Opal Revisiting A Questionnable Decision.

In the Spring of 2017 I published a paper on the OPAL exemption decision on the Institute for Statecraft website, The Opal Pipeline Exemption: The Implications of a Questionable Decision, in which I make the case for the fundamental illegality of the decision as a matter of Union law.  I am glad to say that on September 10th, the EU General Court, in Case-T-883/16 Poland v. Commission agreed with my substantive analysis. The fact that the case reached the EU General Court is due to the grit and determination of the Polish government and their excellent team of lawyers, who were determined that this case would be heard in Luxembourg, and that Union law would be applied equally and uniformly across the territory of the Union.

The full article (save footnotes and some slight typo and citation amendments is below)29583

The OPAL Pipeline Exemption: The Implications of a Questionable Decision

Dr. Alan Riley, Institute for Statecraft, Temple Place, London*.

On 28 October 2016, the European Commission approved the decision of the Bundesnetzagentur, the German energy regulator, to revise the terms of its 2009 OPAL decision. That decision exempted the OPAL pipeline from EU rules on third party access and tariff regulation. The effect of the revision is to substantially increase Gazprom’s access to the capacity of the OPAL pipeline and thereby to extend Gazprom’s dominance in Central and Eastern Europe. Following a challenge by a subsidiary of the Polish state energy company, Polskie Górnictwo Naftowe i Gazownictwo, the EU General Court suspended the Commission’s decision. The final ruling of the General Court will cast a long shadow over the commitment of the Commission to the Energy Union and in particular the security of EU gas supplies. The judgment will also impact the ability of Gazprom and its partners to build the proposed Nord Stream 2 pipeline.

1.0. Brussels Under Pressure and a Polish Challenge

On 28 October 2016, the European Commission’s (“Commission”) approved the decision of the German energy regulator, the Bundesnetzagentur (“BNetzA”), to revise the terms of its 2009 decision to exempt the Ostseepipeline-Anbindungsleitung (“OPAL”) from EU rules on third party access and tariff regulation.The effect of the OPAL Decision is to substantially increase the amount of pipeline capacity that may be booked by Gazprom. The consequences of the decision are far-reaching and jeopardise the EU’s plans to pursue a resilient Energy Union. In addition to strengthening Gazprom’s dominant position in the Czech market, the OPAL Decision could increase Central and Eastern Europe (“CEE”) and Germany’s dependence on Russian gas since it materially reduces incentives to build alternative gas transit routes.

Remarkably, the OPAL Decision proceeds entirely by reference to conditions of supply in the German/Czech border area, neglecting the broader policy and security implications. The decision pays little heed to one of the touchstones of EU energy policy, namely reducing dependence on Russian gas through a diversification of supply and routes.

Given these concerns it is not surprising that PGNiG Supply & Trading GmbH (“PST”), the German subsidiary of the Polish state-controlled energy company Polskie Górnictwo Naftowe i Gazownictwo (“PGNiG”), challenged the OPAL Decision.On 4 December 2016, it lodged an appeal with the EU General Court (“General Court”) for the annulment of the OPAL Decision together with a separate application for its suspension (so called ‘interim measures’).This was followed by the Polish Government launching its own action on 16 December with an application for the annulment of the OPAL Decision and a separate request for interim measures.On 23 December, the General Court temporarily suspended the OPAL Decision. At the time of the publication of this paper, that suspension remains in force. The General Court is currently awaiting responses to a series of additional requests for information from the Commission and PGNiG. It also needs to rule on applications to intervene in support of the Commission from Germany, OPAL and Gazprom Export.

The threshold for granting interim measures is high and applications are rarely successful. This is because an applicant has to demonstrate that (i) it has a prima facie case, and (ii) it will suffer serious and irreparable harm if the suspension is not granted. It follows that PST’s successful application is indicative of the strength of its case. For the reasons outlined below, there is a high likelihood that the General Court will strike down the OPAL Decision. The judgment will not only impact the operation of the OPAL pipeline, but also raises questions as to the viability of the proposed configuration of the Nord Stream 2 pipeline. In particular, it may jeopardise plans to build the Europäische Gas-Anbindungsleitung (“EUGAL”) pipeline. This pipeline will connect Nord Stream 2 with the German mainland, and is intended to carry approximately 50bcm of natural gas annually into the heart of Central Europe.

2.0. The OPAL Pipeline

The OPAL pipeline runs 470km from Greifswald on the German coast (Nord Stream’s landing point) to the Czech border. The pipeline was built to feed natural gas from Nord Stream 1 and deliver it into Germany and Central Europe. It has a total annual pipeline capacity of 36.5bcm. WIGA Transport Beteiligungs-GmbH & Co. KG (“WIGA”), a joint venture between BASF’s subsidiary Wintershall and PAO Gazprom, currently holds an 80% co-ownership share in the OPAL pipeline. Uniper, an E.ON affiliate, owns the remaining 20%.

In 2009, the Commission approved the BNetzA’s 2009 decisions to exempt the OPAL pipeline from third party access and tariff regulation in accordance with the 2003 Gas Directive(the “OPAL 2009 Decision”).As a condition of approval, the BNetzA was required to impose a 50% cap on the capacity that could be booked by dominant players in the upstream and downstream Czech gas markets (i.e., Gazprom and RWE).This cap could only be lifted if an optional annual gas release programme of 3bcm was implemented. The main principles of a gas release programme were agreed between the BNetzA and Gazprom in 2011.However, in 2013, Gazprom indicated that it did not intend to implement the programme.

The OPAL Decision significantly expands Gazprom ability to book capacity on the pipeline. 50% of OPAL’s capacity will be exempt from rules on third party access and tariff regulation. 40% will be subject to tariff regulation, but it will be sold at auction. The final 10% (expandable to 20%) will be made available from the Gaspool trading hub in Germany with Gazprom being able to bid for the capacity at base price.

