pa p e r s e r i e s

SAFEGUARDING INVESTMENTS IN NATURAL GAS INFRASTRUCTURE

LESSoNS LEARNED FRoM REGULAToRy REGIMES IN ThE UNITED STATES AND ThE EURopEAN UNIoN
Tim Boersma

 2012 Transatlantic Academy. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from the Transatlantic Academy. Please direct inquiries to: Transatlantic Academy 1744 R Street, NW Washington, DC 20009 T 1 202 745 3886 F 1 202 265 1662 E Info@transatlanticacademy.org This publication can be downloaded for free at www.transatlanticacademy.org.

Transatlantic Academy Paper Series The Transatlantic Academy Paper Series presents research on a variety of transatlantic topics by staff, fellows, and partners of the Transatlantic Academy. The views expressed here are those of the author and do not necessarily represent the views of the Transatlantic Academy. Comments from readers are welcome; reply to the mailing address above or by e-mail to Info@transatlanticacademy.org. About the Transatlantic Academy The Transatlantic Academy was created in 2007 as a partnership between the German Marshall Fund of the United States (GMF) and the ZEIT-Stiftung Ebelin und Gerd Bucerius. The Robert Bosch Stiftung and the Lynde and Harry Bradley Foundation joined as full partners beginning in 2008, and the Fritz Thyssen Foundation joined as a full partner in 2011. The Compagnia di San Paolo joined in providing additional support in May 2009, as did the Joachim Herz Stiftung and the Volkswagen Stifung in 2011. In addition, the Academy received startup funding from the Transatlantic Program of the Government of the Federal Republic of Germany through funds of the European Recovery Program (ERP) of the Federal Ministry of Economics and Technology.

On the cover: Gas fields in Pennsylvania, United States Corey Johnson

Safeguarding Investments in Natural Gas Infrastructure

Lessons Learned from Regulatory Regimes in the United States and the European Union
Transatlantic Academy Paper Series July 2012

Tim Boersma1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Relations between Legislatures and Regulatory Authority . . . . . . . . . . . . . . . . . . 7 Transport Tariffs or Infrastructure Operator Revenues . . . . . . . . . . . . . . . . . . . . 9 Private and Public Ownership and Investments . . . . . . . . . . . . . . . . . . . . . . . 13 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Tim Boersma is a Ph.D. Candidate University of Groningen and research fellow at the Transatlantic Academy, Washington D.C.

Special thanks go to Dr. Machiel Mulder of the Dutch regulatory authority NMa, Dr. Wim Groenendijk and his team at Dutch Gasunie, Paul ODonovan and Iain Morgan of British regulatory authority OFGEM, Brian S. White and Michael Strzelecki of the U.S. Federal Energy Regulatory Commission, and Helmut Fu of the German Bundesnetz Agentur. Furthermore, the comments and support of Professor Catrinus Jepma and Professor Jaap de Wilde of the University of Groningen and Geert Greving, my supervisor at Dutch GasTerra and his team have been very helpful, as always. Last but certainly not least, I would like to thank my colleagues at the Transatlantic Academy and those of the German Marshall Fund who have provided me with useful comments and feedback, while at the same time contributing to my wonderful time in the United States.

Introduction

he challenge to interconnect and adapt European energy infrastructure is significant and urgent.1 In June 2011, the European Commission estimated that roughly 200 billion in total investments were needed in energy infrastructure up to 2020. Assuming that natural gas continues to play a crucial role in the European Union energy mix, about 70 billion of that total amount would be needed for investments in gas transmission infrastructure, storage facilities, liquefied natural gas (LNG) terminals, and reverse flow infrastructure. The commission estimated that necessary investments will not take place under business-as-usual conditions, because of problems related to permit granting, regulation, and financing (European Commission, 2011). Regarding regulation, the commission considers the existing framework to be not geared towards delivering European energy infrastructure priorities. This raises the question of what can be learned from the United States, which also has a large market for natural gas and has had to deal with comparable challenges. Regulatory regimes regarding gas transmission infrastructure in the United States and the European Union are difficult to compare because of the myriad differences between the two systems. But scholars in the European Union have looked at the regulatory regime in the United States to
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draw lessons from it. Von Hirschhausen (2008) concluded that there is little reason for concern about infrastructure investments, resource adequacy, and supply security in the restructured U.S. natural gas market. Others have found that, taking productivity and convergence as performance indicators, regulation has been rather successful in the United States in a data envelopment analysis of U.S. gas transmission companies (Jamasb, Pollitt & Triebs, 2008). This paper aims to explore whether there are more lessons to be learned from the U.S. regulatory system, in particular when looking at how to secure sufficient long-term investments in gas transmission infrastructure. Although this topic has received academic attention before (Von Hirschhausen, Beckers & Brenck, 2004), there are several reasons to undertake this analysis now. Why the European Status Quo is Suboptimal First, drawing from ongoing research on European Union energy security, the recent scientific debate on this particular topic has been focused on limited resources or unreliable suppliers. The organization of the European Union internal energy market, in particular regarding regulation and energy infrastructure, is not as thoroughly explored. Research on energy regulation appears to face that same pitfall by focusing mainly on efficiency. This is illustrated, for example, when reading that ...Ideally, the purpose of antitrust and regulation policies is to foster improvements judged in efficiency terms... (Viscusi, Harrington Jr. & Vernon, 2005, p.9). However, the point here is that energy regulation is part of a broader policy area. Legislatures often serve multiple and sometimes changing policy goals, which often go beyond and/or against establishing efficient investment decisions and dealing with antitrust issues. In short, as some stated ....economic theory explains the way to maximize efficiency, whereas other societal objectives could not be achieved by

