COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL - The internal market in energy: Coordinated measures on the security of energy supply

1. Completion of the internal market in energy

In accordance with Article 14 of the EC Treaty, the internal market comprises an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured. To help meet this prime objective of the Treaty of Rome, the European Community is responsible for introducing, among other things, the requirements needed to complete the internal energy market which will make it possible to gradually open up the market in order to make the energy sector more competitive. The internal market is also based on the need for solidarity between the Member States of the European Union, more especially in the essential sectors of energy supply which are gas, oil and electricity.

Achievements

Since the beginning of the 90s, the Community has adopted a series of measures in the form of directives which are helping to establish the internal market in natural gas and electricity. The achievement of this objective should make the economy of the European Union more competitive and lead to a significant reduction in consumer prices.

The process of opening up the market in natural gas and electricity to competition is governed by rules relating to access to resources and transport networks, competition and transparency which should protect the countries of the European Union against disruption of their internal supplies. This regulatory framework is essential and will make it possible to avoid crises such as that which hit California in 2000 when it experienced serious disruption of electricity supplies.

Of major importance for the proper functioning of the internal energy market is the interlinking of networks since it plays a fundamental role in the flexibility of supplies. The lack of network infrastructure, including maintenance of the quality of supplies (stability of networks) could hinder the integration of national markets and thus restrict security of supplies. On 20 December 2001, the Commission proposed a set of new measures relating to energy infrastructures aimed at optimising the use of existing gas and electricity infrastructures and encouraging the construction of new infrastructures of European interest. As stated in the conclusions of the Barcelona European Council, the existence of an adequate and effective network of energy infrastructures will ensure the proper functioning of the internal market, while guaranteeing greater security of energy supplies.

Although there is more competition in the oil market within the European Union than in the market for other energy products, further efforts will still have to be made to achieve a more open market. In the Green Paper on security of energy supply adopted by the Commission in November 2000, the Commission noted that obstacles remained on the markets downstream, more specifically distribution. Although the significant differences in prices of petroleum products between the Member States do not in themselves constitute a breach of competition rules, they nevertheless indicate that the integration of markets is still incomplete. Moreover, surveys at Community level and at the level of the national competition authorities have been carried out and sanctions have even been imposed on certain oil companies.

The opening up of the oil market, particularly to new operators, will help to establish the conditions for healthy competition which in turn will help to ensure regular internal supplies for consumers, even if this market will remain exposed to the risks associated with increased external dependence.

An ongoing process

The numerous Community initiatives to create an internal market in gas, as well as various activities to open up the oil market, are helping to establish fair competition and to strengthen the internal security of energy supplies.

On the question of energy supply, the Green Paper on the security of energy supplies highlighted a paradox, however: at the very moment when the European Union is acquiring the most integrated internal energy market in the world, this success has not been accompanied by the necessary coordination of measures guaranteeing security of external supplies, whether oil or natural gas.

The Green Paper showed up the structural weaknesses in external energy supplies in the European Union and its vulnerabilities in geopolitical, economic and social terms. The European economy is based mainly on fossil fuels which represent four-fifths of energy consumption, and two-thirds of this is imported. This vulnerability will become more pronounced in the future with energy imports which could rise to 70% of total requirements in thirty years time, or even up to 90% for oil if nothing is done to reverse this trend.

As regards oil, the rules of the International Energy Agency (IEA) and Community legislation provide for the maintenance by States of security stocks of crude oil and petroleum products as well as possibilities of anti-crisis measures. However, these mechanisms, which were introduced in the early 70s, are no longer suited to the oil market which has undergone numerous changes as the internal market in energy has become increasingly integrated. The Community measures are characterised by a lack of solidarity between Member States which is not compatible with the objectives of an internal market, since energy crises affect all EU countries. More fundamentally, there is no Community decision-making power to dispose of oil stocks on the market. As regards the IEA, the basic elements of the 1974 Treaty are no longer applied. Other provisions have been put in place, but these require the unanimity of the 26 participating countries. The mechanisms have become obsolete in as much as they provide for joint action by all the Member States only if there is a physical disruption of oil supply. There is no legal framework for the coordination of action in the event of a threat of a physical disruption, which would increase oil prices beyond what is reasonable.

The Community legislation on oil stocks, the first directive of which dates from 1968, and the IEA set up in 1973 were an important first step in the process of better management of external energy dependency. It must however be acknowledged that these mechanisms, the underlying philosophy of which has not been subjected to detailed scrutiny for thirty years, are no longer suited to the present energy situation. They were put in place at a time when the internal market in energy was still in its infancy. At that time there was very little in the way of intra-Community electricity exchanges or interdependence of the electricity system.

Given this situation, the Commission has already announced, in its Communication on oil supplies of 4 October 2000, its intention to examine ways in which strategic oil stocks could be made more effective by placing their use on a Community footing.

The European gas industry, for its part, has so far been effective in ensuring security of supply. The fact that the gas companies were partly or wholly-owned by the public authorities and that these dominant companies controlled all infrastructures and regulated supply and demand meant that there was no need to draw up common rules to guarantee gas supplies.

In the new internal market in gas which requires the industry to restructure in order to create an integrated market in which new companies will emerge in an increasingly competitive environment, there will no longer necessarily be a single player which will assume overall responsibility for security of supply. The question is all the more urgent as dependency on gas imports will increase significantly in the decades to come. Security of supply in the gas sector therefore cannot be left entirely to the industry which is itself dependent on its external suppliers from an extremely limited number of supplier countries.

