http://www.fertilizerseurope.com/documents/file/EFMAGASPUBLICATIONMAY2006

THE EUROPEAN FERTILIZER INDUSTRY'S VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET european

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CONTENTS INTRODUCTION

INTRODUCTION 2

SUBSTANTIVE EXPANSION OF GAS SUPPLY INFRASTRUCTURE TO SERVICE THE CONSUMER

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SMALL PHYSICAL INFRASTRUCTURAL PROJECTS

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ENCOURAGEMENT OF VOLUNTARY ENERGY EFFICIENCY SCHEMES PROMOTING BEST AVAILABLE TECHNOLOGIES AND PRACTICES

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ANOTHER CONCERTED EFFORT ON THE EU REGULATORY LIBERALISATION FRAMEWORK BACKED BY EFFECTIVE AND REINFORCED COMPETITION INSTRUMENTS

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THE PAN-EUROPEAN AND INTERNATIONAL REGULATORY FRAMEWORK ON THE SUPPLY OF GAS IS UNDERDEVELOPED

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THE BUYERS’ WISHLIST – EFMA SURVEY 2005

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CONCLUSION

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As the largest single sectoral user of natural gas in the EU’s manufacturing sector, the European fertilizer industry applauds the EU institutions' renewed commitment to establish a truly world competitive EU single gas market.

To achieve this, the vision and practice required must be aimed at a fully integrated pan-European, and even inter-continental, transparent, free and fair market place.

The European fertilizer industry agrees with the Council of the European Union that the security of supply factors to the market are complementary, not contradictory, to competitive supplies to European manufacturing industry.

To achieve this now imperative completion of a fully inter-connected, transparent and free market requires bold strategic actions focused on the following five strategic factors:

• The expansion of BIG INFRASTRUCTURE, i.e. new pipelines, LNG terminals, storage and conversion facilities as well as the true development of European physical and financial trading hubs.

• The allied expansion of physical and organisational SMALL INFRASTRUCTURE to guarantee and improve the interconnections and storage facilities comprising an efficient pan-European network.

There is a need for the ACCELERATED INTRODUCTION OF TECHNICAL REFORMS and BUSINESS DEVELOPMENT, especially those facilitating cross-border trading and interconnectivity.

• The encouragement of VOLUNTARY ENERGY EFFICIENCY SCHEMES promoting best available techniques and practices.

• CONCERTED REGULATORY ACTION FULLY LEVERAGING THE EXISTING GAS DIRECTIVE together with more enhanced vigorous ENFORCEMENT OF EU COMPETITION LAWS. The on-going merger and consolidation on the supply side is an increasing concern.

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

The EU and national institutions should devote their efforts towards establishing a regulatory environment which assures the creation of a truly free transparent demonopolised market place. This effort should include: - Capping the EU market share of national incumbents by a 30% reduction over three years.

- Further consideration of capping the EU market share of the national incumbents by 50% over eight years if this is considered appropriate to free up the market further.

- EU competition law and practice should be applied with rigour especially with regard to dominant positions. The convention here is that no supplier should be permitted to reach a dominant 40% market share position – in EU market terms.

The recent announcement of potential EU-Russia and EU-Ukraine Free Trade Areas including energy chapters should be taken as an opportunity to secure a pan-European infrastructure. This should allow for security of supply and demand; and predictability and transparency of energy trade backed by market economy instruments and energy exchanges.

Equal and non-discriminatory access to pipeline transportation in Russia and EU should also be secured.

Over recent years, the European fertilizer industry has been forced to use anti-dumping actions as a short-term correction to dual-pricing practices, which do include local government support for unfair artificially low gas prices to the local industry. Russia is the most classic example. The real correction, to a significant degree, involves the prevalence of non-discriminatory market prices built on true market structures in all countries – whether it is a producer and/or consumer country.

• EU AND INTERNATIONAL AGREEMENT AND ACTION TO PROMOTE THE FREE AND FAIR PRICING of gas and its transit from producer/ supplier sources. In particular, the EU should enhance the authority of the Energy Charter and the application of free and fair trading practices therein. Russia must be persuaded to finally sign up to the Transit Protocol. Longer-term, an international level playing field for gas/energy supply could lead to the development within the WTO of ‘Trade Related Rules-for-Energy-Supply (TRES)’.