The commission estimated that necessary investments will not take place under business-asusual conditions, because of problems related to permit granting, regulation, and financing.

In order to give a representation of the regulatory regimes in the European Union, in this study I examine the regulatory regimes of Great Britain and the Netherlands. I do not refer to the United Kingdom in this paper, for Northern Ireland has its own regulatory authority that has not been considered here. Great Britain has been the front runner in the liberalization of the European energy market. The Dutch are somewhat behind, with an advantage of easy access to relevant data. More importantly the discussion on allowing private funds to have a role in future investments in gas infrastructure is contemporary in the Netherlands. For the United States, federal rules applying to investments in gas transmission infrastructure are studied, particularly those following the Natural Gas Act and 1992 Order 636 (A) and requiring significant structural changes in the services provided by natural gas pipelines.

Safeguarding Investments in Natural Gas Infrastructure

There appears to be growing consensus among European policymakers that the existing regulatory framework is not fit to address the major challenges facing energy infrastructure companies in the decade ahead.

competitive markets... (Kwoka & Madjarov, 2007, p.26). Furthermore, transmission system operators may be required to carry out tasks that are not per definition part of the regulatory framework. For example, the Dutch transmission system operator is required by law to make provisions safeguarding security of supply,2 while at the same time Dutch regulatory authorities do not use security of supply as a criterion when assessing proposed transport tariffs.3 Second, practice shows that the current organization of the European Union energy market regarding this matter is not efficient. Good examples are the different tariffs that infrastructure companies are allowed to calculate for the transport of natural gas in the Netherlands and Germany. In the Netherlands, since 2004, there has been a single gas transmission system operator,4 named Gas Transport Services or GTS.5 This is a wholly owned subsidiary of Dutch Gasunie private limited liability company, in turn owned (100 percent) by the Dutch state6 but required by law to act independently. In July 2008, GTS purchased two transmission networks in northern Germany, BEB and EMGTG, from Shell and Exxon Mobil, respectively. This extended the network of GTS to Berlin, supposedly providing it with a strategic position regarding the Nord Stream pipeline that runs from Russia through the Baltic Sea to northern Germany. Shortly after the purchase, in
2 3

2009 the German regulation authority BundesNetz Agentur, tasked with administering and approving the tariffs calculated for the transportation of natural gas, decided to lower the maximum turnover to be achieved by gas infrastructure companies in Germany. GTS had to devalue approximately 5 percent of its total purchase, which was estimated at about 10 billion.7 This resulted in a political debate in the Netherlands regarding the spending of public financial means in risky purchases abroad, and in addition it is also said to have negatively influenced the possible purchase8 of the adjacent gas network of German multinational company Thyssengas Netz (RWE), that had been put on sale at the end of 2008 under pressure from the European Commission.9 Third, there appears to be growing consensus among European policymakers that the existing regulatory framework is not fit to address the major challenges facing energy infrastructure companies in the decade ahead. This conclusion is based on the realization that some projects are not taking place because they provide higher regional than national benefits, while others are not because they use innovative technologies with higher risks and uncertainties. In addition, there are projects with externalities that are generally not taken into account by market demand.10 All this can be linked to broad European policy goals, such as energy security, the development of renewable forms of energy, and the promotion of the interconnection
7

Gaswet, article 10a, sub 1, part a. Note that indirectly, security of supply does play a role in the Dutch case, as the analysis will show later. The gas transport facilities that are not part of the national transmission system are administered by regional infrastructure companies. In the Netherlands, there are 12 of these companies, namely Cogas, Delta, Enexis, Haarlemmermeer, Intergas, Liander, Obragas, NRE, Rendo, Stedin, Westland, and Zebra. In 2005, the integrated gas company Gasunie was unbundled into the commercial company Gasterra and the public transmission system operator GTS. Represented by the Treasury. For more information, see the Dutch letter of the Minister to the Treasury, number FIN/2010/230U of April 12, 2010. As announced on February 2, 2009. This is supported by an official press release of Dutch Gasunie on March 23, that stated it had no interest in Thyssengas (kein weiteres Interesse) since the German investment climate had become unpredictable through regulatory changes (Reguliering hat das Investitionsklima in Deutschland unberechenbar gemacht). See for more details Commission staff working document SEC (2011) 755 final, page 6 and further.