The Commission has underlined the importance of auctions as a means of opening up the market.However, this entirely overlooks market reality. OPAL was built for one reason: to act as the connection pipeline for the delivery of Russian gas from Nord Stream 1 into Eastern Germany and Central Europe. In practice, Gazprom’s export monopoly means that Nord Stream 1’s principal gas entry point (i.e., Griefswald) only carries Gazprom-sourced gas. Although there are other entry points along the pipeline, the economic reality is that only Gazprom’s partners are likely to make use of those entry points. These partners are highly dependent on Gazprom for gas as a result of their upstream asset relationships.

It follows from the above that however formally open the auction process may seem on paper, most of the capacity will in fact end up in Gazprom’s hands. This is evidenced by the events that followed the OPAL Decision until its suspension on 23 December, 2016. During that period, a number of day-ahead capacity auctions were held and on monthly auction on 19 December 2016. It is understood that all of the available capacity was booked by Gazprom. This led to an increase in the capacity utilisation of the OPAL pipeline. According to OPAL Gastransport GmbH & Co. KG, the operator of the OPAL pipeline, on 27 December, “OPAL was loaded 81% in

Greifswald and 91% in Brandov”.This reflects the significant increase in gas transit through the OPAL pipeline between 22 December 2016 and 16 January 2017. At the Greifswald entry point, gas transit volumes went up from an estimated daily average of 59.4 mcm between 1-22 December to levels sometimes in excess of 100 mcm per day; and at the Brandov exit point, gas transit volumes went up from an estimated daily average of 64.5 mcm between 1-22 December to levels sometimes in excess of 90 mcm per day.Moreover, the corresponding reduction of gas flows via the Urengoy– Pomary–Uzhgorod (“Brotherhood”) pipeline, the Ukrainian transit route, is the clearest indication yet that increased access to the OPAL pipeline is a critical part of Gazprom’s plans to divert gas flows from Ukraine.

3.0. An examination of the OPAL Decision

Following a delay of over two months, the OPAL Decision was published on 3 January, 2017. A close examination of the decision reveals fundamental gaps in the analysis, and the key arguments used to justify changes to the terms of the OPAL 2009 Decision are singularly unconvincing.

3.1. The Basis for the Review of the 2009 OPAL Decision

The 2009 Gas Directive contains no review mechanism for exemption decisions.Similarly, the OPAL 2009 Decision contains no specific review clauses. It follows that there is no clear legal basis for the variation of the OPAL Decision. Consequently, the Commission relied in part on its decisional practice in connection with the Nabucco pipeline (“Nabucco Decisions”)to justify its decision to review and revise the OPAL 2009 Decision.

However, the Nabucco Decisions are not as helpful a precedent as they first appear. This is because the circumstances that led to the Commission’s decision to review (and vary) the Nabucco Decisions were fundamentally different. In particular, the plans to build the pipeline were not advanced and the final decision approving the investment had not yet been taken. Moreover, there were a series of developments that necessitated an extension of the exemption including delays to the start of the exploitation of the Shah Deniz II gas field in Azerbaijan, the main source of supply for the Nabucco pipeline; the delayed conclusion of the Intergovernmental Agreement between the countries along the pipeline route; and difficulties obtaining long-term financing as a result of the 2007-2008 financial crisis.By contrast, the OPAL pipeline has already been constructed: there is no clear basis to draw a parallel with the factors that led to a review of the Nabucco Decisions. These differences of fact call into question the Commission’s decision to attach precedential value to the Nabucco Decisions.

Moreover, a key requirement for an exemption to be granted is that but for the grant of an exemption, the infrastructure would not be build. This is reflected in the wording of Article 36 (1)(b) of the 2009 Gas Directive which provides that:

“the level of risk attached to the investment must be such that the investment would not take place unless an exemption was granted”

It follows from the above that even if it is possible as a matter of procedure to conduct a review of an exemption, the wording of the 2009 Gas Directive does not appear to permit a review of exemption decisions where the investment has already been made and the infrastructure is operational. Even more so where the effect of the review is to give a greater benefit to the owner of the pipeline than that was identified as a dominant gas supplier (see below). There may be grounds to justify a review of an exemption where market conditions have changed radically or the continued operation of the OPAL pipeline is at risk as a result of financial difficulties. However, Gazprom remains dominant in the Czech Republic and there was no suggestion in the OPAL Decision that the financial viability of the pipeline was at stake. If the conditions that were imposed in the OPAL 2009 Decision were sufficient to ensure the construction, operation and solvency of the pipeline, it is difficult to justify granting a dominant Gazprom increased access to capacity.

3.2. Key Competition, Security of Supply and Internal Market Conditions.

Article 36 provides that in order for an exemption to be granted, a series of cumulative conditions must be satisfied. The Commission’s assessment of two key conditions is fundamentally flawed in the OPAL Decision, namely:‘

“the investment must enhance competition in gas supply and enhance security of supply; and the exemption must not be detrimental to competition or the effective functioning of the internal market in natural gas…”

The scope of the Commission’s analysis is narrow and entirely focused on the Czech market.Given that gas can flow onward from the OPAL pipeline and into other parts of the EU, an assessment of whether the above conditions have been satisfied would necessarily entail consideration of the impact of the decision on competition in the wider EU market, not least neighbouring territories in CEE. This point is reinforced when one takes into account the potential adverse impact on Poland. The fact that Gazprom is able to deliver natural gas into Poland via OPAL (i.e., from West to East), leaves PGNiG vulnerable to predatory pricing. Indeed, Gazprom is aware of the terms of its long term supply contract with PGNiG, which would enable it to target a lower price than what PGNiG is able to offer its customers. The effects of Gazprom employing such a strategy would be two-fold. In addition to increasing Gazprom’s share of Polish gas supplies, PGNIG would be forced to pay for the gas it has not been able to sell under the ‘take or pay’ clause of its long term supply contract.