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SUBSTANTIVE EXPANSION OF GAS SUPPLY INFRASTRUCTURE TO SERVICE THE CONSUMER should receive strong political and legitimate governmental financial backing.

Demand should not be allowed to outstrip supply.

BIG INFRASTRUCTURAL PROJECTS – both new pipeline projects and LNG projects must be encouraged and accelerated. Only then can prolonged peak pricing or damaging price spikes, which characterise current gas markets, be avoided or at least minimised.

Supply shortages can lead to spiralling gas prices threatening EU industry ability to compete – even on its own home market.

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Particular encouragement should be given toward the full commissioning of new pipeline constructions. Of particular importance will be the North European (NEGP) pipeline from Russia; the Medgaz project from Algeria to Spain; and the Nabucco pipeline representing vital new sources from the Caspian Sea region. The Langeled project should greatly assist in compensating the UK’s very significant reduction of local production.

LNG from North Africa and the Middle East represent major new supply sources which should be developed without undue hindrance arising from local environmental, health or competition concerns. Proposed LNG terminals in Italy, Poland, Spain and the UK are welcome supply-side additions. Projected future surpluses arising in certain of these countries should – with the necessary creation of sub-regional interconnections – assist the wider rational market functioning of Europe’s gas market.

New storage facilities or the expansion of existing storage facilities would greatly assist physical supply – and especially new supplies - to the market.

It will also improve liquidity in the market. This supply and liquidity is especially important in the peak winter months of high demand.

National governments must encourage local and regional authorities to adopt speedier and effective approval planning processes.

Certain regions of Europe do merit LNG terminal facilities for reasons of security, e.g. France suffers from limited capacities; the Baltic region and Poland relies too heavily on Russian pipeline gas.

Diversification of source supplies is indeed becoming increasingly important. Europe is structurally over-dependent on five key suppliers, i.e. Algeria, Russia, Norway, the Netherlands and the UK. While all

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

Hub services typically serve short-term market needs

have proven reliable supply histories, the external EEA suppliers are not without political and economic risks.

Russia’s recent stoppages to Belarus and Ukraine seriously affected supplies to Poland, Romania, Bulgaria and the Baltic states. Algerian supplies were threatened by near civil war. The Caspian Sea and Africa are regions with relatively high political and economic risks.

Major pipelines and LNG projects

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Consequently diversification of supply sources of gas must be factored into European infrastructural developments. There must also be a clear last resort supplier in each EU Member State or group of Member States, e.g. Baltic, Iberia, North-West Europe.

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Also critical to the creation of a transparent and free market scene is the significant potential to have MODEL HUBS in Europe combining financial market and physical trading. Key characteristics for success will include the active participation of many suppliers and customers; a variety of physical source suppliers; excellent connectivity in several directions; and a wide range of different and various types of contract, e.g. spot, index, long-term.

Source: IEA

Presently, Zeebrugge in Belgium has the greatest potential as a combined financial/physical trading hub.

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of new pipelines and LNG facilities by supporting legitimate government and/or private concessionary finance packages, i.e. credit, insurance and re-insurance instruments. WTO, EU and OECD rules should be respected here.

• National governments should encourage and facilitate local and regional authorities’ development of new or expanded storage facilities for gas.

• While hubs arise because markets (suppliers and customers) and traders find them useful, Member State or communautaire interventions which promote positive physical or financial facilitation should be considered as in the best interest of the single European gas market.

• Most specifically the Commission and Member States should establish a statistical bureau – such as the AEI (Agency for Energy Information in the USA) to supply transit, storage and turnover per hub information.

• Such a bureau could greatly enhance transparency at key hubs.

• Creation of an index reflecting the weighted average of all contracts realised via the hub trading platform.