8 9

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of energy networks.11 While energy regulatory authorities currently appear to focus mainly on efficiency when setting tariffs for the transport of natural gas, this is remarkable given the broader policy agenda that looms in the background. It is worth investigating to what extent the other policy goals just described are considered when designing tariff structures. Fourth, relations between national legislators and regulatory authorities are not always clear. At the request of the European Parliament,12 the Dutch regulatory authority (and its colleagues in other member states) was granted the judicial status of an autonomous administrative authority in 2005.13 In short, the goal of creating this status was to confirm the importance of having an independent regulatory authority in the energy sector and thus depoliticize the work of the national competition authority. In 2010, this status caused remarkable friction when the Dutch Trade and Industry Appeals Tribunal (CBb) annulled the tariff regulation that the Dutch transmission system operator GTS had designed in accordance with Dutch government policy. The minister of economic affairs laid down several conditions that GTS had to apply when designing tariff structures, such as the value of the national infrastructure system, the terms of depreciation, and the remuneration of the cost of capital. However, the Council for the Judiciary stated this was unlawful since the minister was meddling

with the competences of the regulator.14 Under these circumstances, in 2010 the Dutch regulator proposed a new method of regulation for the period starting in 2006.15 While these tariffs have been published and a settlement deal of 400 million has been proposed by the regulator,16 both GTS and the joint major industrial consumers have indicated they are not satisfied and have announced a new tug-of-war in court. This has created insecurity for the infrastructure company and negatively affected the development of new similar business ventures in the Netherlands.17 Fifth, in the Netherlands there is an ongoing political debate about whether gas networks should be (partly) privatized. GTSs limited financial means to make necessary investments are said to have fuelled this debate. The unbundling of vertically integrated energy companies, driven by the European Commission from the late 1980s, has always been answered by the argument that networks should always be in public hands in the Netherlands, since the secure and stable access to energy is a major public concern. Hence, in a liberalized European energy market, the only
14

To be more precise, in 2006 CBb ruled that regulatory format and existing legal framework did not fit. Then Minister of Economic Affairs Van der Hoeven issued a new policy rule, setting concrete parameters regarding GTSs capital expenditures. Then in 2010, CBb argued that the minister had impinged on the independent decision-making process of the Dutch regulator NMa. See also http://www. nma.nl/en/documents_and_publications/press_releases/ news/2011/11_21_nma_makes_draft_method_decisions_gts_ available_for_perusal.aspx LJN: BM9470, June 29, 2010. Comparable verdicts were published on the regulations for electricity TSO and DSOs in that same period. http://www.nma.nl/en/documents_and_publications/press_ releases/news/2011/11_49_nma__dutch_gas_transmission_ system_operator_is_to_return_eur_400_million_to_its_ customers.aspx The announcement of new court quarrels published on November 21 2011 is at http://www.energiekeuze.nl/nieuws. aspx?id=864

15

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As laid down in for instance the Lisbon Treaty, 2007/C, 306/01, article 176 A. Report of the European Parliament following the proposed regulation 1/2003 A5-0229/2001, June 21, 2001, page 22. Staatsblad 327, June 30, 2005.
17

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Several years later, the unbundled system operator GTS itself appears to be one of the advocates of the privatization of a minority share of the Dutch transmission system, allegedly because it needs additional funds to make required investments.