The possibility that Gazprom would be able to engage in such a strategy was put beyond all doubt in the period that followed the adoption of the OPAL decision until the suspension of the General Court began to bite: increased flows through the OPAL pipeline were inversely reflected by a sharp decrease in flows through the Brotherhood pipeline, which carries gas through Ukraine and Slovakia (see above).

The increased utilisation of OPAL is also likely to negatively impact the delivery of more competition in the marketplace both in terms of new routes and modes of supply. We already have real world evidence of the negative competitive impact of the OPAL pipeline. Following the OPAL 2009 Decision, investors exited the competing Nordal pipeline project which would have run partly in parallel with the OPAL.Equally, the impact of increased utilisation of OPAL is likely to undermine incentives to deliver interconnectors in Poland, the Czech Republic and Slovakia which would make it possible to obtain greater access to the Świnoujście LNG terminal in Poland. These interconnectors are in fact one of the four gas corridor priorities set out in Commission Delegated Regulation 2016/89/EU.

A further consequence of the narrow frame of reference in the OPAL decision is that the Commission has overlooked the potential impact of the increased utilisation of the OPAL pipeline on the security of gas supplies in CEE. The existence of the Yamal- Europe (“Yamal”) and the Brotherhood pipelines provides CEE EU Member States with a degree of ‘throughput security’. A reduction in the flow of gas that is destined for Western Europe will lead to a corresponding reduction in throughput security. Given Gazprom’s history of politically-motivated gas supply interruptions, this danger cannot be dismissed as merely hypothetical. According to Robert Larsson, in his seminal work on the subject Russia’s Energy Policy: Security Dimensions and and Russia’s Reliability as an Energy Supplierthat between 1991 and 2004 there were over 40 politically motivated interruptions of Russian gas and oil supplies in CEE and Baltic States.More recently, Gazprom cut off gas supplies to CEE states in an attempt to stop gas from being dispatched via reverse flow to Ukraine in 2014 and 2015.

The security of Ukraine’s gas supplies is also a relevant consideration to the Commission’s assessment since both the EU and Ukraine are members of the Energy Community. In particular, the loyalty clause contained in Article 6 of the Energy Community Treaty provides that the Commission should at least take into account the open market and security of supply concerns of Ukraine.

However, increased gas flows through the Gazprom-controlled Nord Stream 1 and OPAL pipelines are likely to make it more difficult for Ukraine to obtain reverse gas flows from EU Member States. A reduction of reverse flows limits the ability of Ukraine to benefit from competitive North West European hub pricing. Naftogaz, the Ukrainian state energy company, has been able to successfully obtain reverse flows of gas from CEE EU Member States and Germany to replace most of its Russian gas imports, and pay significantly less for imported gas. These reverse flows have been critical to the improvement of Ukraine’s security of supply. Crucially, Naftogaz is able to rely on its wholly-owned domestic transit system, the Brotherhood pipeline and the pipeline networks of CEE states, where Gazprom influence and ownership is limited. Gazprom’s interests in the Nord Stream 1 and the OPAL pipeline, and potentially Nord Stream 2 and its connection pipeline EUGAL, increase its control over gas flows through CE Europe.This will threaten future reverse gas flows. Moreover, the additional transit costs associated with gas that is delivered via Nord Stream I, OPAL and the CEE pipeline network will render the delivery of gas through the Brotherhood pipeline less financially attractive.

Astonishingly, none of these matters are acknowledged – still less discussed – in the OPAL Decision. Instead, the Commission undertakes a myopic examination of the Czech and German markets. However, even within that limited frame of reference, it is difficult to see how permitting Gazprom to make greater use of the OPAL pipeline will enhance competition in accordance with Article 36 of the 2009 Gas Directive. The decision to allow Gazprom increased access to OPAL capacity will strengthen its dominant position in the Czech Republic and increase Russian gas flows to Germany. It also undermines rather than enhances local security of supply as it makes both the German and Czech markets more dependent on Russian gas.

4.0. A Misleading Commission Press Release

A further disturbing feature of this case was the opacity and lack of transparency surrounding the OPAL Decision as well as the fact that the little information that was provided by the Commission was highly misleading. For over two months, the only information the public had concerning the OPAL Decision was limited to the press release of 28 October, 2016.

Given the discussion above of the actual effect of the OPAL Decision, it was staggering that Commission chose the following headline: “Gas Markets: Commission Reinforces Market Conditions in Revised Exemption Decision on OPAL Pipeline.” In what is perhaps the most misleading paragraph, the press release makes the following claim:

“The Commission has today adopted stricter exemption conditions for the operation of the OPAL gas pipeline. The Commission wants to ensure properly functioning liquid and competitive gas markets in Europe, and today’s decision follows these guidelines.”

For the reasons outlined above, this is clearly not the case. The effect of the OPAL Decision is to permit Gazprom to potentially access the entire capacity of the OPAL pipeline, whereas its access was previously restricted to 50% of capacity. Furthermore, the statement ignores the adverse impact of the OPAL decision on security of supply and competition. Indeed, the Commission’s actions are entirely inconsistent with ensuring ‘liquid and competitive gas markets’ in Europe.

5.0. Conclusion: OPAL, the Rule of Law and EU Energy Security

The OPAL Decision raises significant concerns about respect for the rule of law and diminishes the credibility of the EU’s energy security policy.