Hubs & pricing points

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Recommended Actions: • EU governments should facilitate construction

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Here government planners and private investors should be encouraged to go beyond the 2006 10 BCM/year expansion and consider creating the European equivalent to Henry Hub in the USA. Such model hub developments in the USA and (to some extent) the UK (National Balancing Point − NBP) are key components toward providing transparent trading and liquidity to gas. There must, however, always be sufficient supply and sufficient infrastructure capacity to make such model hubs work efficiently. Malfunctions such as those experienced in the UK with NBP in recent times can be extremely damaging.

Another potential approach is to encourage the development of virtual hubs. In North-West Europe a virtual triangle involving Zeebrugge – NBP – TTF presents the potential of an open and free trading environment.

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The vital need in the gas market – especially on hub trading – for objective information is regularly underestimated by EU governments.

Buyers are often unaware of the facts impacting the market.

The incumbents, in contrast, with their daily operational functions optimise the system to their advantage. For example, suppliers blatantly ignore the GGPSSO guidelines on storage agreed in April 2005. Buyers do not therefore know how full storage is in Germany or France ahead of a winter period. Very simply, traders and consumers cannot make efficient pricing decisions.

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

SMALL PHYSICAL INFRASTRUCTURAL PROJECTS do have very significant competitive and security benefits.

Relatively SMALL ORGANISATIONAL changes to the existing system including the management and control of physical infrastructure, could bring major benefits to the market and consumers.

There is a real need around the whole pan-European gas supply scene to give consideration and investment toward the removal of secondary barriers – whether they are physical or organisational in nature.

Hereunder is an illustrative list of such secondary barriers which should be removed.

SECONDARY BARRIERS Secondary barriers are physical or organisational: • Capacity at border crossings is far too much in the control of incumbents for long-term contracts; there is no space for newcomers.

• Capacity at borders is built for a “logical” supply direction, i.e. from source to customers. New markets demand other connections.

These are not built due to TPA, unless exemptions are obtained. In such cases there is no space for third parties.

• New entry points (e.g. LNG terminals) have severe capacity reservation problems at the connection to the main transit systems.

• The “Use It or Lose It” principles are not rigorously applied to all infrastructures (terminals, pipelines, storage). There is an urgent and real need to make spare unused capacity available to the market on a cost-related regulated Third Party Access basis (r-TPA).

• While giving due consideration to investors, pro-competitive provisions preventing restrictions on supply to the consumer should be included in any exemptions granted by competition/regulatory authorities.

• EASEE-gas gives the impression that it organises connectivity. In fact it creates the barriers for those who cannot comply, e.g.:

- Most LNG does not fit the EASEE-gas quality criteria, so mixing facilities of the incumbents are needed.

- One needs a large, expensive, complicated computer system to comply with the transfer protocols of the incumbents.

• Restrictions on time units for capacity bookings, e.g. in most places it is not possible to book transportation for 2 or 3 months. Nearly always a booking of one full year is mandatory. Sometimes there is an incentive to book a full year, e.g. winter months cost 40% of a full year so booking January-March is equal to a full year in costs.

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SUMMARY OF KEY REQUIRED TECHNICAL REFORMS AND BUSINESS DEVELOPMENTS There are a number of technical improvements which would undoubtedly assist accelerated progress toward a more liberalised and efficient market for consumers.

The Recommended Actions Include: • Reduce control and reservation of pipeline capacity at borders by the incumbents.

• Open up key and new entry points typically dominated by the incumbents, while also supplying information sources for verifying entry/exit capacities.

• Storage capacity and access should be made more transparent and priced at fair levels.

• There should be more daily, rather than hourly, balancing network codes and the transfer mechanisms between systems.

• Simplification and acceleration of the regulatory discussion on gas quality issues; there needs to be investment in quality conversion infrastructure thus avoiding bottlenecks.

Recommended Actions: • The Benelux countries, despite a history of longer economic integration than the EU itself, still suffer from planning delays and cross-border trading frustrations. Gas quality criteria still equate to a dependence of the mixing facilities of the incumbents.

• The Baltic States and Poland are not linked. Both can benefit from being connected.

• Indeed from Germany and the East, the major flows are westwards.

• Spain and France do not have two-way interconnection. Spain’s projected surpluses cannot be always easily transferred.

• In Italy, there is currently no facility for physical flows northwards or north-westwards out of the market.