At the fifth meeting of the European forum for the regulation of the gas sector, which brought together national regulators, Member States, economic operators in the gas sector and the Commission in Madrid in February 2002, it was moreover agreed that in the new regulatory environment for the internal gas market, which is characterised by a multitude of players and the unbundling of the activities of the integrated gas companies, security of supply can no longer be considered the responsibility of a single party. A new chain of responsibilities concerning security of supply and the planning of infrastructures between the public authorities and the various market players must therefore be established in order to guarantee certainty in this connection. Responsibilities must be assigned to the various players in a clear and appropriate manner on the basis of their role.

It is therefore necessary to provide for harmonised measures which will guarantee unified and coordinated action with regard to the security of supply of gas, in particular measures with regard to storage and infrastructure. Stockpiling and infrastructures play an essential role in gas supplies in the European Union and in the functioning of this market, both under normal market conditions and in crises. These measures will "accompany" the process of opening up the EU market in gas in order to ensure its proper functioning.

A Community process

The European Union is making steady progress towards the completion of the internal market in energy, which will be the largest, integrated and most open regional market in the world. In this liberalised market, the European Union has an important part to play in coordinating and supporting the Member States with regard to security of supply. The task is to ensure the proper functioning of the market and in this context to guarantee a sufficiently high level of security of supply.

Measures to improve the security of supply of oil and gas will have little or no effect unless they form part of the more general framework of the internal market in energy. These measures will not have a positive impact if they are, for example, thwarted by price manipulation, or if access to the transport networks is limited. The internal market is therefore the necessary basis for measures with regard to security of energy supplies.

Conversely, it is not possible to construct an internal market in energy if this objective is not accompanied by harmonised rules on security of supplies. The power cuts which severely affected California in 2000 clearly bear witness to this. These cuts were due not to inadequate rules on security of supply, but to a process of electricity market liberalisation which was not accompanied by adequate rules to guarantee a sufficient security of supply level. In the normal competitive environment, the (short-term) priority of companies has been to maintain or increase their stake in the Californian electricity market. In doing this, they did not make the (medium or long-term) investments which would have been necessary to guarantee a sufficient supply for all consumers.

Measures to improve oil and gas supplies must therefore be based on the proper functioning of the internal market, and the internal market in energy is itself based adequate measures to guarantee the security of supplies. It must be noted that national laws on the security of oil supplies, which are not adequately coordinated at EU level could lead - and indeed have led - to distortions in the internal market in petroleum products.

These measures with regard to security of supplies must form part of a competitive natural gas and oil market and there must be no discrimination as regards the rights and obligations of companies in the sector. The obligations regarding the security of energy supply must therefore be clearly defined, transparent, non-discriminatory and controllable. They will not go beyond what is strictly necessary to overcome potential supply difficulties. Thus, they will cause the least possible disruption in the functioning of the internal market.

There is therefore a clear need to define a Community framework for the implementation of measures to ensure security of external energy supplies which will place minimum restrictions on competition. These rules will clearly set out the roles and responsibilities of the various players in the oil and gas market as regards security of supplies. Any lack of clarity as regards these roles and responsibilities will increase the risk of an energy supply crisis.

According to the principle of subsidiarity, these rules will form a framework, the implementing arrangements for which should be left to the Member States to adopt. They will be implemented in close cooperation with the industry.

It is important to note that the construction of an internal market in oil cannot be considered without the development of other sources of energy, in particular the natural gas market. Oil and gas are two products which are part of the same energy market. They can also be substituted for each other and are in competition with each other as far as some uses are concerned. Furthermore, gas prices are largely indexed to oil prices. These two energy sources are therefore closely linked.

2. Energy dependence in the European Union

The energy situation in the European Union

The European economy is based mainly on fossil fuels (oil, gas, coal) almost two-thirds of which are imported. These fuels represent 80% of energy consumption in the European Union. If nothing is done, in 20 to 30 years' time, they will play an even bigger role in the European energy balance and imports will amount to 70% of overall energy needs. The Union's external energy dependence could even reach 90% for oil and 70% for gas by 2020. It should also be noted that 90% of oil is currently transported by sea.

The risks associated with the fact that the Union is, structurally, highly dependent on imported fossil fuels are further exacerbated by the political instability prevailing in many producer countries. It has been seen on a number of occasions that the events in the Middle East or certain political crises which have destabilised the political power in place in producer countries could put the energy market under severe pressure. This pressure leads if not to the actual physical disruption of supplies, then at least to sharp fluctuations in oil prices which inevitably affect economic growth in the consumer countries.

It is important to note at this point that the objective, given a globalised economy, is not in itself to maximise energy autonomy or to minimise dependence, but to take account of the risks inherent in such dependence when they reach worrying levels.

The question of security of energy supplies is a vital one for the European Union. In spite of a lessening of the oil burden on our economies, brought about by successive crises, oil remains a vital economic component in the Member States. In 2004, the European Union will consume almost 20% of world oil production.

The situation in the transport sector is very revealing in this connection. A captive market 98% dependent on oil (which is equivalent to 67% of overall demand for oil), this sector accounts for an increasing share of energy demand. The energy intensity of the sector increased by 10% from 1985 to 1998. Growth in the transport sector is likely to continue at an annual rate of 2% over the next decade.

Gas, for its part, has become a broad spectrum energy vector penetrating all sectors of energy consumption, including electricity production and combined heat and power production but also, albeit still at an embryonic stage, transport. By 2020-2030, almost half of all electricity will be produced from natural gas. Although natural gas appears today as the diversification product which is essential for a healthy balance in energy consumption, capable of reducing CO2 emissions, its rapid growth on certain markets such as electricity could give rise to fears of the emergence of a new structural weakness in the European Union in terms of external dependence.