reasonable thing to do was unbundle the integrated companies. Several years later, the unbundled system operator GTS itself appears to be one of the advocates of the privatization of a minority share of the Dutch transmission system, allegedly because it needs additional funds to make required investments. In addition, in June 2011, a European Commission staff working paper stated that ... Investors, such as public banks or investment funds, confirmed that transmission system operators have largely exploited their ability to raise debt capital and that future investments will require large equity injections by private investors or the State (in case of publicly owned transmission system operators).18 Examples like these demonstrate the need to examine privately funded energy networks, by for instance looking at the United States or Great Britain. Sixth, investments in gas infrastructure are both costly and time consuming. Assuming that the current operating framework is in need of improvement, it should be changed soon, if only because errors are not easily fixed and because investors need something to go by to make large and long-term investment decisions. The examples above suggest that the debate on gas market regulation requires more than a regulatory economic approach. Methodology and Limitations This study comprises a comparative analysis between regulatory regimes in the United States and the European Union. While there is not a single regulatory approach within the EU, most member state regulatory authorities seem to follow the examples set by Great Britain and the Netherlands (Jamasb, Pollitt & Triebs, 2008), and therefore this study focuses on these two examples. It describes the relation between legislature and
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regulatory authorities and their mandates in the EU, the individual member states and in the United States. Next the criteria that regulatory authorities apply when determining gas transport tariffs are analyzed. Hereto the broad energy policy goals as laid down in the Lisbon Treaty are used, i.e. security of supply, efficiency/affordability and sustainability. These criteria apply to the U.S. case as well. In an attempt to quantify these policy goals, efficiency/affordability is examined by looking at what rates of return regulatory authorities allow gas infrastructure operators to make, together with transport tariffs that operators charge for gas transmission. Quantification of the other policy goals is more challenging. Security of supply/ reliability could be measured by collecting data on interruptions in gas flows, but those are not always available and interruptions can have multiple causes. Sustainability through regulation could, for instance, be measured in terms of net CO2 reductions, but no such studies have been carried out thus far. After examining the criteria used by regulatory authorities to determine transport tariffs, this study focuses on the role of both private and public funds used in gas infrastructure and what lessons can be derived from differing existing practices. Both primary and secondary data will be used in this analysis; the former is qualitative and derived from interviews with representatives of regulatory authorities and infrastructure companies, while the latter consists mainly of academic contributions, policy papers, and legal documents.19

19

Commission staff working document SEC (2011) 755 final, page 5.

Most academic literature on regulation focuses on electricity and not on natural gas. This probably has to do with some special characteristics of electricity and the dynamics this brings for regulation, see for instance Kwoka & Madjarov who mention non-storability, low demand elasticity, and high capital intensity and argue that market clearing is the key characteristic that makes electricity unique (2007, p.27).

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There are some important limitations to the approach taken here to compare regulatory regimes of natural gas transmission in the United States and the European Union. First, as described, the regimes are fundamentally different and there is no single approach in the European Union. Second, the U.S. market for natural gas is under-researched, according to some because the sector used to be considered as competitive and there were no concerns about supplies and infrastructure (Von

Hirschhausen, 2008, p.2). Most fundamentally, this research approach struggles with the quantification of the policy goals, i.e. security of supply and sustainability. While the British case provides a good example that demonstrates how sustainability concerns can be part of regulatory considerations, more tangible long-term study of, for instance, realized carbon reduction related to gas infrastructure would be useful.

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Relations between Legislatures and Regulatory Authority

to monitor security of supply to the regulatory authority.22 The broad policy goal from the Lisbon Treaty, sustainability, is not mentioned in Directive 2003/55/EC. It is, however, the main subject of Directive 2009/28/EC on the promotion of the use of energy from renewable sources. Both legislatures and transmission system operators have clear roles regarding investments in grids and grid codes.23 Yet the mandate of the regulatory authority in terms of approving transportation tariffs, as described in the previous paragraph, does not apply as strictly here, for ...If significant measures are taken to curtail the renewable energy sources in order to guarantee the security of the national electricity system and security of energy supply, Member States shall ensure that the responsible system operators report to the competent regulatory authority on those measures and indicate which corrective measures they intend to take in order to prevent inappropriate curtailments.24 The member states themselves appear to have a decisive say in the investments needed when it comes to safeguarding sustainability related investments in infrastructure, as for instance indicated in article 16, sub. 4: Where appropriate, Member States may require transmission system operators and distribution system operators, to bear, in full or in part, the costs referred to in paragraph 3... United States The roles of both legislature and regulatory authorities in the United States are different than those in the European Union, and are more marketoriented. This is underlined by the mission that the Department of Energy pursues, namely to ensure Americas security and prosperity by addressing
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n regulation theory, the relationship between legislatures and regulatory authority is subject to debate. Although economic theory of regulation has assumed that legislatures adequately control the relevant regulatory authority, others have argued that these are difficult to control because they have access to information that is not available to legislatures and because it is very costly for legislatures to draft new policies to redirect regulation (Viscusi, Harrington Jr. & Vernon, 2005, p. 391). The agendas of legislature and regulatory authorities normally differ, and this can cause friction in practice. This section analyzes relations between legislatures and national regulatory authorities in the European Union and subsequently the United States. European Union Within the European Union, the relationship between national legislatures and regulatory authority in the gas industry is based on Directive 2003/55/EC. Member states are summoned to designate one or more competent institutions with the function of regulatory authority that ... shall be wholly independent of the interests of the gas industry...20 The driving force behind this clear separation was the European Parliament. Regulatory authorities in the European Union are responsible for two activities: monitoring and ensuring non-discrimination, effective competition, and the efficient functioning of the market; and fixing or approving, at least the methodologies used to establish the terms and conditions for connection and access to national networks, including transportation tariffs and terms and conditions regarding balancing services.21 Furthermore, member states may delegate the task

The agendas of legislature and regulatory authorities normally differ, and this can cause friction in practice.