The Commission is supposed to be the ‘Guardian of the Treaties’, and has a responsibility to consistently apply the ‘acquis communautaire’. The OPAL Decision represents a clear failure by the Commission to correctly apply the terms of Article 36 of the 2009 Gas Directive. This is compounded by the willingness of the Commission to mislead the public and the European Parliament over the true consequences of its decision. Equally concerning, is the fact that the delayed publication meant that Gazprom could access the additional capacity before interested third parties could read the decision. The OPAL Decision appears to be another example of the Juncker Commission positioning itself as a ‘Political Commission’.It demonstrates a failure to recognise that its overriding duty is to apply, support and enforce EU law, and not gloss over those rules in order to accommodate a political fix.

In addition, the OPAL Decision undermines the credibility of the EU’s Energy Union.This is one of the policy priorities of the Juncker Commission. At its heart is a commitment to diversify supply sources and routes in order to increase the EU’s resilience to supply gas interruptions recognising that “energy policy is often used as a foreign policy tool”.The OPAL Decision undermines that commitment. As outlined above, it threatens alternative supply routes and strengthens Gazprom’s dominant position since it lowers the likelihood of market entry by alternative suppliers, and threatens future reverse flows. If the Commission cannot be relied upon to support the implementation of the Energy Union, there is a considerable credibility and legitimacy gap.

The OPAL Decision is also important as a precedent for EUGAL, the connection pipeline for Nord Stream 2. If Nord Stream 2 is built, as outlined above, EUGAL will follow the same route as the OPAL pipeline. This would bring an enormous supply of gas amounting to 50bcm into the heart of CEE (see above). The problems attached to the OPAL pipeline would be exacerbated considerably by EUGAL. Nord Stream 2 represents strategic over-investment on a massive scale, designed to stifle alternative infrastructure initiatives and reinforce Gazprom dominance in CEE.

However, the problem for the Commission, Gazprom and its partners is that the OPAL Decision is now subject to the scrutiny of the EU General Court. The Commission’s failure to take into account prevailing market conditions in CEE and wider geo-political considerations in its assessment of competition and security of supply makes it likely that the General Court will strike down the OPAL Decision. Furthermore, any judgment by the General Court could impact the prospect of the Commission issuing an exemption decision for the construction of the EUGAL pipeline.

  • In the interests of full disclosure Dr Riley has previously acted as an adviser to PGNIG and Naftogaz.

Nord Stream 2: The Pipeline Controversy Enters its Fifth Year.

160816_nord-stream_2_route-map_colour_rgb_eng.png.1920x0_q90_detailWe are now entering the fifth year of the Nord Stream 2 pipeline controversy. I suspect  that President Putin imagined when he launched the project in June 2015 at the St Petersburg International Economic Forum that by now gas would be flowing through Nord Stream 2 along the floor of the Baltic Sea. The delays and controversies are in large part due to Gazprom taking the procedures and tactics that worked for Nord Stream 1 and then seeking to apply them again in a very different and far less benign political and legal environment.

Gazprom overlooked several key factors. First, the Central and Eastern European States were no longer newcomers to the European Union who had only recently joined. By 2015 most CEE states had been in the Union for almost a decade. As a consequence, they had a far better understanding as to how the rules worked and how to build alliances than in the 2008-2011 period. They were much more effectively able to raise objections to the project and co-ordinate opposition than with Nord Stream 1. Second, the political environment had changed profoundly, Russia had not invaded eastern Ukraine and annexed Crimea, nor was it waging hybrid war against the West. In such circumstances the willingness of states to seek to stop Nord Stream 2 was far greater than in 2008-2011. The third factor, was that the legal regime. Unlike in 2008-2011, the third energy package is far more deeply embedded with established case law and decisional practice to draw upon. A four factor, which i discussed in my Atlantic Council paper was the increasing realisation in Brussels and a number of key EU capitals the scale of the damage that Nord Stream 2 would do to the single market in gas and EU ambitions for energy union.

All these factors have resulted in much more delay and controversy than in the 2008-2011 period when the Nord Stream 1 project was planned, launched and executed. Nevertheless Gazprom is relentlessly continuing with the project. Pipeline is being laid in  parts of the Baltic sea route, even though there is as yet no permission to access Danish waters, which is necessary to complete the project. Gazprom is clearly seeking to build an ‘aura’ of inevitability round the project.

However, there are a number of reasons why notwithstanding the bold move of beginning to lay pipelines even without permitting being available for the whole route, Nord Stream 2 may well be in jeopardy. The first reason surrounds the question of Danish permit permission of the pipeline. New Danish legislation which allows Denmark to block infrastructure in its territorial sea on grounds of national security. As a consequence Gazprom has filed another permit for a route which avoids Danish territorial waters and instead runs through the Danish exclusive economic zone where the new legislation will not apply. It is unlikely that any decision will be forthcoming from Copenhagen from much before the end of 2019. One consequence is that Gazprom is likely to ultimately enter into some arrangement with Ukraine to continue high levels of gas transit flows via the Brotherhood pipeline.

A further and perhaps more fundamental problem for Nord Stream 2 is this: The Danish delay gives the US authorities the time to ultimately adopt sanctions against Nord Stream 2. One major reason why Congress may impose sanctions is that more evidence is likely to come out from the US in 2019 from both the Special Counsel investigation and via investigations by the House Committees of the scale of Russian interference in the US Presidential election in 2016. Such evidence would be likely to increase pressure in Congress for further sanctions against Russia. Given the existing controversy over the pipeline, Nord Stream 2 remains a first order target of any new sanctions.

