European Union is willing to acheive its internal market for gas as soon as 2014. It comes as a logical conclusion in the implementation of the third energy package. However this package does not give a comprehensive vision of what could be or should be its gas internal market. Florence School of Regulation is providing a basic market design for this: it is the FSR Gas Target Model. This Target Model has been largely discussed by the Europen association of energy regulators (CEER) as well as the European agency for energy regulation (ACER).

1. Florence School of Regulation
A ‘Target Model’ for the Internal Gas Market
Jean-Michel Glachant
Director Florence School of Regulation
& Professor “Loyola de Palacio EU Energy Chair”
AEEG, Roma 2 February 2012
1

2. Gas Target Model: What‘s?
*A non biding vision of the European Internal Market in 2015-2020…
…which gives consistency to issues addressed in ACER “Framework
Guidelines” and ENTSOG “Grid Codes” ... as Third Package does not
*The starting point is the use of “entry/exit zones” as the regulated basis for the
European Internal Market (the whole EU market has this regulated basis)
*This choice implies that a number of regulatory questions must be answered in
order to conceive the Framework Guidelines or implement the Grid Codes
2

3. OVERVIEW OF THE MECOS TARGET MODEL
MECOS Model
Pillar 1 Pillar 2 Pillar 3
Enable functioning Tightly connect Enable secure
wholesale markets these markets supply patterns
Common foundations
Improve market effectiveness
by realizing economic pipeline investments
3

4. The Logic for FSR MECOS Target Model
“MECOS” stands for:
“Market Enabling and Connecting for Secure Supply”
Florence School’s “MECOS” aims at improving cross-border trade.
It proposes answers to questions posed by European markets integration :
Short-term: Enabling functioning markets within and across national
borders
Long-term: Connecting these markets through contracts and capacity
reservation
Security of supply: Permitting long term contracting
+ pushing some investments defined as national or EU priority
+ easy short term flows
4

5. MECO PILLAR 1
ENABLE FUNCTIONING WHOLESALE MARKETS
• “Functioning” wholesale markets essential for:
– Fostering supply competition
– Efficient use of gas assets (incl. procurement contracts,
storage, or LNG terminals)
• “Functioning” markets cannot be replaced by tightly
connected “non-functioning” markets. Effects on supply
competition and market efficiency never be the same.
5

6. MECO PILLAR 1 (Cted)
ENABLE FUNCTIONING WHOLESALE MARKETS
• MECOS creates structural conditions for functioning markets
by arranging “entry/exit” pricing zones:
– Large enough to be interesting for a substantial number of
wholesalers (minimum of 20 Bcm)
– Well connected to other markets and supply sources (as
with 3 different gas sources)
6

7. Pilar 1 (Cted): ARCHITECTURES
TO ENABLE FUNCTIONING MARKETS
• To create structural conditions for functioning markets, two
architectures foreseen in MECOS:
– 1. Market Areas (complete market fusion)
• i.e. a single entry/exit price zone
+ single “balancing zone” from import points to end-
users, either structured as:
*National (if “functioning Wholesale markets” can be
achieved stand alone); or
**Cross-border (if cross-border cooperation is required to
achieve “functioning Wholesale markets”: 20 Bcm + 3 gas
sources)
7

8. ARCHITECTURES (Cted)
• To create structural conditions for functioning markets, a second
architecture foreseen in MECOS:
– 2. Trading Regions (Balancing being left apart)
• i.e. a single cross-border price zone (entry/exit) for
wholesale markets with congestion-free interconnection
• BUT balancing zones left to several national end-user
zones.
8

9. MECOS PILLAR 2:
To TIGHTLY CONNECT
the FUNCTIONING WHOLESALE MARKETS
• Tight connection between the several EU “functioning
markets” essential for:
– price alignment between adjoining markets,
– driving market efficiency and public welfare on a
European scale, and
– improving market liquidity and increasing competition,
reducing market dominance
• The MECOS model foresees a number of measures in order to
connect all European markets, differentiated by time horizon
9

10. Pillar 2 (Cted): ENHANCED TRADING CONDITIONS
• “Enhanced Trading Conditions” ETC (Economize Transaction
Costs!) are measures to be implemented foremost in the ENTSOG
grid codes in the areas of:
– Capacity Allocation Mechanism / Congestion Management
Procedure
 open seasons, VP2VP-products, coordinated auctions for
longer term capacities, FCFS for the intra-day market,
harmonized contract start dates, standards for secondary
capacity trading…
– Nomination and Balancing
 common gas day, harmonized nomination schedules, limits
on re-nomination, …
– Tariffs
 harmonized date for change of tariffs, structure methodology
(cf. transit), inter-TSO compensations within large zones
– Gas quality to enable bidirectional flow at all border points
10

