NATURAL GAS MARKET (4 )PHYSICAL AND FINANCIAL TRADING

• There are two primary types of natural gas marketing:• Physical natural gas trading, that involves buying and selling the physical

commodity.commodity.• Financial natural gas trading, that involves derivatives and sophisticated financial

instruments in which the buyer and seller never take physical delivery of the naturalgas, albeit futures in order to avoid any misunderstanding, futures with physicaldelivery also exists.

• Physical natural gas trading: • can be regulated in exchange trade or OTC; • can be spot, long-term or future• When done in exchange trade gas, the exchange is operating as the clearing house.• Exchange trade is normally fully anonymous and standardized.

11

A WHOLESALE NATURAL GAS MARKET ( )A WHOLESALE NATURAL GAS MARKET (5 )PHYSICAL AND FINANCIAL TRADING

Main terms and conditions for Physical Contracts:

• Quality of the gas• Quality of the gas• Point of delivery and delivery pressure• Commitment and Date of Delivery

Transfer of Ownership• Transfer of Ownership• Pricing• Duration

M t d t ti f l• Meters and computations of volumes• Volume Flexibility• Take or Pay (in gas hub traded contracts such clause loose part of its credibility

given that the buyer could take the gas and sell it at that hub with a small risk to hisgiven that the buyer could take the gas and sell it at that hub with a small risk to hisrevenue).

• Payment• Force Majeure• Force Majeure

12

A WHOLESALE NATURAL GAS MARKET (6 )A WHOLESALE NATURAL GAS MARKET (6 )PHYSICAL AND FINANCIAL TRADING

• One of the main reason for Financial Trading is to financially hedge a future position(the trader takes a futures position that is equal but opposite to a position held in thephysical market, managing the risks of a total portfolio, diversifying physical products,p y , g g p , y g p y p ,clients, counterparts is obviously also possible). Another reason is pure financialtrading without any physical interest, simply to generate profit based on speculation, inwhich case, obviously, the settlement is made in cash

• Futures Main Terms and Conditions:

T di S h d l (h f t di )• Trading Schedule (hours for trading)• Trading Unit• Minimum Fluctuation• Position Limits• Measurement • Delivery and Delivery Procedure or Settlement Price• Initial Margin (as defined in the ICE Clear Europe Clearing Rules, the Initial Margin is calculated on all open

contracts, and is a deposit held by ICE Clear Europe in order to cover the costs that may be incurred in closing out a position in default It is returned upon the closing of the position or at expiry with interest)out a position in default. It is returned upon the closing of the position, or at expiry, with interest).

• Daily Margin (as defined in the ICE Clear Europe Clearing Rules, all open contracts are 'marked-to-market' daily with Variation Margin being called for as appropriate).

13

SPANISH GAS MARKET (1)SPANISH GAS MARKET (1)

Si th i t d ti f th lib li ti t i d b th l t1. Since the introduction of the liberalization process triggered by the new regulatoryframework (1998 Hydrocarbons Law transposing Directive 98/30/EC), Over-the-Counter (OTC) natural gas trade in Spain has taken place.

2.In Spain historically most of the gas supply contracts of all Spanish marketers havebeen long-term contracts with producing countries. OTC long-term bilateral contractsconstitute the most common form of trading.g

3.Buyers and sellers enter into non-standard OTC long terms contracts with each other.Bilaterally negotiated contracts are contracts on no standard terms with manyvariations Every aspect of each contract will need to be negotiated: quality locationvariations. Every aspect of each contract will need to be negotiated: quality, location,quantity, volume and all relevant terms and conditions. These agreements cover allaspects of mutual trading and credit exposure, as well as the physical and financialsettlement of trades.

4.It became a “separated” “contracted” market with exceptional additional “trading”.OTC contracts are made without a public price signal.

14

SPANISH GAS MARKET (2)

1. In 2005 Spanish Transmission System Operator (TSO-Enagás) implemented theexchange platform, connected to TSO logistic system. All transactions in the system aretracked by this platform.y p

2. OTC gas market takes place linked to the transmission network, LNG plants andunderground storages. For that reason distinction must be made between contracts forthe commodity (gas) and for the capacity (transport and storage)the commodity (gas) and for the capacity (transport and storage)

3. The Royal Decree-Law 13/2012, of March 30th, partially transposing the thirdpackage attributes Regulator (CNMC) new duties among other respecting contractualpackage, attributes Regulator (CNMC) new duties, among other, respecting contractualfreedom with regard to interruptible supply contracts as well as with regard to long-term contracts provided that they are compatible with Community law and consistentwith Community policies.