There is also finally the dog that has not yet barked. A further issue hovering over the pipeline is the prospect that either EU energy law or EU antitrust law may be deployed against the pipeline. There is the ongoing parliamentary debate on whether EU energy law applies to import pipelines. That debate however overlooks the rather salient fact that EU energy law has been applied to an import pipeline, notably the Yaman-Europe pipeline. Any legal challenge, as I explained in my International Energy Law Review article would jeopardise the prospects of the pipeline. It cannot be discounted that such a challenge will be launched in 2019.

So notwithstanding the laying of pipelines the prospects for the completion of Nord Stream 2, the completion of the pipeline is not inevitable. We should however, finally find out this year whether Nord Stream 2 is ever to be completed or whether it will turn into a classic study of political pipeline overreach for generations of students of energy geopolitics yet to come.


The ECJ Undermines the Single Market in the Achmea Case.

europas-ecjIn my latest article in The American Interest How the European Court of Justice Undermined Europe I examine the consequences of the Slovakia v Achmea case. In Achmea the ECJ handed down a judgment which had the effect of making unlawful at least all the intra-EU bilateral investment treaties (BITS) across the continent. The tenor of the judgment, (and this argument appears to have significant support within the European Commission) is that the ruling can be extended to all BITS with third countries. The ECJ’s argument focused on the issue of the autonomy of the EU legal order i.e. that investor dispute tribunals necessarily make decisions involving EU law which cannot be reviewed by the Union’s own superior courts. Aside from the argument that such rights of appeal could be put in place, which the ECJ refused to do, there was no recognition on the Luxembourg bench of the consequences of their decision.

One of the major objectives which runs through the case law of the ECJ since it opened its doors in 1952 as the Court of the European Coal and Steel Community has been to promote the integration of the European market. Achmea by contrast is likely to have a significant disintegrative effect. Most of the capital that flows into CEE and Baltic states comes from other EU states, Japan and the US. Those capital flows are protected by a network of BITs across the eastern half of the continent (US firms usually deploying EU vehicles to obtain BIT protection). There is now a real danger that with the removal of BIT protection those flows are disrupted. Given the CEE and Baltic states are recovering from more than 40 years of Soviet occupation, they need to maintain significant capital flows in order to  catch up with the economic development of Western Europe.

A range of problems in the region largely emanating from the Soviet occupation judicial legacy of slow procedures. legal formalism, and politicisation undermine confidence of Western investors. Whilst they are Member State legal systems subject to Union law, there is very little Union law can do to ensure that the rights of investors are protected.

In addition, there is a further problem that if capital flows are disrupted the CEE states may be subject to greater capital leveraging by China, who has already announced a €10 billion infrastructure fund for CEE states. This fund has not been substantially deployed so far, Achmea may provide an incentive to do so.


Are the EU Institutions and the Member States Undermining the Energy Transition?

In my latest article How the European Commission, the European Court of Justice and Member States are Scaring Away Investors in the Energy Sector I argue that the energy transition may be at risk from its own authors. In order to substantially decarbonise the energy sector by 2050 (with a target of 80% decarbonisation) the EU will require approximately $2 trillion worth of capital investment into the energy sector.

In order for that capital to be levered into Europe’s energy markets it is vital that investors are provided with a stable, predictable and transparent markets into which they can safely invest. It highly unlikely that state capital resources on their own can ever be deployed on the scale necessary to achieve the scale of decarbonisation required by the EU and the Member States.

Despite the need for huge capital flows and the inability of the public sector to deliver them on its own the EU and the Member States have not shown any great willingness to encourage such flows. In Slovakia v. Achmea at the beginning of March, the ECJ, threw doubt on the legality of all intra-EU bilateral investment treaties (and potentially all bilateral investment treaties). It is not unreasonable to say that at least there is a significant difference in the quality of court systems across the Member States. The ECJ in one fell swoop undermined the one type of mechanism that operated across the Union to protect investment flows. Meanwhile not to be outdone in Decision 2017/442 the European Commission sought to argue that arbitration awards in cases involving subsidy regimes could constitute payments of non-notified state aid-further undermining the investment arbitration system.

The Member States have lent a helping hand to the EU institutions in undermining investment flows. In Germany, Berlin dragged its heels over compensation for the sudden decision to close its nuclear power station fleet. It was only after being brought before the German supreme court did Berlin agree to negotiate a compensation package. Spain’s equally sudden decision to revise its RES subsidy regime, has resulted in a flood of cases to the courts and arbitration panels, with a further 30 cases waiting in the wings. In the Netherlands, the energy sector has been subject to a double whammy, of new coal fired power stations being closed down without any immediate prospect of compensation. And in the Groningen gas field, rapid production cuts have been imposed on a field that still has significant potential, and raise again concerns over compensation.

Given the Paris Agreement, the oil and gas sector will be substantially phased out between now and 2050. However, if coal power stations are encouraged to be built and not compensated, then the consequence is likely that as a result investors are also less likely to invest in renewables as well. They may well take the view that renewable investment that is welcomed today, will be deemed an albatross tomorrow and end up being treated like the coal fired power stations of yesterday.

The Member States in particular need to recognise the reality of protecting investment flows. Take the Groningen Field. It is true that the reason for ordering production cuts were the tremors caused by production from that field. The danger here is that an over-reaction reinforces the sense that the Member States do not really appreciate the impact of their decisions on future investment flows. The particular danger here is that decision, combined with the preemptory closure of the coal-fired power stations may undermine the capacity of the Dutch state to ensure continued investment flows.

Without a recognition that the energy transition requires a stable, predictable and transparent investment climate, it will be impossible for the EU as whole to deliver on its ambitious environmental goals.

