EXAMINING THE ROLE OF REGULATION IN RESTRUCTURING AND DEVELOPMENT OF GAS SUPPLY MARKETS IN THE UNITED STATES AND THE EUROPEAN UNION.

• Author: Oyewunmi, Tade

1. SELECTED ABBREVIATIONS II. INTRODUCTION III. THE GAS SUPPLY VALUE CHAIN IV. AN INSTRUMENTAL REGULATION PERSPECTIVE TO GAS MARKET DEVELOPMENT A. Law and regulation as facilitative instruments B. Instruments and Mechanisms of Regulation C. Regulating network-bound industries: energy and gas supply 1. Economic regulation and liberalization in gas supply markets V. THE REGULATION AND DEVELOPMENT OF GAS SUPPLY MARKETS IN THE U.S. AND EU A. The role of regulation in restructuring the U.S. gas Supply industry 1. The rise of federal regulation in gas and energy supply 2. Economic regulation and liberalization in gas supply markets V. THE REGULATION AND DEVELOPMENT OF GAS SUPPLY MARKETS IN THE U.S. AND EU A. The role of regulation in restructuring the U.S. gas supply industry 1. The rise of federal regulation in gas and energy supply 2. The restructuring and deregulation of the U.S. gas supply markets B. Gas supply industry restructuring and regulation in the EU 1. The evolution of EU regulation and policy for energy and gas supply a. Developing the IEM regulatory framework for secure and competitive supply b. Highlighting the role of institutions in market restructuring and open access c. Competing for access: dominant incumbents versus new entrants The Distrigas case and the Marathon Corp. case d. A Pro-liberalization era following the Energy Sector Inquiry e. Regulatory Authorities and the IEM's institutional framework 2. Facilitating EU energy law and policy objectives a. Exemplifying the CJEU and the Commission regulatory approaches i. Citiworks AG (2008) ii. Federutility case (2010) VI. CONCLUSION II. INTRODUCTION

   The main objective of this paper is to examine the role of regulation by formal and organizational institutions in restructuring and development of competitive and secure gas supply markets. The discussion focuses on relevant experiences in the U.S. and the EU pertaining to the implementation of liberalization as a regulatory and market development paradigm. In this regard, regulation is considered in a facilitative and instrumental sense by considering the notion that the effectiveness of the identified institutional and regulatory framework is best examined in relation to the extent in which the cardinal policy objectives (such as security of supply, sustainability, and curtailment of market power of natural monopolies for the sake of competitiveness) are realized. The paper discusses the relevant rationale, theories, and principles that informed the development of regulation in the context of restructuring an industry such as gas supply with network-bound natural monopoly elements and, in most cases, monopsony and oligopoly features towards more effective competition, open access and non-discrimination amongst operators in accordance with the tenets of liberalization and/or deregulation. (1)

   The institutional development of the U.S. gas supply industry can be categorized into: (i) an era predominated by state regulation (1889-1937); (ii) the era of increasing federal regulation (1938-1983); and (iii) the era of restructuring, deregulation and to a limited extent some re-regulation (1985-present). (2) In this regard, the role of regulation through formal legal institutions (such as laws, rules, judicial decisions, regulatory instruments) and organizational institutions (e.g. contracts, public agencies, and private corporations) has been pivotal. In the EU, the controlled implementation of liberalization and gas supply market integration from the 1990s until now, while implementing the parallel and sometimes counteracting energy policy objectives like security of supply and sustainability (environmental protection and climate change mitigation) also reveals the facilitative role of regulation. (3) This paper does not aim to compare the U.S. and EU legal systems but rather focuses on the similar and peculiar experiences in the U.S. and the EU relating to the restructuring and liberalization of the respective gas supply markets and the role of regulation in that regard. (4)