11. Pillar 2 (Cted): METHODS FOR CONNECTING
MARKETS IN MECOS MODEL
15Y Long term market
From 15 years horizon to 1 month:
1Y Mid term market
Cross-market trading furthered by
1M Short term market “Enhanced Trading Conditions”
Day Ahead Market Coupling if proved
24H Day ahead market feasible + C-M Trading furthered by “ETC”
Cross-market trading furthered by
4H Intra-day market
“Enhanced Trading Conditions”
11
* i.e. by shippers

12. MECOS PILLAR 3:
ENABLING THE ESTABLISHMENT
OF SECURE SUPPLY PATTERNS
• To cross several markets “Link-chain” products should be
auctioned allowing the sale of capacity in combined border
points
• These products may have different durations (LT to ST)
• For security of supply purposes, TSOs may buy capacity in
adjacent systems (“fallback” contracts: TSO country “A” pays
for capacity in country “B”)
12

13. MECOS 4: COMMON FOUNDATIONS
REALIZING ECONOMIC PIPELINE INVESTMENTS
• Investments between markets for interconnections
– “open seasons” with pre-set evaluation criteria (can go
down to xx% booking)
– regulatory authority could add more capacity for *security
of supply or **openness of market (incl. short term)
• Investment within markets (in a pricing zone), to be evaluated
against congestion costs
13

14. MECOS MODEL (1 to 4): Overall BENEFITS
Once a MECOS Model-like implemented:
– All European end-users linked to a functioning wholesale
market.
• These markets enable supply competition because
they provide easy access to competitively priced gas
and are basis for proper risk management.
– Prices across wholesale markets to be aligned as much as
possible
• This should maximize efficiency and public welfare in /
from trading on a European scale by making sure that
gas assets (procurement contracts, storage, …) are
used in the most economic manner.
14

15. Beyond MECOS:
3 key questions addressed by gas target models
1# Short-term coordination
“Entry/exit” system needs particular mechanisms to bridge the gap
between “commercial network” and “physical network”
2# Long-term coordination
Connection between several EU market zones is badly needed and this
requires mechanisms to allocate the network capacity
3# Investment and security of supply
Improving connection between markets has to come with mechanisms
securing European gas supply (notably: entry of Foreign gas in EU)
15

16. Four other Target Models proposed:
CIEP – Frontier Economics – LECG - EURAM
¤ Capacity Allocation for Short-term Cross-Border
*CIEP, Frontier Economics and LECG do not propose any new important
regulatory change
**EURAM supports “implicit allocation” (market coupling) in specific cases
(whether inefficiency of capacity allocation is higher than transaction cost)
¤ Capacity Allocation for Long-term Cross-Border
*All models have a consensus in “explicit allocation”
**EURAM propose a new mechanism “Open Subscription Procedure”
16

17. Various Target Models (Cted)
¤ Investment on Cross-Border Capacity
*CIEP, Frontier Economics and LECG propose cross border investment through
bilateral contracts and open season
**EURAM propose long term contracts through a bidding centralized
mechanism: ‘Open Subscription Procedure’
¤ EU Security of supply
CIEP, Frontier Economics, LECG and EURAM rely on long term contracts
17

18. Model Proposals on Investment and Long Term Proposals on Short Term Capacity
Capacity Allocation Allocation
MECOS • Long term contracts with open season • Implicit allocation
(Glachant • The NRAs keep a right to influence investment • Coupling or merging markets
capacity • Development of virtual hubs
# CEER) - to guarantee capacity in the short term
- to guarantee SOS objectives
Overview ofcentralized process •Explicit allocation
• Long term contracts under
alternative proposals
EURAM
(Ascari) the ‘Open Subscription Procedure’ - Contracts – with tariffs – American kind
- Allow all players express their preferences (Open Subscription Procedures)
- Allow public institutions to buy capacity • Limited role of implicit auctions in day-
ahead adjustment
CIEP • Long term contracts • Explicit allocation
(Dutch hub) - Open season Procedures - Auction for capacity allocation
- Merchant Procedures
LECG • Long term contracts
(OFGEM) - Investment decisions based on open season • NEW: Implicit Allocation Intraday
- The TSO receive the capacity auctions revenue + • Cross Border Explicit Allocation
an additional system charge to adjust the TSO - Bundle Products exit/entry on cross
returns border
- UIOLI
Frontier • Long term contracts • Cross Border Explicit Allocation
Economics - Low regulatory intervention on cross- border - Auction of capacity allocation –sharing
contracts (supply oligopoly: no sweet to fringe) cost recovering between entry/exit capacity
(Gdf-Suez) - TSO decision under regulation at national level - Make available C-B residual capacity
(vertically integrated utility: revenue guaranteed) - Congestion management procedure
18