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

ENCOURAGEMENT OF VOLUNTARY ENERGY EFFICIENCY SCHEMES PROMOTING BEST AVAILABLE TECHNOLOGIES AND PRACTICES

The European fertilizer industry has already an outstanding record for improved energy efficiency. This has been achieved by self-help means such as full implementation of Combined Heat and Power (CHP) technologies; plant re-vamping directly accounting for energy and feedstock efficiencies; and the application of continuous improvement management systems including the shared use of EU/EFMA fertilizer industry agreed BAT/BREF standards and documents.

It is now well recognised by many Member States and the European Commission that the EU fertilizer industry generally has – by its own collective and individual company voluntary efforts – significantly contributed to the reduction in energy and feedstock use. Indeed the world class assets of the European industry represent the world’s most energy efficient nitrogen fertilizer manufacturers.

Average Ammonia Plant Efficiency, 2006

Recommended Actions: • Fertilizer industries in Europe and the world – and indeed all industries – should adopt voluntary self-help energy efficiency programmes using the BAT/BREF models and documentation available from the EU industry experience.

EFMA’s best available assessment of public sources identifies the average energy efficiencies of other major competitor regions as considerably lower than Europe’s. For example, in Russia – a major world exporter of nitrogen fertilizers – the average FSU ammonia plant is at almost 40 mmBtu/t NH3; a typical USA plant is at 36 mmBtu/t NH3; while the West European (all) average is 35 mmBtu/t NH3. The West European performance represents the best regional performance in the world.

The drive for energy efficiency has meant good business and good environmental performance sense. This voluntary self-help model has been promoted by EFMA internationally through the International Fertilizer Association and through other fellow national representative bodies. We remain confident that this model – as opposed to regulatory controls or fiscal advantages – is the best route forward for all the world’s industries, not only the fertilizer industry’s energy efficiency programmes.

Source: Integer Research

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ANOTHER CONCERTED EFFORT ON THE EU REGULATORY LIBERALISATION FRAMEWORK BACKED

BY EFFECTIVE AND REINFORCED COMPETITION INSTRUMENTS

The current second EU Gas Directive has positioned consumers and indeed the whole liberalisation process in an unsatisfactory mid-way point, i.e. neither full departure from national monopolies or dominant long-term incumbents nor a truly free liquid market situation.

There is a need for a full enforcement action by the Commission and the Member States on the second Gas Directive.

Recommended Actions: • Legally force unbundling all producers and transporters.

• Introduce the overt limitation/capping of the current incumbents

cannot actually address the problems explained by consumers.

• Commission and Member State authorities must be legally obligated to work together to create competitive supply conditions.

• The current trend toward consolidation of supply can be anticompetitive under EU competition. Rigorous vetting of mergers is essential. No supplier should be able to control a dominant position in the market place – the convention being that 40% of the total EU market is a dominant position.

dominant share of supplies. This should be done as follows: - Capping the market share of national incumbents by 30% in three years.

- If appropriate and necessary in the future, further capping the market share of the national incumbents by 50% over eight years.

Parallel to this, competition law should continue to be applied in an ever more vigorous manner: • The Commission should continue to intervene to remove destination clauses of all type and character from producer/suppliers’ gas supply contracts.

• Oligopolistic behaviour by suppliers within the European Economic Area, i.e. the Netherlands, UK and Norway must be corrected according to the practice and spirit of EU free market competition principles.

• The current sector competition study should lead to consideration of improvements in gas liberalisation and competition laws if these

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

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THE PAN-EUROPEAN AND INTERNATIONAL REGULATORY FRAMEWORK ON THE SUPPLY OF GAS IS UNDERDEVELOPED This is especially true from a consumer’s perspective. It is either not adequately adhered to or enforced, e.g. the Transit Protocol of the Energy Charter.

Or it is underdeveloped as in the case of the absence of trade rules for energy in the World Trade Organisation.

IMMEDIATE INTERNATIONAL ACTIONS SHOULD INCLUDE: • Russia’s full adherence to the Transit Protocol in the Energy Charter.