CAATSA is not the Only Sanctions Act to Worry About


Yesterday the US government published its Section 241 list under the Countering America’s Adversaries Through Sanctions Act 2017 (CAATSA). The 210 persons on the list are not subject to sanctions directly. The US government was required to submit to Congress a list of the most significant senior figures in political and business and amongst parastatal entities.  Clearly though just being on the list is going to cast a shadow over the business operations and movements of the listed individuals. There are however, more direct and immediate concerns for the persons listed under Section 241 stemming from another move by the Trump White House.

What I argue in my latest Statecraft piece Dealing with Trump’s Magnitsky Expansionism is that the largely overlooked Executive Order 13818 (EO) is likely to bring sanctions more rapidly down on members of the Russian elite than CAATSA. In essence, the EO reduces the legal standards for human rights abuses and corruption under the Global Magnitsky Act (GMA) adopted in 2016, and operationalises, even weaponises the GMA. With a lower legal bar to action; a broader range of actors who can be subject to sanction liability and the capacity of Congress to make its own GMA filings, NGOs, civil society and the Russian opposition now have a powerful tool in their armoury.

There is now even a danger that the CAATSA and the enhanced GMA may begin to interact, with one another-in that the Section 241 list could be deployed as a target list for sanctions under the GMA.

The danger for Russian businesses and their Western partners is that the number and scope of potential sanctions is likely to undermine confidence and willingness to go through with transactions. This freezing of business confidence is likely to reinforced by GMA filings, which are likely to occur in small batches, a regular drip, drip drip of GMA filings will act as an ever present concern in dealings with Russian entities for the foreseeable future.

Stockholm Bombshell: The Implications of the Gazprom v. Naftogaz Arbitration

It is clear even from the first ruling that Naftogaz and Ukraine have been substantially strengthened and Gazprom Weakened.


Almost all gas contract disputes between Gazprom and its customers have ended up with an amicable settlement between the parties. The German, French or Hungarian customers may push Gazprom on the pricing, Gazprom pushes back and ultimately everyone settles on a number they can live with-and each side claims victory. Rarely does either side actually intend to seek a final ruling from an arbitrator. However, when Gazprom launched its case against Naftogaz in the summer of 2014 the Russian aim was to push the case to a final arbitration ruling, and with that ruling cripple the Ukrainian company. Gazprom claimed the huge sum of $35 billion plus interest, amounting in mid-2017 to $44 billion, half Ukraine’s current GDP. The claim revolved around the take or pay clauses from the 2009 supply contract agreed in the shadow of the 2009 Ukraine-Russia gas crisis. Gazprom was confident that it would prevail. Much to its shock on the 31st May the Stockholm arbitration tribunal sided with Naftogaz and ruled that the take or pay clause was unenforceable. Although the tribunal has to yet rule on other parts of the Gazprom v. Naftogaz dispute, this central Gazprom claim has been struck out. With limited rights to appeal the ruling Gazprom has few possibilities to reverse the decision. By pushing the case to a final ruling Gazprom has forfeited all leverage over Naftogaz, strengthened the economy of Ukraine while undermining its own financial prospects.

The case against Naftogaz was launched by Gazprom in June 2014. The main claim revolved the alleged failure of Naftogaz to pay for natural gas under the terms of the take or pay clause of the 2009 supply contract. A take or pay clause requires the customer to either use the gas contracted for or pay for it if not used. This clause usually limits the ‘pay for in all cases’ element of the clause to a specific percentage of the total amount contracted. In this contract it was 80% of the 52 bcm that Gazprom agreed to supply Naftogaz. Naftogaz did not on a number of occasions from 2013 take the full amount of gas it was required to under the contract. At first sight the Gazprom claim appeared to be quite strong.

While as yet we do not know the details of the arbitration ruling we do know that the 2009 contract was agreed under circumstances where Ukraine and Naftogaz were put under considerable pressure to agree to the contract. In addition, the amounts of natural gas that Naftogaz agreed to take in 2009 was far more than Naftogaz could ever use. Furthermore, the contract included a destination clause which means that Naftogaz could not onsell the gas to third parties. In addition, the pricing mechanism linked resulted in Ukraine paying a far higher price for gas than EU states, even those in Western Europe, despite the significant additional transit costs to bring gas to France, the Netherlands and Germany. A further factor was that the natural gas price in the contract bore no relation to the prices on the gas hubs in the EU states, now increasingly the bench mark for European natural gas prices.

All of these factors clearly fed into the ruling of the Stockholm tribunal. In its first end of May ruling it held that the take or pay clause on which Gazprom’s $35 billion claim rested was unenforceable. It then also held that the destination clause, that prohibited the reselling of gas Naftogaz had bought from Gazprom to third parties, was unenforceable and that the pricing mechanism in future must reflect the pricing on the main European gas hubs.

Potentially for the harm caused by the application of the destination clause and the existing pricing mechanism Gazprom may be facing a damages award against it (which will be decided later on in the proceedings). However, the most significant issue is the striking out of the take or pay claim. This is an enormous relief for Naftogaz and Ukraine. At a stroke a $35 billion ($44 billion with interest) claim is struck out, removing a huge potential liability over the company. The way is now open to restructure Naftogaz and fully liberalise, on EU lines, the Ukrainian gas market. It also makes a liberalised Ukrainian gas market a much more attractive market for foreign investors to enter. Furthermore the removal of the shadow of the Gazprom liabilities strengthens Ukraine’s overall financial position, reducing the perception of sovereign risk and increasing the appetite of the capital markets for Ukrainian debt.