Ibid, article 5. Directive 2009/28/EC, article 16. Directive 2009/28EC, article 16, sub 2(c).

20 21

Directive 2003/55/EC, article 25, sub 1. Ibid, article 25, sub 2.

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Safeguarding Investments in Natural Gas Infrastructure

Basically, the U.S. Department of Energy relies on the market to safeguard sufficient and affordable energy supplies.

its energy, environmental, and nuclear challenges through transformative science and technology solutions.25 Basically, the U.S. Department of Energy relies on the market to safeguard sufficient and affordable energy supplies. The departments main activities are to gather statistics and fund research on the topics that are mentioned in its mission statement. The Federal Energy Regulatory Commission (FERC) is the U.S. regulatory authority at the interstate level. When focusing on the market for natural gas, the FERC deals mainly with interstate transmission pipelines and spends an estimated 10 percent of its time on intrastate pipelines (lines taking natural gas from transmission up to distribution level).26 Similar to the U.S. Department of Energy, the FERC has adopted a laissez-faire approach, resulting in the application of a competitive regulatory model at transmission level. The method and criteria used to determine transport tariffs and rates of return are examined in more detail in the next section. Overall, a system operator can, together with market entities (e.g. shippers), submit a proposal for a new transmission pipeline at the FERC, that thereafter consults the market and the public about the intended project, controls the proposed rates, and whether third party access is safeguarded and subsequently approves of the project (or not). If, at any stage after construction, tariffs are changed (either due to construction costs, desire by shippers or because of other reasons) the FERC has to approve of these changes. If, however, all parties involved are satisfied with the status quo, the initial tariffs can remain unchanged, unless the FERC starts its
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own investigation. The basis for this competitive structure is found in 1992 Order 636 that aimed to ...further the creation of an efficient national wellhead market for gas without adversely affecting the quality and reliability of the service provided by pipelines to their customers. This regulation, among others, required pipelines to unbundle their sales and transportation services, provide access to storage on an open access contract basis, open access transportation services that are equal in quality for all gas supplies, offer all shippers equal and timely access to information relevant to the availability of their open access transportation service, and implement a capacity releasing program so that firm shippers can release unwanted capacity to those desiring it.27 In sum, while in the European Union national regulatory authorities by law have a strong mandate regarding market functioning and setting the groundwork for transportation tariffs, monitoring security of supply and facilitating sustainability are matters that may be delegated to the regulatory authority. As the next section will demonstrate, and as is shown in Table 1, this in fact happens in some cases. In the United States, the federal regulatory authority mainly monitors market functioning by a laissez-faire approach, while security of supply and sustainability are not part of its mandate.

Quoted from website http://energy.gov/mission on November 25, 2011. Note that the FERC has no jurisdiction at the distribution level, following Natural Gas Act article 717, sub b and c. State level regulation may apply to distribution networks, but that does not fall within the scope of this paper.

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Docket no. RM91-11-002, et al. Order no. 636-A section II.

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Transport Tariffs or Infrastructure Operator Revenues

taxes.28 The regulatory asset value is one of the incentives that OFGEM uses to stimulate investments while at the same time reducing operation costs. This is elaborated on in the next section, when discussing the incentives to generate appetite for investment in gas transmission infrastructure in relation to the role of private and public funds in gas transmission operation. Next to safeguarding efficient tariffs, the tasks of OFGEM were recently expanded through new legislation. Starting in 2004, its mandate has also been to contribute to the achievement of sustainable development. This was confirmed in the 2008 Energy Act, which added to the duties of the Gas Markets Authority ...the need to contribute to the achievement of sustainable development...29 How does this materialize on a daily basis? No examples have been found in the natural gas sector, but in electricity transmission, one can think of incentives that were added to regulation in order to diminish the release of sulfur hexafluoride (FS6) to the atmosphere because of its negative impact on the climate, and because this particular greenhouse gas is not covered under the European emissions trading scheme.30 Furthermore, the regulatory authority publishes annual policy documents containing a sustainable focus of its activities.31