This would make for a freer, more certain flow of FSU gas to Europe.

• The WTO's development of Trade Related Rules-for-Energy-Supply (TRES). This should address the need for a global level playing field and corrective instruments to correct unfair pricing practices.

Pan-regional alternatives such as the Common Energy Space; or Free Trade Area with an energy chapter with Russia; and with the Euro-Med agreements; have not yet materialised into working institutions. Be it international or pan-regional, a balance of rights and obligations between producer suppliers and consumers according to established free and fair trading principles and practices, e.g. the WTO or ICC should be clarified and re-affirmed in Treaty law. A gas OPEC-type situation must be actively prohibited.

Counter-measures on the unfair preferential gas pricing policies of the major producer/suppliers are necessary. It is entirely unfair that EU consumers pay premium oligopolistic prices while industries in supplier/producer countries receive direct subsidies, state-fixed or even below-cost gas prices.

EFMA welcomes the commitment made by mutual agreement between the EU and Russia that Russia will cease to fix its gas prices by statute deliberately below full cost. Other similar agreements with African and Asian producer/suppliers are equally necessary. The WTO accession process can be used in the case of Algeria, Iraq and Iran but the true effectiveness of this process very much depends upon the ultimate WTO treaty accessions agreed, especially Russia’s WTO accession.

The EU-Russia and Euro-Med dialogues do represent an opportunity to secure a pan-European regulatory framework over an existing and growing pan-European gas supply infrastructure. A pan-European regulatory framework should facilitate security of supply and demand; provide for predictability and transparency of energy trade backed by market economy instruments and energy exchanges; and ensure equal and non-discriminatory access to pipeline transportation throughout the pan-European scene.

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

The WTO accession process is limited in geographical scope and limited by the nature of specific accession negotiations. More preferable would be a comprehensive international agreement in the WTO on the Trade Related Rules-for-Energy-Supply (TRES).

DUAL-PRICING Moreover, a true level market playing field should really only involve a difference of transport cost from the gas field. Presently dual-pricing, i.e. pricing very high into the consumer regions while pricing low in

the producer regions is highly prevalent. Dual-pricing is effectively forced cross-subsidisation by the host producer supplier on to the consumer. As such it is unfair and should be corrected. To date, the European fertilizer industry has been forced to use anti-dumping actions as a short-term correction. The real correction involves the prevalence of market prices built on market structures in all countries – whether a producer and/or consumer country.

Dual-Pricing Example, Russia

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THE BUYERS’ WISHLIST – EFMA SURVEY 2005 • Encourage new infrastructure using legitimate private/government finance.

• Place significant restrictions on the national and EU market share of the oligopolistic/monopoly incumbents.

• Enforce full unbundling of integrated oligopolistic incumbents.

• Reduce control and reservation of pipeline capacity at borders and key points by the incumbents.

• Propose daily rather than hourly balancing network codes and the transfer mechanisms between systems.

• Encourage trading hubs promoting transparency and liquidity to match the emergence of physical hubs.

• Create EU or Member State statistical bureaux to act as clearing house/reporter on production, imports, storage and hub contract activity.

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OUR VISION OF A WORLD COMPETITIVE EUROPEAN GAS MARKET

CONCLUSION As the single largest industrial sector consumer of natural gas in Europe, the European fertilizer industry is fundamentally interested to have fair and equal market economy gas pricing by all suppliers of gas to the European Union. Indeed with natural gas representing between 40 to 60% of the total cost of finished nitrogen fertilizer products, it is vital that gas is priced on a true market economy basis.

EFMA congratulates the Commission upon the efforts taken with regard to Gas Sector Study; the Green Paper on a European Strategy for Sustainable, Competitive and Secure Energy and the need to better manage external gas supplies to Europe especially with regard to Russian supply.

There is indeed a real urgency now for energy intensive industries in Europe living with today’s exaggerated gas prices in Europe that real reforms are made over the short-term.

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Avenue E. van Nieuwenhuyse, 4 - B-1160 Brussels - Belgium - Tel: +32 2 675 35 50 - Fax: +32 2 675 39 61 - E-mail: main@efma.be - Website: www.efma.org european

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