The next main stage of the arbitration case is the Naftogaz claim against Gazprom for approximately $30 billion. This claim was brought by Naftogaz following the June 2014 claim against it by Gazprom and is being dealt by the same tribunal panel. This claim surrounds the scale of fees that Gazprom should pay for transit of gas across Ukraine. The claim involves two principal elements. First, a claim that the transit price is too low. The second claim is that Gazprom was obliged under what are known as a ‘ship or pay’ clause to ship a certain amount of gas through the Ukrainian pipeline system. Under a ship or pay clause a failure to ship the full amount still results in a requirement to make a full contractual payment.

Clearly if Naftogaz were to win this claim, a claim which would amount to almost half Ukrainian GDP, this would further enhance Naftogaz and Ukrainian state finances. The success of this claim would also impose significant financial damage on Gazprom, undermine its financial stability and make it much more difficult for the company to raise capital. The claim would also be enforceable as Gazprom has extensive assets in the West which could if necessary be seized.

However, even if the tribunal does not rule wholly in Naftogaz’s favour Gazprom is in some trouble itself even from this initial ruling. The damage to Gazprom itself can be seen in the immediate fall in Gazprom’s share price following the announcement of the ruling. The prospect that none of the take or pay claim is recoverable will damage the company’s financing standing as major source of revenue has just evaporated. This fear of evaporating revenue will be reinforced by the prospect that defeat on the take or pay clause issue in the Naftogaz case may well encourage other companies across Central and Eastern Europe who have substantial take or pay debts with will now rely on the Naftogaz precedent to seek to challenge the legality of their own debts.

Furthermore, even without any more damages awards against Gazprom the case will make it more difficult for the company to raise capital for major infrastructure projects such as Nordstream 2. The scale of the difficulty of raising capital for Gazprom is likely to depend on how much the company is faced to pay out as the tribunal completes its rulings, expected by late summer and autumn 2017.

For Naftogaz, and Ukraine any significant awards will help improve both the corporate and state financial position, permitting a much more rapid advance to a more liberalised European style gas market. It very much appears to be the case that Gazprom by pushing the case into a tribunal and forcing a ruling has done much to liberalise the Ukrainian gas market on the European model, improve Ukrainian state finances, and ensure a far greater degree of Ukrainian independence and autonomy.

*Dr Riley has been an adviser to Naftogaz but took no part in the arbitration proceedings. This article was first published in Natural Gas World.


Making the Most of An Antitrust Brexit.


Is there any Silver Lining in Brexit from an Antitrust Perspective?

Almost all of the commentary on Brexit from an antitrust perspective is negative. Its all about minimising the costs from duplication of merger assessments and the prospect of legal uncertainty. This is combined with a fear that in the process of Brexit British antitrust will lose its European antitrust moorings. The CMA it is feared will head off in the direction of MMC pre-1973 opaque public interest justifications for merger clearances and market investigations.

Is it possible however for the UK free of European regulatory structures to enhance in some respects the operation of its antitrust regime? And potentially could the UK become a regulatory laboratory for development of antitrust policy in Europe? The potential is that the British authorities could take Brexit and turn it into a win win for both Britain and the rest of Europe.

To give two examples. First, once free of the European regulatory structures the UK could seek to significantly enhance its criminal cartel regime. Greater use of plea agreements, director disqualification orders, an enhanced leniency regime and reshaping the civil procedures against companies so they followed immediately on the back of the criminal procedures seamlessly. The overall impact would be to create the most formidable anti-cartel regime in Europe. Given the economic footprint of the British economy (even post-Brexit) the British regulator would end up creating a significant additional deterrent effect against price-fixing cartels that would have a positive effect both in the UK and EU economies.

A second example would be to look again at the issue of exemption decisions in respect of the UK’s restriction of competition provision contained in Section 2 of the Competition Act 1998. Following the abolition of the notification and exemption system in respect of Article 101 in Regulation 1/2003 the UK followed suit and abolished its own notification and exemption system. The UK now has only a limited and little used opinion system.

There has always been a compelling argument that it was a mistake to abolish the notification and exemption system: That the real problem was the over-broad jurisdiction of Article 101. The old pre-2004 notification and exemption system was valuable in terms of legal certainty for business. Post-Brexit the British authorities could envisage bringing back a modernised notification and exemption system which would be  voluntary; where the scope of Section 2 was expressed in more limited terms than  the Commission’s traditional interpretation of the scope of Article 101 (or rather as would then have been Article 81) and would imposed a filing fee to limit the cost implications for the CMA in dealing with  exemption assessments.

This UK experimentation would give EU states the opportunity to see how a modernised notification and exemption system would work to everyone’s benefit. It also may give the UK a competitive advantage by help keeping some business on British shores, as some capital intensive businesses who desire legal certainty make base themselves in the UK to take advantage of exemptions granted by the CMA. However, for the exemption to be valuable in the EU, the CMA would still have to ensure its exemptions kept close to the accepted canons of EU antitrust law. Hence while a notification and exemption system may give the UK a competitive advantage it would also have the effect of helping to anchor Britain close to mainstream EU antitrust law.

*This article originally appeared as the leader in Competition Law Insight, 9th May 2017.

Nordstream 2: A Legal and Policy Analysis: A Brief Review So Far.