Economic studies have estimated that an increase of $10 in the price of a barrel of crude oil is likely to reduce economic growth in the industrialised countries by around 0.5%. For developing countries, such a price increase would reduce economic growth by around 0.75%. It must also be borne in mind that the impact of oil prices on economic growth is not linear: sudden unexpected and very sharp increases in prices are likely to cause much greater damage to the economy than the estimates given above. It is moreover interesting to note that since 1973 significant reductions in economic growth in the United States and Europe have all been preceded by sudden sharp increases in the price of crude oil.

Instability in energy supplies, whether it is due to market volatility, relations with supplier countries or a particular chance event, could lead to social disruption. This is likely to result in social demands, a backlash from business, even conflicts. It should be recalled that the first two oil crises contributed to a sharp increase in unemployment. In this situation, it would be impossible to attempt to construct an internal market between the economic operators whose objective is to increase the efficiency of the European economy if such a market is not based on principles which guarantee social cohesion. An example of this is the road hauliers' strike which affected many countries in Europe in the autumn 2000, following a sharp increase in oil prices. This resulted in major fiscal disruptions, insofar as Member States tried to counterbalance the effects of the energy price increases on economic sectors through uncoordinated reductions in taxation. These individual initiatives are a serious obstacle to the proper functioning of the internal market, in particular for a common and coordinated transport policy.

As stated at the Barcelona European Council, an integral part of establishing the internal market in the European Union is ensuring security of energy supplies. This objective will help to ensure, for the welfare of citizens and the proper functioning of the economy, the constant physical availability of energy products on the market at a price which is affordable for all consumers, whether private or industrial.

The risks

In this situation of energy dependence, the European Union has to face up to two types of risk in the energy field:

* Physical risks Permanent physical disruption of supply may result from the exhaustion and abandonment of an energy source. It is possible that in the long term the European Union will have no more significant Community resources of oil and gas at a reasonable cost. Thus, experts estimate that North Sea oil reserves should gradually run out by 2030-2050. Mention should be made in this connection of the example of coal, the production of which is gradually being abandoned by the Member States. The European Union is also very vulnerable to a risk of temporary physical disruption of supply which may result from serious accidents affecting transport and storage infrastructures, whether within or outside the Community, which are important for the security and continuity of Community supplies. Moreover, events of, for example, a political and/or military nature in an oil production or transit region may at any time cause the temporary physical disruption of world oil supplies.

* Economic risks An economic risk is posed by the volatility of the markets, which can be caused in particular by a threat of a physical disruption of supplies. An analysis of recent energy market trends shows that, apart from physical disruption of supplies, there is another cause for concern: speculative movements in anticipation of a potential disruption of supplies. The general perception by operators of a risk of a potential future disruption leads to panic buying even when supply and demand are apparently in balance. The result is sharp price rises which directly affect business costs and the purchasing power of private consumers. These uncertainties in the international market are likely to jeopardise growth in the EU economy at any time, with serious consequences for employment. During the recent period between 1998 and 2000, when there was a slight reduction in oil supplies of 3%, there was a very sharp increase in prices from $10 a barrel up to - at certain times - $37 a barrel. Taken over a year, such a price increase may be estimated to add some EUR100 billion to the oil bill. The main risk with regard to energy today is economic. Although it cannot be totally ruled out, the physical risks of disruption of supply is only likely to come about as a result of exceptional circumstances such as major conflict in an oil- or gas-producing area. The economic risk has therefore become the real issue, since price rises have a direct effect on business costs and the purchasing power of private consumers.

3. Lack of adequate means of action

It is vital that the energy dependence of the European Union should be managed as effectively as possible since this will contribute to the construction of the internal energy market.

Where energy demand management is concerned, beyond making mere proposals to encourage or exchange good practice, the Commission has already made regulatory proposals, some of which have been adopted by the Council and the European Parliament, in particular the Directive on the production of electricity from renewable resources, the Directive on energy savings in buildings and the biofuels package. Implementing these texts will bring about a saving in terms of consumption of conventional energies of around 10% in the next few years and make it possible to limit the upward trend in the EU's energy demand as a result of increased consumption in the domestic and tertiary sector.

On the demand side, the debate on the Green Paper on security of energy supply has shown that the European Union has no scope for influencing oil and gas supply conditions. It brought out the dangers for the European Union of supply disruption and showed up the structural weaknesses of our energy supplies and their geopolitical, economic and social vulnerability. Even before the events of 11 September 2001, it highlighted the need to include questions relating to the safety of installations in the concept of security of supply.

In accordance with the position taken by the EU at the recent Johannesburg World Summit on Sustainable Development, in this context, the indigenous renewable energy production of a given Member State has a positive impact on the security of energy supply and reduces the quantity which it is obliged to hold as strategic gas or oil stocks.

Insufficient harmonisation of Community measures with regard to oil stocks

Three Community directives govern the establishment of national reserves of crude oil and petroleum products by the Member States. Member States must maintain a level of stocks equivalent to 90 days' consumption for each of the three main categories of petroleum products for energy use. Member States must also be ready to act when there is a risk of physical disruption, i.e. they must draw up action plans and set up appropriate bodies and powers enabling them to place stocks on the market and restrict consumption, guarantee supplies to priority consumers and regulate prices.

In the event of a crisis, the European Commission may, at the request of a State or on its own initiative, fix a target in terms of a reduction in consumption. However, the Commission has no powers to order stock disposal. The decision to release oil stocks is a matter for the States, although consultations are arranged at Community level for coordination purposes. Ultimately it is each individual State which will decide whether stock disposal measures should be taken. Apart from the fact that individual action by each Member State would upset the internal market, uncoordinated action would have little or no impact in view of the size of the oil market.

There is then no Community mechanism for using oil stocks which establishes solidarity between States forming part of the same internal market in the event of supply problems.