hereas European regulatory authorities apply incentive regulation for the (unbundled) pipeline companies, the FERC promotes competition through unbundling, flexible short-term rate setting, strong property rights and controlling the abuse of market power (Jamasb, Pollitt & Triebs, 2008, p.3399). Rate of return regulation prescribes a reasonable rate of return on investment for companies investing in infrastructure. One of the critiques is that it contains few incentives to operate efficiently. Incentive regulation in theory is designed to create incentives for the regulated firm to lower costs, innovate, adopt efficient pricing practices, and improve quality. However, proper implementation is crucial, for the time path of the price cap must be independent of the firms actual realized costs, so that efforts by the firm to lower costs do not automatically translate into a lower price (Viscusi, Harrington Jr. & Vernon, 2005, p.436 and further). In addition, some have argued that incentive regulation results in lower quality of electricity service. This manifests itself in increased duration of service interruptions, not in increased frequency of interruptions (Ter-Martirosyan & Kwoka, 2010, p. 260). This section focuses on the forms of regulation applicable to Great Britain, the Netherlands, and the United States. European Union The Office of Gas and Electricity Markets (OFGEM) applies incentive regulation with price caps in Great Britain. The regulatory formula, in short, leads to an allowed revenue derived from an estimate of the operating expenditure, capital expenditure, financing costs, and taxes for the relevant period, together with the regulatory asset value for the transmission system operator. For the most recent regulatory period, 2007-2012, the allowed rate of return was (to the transmission system operators satisfaction) 4.4 percent post

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See National Grid investor update from 2006: http://www. nationalgrid.com/NR/rdonlyres/0C5D350E-3B87-469B-BD8073895876C953/13654/NGTPCR4overview15DEC06FINAL. pdf Energy Act of 2008, part 5, article 83, sub 1c. For more information, see chapter 11 of http:// www.ofgem.gov.uk/Networks/Trans/Archive/ TPCR4/ConsultationDecisionsResponses/ Documents1/16342-20061201_TPCR%20Final%20Proposals_ in_v71%206%20Final.pdf For the most recent example, see http://www.ofgem. gov.uk/Sustainability/SDR/Documents1/Sustainable%20 development%20focus%202011_WEB.pdf

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Table 1. Focus of British and Dutch regulatory authorities, In the Netherlands, in terms of Lisbon Treaty broad policy goals incentive regulation with Efficiency/ price caps is applied Security of Supply Sustainability Affordability as a mechanism as well. The Dutch Shared responsibility with Nederlandse Department for Energy Explicit Mededingings and Climate Change regulatory task Explicit Autoriteit (NMa) Great Britain (DECC), and active in of OFGEM regulatory task carries out an engagement with UK since 2008 efficiency check, government to carry out and, based on this Gas SCR* assessment, then Shared responsibility with determines the Ministry of Economic total revenues the Affairs (though no explicit transmission system Explicit mandate) for the NMa, No delegated operator can generate Netherlands regulatory which plays role in design task for the in each three-year focus of new balancing regime, NMa period of regulation. in order to safeguard The operator then uses security of supply in most these total revenues efficient manner. to propose transport Green = green light for the regulatory authority to engage in the referred policy area (for instance affordability) tariffs for usage of Red = it does not have a mandate its transmission Yellow = a shared policy domain between legislature and regulatory authority pipelines.32 The * The Gas Security of Supply Significant Code Review is undertaken by OFGEM with support of the British reasonable rate government in order to determine whether reforms to the current gas balancing arrangements and/or enhanced obligations are required in order to improve security of supply. of return in The Netherlands is equal performance, the NMa applies incentives to to the so-called Weighted Average Cost of Capital stimulate efficient operations (X-factor) and (WACC). The NMa calculates a bandwidth of safeguard quality standards that are required by real WACC values before taxes and subsequently Dutch law (Q-factor). For the current regulatory averages the high and low values to determine the period (2010-2013), the real WACC before taxes is WACC. By doing this, the regulatory authority 5.8 percent,33 whereas this return was 6.5 percent expects that the network operator receives the return it needs to operate efficiently, while at the same time expecting that this return will be representative for the whole period of regulation. Note that the WACC is gradually introduced by means of a yearly correction of the maximum WACC value or cap (X-factor). Based on yearly
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Gaswet, article 12, sub 1.

http://www.nma.nl/images/Bijlage%202%20WACC%20bij%20 Methodebesluit%20Transport%20GTS%202010-2013%20 (2)22-193277.pdf