10fb193a9699b7d6b5d132f2fcca9d60My CEPS paper published in November examining the legal and policy issues surrounding Nordstream 2 has had over 3000 downloads and sparked significant debate. I will be discussing the legal issues surrounding Nordstream 2 at the upcoming Lennart Meri and Globsec conferences. There is an initial response from Nordstream 2 by Mr Lissek. To my mind however the most substantial response to my paper has been by Professor Kim Talus in his the Application of EU Energy and Certain National Laws of Baltic Sea Countries to the Nordstream 2 Pipeline Project

One of the main contentions is whether EU law applies to Nordstream 2. I find it difficult to see how one can argue as a matter of principle that EU law does not apply at least to the inland waters of the Member States, and their territorial waters, and possibly following the Habitats case to the exclusive economic zone. The key issue I would therefore argue is whether the EU energy law regime envisages the application of the regime to import pipelines. Professor Talus argues robustly and coherently that EU law energy regime is not envisaged as applying to import pipelines. This is clearly a much more compelling argument than that of some of the Nordstream lobbyists who seek to distinguish between import pipelines running on the seabed and those running on land. However, the difficulty with Professor Talus’s argument is that EU law has been applied already to two import pipelines Yamal, and Southstream. More recently parts of the Commission have been much more circumspect and the Legal Service of the European Commission produced a four page note seeking to argue that EU law may not apply to Nordstream 2. It is despite that note difficult to evade the reality that EU law has in fact been applied to import pipelines-and that the Union’s legal regime-in order to ensure uniform application of competitive conditions amongst all market operators requires to be substantially applied to both import and non-import supply pipelines.


Brexit: Causes and Consequences

eu-union-jack-flagsIn this new paper I argue (with Francis Ghiles) that Brexit is the most significant event in Europe since the fall of the Berlin Wall in 1989; that while some of the causes of Brexit are largely home grown, many of them are not and that the consequences are more likely than not to further fragment and divide Europe further absent a significant step up in the quality of leadership that has been provided over the last decade.

Dangerously for China its Market is a Potemkin Market


In my new book The Potemkin Dragon I argue that China does not have a real market economy. Instead it has a sham or Potemkin market. At first sight this argument looks impossible to sustain. After all China has seen tremendous economic growth over the last forty years. It has gone from being a $170 billion economy in 1979 to a $10 trillion plus economy today. This economic miracle has lifted 800 million people out of poverty. Surely this only could be because China has a market economy?

It is true that all the formal institutions of a market economy are in place. China has a stock exchange, law courts, commercial codes, publicly listed and privately held companies and several antitrust agencies. Scratch the surface however and it becomes apparent that the Chinese market is unlike any other ‘market’ economy on earth. Take its largest stock exchange in Shanghai: 80% of the market by value is constituted by wholly or largely state-owned companies. Those companies in reality only trade a small percentage of their equity on the exchange. As a consequence, the Shanghai exchange cannot function as most Western exchanges do. A core part of a company’s valuation, namely who exercises corporate control is not factored into Chinese stock prices. Essentially share prices reflect liquidity and demand at any given time, encouraging a pure gambling mindset amongst traders.

The Shanghai exchange is just one example of the clash between market formalism and Chinese reality. Take most of the largest 100 plus state owned companies. These are not run by large arms-length partly privatised public companies such as France’s EDF. The largest 100 have one shareholder the State-Owned Assets Supervision and Administration Commission (SASAC). SASAC does not operate at arms length. It appoints and dismisses executives, assesses business plans and issues directions to the companies it owns. These are not small companies. Approximately half of SASAC’s stable of companies are in the global fortune 500. In all the market value of SASAC is put at some $6 trillion. SASAC also directs provincial and local SASAC’s which control a further 150,000 companies, some of which are also like China Bright Foods, are also major international companies, and together they have a market value of a further $10 trillion. There is a financial equivalent to SASAC in the Central Huijin Investment Ltd, which controls the top four tier one banks and nine of the ten top tier two banks. This level of control over the financial system allows the state to direct capital at will to state owned companies.

In addition to state control there is control by the Party. Through the Chinese Communist Party’s (CCP) Central Organisation Department (COD) several thousand posts in the State Owned Enterprises (SOEs), banks, state administration, media, universities are all appointed at the behest of the COD. Party-State control also flows deeply into the private sector. Every major private business will have a Party Committee where decisions will be made before the formal meeting of the Board of the company. Even if the Party Committee is not sufficient to ensure control of ‘private’ Chinese companies, Party-State control of the banks will convince even the most private entrepreneurs that fidelity to state and Party objectives is worthwhile in return for access to capital at fine rates. Furthermore, both the National Development and Reform Commission (NDRC) and the sectoral Chambers of Commerce maintain significant regulatory controls over SOEs and private businesses.

This system worked well enough in turbo-charging Chinese growth in past decades. Whilst not a market economy where price signals operate across the market and capital is allocated on the basis of an assessment of risk it did allow the state to direct capital to build the infrastructure and businesses to fuel the first stages of Chinese economic growth. However, this model is far less efficient when it comes to bringing on the next stage of economic development. China needs to shift to developing high value added innovative products, services and a consumption led economy. For this China needs to let real markets flourish. The CCP has to give up controlling much of the economy. Private businesses have to make their own decisions and capital has to be allocated on a commercial basis. In order for intellectual property rights to be secured and innovative markets to be developed, the rule of law has to be entrenched and independent courts established. However, the difficulty for the CCP is that to give up control on this scale would be to undermine its capacity to run the economy and society. Liberalisation would take away its main economic levers and threaten its hold on the country.

All of these pressures and conflicts can be seen in the reaction of the CCP to the 2008 economic crisis. The CCP reacted by pouring credits into the state sector, expanding the capacity of the SOEs to maintain employment levels and social peace. The consequence was that local government, central government and corporate debt exploded. That cumulative debt now stands at 283% of GDP, three quarters of which has been incurred since 2008. The DNA of the Chinese state kicked in: Use the SOEs, direct capital and maintain social peace and do not worry (for now) about the debt. However, as China becomes more and more indebted, ever increasing bursts of injections of cash from the state banks has less and less effect. Meanwhile innovative private firms who could be China’s future have far less access to capital and are undermined by state regulation and empowered SOEs.

The danger for China is that its economic future is strangled by its Potemkin market and the CCP’s underlying political logic for keeping the Potemkin market in being.