Furthermore, in most countries of the European Union - and unlike the Strategic Petroleum Reserve in the United States where stocks are held by the public authorities - the security stocks are held by the oil companies and are mixed up with their operational stocks. Only some of the Member States have set up ad hoc bodies responsible for holding all or part of their security stocks. This fragmentation of the storage arrangements affects the proper functioning of the internal market in energy and causes distortion of competition between refiners and non-refiners which have low levels of operational stocks. In addition, the amount of oil products actually available to the Member States in the event of a crisis, i.e. which can actually be mobilised in the short term, is very uncertain since operators' security stocks are mixed up with their operational stocks. It should be noted in this respect that the stocks of the Strategic Petroleum Reserve currently amount to 545 million barrels and that the United States has decided to gradually increase their volume to 700 million barrels by 2004.

EU legislation also does not provided for harmonised rules on the use of security stocks to deal with a physical disruption of oil supply, but is an instrument for managing an existing physical shortfall which is no way intended to cope with market volatility. Volatility in the markets due in particular to the expectation of a possible physical disruption of supplies is likely to have a serious effect on the growth of EU economies.

Given the inadequacies of the Community system for the security of oil stocks compared with the reality of the energy situation and developments in the internal market in energy, it is therefore easy to understand why this system has never worked. Rules should therefore be laid down which will help to bring the national provisions closer together and which, in the event of a crisis or the threat of a crisis affecting oil supply, will ensure the solidarity and unity of action which are needed for the proper functioning of the internal market.

Inadequacy of the International Energy Agency framework

The Treaty setting up the International Energy Agency (IEA) lays down an obligation on participating States to maintain stocks equivalent to 90 days' of net imports of oil or petroleum products. It establishes a mechanism for responding to supply crises, i.e. on the one hand an obligation to reduce consumption where a certain threshold of supply disruption is exceeded and, on the other, a procedure for disposing of stocks and allocating the available oil between the participating States.

At the beginning of the '80s, the IEA had come to the view that the mechanisms of the 1974 Treaty were no longer adapted to developments on the oil market. Another crisis mechanism, the CERM (Coordinated Emergency Response Measures) was introduced by the Governing Board of the IEA to make stock disposal an easier option. However, any decision taken in relation to CERM requires unanimity of the Governing Board which is made up of representatives of the 26 participating countries, whose geographical origins and at times very different interests do not make it easy to reach a consensus (the participating countries include in particular the US, Australia, Japan and Korea.). Given the lack of clear criteria for activating this mechanism and the differences between the participating States, the risks of measures being blocked are obvious.

In fact, the CERM has been used only once, more than five months after the outbreak of the Gulf War following the invasion of Kuwait by Iraq, although oil prices had already peaked and the negative impact on the economies of the oil consumer countries had already been felt.

In addition, the IEA mechanisms link the management of the oil stocks of the European Union to that of numerous external partners (26 States) whose priorities are not necessarily the same as the EU's. Moreover, it should be pointed out that the gradual establishment of an internal energy market, as is the case between the Member States of the European Union, is a unique achievement: no other country in the IEA, including the United States, has succeeded in developing such an integrated structure.

Under the IEA Treaty as it stands, even a stock disposal measure proposed by a majority of the IEA countries - for example the European Union - could, in view of the unanimity rule governing the work of the CERM, be blocked by a single country. The mechanisms put in place within the IEA do not therefore allow the European Union, the second economic power in the world, to have its own power of decision in such a strategically important field as energy or to ensure the proper functioning of its internal market.

As with current Community legislation, the IEA mechanisms were set up only with a view to a possible physical disruption of oil supplies. The basic elements of this system, which date from 1974, were put in place to respond to measures such as the embargo imposed by OPEC on certain industrialised countries in the difficult political situation in the Middle East at the end of 1973. The circumstances today are far removed from that situation.

Lack of coordinated measures for gas supplies

Given the strategic importance that natural gas will assume in the future, an innovative approach is required insofar as there is currently no Community framework for harmonisation of the measures which will guarantee a minimum level of security of gas supplies in the European Union. It should also be pointed out in this connection that the IEA also has no specific measures to guarantee external gas supplies to participating States. 40% of EU gas imports come from three main sources of supply. Moreover, since 1995, the production of electricity from gas represents 50-60% of new investments in the production of electricity in the European Union each year. Security of gas supplies is therefore particularly important to ensure continuity of electricity production.

The European gas industry has succeeded in ensuring security of supply on a constantly expanding European gas market over the last forty years. However, the European gas market is undergoing rapid change at the moment and the role of traditional market players is also changing.

Hitherto, the work of planning and developing the gas network to achieve the objectives in terms of security - often defined by the gas industry itself - was relatively simple, given that the main suppliers possessed all the infrastructure, the data relating to supply and demand for gas, information and the other instruments necessary for a successful outcome of such planning. In addition, direct State involvement was less necessary as the national gas companies responsible for security of supply were in many cases partly or wholly State-owned.

On the new liberalised gas market, no player will henceforth necessarily assume sole responsibility for short and longer term security of gas supplies at national level because of the restructuring of the industry, the integration of national markets, the emergence of new companies and greater competition. The policies and procedures relating to security of supply therefore have to be reviewed and formalised in this new context. In a competitive market, it is not certain that gas suppliers will give a strategic priority to security of supply; competitiveness is increasingly becoming the main objective of the gas companies.

The organisation of security of gas supply can therefore no longer be entrusted solely to the industry. A new legislative framework is therefore required to ensure that all market players take basic measures to ensure that this objective is achieved.

It should be added that it is extremely important to avoid, in a rapidly changing market, any uncertainty as regards responsibility for security of supply. Any lack of clarity on this point will increase the risk of a supply crisis.