   As stated by Joskow and highlighted in this paper, "there is no inherent conflict between the liberalization of [electricity and] gas sectors that meet objectives such as security of supply, if the appropriate market, industry structure, market design, and regulatory institutions are developed and implemented." (5) In the context of the natural gas industry and energy markets generally, the attainment of "security of supply" involves the legal and contractual arrangements for safeguarding adequate and timely investments in essential infrastructure. (6) It entails the capacity of the production, transmission and distribution aspects of the supply chain to guarantee reliable access to sufficient energy at reasonable prices. (7) As a quintessential dimension of energy security, the notion of "security of supply" has been central in socio-economic and industrial growth witnessed in the 21st century globally. Thus, it remains a major factor in the attainment of other mainstream energy policy objectives such as competitiveness and sustainability. (8)

   The quest for safeguarding the delivery of energy in a commercial and economic sense is often linked to fears bordering on the adequacy and efficiency of investments in supply network(s) and infrastructure by vertically-integrated and centralized industry versus competitive and decentralized value chains, due to the network-bound nature of the industry. (9) Gas production and supply projects are capital intensive and require substantial ex ante investments. (10) The management and regulation of the industry also entail significant technical know-how and ex post monitoring and maintenance costs. (11) Thus, financiers and investors understandably would require assurances relating to reasonable returns and cost-recovery, predetermined demand centers, and the efficiency of the overarching regulatory and institutional framework relating to pricing and resource allocation. (12) The typical long-term duration and long payback time of energy projects combined with uncertainties and volatilities relating to commodity pricing and policies also make these "investor" expectations reasonable. (13) Without such investments and assurances of reasonable returns and profit, the essential infrastructure generally remains inadequate or becomes increasingly unreliable in supporting the energy demand and supply needs of society, thereby putting energy security at risk. (14) In the same context, consumers and the general public in an economic sense also expect to be protected from the opportunistic tendencies of the vertically intergrated Utilities or operators of natural monopoly networks. (15) In a social sense, there is also the typical expectation of public protection from possible externalities such as air and water pollution. Thus, there is the essential need for an effective institutional setup, (16) which provides sufficient incentives to stakeholders towards making required investment decisions, while policy objectives like security of supply and sustainability can also be pursued. (17)

   In reality, there are no perfectly efficient markets. (18) Moreover, incidents such as: (i) the California energy crisis in 2000-2001 and the Enron collapse (2001) in the U.S.; (19) (ii) North American and European blackouts in 2003; and (iii) the mid to long term energy adequacy concerns recently witnessed in the EU's internal energy market ("IEM") mainly due to the counteracting implementation of competitiveness objectives through liberalization versus sustainability through state and regulatory interventions gives credence to the argument that liberalization or economic restructuring of energy supply markets should not be seen as an end by themselves or an event, but rather a means to an end. (20) The application of such regulatory paradigms and policies can also be considered as a process for developing greater regulatory efficiency and effectiveness. (21) Thus, it is essential to have responsive and efficient institutions based on an effective regulatory framework to control the occurrence or implications of market imperfections, uncertainties, bounded rationality, and opportunism, (22) as well as rent-seeking behavior of public or private sector operators as the case may be. It is also worth noting that an efficient institutional framework or effective combination of 'specialized governance structures,' is essential in addressing the challenges market failures and the abuse of economic powers which may arise in energy supply markets as a result of natural monopoly or oligopoly elements. (23)

   This paper comprises of five parts. Part two discusses the key features of the typical gas supply value chain. Part three identifies and examines relevant notions and principles of gas supply regulation in an instrumental sense and in the context of developing competitive and secure gas supply markets. Part four discusses the key trends and highlights of the U.S. and EU gas supply markets while portraying the instrumental role of regulation in the evolution and restructuring of these markets. Part five concludes the discussion and highlights that it is essential for institutional capacities and enablers to effectively deal with the relevant trade-offs between essential and sometimes counteracting objectives or values in the regulation of gas supply. The paper also contends that a more pragmatic approach to the assessment of energy supply regulation will be needed to adopt concepts such as the 'instrumental' effectiveness of regulation which portrays institutional paradigms like liberalization and relevant regulatory mechanisms as a means to an end rather than an end in themselves.

3. THE GAS SUPPLY VALUE CHAIN

   As depicted in Figure 1 below, a typical gas supply industry is comprised of upstream producers that hold a license to explore, find and produce gas, which is thereon gathered through small diameter...