15

AN IBERIAN GAS HUB

1. The development of the organized gas market (an Iberian Gas Hub) would help toi h li idi d f h OTC k d ldincrease the liquidity and transparency of the OTC market and would promote anexchange market based on short-term contracts (they would co-exist).

2. An appropriate development and consolidation of an Iberian Gas Hub needs:2. An appropriate development and consolidation of an Iberian Gas Hub needs:

• Legal and technical requirements compatible with European trends through thed l t f h b hi h f ilit t t ti b t t di t t kidevelopment of a hub which facilitates transactions between trading centers, takinginto account the three basic infrastructures: transmission system, LNG plants andunderground storages

• A progressive adaptation of the national regulatory framework in order top og ess e adaptat o o t e at o a egu ato y a e o o de toimplement European regulation.

• Priority on the promotion of liquidity in short-term transactions and its flexibilityand transparency, seeking a similar model to other European hubs.S i ith l dd d l f t k• Services with a real added value for network users.

• To be open to the integration of REN (Portuguese TSO) to advance into the creationof the Iberian Gas Market within the Gas Target Model.

16

AN IBERIAN GAS HUB (2)

Th i t d ti f Ib i G H b l k ft t t k t i i3.The introduction of an Iberian Gas Hub looks after a more transparent market pricing,increasing liquidity and competitiveness and traded volumes

4 The initial services offered and the value provided for an Iberian Gas Hub would4.The initial services offered and the value provided for an Iberian Gas Hub wouldinclude:

Standardized short-term contracts for exchange trading (versus long-termcontracts)contracts)

Title transfer through validation of transaction by TSO.

Listed “Forward” range products embracing the traded markets

Daily market for imbalance management.

Gas loaning and nominations.

Daily monitoring of guarantees and deposits, through a “Clearing house”.

17

IBERIAN GAS HUB LEGAL FRAMEWORK

Th f ll i t t t f th SPANISH ENERGY REGULATOR’S NATIONAL REPORT1. The following statements from the SPANISH ENERGY REGULATOR’S NATIONAL 2013 REPORTTO THE EUROPEAN COMMISSION can summarized as follows:

• In April 2010, CNE published a road map to develop a gas exchange in Spain. The objective is top , p p p g g p jaccelerate the creation of a gas hub in the Spanish Gas System in order to promote competitiveness,transparency, and reduce the lack of transparency of the current OTC market.

• The analysis concluded that the current conditions experienced in the Spanish Market are sufficient• The analysis concluded that the current conditions experienced in the Spanish Market are sufficientfor the development of the hub, with similar services to those offered in other gas hubs in Europe.However the wholesale market is facing problems regarding lack of liquidity and transparency inprice issues.

• In 2012, the Spanish Regulator, CNE, has created a new working group, working in parallel with theSouth Gas Regional Initiative in order to analyze and discuss the regulatory measures needed toremove all the regulatory barriers to develop this gas hub between Spain and Portugal

• The final regulatory proposals of this group will be submitted to the Government, upon priorconsultation to the Hydrocarbons Advisory Board.

18

IBERIAN GAS HUB LEGAL FRAMEWORK (2)

2. In 2014 a modification of 1998 Hydrocarbons Law to introduce an Iberian4 99 yGas Hub is expected, based in the regulatory proposals to be submitted to theGovernment.

3. After the legal modification, further regulatory developments are needed, mainly:

/ / l d i i i l i RD 949/2001, RD 1434/2002 gas related activities regulation. Approving new Transmission Operator System Technical rules: Balancing rules New EU Balancing network codes to be introduced on this package New EU Balancing network codes to be introduced on this package

Regulating “Third party Access Contracts”

4 Future framework development legislation: Upgrades on the France-Spain4. Future framework development legislation: Upgrades on the France Spaingas interconnections are contemplated for 2015; are likely to add to gas pricepressure in the south of France, as greater gas volumes will flow to Spain.

19