While the gas industry will have to continue to assume operational responsibility, the European Community now has a vital coordination and support role in relation to security of gas supplies. The role of the Community is to ensure the proper functioning of the internal market and give market players a clear framework within which they can interpret and manage change, while guaranteeing an adequate level of security of gas supplies.

As for oil, minimum measures are therefore needed to ensure the proper functioning of the internal market in gas. This will involve harmonised measures which will guarantee uniform and coordinated action between all Member States in the event of a supply crisis.

4. The solution: A Community framework

As the Green Paper on security of energy supply stated, the Member States are interdependent as regards both measures to combat climate change and the creation of the internal energy market. Any energy policy decision, particularly in relation to supply of oil and gas, taken by a Member State will inevitably have a knock-on effect on the functioning of the market in other Member States. Similarly, operations carried out by companies, aided by the gradual establishment of an internal energy market, are no longer limited to national territory.

Moreover, a response taken by a Member State to a change in oil and gas supply conditions without regard to the other Member States will have little or no real impact. A coordinated response by all Member States, acting in a spirit of solidarity, is the only means of finding effective solutions which will guarantee an adequate level as regards safety, security and the prevention of serious crises and accidents.

The European Union is furthermore engaged in the major political process of enlargement. Faced with this challenge, it is essential for it to take account of the proper management of one of its vital needs, namely oil and gas supplies.

Consequently, in accordance with Article 5 of the EC Treaty, the objectives of the proposed action cannot be sufficiently achieved by the Member States and can therefore, because of the scale or effects of the proposed action, be better achieved by the Community.

The Green Paper on security of energy supply has already considered various proposals in general terms:

* looking at ways of strengthening the system of oil reserves system by placing their use on a Community footing;

* the possibility of extending the oil reserves mechanism to natural gas reserves;

* the need to institute a permanent dialogue with producer countries with a view to improving price formation mechanisms, conclusion of agreements and the use of reserve stocks in the mutual interest;

* greater integration and diversification of supply networks and improved guarantees of their safety and security.

In its communication of 26 June 2002 to the European Parliament and the Council on the final report on the Green Paper on security of energy supply, the Commission indicated that geopolitical uncertainties and oil price volatility meant that thinking was needed on better organisation and coordinated use of stocks.

Objectives

The measures to be implemented to help ensure the proper functioning of the internal energy market will adopt a Community approach in order to:

* promote solidarity between the Member States of the European Union in the event of an energy crisis by putting in place predefined measures and mechanisms which will guarantee coordinated action;

* managing security of supplies by providing for adequate mechanisms to deal with physical disruption of energy supplies.

* manage the safety of supplies and infrastructures by adopting safety measures which will ensure maximum reliability of supply flows from producer countries.

* promote market stability, in consultation with producer countries, by providing for possible responses where the markets anticipate a physical disruption of supplies in order to restore the proper functioning of the market.

These objectives must be achieved within the framework of an internal energy market in which the Commission will take the necessary measures to ensure fair competition. Measures aimed at improving the supply of oil and gas will have little or no positive impact if they are thwarted by price manipulation or if access to transport networks is limited.

Measures aimed at improving the security of supplies must therefore not create any barriers to the entry of new players onto the European energy market or any additional difficulties for undertakings with small market shares. Attention will also have to be paid to ensuring that regulations introduced by the Member States guarantee fair and non-discriminatory conditions as regards storage, in particular for the construction of storage installations and access to storage capacities.

Given these objectives, and the points considered in the Green Paper on security of energy supply, a number of initiatives need to be taken at Community level.

Harmonising the organisation of oil stocks and promoting their coordinated use

1. Harmonisation of national storage systems

Some Member States have set up ad hoc bodies responsible for holding all or part of their security stocks. In others, the stocks are held by private operators.

This fragmentation of the storage mechanisms adversely affects the proper functioning of the internal market in energy. The independent distributors or importers of refined products which need only limited operational stocks consider that the obligations to hold stocks constitute a net cost that they have to bear whereas the refining companies would in any event hold stocks for operational purposes even where there is no requirement to hold security stocks. Storage obligations may therefore cause distortion of competition. To remedy this situation, all Member States will set up a public body to hold oil stocks which will own stocks representing at least one third of the new obligations imposed. This is very partial alignment of the rules on stocks in the Member States and does not cover everything that is needed, but it will help to improve the functioning of the internal market by establishing rules which will increase competition between the economic operators. The setting up of a central body responsible for strategic stocks will release independent distributors or importers of refined products from the obligation to build up these stocks themselves. They will be able to pay a reasonable charge to the central body for it to fulfil their storage obligation for them. These conditions for healthy competition between various types of oil distributor will help to guarantee diversity of sources of supply on the market and will therefore themselves contribute to improving the supply for consumers.

It should also be noted that security stocks currently suffer from a lack of visibility, and thus of credibility. The operational stocks held by industry may be taken into account as part of the obligation to maintain minimum security stocks. Stocks held in addition to operational stocks, for the specific purposes of security of supply, are therefore very difficult to identity. Having some of these stocks held by a central body will therefore make it possible to redress the lack of visibility of security stocks, and will guarantee the effective and efficient mobilisation of these stocks in the event of a crisis.

2. Coordinated use of security stocks

Community legislation provides only for mutual consultations between technical experts from the Member States, under the aegis of the European Commission, for the purposes of releasing stocks. Each State is therefore able to dispose of stocks however it wishes.

The mechanism currently used by the IEA (the CERM) is subject to the rule of unanimity between the 26 participating countries. Furthermore, even if action is taken under the aegis of the IEA, the broad discretion left to the States as to how they can contribute to the measure means there is a flagrant lack of unity of action.