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in the period from 2006-2009.34 The regulatory authority also advises the government regarding proposed investments by the TSO and plays a role in the design of market mechanisms such as the balancing system. United States In contrast to the European Union member states, the FERC has made a fundamentally different choice when it comes to the model of regulation where rate of return regulation is applied. As with incentive regulation, transmission system operators know up front what rate of return will be allowed by the regulator, but provisional correction mechanisms differ substantially. Whereas incentive regulation provides a safeguard for yearly adjustments of tariffs following, for instance, an X-factor or the regulatory asset value, in the United States most of the agreed tariffs are not renegotiated.35 Instead, day-to-day regulation has been reported to be a complex process of exogenous regulation by FERC, selfregulation between pipeline and shippers, and market processes, e.g. for secondary capacity (Von Hirschhausen, 2008, p.6). This hints at a major problem that has been linked to rate of return regulation, namely that it provides weak incentives for firms to reduce costs or adopt efficient practices (Viscusi, Harrington Jr. & Vernon, 2005, p. 436). When judging over a proposed business case, FERC by law exclusively examines efficiency and market manipulation, as ...all rates and charges made, demanded, or received by any
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natural-gas company for or in connection with the transportation or sale of natural gas subject to the jurisdiction of the Commission, and all rules and regulations affecting or pertaining to such rates or charges, shall be just and reasonable...36 Market manipulation is excluded by demanding third party access and fixing tariffs, at any moment when unreasonable or unjust prices are identified.37 Currently, the standard rate of return that is allowed for a new pipeline is 14 percent. This number functions as a market incentive. If operators and /or shippers consult the FERC in order to change the tariffs of an existing pipeline, due to operational costs, complaints of shippers, or other reasons, the regulatory authority proposes a rate of return of 11.55 percent. These pipeline rate cases are always open to the public. Note that on the state distribution level, the rates of return are lower, namely between 8 and 9 percent. In order to safeguard reasonable tariffs, FERC staff advocates positions on behalf of the public interest in pipeline rate cases. In addition, FERC has recently undertaken proceedings to reduce existing pipeline rates that it believes are no longer just and reasonable.38 The judicial competences of FERC are clear and focus on efficiency, as shown in Table 2. Whereas in the European Union, broader policy goals are agreed upon and, as we have seen, some regulatory authorities have them as core competences, in the United States these broader policy goals are not expressed in U.S. energy policy documents. However, the FERC does share strategic goals that resemble the ones defined in the Lisbon Treaty, such as the Strategic Plan 2009-2014, which states that FERCs mission is to ...assist consumers in obtaining reliable, efficient and sustainable energy
36 37 38

Whereas in the European Union, broader policy goals are agreed upon and, as we have seen, some regulatory authorities have them as core competences, in the United States these broader policy goals are not expressed in U.S. energy policy documents.

Note that these rates have only been established in November 2011 due to an (ongoing) debate between network operator GTS, heavy industry, and the regulator that was explained the introduction. It has led to the status quo in which GTS has to repay 400 million to the users of its network, while the industry expected over 1 billion. Both parties are not satisfied with this and more legal tug-of-war has been announced. As confirmed in an interview with representatives of the FERC on November 23, 2011.

Natural Gas Act, section 5, article 717C, sub a. Ibid. Article 717C-1 and article 717D, sub a. Data derived from interviews with FERC representatives.

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Regulatory authorities in the European Union take a fundamentally different Efficiency/ Security of Sustainability approach toward calculating Affordability Supply transport tariffs than their U.S. Exclusive federal counterparts. Regulatory No delegated No delegated United regulatory authorities in both Great Britain task for the task for the States focus in the and the Netherlands apply forms FERC FERC United States of incentive regulation and focus on efficient tariffs while Green = green light for the regulatory authority to engage in the referred policy area (for instance affordability) sharing tasks and responsibilities Red = it does not have a mandate regarding security of supply with legislature. On top of that, services at a reasonable cost through appropriate in Great Britain, sustainability has been an explicit regulatory and market means...39 In practice, this legal task of OFGEM since 2008. In the United means FERC works in line with its philosophy States, the FERC focuses exclusively on helping that new pipeline facilities and expanding the the market function, by applying rate of return interstate pipeline grid will increase the overall regulation and only occasionally renegotiating safety of the industry (allowing for older facilities tariffs as set between system operators and to be abandoned) and hence enlarge reliability and shippers. The difference between allowed revenues efficiency. is remarkable, with European Union rates of return wobbling around 5 percent while new pipelines in 39 Strategic plan consulted online on November 23 http://www. the United States can count on almost three times ferc.gov/about/strat-docs/FY-09-14-strat-plan-print.pdf that. Table 2. Focus of FERC, in terms of efficiency, security of supply, and sustainability

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Private and Public Ownership and Investments

start of the regulation but picking up later on... (Haffner, Helmer & Van Til, 2010, p.35). While the academic verdict on this topic is out, regulatory authorities are obviously occupied with the question of how to generate sufficient appetite for investment, albeit from private or public investors. It seems the FERC has chosen the path of least resistance, with significantly higher allowed rates of return to be made on gas transmission tariffs than the European samples in this comparison. In addition, with rate cases only being filed when users or operators bring the case to the regulatory authoritys attention or when the regulatory authority itself decides to put a case to the test, investors have a reasonable period of certainty to get their moneys worth. There is empirical evidence that there is sufficient investment in transmission gas pipeline infrastructure in the United States (Von Hirschhausen, 2008, p.7). That leaves the question open whether the rates of return in the United States will trigger overinvestment and inefficient use of capital. The answer may well be yes. With significantly lower rates of return, the British regulatory authority like its European colleagues has been occupied with the question how to attract sufficient appetite for investment. It boasts about its so-called regulatory asset value, which is the value upon which investors earn a return in accordance with the regulatory cost of capital. It is based on the historical investment costs and is set yearly, to complement existing longer term rates of return. In addition to the asset value, OFGEM is currently working on new rates of return, for a longer regulatory period (2013-2021). The main reason for this three-year extension is to provide more long-term security about the rates of return, i.e. to attract more longterm capital intensive investments such as those in gas transmission capacity. As for the Dutch case, where currently legislature is examining whether a