In the future, the European Community must be able to decide on a common strategy which will be adopted by all Member States to provide an effective response to a physical or economic disruption of oil supplies. This strategy will give details of the measures to be taken, their objectives, their duration and the resources that the Member States will have to provide.

In order to be effective, the action to be taken in response to a disruption of oil supplies, or a threat of a disruption which is causing volatility in the markets (economic risk), must be rapid. Therefore, if there is an imperative need arising from oil market trends, the European Commission will be empowered to urgently adopt the necessary measures, taking account of the general objectives of the mechanisms for the use of security stocks. The Commission will be assisted by a committee made up of representatives of the Member States and chaired by a Commission representative.

3. Harmonisation of intervention criteria

Current EU legislation lays down rules for the use of stocks only in the event of a physical disruption of oil supply. This provides a way of managing an existing physical shortage but cannot be used to react to volatility in the markets due to particular expectations of a physical disruption of supply.

An analysis of volatility in the markets shows that the perception by operators of a risk of a potential future disruption leads to panic buying even supply and demand seem to be in balance. Moreover, the impact of "non-commercial" operators will be to accelerate and accentuate the effects of the perception of a physical disruption on prices.

In addition to the conventional criterion for the use of stocks, namely a physical disruption of oil supply, it is therefore necessary to provide for common rules on the use of security stocks in order to react in a unified and coordinated manner in the event of an economic risk, more especially if there is a general perception of a risk of a physical disruption which is causing volatility in the markets. Action taken individually by each of the Member States would run counter to the objectives of the internal market and would also be ineffective in re-establishing smoother operation of the oil market. Common rules will help to ensure the solidarity and unity of action needed for the proper functioning of the internal market in the event of a crisis.

Any decision by the Commission to take action will be based on the convergence of a number of factors pertaining to the precise circumstances of the energy crisis. It is clear that the "price" element will be one of the essential elements when defining an economic risk situation, given that the perception of a supply disruption will have an effect on prices. In these circumstances, the potential alert threshold should be deemed to have been reached when the price of crude oil on the spot markets is such that, if the price is maintained at this level for 12 months, the external oil bill of the European Union over the following 12 months would be increased by an amount equivalent to more than half of one percent of the GDP of the European Union in the preceding year as compared with the average external oil bill over the last five years. By way of example, in the present circumstances (2002), the Community mechanisms could be implemented by the Commission if the price of a barrel of Brent goes beyond a threshold of $30 (which corresponds to a threshold of around $28 for the OPEC basket).

This alert threshold is a necessary, but not a sufficient, condition for action in the event of a general perception of a risk of disruption of supply: exceeding the threshold simply initiates a phase in which the Commission examines all the factors contributing to the crisis, in particular the nature, duration and scale of the factors involved. Any decision concerning the advisability of taking action will be based on the convergence of several factors which make it possible to conclude to what extent there is a threat of a disruption of supplies necessitating a reaction.

In this new situation, in which mechanisms for using security stocks will play an increasingly important role, the volume of these stocks will have to be increased. The current minimum volume of 90 days' consumption will have to be increased to 120 days so that these crisis measures can be effective and credible. These stocks will be increased gradually, taking account of the possibilities of expanding the necessary storage capacities. Average Community security stocks are currently about 114 days' consumption.

In this respect, account will also have to be taken of the situation in the candidate countries for EU membership. Under the accession negotiations, transitional periods have already been agreed with most of these countries until 31 December 2009, to enable them to gradually build up security stocks equivalent to 90 days' consumption. The Commission expects the new Member States to adhere to the principle of building up security stocks of a volume equivalent to 120 days' consumption. It nevertheless recognises that, in duly justified cases, it will be necessary to allow the gradual introduction of new provisions aimed at boosting oil stocks beyond the transitional periods already agreed upon.

Harmonising minimum measures for the security of gas supplies

Although the conditions for stocking gas are different from those for oil and petroleum products, including the technology involved, the mechanism for fixing gas prices is nevertheless index-linked to that for oil prices. The problems which arise in terms of security of supplies and the solutions to be applied are therefore similar for these two energy sources. Hence the importance of putting in place, as for oil, measures providing for a certain level of gas stocks as well as the powers to release these stocks. These new measures will be incorporated into existing Community legislation aimed at granting third parties access to gas stocks.

1. Definition of a supply policy and clarification of responsibilities

Most Member States currently do not have a very coherent approach to guaranteeing security of gas supplies in the internal market. Before any other action is taken, therefore, Member States must take the necessary steps towards defining a general policy and standards for security of gas supply. This policy, which must contribute to the proper functioning of the new open market in gas, calls for a clear definition of the roles and responsibilities of the various market players as regards security of supply.

When they formulate this general policy on security of supply, the Member States will pay the greatest possible attention to the importance of ensuring continuity of gas supplies in difficult circumstances, especially to consumers who have no alternative energy source, and the need to ensure adequate stocks of gas or alternative fuels, to diversify supplies and to establish a balance between the various sources of gas supplies.

This policy of the Member States will have to be transparent. To this end, the Member States and the Commission will draw up reports at regular intervals which will describe the mechanisms put in place for emergency situations and unexpected events to reduce the effects of any crisis on the gas market and the levels of stocks and measures taken or planned to achieve the indicative stocking targets. The Commission will also evaluate the degree of harmonisation of the measures for the security of supply and their contribution to the functioning of the internal market in gas.

2. Harmonising minimum standards for security of gas supplies

Member States will take the necessary measures to ensure that the supply to vital consumers who are not in a position to replace gas with another fuel is assured in the event of disruption of the single biggest source of supply of gas for a period of sixty days under average weather conditions. Harmonised measures will also be taken by the Member States to guarantee security of supply, in the new open gas market, in the event of extremely low temperatures.

These security of supply standards will be implemented by means of instruments that Member States will use depending on the circumstances of the supply crisis and the peculiarities of the national gas market of each Member State.

Among the measures to be implemented in response to a disruption of supply, Member States will take the necessary steps to ensure that gas stocks make at least a minimum contribution towards achieving the security of supply standards. The establishment or maintenance of a minimum level of gas stocks will take account of the geological and economic storage possibilities in the Member States, since in some Member States the geological sites available for new underground gas storage facilities are limited or non-existent.

3. Coordinated use of crisis measures - Gas stocks

Uncoordinated action by the Member States in the event of an energy crisis is likely to jeopardise the proper functioning of the internal market in gas. For the proper functioning of the internal gas market and security of supply, it is essential that Member States should act in solidarity in extraordinary supply situations. Mechanisms must therefore be put in place which will allow the coordinated implementation at Community level of measures to face up to such situations.

Depending on the gravity of the situation, the Commission will therefore have to act to ensure that the necessary measures are taken to provide specific assistance to Member States which are particularly affected by the disruption of gas supplies. In these circumstances and given the specific characteristics of the natural gas market, there is good reason to have a dual intervention mechanism.

In the event of an extraordinary gas supply situation, including a serious disruption of gas supplies from one of the main suppliers of the European Union, the Commission will be able to issue recommendations to urge Member States to take the necessary measures to provide specific assistance to the Member States particularly affected by the disruption in supplies.

If the measures taken by the Member States are inadequate in the light of the market trend or if the economic consequences of the extraordinary gas supply situation become extremely serious, the Commission will be able to take a decision requiring Member States to take specific measures to provide the necessary assistance to the Member States particularly affected by the disruption in gas supplies.

These measures, which will be the subject of either a recommendation or a decision by the Commission depending on the circumstances, may include the deblocking of gas stocks, the provision of gas pipelines to supply the gas to the regions affected or the interruption of non-essential supplies to allow redistribution of the gas and guarantee the flexibility of the system.

As with the measures to be taken in relation to security stocks of oil, the Commission will be assisted by a committee made up of representatives of the Member States.

The new Community arrangements do not at this stage, as they do for oil stocks, lay down the minimum quantities of gas stocks that Member States should hold to guarantee security of supply. Nonetheless, they do introduce quantitative requirements as regards standards of security of supply. The new Community arrangements therefore in particular require Member States to define how they will guarantee that customers who are not in a position to switch to substitute fuels will continue to be supplied for 60 days in the event of a disruption to the largest supplier on the market concerned. To meet this obligation to guarantee supply for 60 days, each Member State will have to implement a combination of measures, including the storage of gas, but also the interruption of non-essential supplies to allow redistribution of the gas and guarantee the flexibility of the system and of supply.

This combination of different measures will enable each Member State to guarantee security of gas supply equivalent to the security of oil supply to which the compulsory oil-storage measures contribute, while taking account of the intrinsic characteristics of the gas market. Not all Member States are able to build up underground stocks due to unfavourable geological conditions. Some countries do not even have appropriate gas storage sites.

However, given the importance of storage among the various measures which can be implemented, it is planned that the Member States will have to determine national indicative targets for a minimum contribution of gas stocks to the security of supply standards. These stocks may be located in the Member States or outside their territory.

It should be noted that the measures with regard to gas supply, like the oil storage obligations, do not affect any measures which may be taken with regard to the security of storage installations.

4. Supply contracts

Long-term supply contracts have played a fundamental role in the development of the European gas market. They are essential for the launch of major investment projects for the development of gas fields and long distance infrastructure projects. For consumer countries, these contracts provide an element of stability for their purchases. Long-term contracts also facilitate diversification in the medium term of gas supplies in the European Union and help to bring new sources of gas onto the market, which encourages competition on the supply side. It should therefore be ensured that an appropriate proportion of gas supplies from non-EU States is based on long-term import contracts. The Commission will monitor the trend in the Member States' gas supply structure and, where appropriate, will be able to decide upon any measures that prove to be needed.

Alongside the long-term contracts, Member States will take the necessary measures to ensure greater liquidity on the gas market and the development of transparent prices in order to promote security of supply, facilitate access to gas and provide possible outlets for companies tied by long-term contractual obligations. In this connection, a minimum proportion of new supplies of gas will have to be based on short-term "spot" contracts or on long-term contracts whose prices are geared to the spot markets in gas.

A misunderstanding arose, first of all in relations with Russia, when certain third countries apparently took the view that the European Union was no longer in favour of these long-term supply contracts. The European Commission confirmed, however, that these contracts were a necessity, as a factor of stability for both producer and consumer countries. These long-term contracts are moreover expressly recognised in Community legislation on common rules for the internal market in natural gas.

The Commission will ensure that these contracts do not create distortions of competition, whether as a result of clauses which would result in restrictive market conditions or by creating dominant market positions. It is therefore important these contracts develop in line with the new elements of the internal market for gas.

Organising an energy dialogue between producer and consumer countries

All these measures for the coordination of action on the security of oil and gas supplies are conceivable only in cooperation rather than confrontation with the producer countries. The enlarged European Union borders the main oil and gas producing areas (Russia, Caspian Sea, North Africa). This geographical benefit of enlargement will have to be taken into account when deciding where to locate oil and gas stocks. These stocks could, for example, be held in the Member States and candidate countries or equally in producer or even transit countries.

The European Community must therefore develop, institutionalise and give substance to the energy dialogue between producer and consumer countries. In this context, it will act in cooperation with the International Energy Forum (Riyadh).