heory does not provide a verdict regarding a preference towards public or private ownership of gas transmission companies. Although some studies report that regulated private electric utilities appear to perform more efficiently than publicly owned utilities, the evidence is not strong (Viscusi, Harrington Jr. & Vernon, 2005, p.508 and further). Others have argued that ... while often suspected of inferior cost performance, the evidence here shows that publicly owned utilities achieve costs comparable to those under competition. As between those two regimes, public ownership appears more successful in controlling costs by itself, though regulation buttressed by benchmark competition achieves a similar result (Kwoka, 2006, p.146). A study of electricity markets in Great Britain concluded that ...empirical evidence on the merits of private ownership and privatization in the context of market-oriented infrastructure reforms can be characterized as inconclusive. However, when accompanied by effective regulation, privatization has achieved efficiency improvements... (Jamasb & Pollitt, 2007, p.6164). A recent study on the relationship between investment and regulatory regimes (incentive regulation versus rate of return) found not only that investments are higher under incentive regulation regimes, but also that there is no empirical evidence that private ownership boosts investment incentives (Cambini & Rondi, 2010, p.4). This is remarkable, since theory suggests that incentive regulation carries the potential risk of underinvestment: reduction of investments leads to higher return and can therefore be tempting. However, analysis has shown that in Dutch electricity and gas networks since 2001, incentive regulation has ...ensured a more rational and professional approach towards investments, with investment levels coming down somewhat at the

The question [is] open whether the rates of return in the United States will trigger overinvestment and inefficient use of capital. The answer may well be yes.

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minority share of the transmission system operator should be privatized to attract more capital; the aforementioned experiences in Great Britain demonstrate that even when private capital is involved, attracting investment is a complicated regulatory task. Extending the regulatory period may provide additional stability for investors.

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Conclusion

uestions related to investments in gas infrastructure are becoming the focus of renewed attention in the United States and Europe. The European Commission is openly acknowledging that the status of the internal energy market is precarious and this is one of the reasons why much needed investments in energy infrastructure have failed to materialize. This paper has given some insights to the challenges policymakers, regulatory authorities, and gas infrastructure companies face in the Netherlands and Great Britain and the possible solutions that are currently being explored. It also looked across the Atlantic to draw lessons from experiences in the United States. There are several interesting conclusions to draw from the comparison of transatlantic regulatory regimes regarding gas infrastructure. First, the cases of Great Britain and the Netherlands show considerable resemblance. Being a European frontrunner when it comes to liberalizing its energy markets, the British OFGEM explores the boundaries of its mandate, e.g. when it comes to the strict separation between legislature and regulatory authority as required by European institutions. Obvious examples are the explicit mandate of OFGEM to contribute to sustainability by means of its regulation (while Brussels prescribed a clear distinction between politics and regulation) or the recent British decision to

extend its regulatory periods to provide private investors in infrastructure projects with more long-term stability. In so doing, it has faced many of the same challenges that other European regulatory authorities, such as the Dutch, are currently grappling with. Second, there is no underinvestment in gas infrastructure in the United States according to the FERC and some academic contributions. This can be attributed to the substantial rates of return that private investors have been allowed to accrue, a mechanism that is assumed to take care of security of supply-related issues. Yet it may well be that users of pipeline infrastructure and consumers in fact collectively pay too much for their gas transport. Furthermore, sustainability does not play an important role in the current U.S. regulatory framework. More fundamental research is needed regarding the role of regulation in safeguarding security of supply and sustainability. While data regarding network quality is scarcely available and would provide guidance for further research, linking sustainability to network regulation is more difficult, for it is directly linked to electricity generation and less to regulation. Having said that, in Great Britain, the OFGEM has an explicit legal task to safeguard sustainability and is currently exploring how to fulfill this role. This is expected to provide future insights, from which its counterparts on both sides of the Atlantic could reap enormous benefits.

In Great Britain, the OFGEM has an explicit legal task to safeguard sustainability and is currently exploring how to fulfill this role. This is expected to provide future insights, from which its counterparts on both sides of the Atlantic could reap enormous benefits.

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References

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