An energy dialogue between producer and consumer countries will help to provide greater stability of supply. It will also enable the safety standards of the European Union to be applied to external supplies, particularly as regards the construction and operation of oil and gas infrastructures or the transport by sea of gas and oil and dangerous derivatives.

Moreover, a more intense dialogue between the European Union and the producer countries is one of the essential conditions for improving the price mechanism and the conclusion of satisfactory supply agreements. As the Green Paper on security of energy supply underlined, such a dialogue must continue whatever the state of the international economy, whether prices are rising or falling, and it must also cover the conditions for the formation and use of stocks. More specifically as regards natural gas, this consultation framework could turn into a negotiation framework in order to meet among other things the need for long-term supply contracts.

From this point of view, the dialogue between the European Union and Russia could constitute a basic model. The Paris and Brussels Summits have confirmed that its aim is to create a new energy solidarity. Thus, actions have been initiated on security of networks, the protection of investments or the identification of major projects of common interest. It may be hoped that this dialogue will enable more effective use to be made in the future of long-term intergovernmental agreements and production-sharing agreements.

Moreover, the dialogue with Russia will not hinder any dialogue with other partners of the European Union, particularly Norway, the Caspian Sea countries, the countries of the European Mediterranean region and the Middle East. Consideration must also be given to relations with OPEC, an organisation with which relations should always be maintained, even when oil prices are not abnormally high.

Acquiring technical expertise for the implementation of measures

The creation of the internal energy market is a gradual and very complex process insofar as it involves very technical rules. It is therefore important to ensure that the new legislative framework is applied effectively and uniformly by all market players under conditions which will guarantee competitiveness.

It is for this reason that the various stages of completing the internal market in gas and electricity have been accompanied by mechanisms allowing the national regulators, the Member States, the economic operators and the Commission to attend technical meetings together (Florence Forum for electricity; Madrid Forum for gas). These working meetings examine the most appropriate measures to take in order to open up the gas and electricity markets and regularly submit highly technical recommendations to the Commission.

Similarly, the new Community framework to be established to consolidate measures, as part of the process of constructing the internal market in energy, relating to security of supplies of oil and gas will require complex and technical tasks to be carried out. It will be necessary among other things to monitor trends on international oil and gas markets and assess their impact on the security and safety of supplies of oil and gas. There will have to be continuous assessment of the effectiveness of the measures taken; in this connection, the level of stocks of oil and gas in the Member States will have to be monitored. For these tasks to be carried out, objective, reliable and comparable data will have to be available.

In the event of an energy crisis, when the European Commission decides on or recommends measures to release stocks of oil or gas, it will be necessary to assess the impact on the energy market and the economy as a whole.

It could also be mentioned that there is an increasing need to develop more reliable price indices more attuned to the realities of the market than the current ones. The Commission has already stated, in its communication of 4 October 2000 on oil supplies in the European Union, that the producer countries, market operators and the industry should be encouraged to improve price formation indicators, particularly on the basis of a global index which would reflect the whole of the market.

It therefore appears essential to create, within the Commission, a European observation system for oil and gas supply, which will gather the necessary expertise in order to respond to the highly technical issues involved in these tasks. It will provide, under the aegis of the Commission, the technical and scientific assistance and high level of expertise to assist in the correct application of Community legislation in the field of oil and gas supply.

This European observation system will be run by the Commission, which should invite to the meetings representatives of the Member States as well as representatives of the sectors concerned.

5. Conclusion

The European Community is gradually putting in place the conditions required for the establishment of an internal market in energy. The achievement of this objective should make the economy of the European Union more competitive and lead to a significant reduction in consumer prices. It will also help to improve internal security of energy supplies.

The completion of the internal market in energy must be accompanied by the necessary coordination of the measures which will guarantee security of external supplies of both oil and natural gas. The creation and development of an internal market in energy makes the Member States increasingly interdependent as regards the security of their supplies. Not having minimum rules on the security of supplies for all the Member States is therefore likely to adversely affect the proper functioning of the internal market in oil and gas.

The only way of guaranteeing an adequate level of safety and security of energy supplies which will contribute to the smooth functioning of the internal market in energy is to take action at Community level and globally. A coordinated and joint reaction by the States which make up the single internal market is the only effective response to an energy crisis.

The coordination of action by the Community with action by other consumer countries, including within the IEA framework, should therefore be prioritised, since action in the event of a crisis or threat of a crisis requires the deployment of means at the most global possible level.

It is therefore necessary to provide the European Union, in coordination with the International Energy Forum (Riyadh), all the consumer countries and the producer countries, with its own means of responding to energy crises. It is above all necessary to provide for means which will enable the European Union to better coordinate measures with regard to security of supplies. These mechanisms will contribute to the construction of the internal market in energy.

This initiative, which concerns an essential feature of the functioning of our economies, should be made even more of a priority since it will be part of the process leading to the accession of new countries to the European Union which are highly dependent on energy from fossil fuels. The European Community will take account of the situation in each of the candidate countries in order to provide, if necessary, for transitional periods for some obligations.

Appropriate measures for the security of oil and gas supplies will reduce the permanent or temporary risks of physical disruption and the economic risks linked to supplies. These means of action will be implemented in cooperation with the partner producer countries as part of an energy dialogue not only with the OPEC countries but also the main partner which is Russia.

In the light of the above, the Commission proposes, on the basis of Article 95 of the EC Treaty, two legislative measures, namely:

(1) A proposal for a Directive of the European Parliament and of the Council concerning the alignment of measures with regard to security of petroleum product supplies.

(2) A proposal for a Directive of the European Parliament and of the Council concerning measures to safeguard security of natural gas supply.