Communication from the Commission - The European Union's oil supply
Date: 2000-10-12
Institutions: European Commission
Subjects: energy policy, energy supply, petroleum product, price of energy, security of supply

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 11.10.2000
COM(2000) 631 final

COMMUNICATION FROM THE COMMISSION

The European Union's oil supply

CONTENTS

I. Present situation

1. Crude prices

2. Refining and distribution margins

3. Oil product taxation

II. Medium- and long-term prospects

1. Key figures

2. Key factors to be taken into account

a)

environment

b) Security of supply

(i) The geopolitical context

(ii) Strategic reserves

- The role of the International Energy Agency

- European Union legislation

- The USA's Strategic Petroleum Reserve

III. Possible action

1. Relations with producer countries

P. 3

P. 3

P. 5

P. 6

P. 7

P. 7

P. 8

P. 8

P. 9

P. 9

P. 10

P. 10

P. 11

P. 12

P. 13

P. 13

2. Competition policy in the oil sector downstream (refining - distribution)

P. 13

3. Use of tax instruments on oil products

4. Achieving a balance between modes of transport

5. Making Europe's economy less oil-intensive

IV. Outlines of a strategy

Annexes

P. 14

P. 14

P. 15

P. 17

P. 18

-2-

I.

PRESENT SITUATION

Oil prices in the last few weeks have reached historical levels since the Gulf War. This
increase in oil prices since early 1999 has triggered a debate over the three components of
the prices paid by European consumers: 1) the price of crude oil; 2) refining and
distribution margins and 3) the taxation of oil products.

The sharp rise in prices is clearly due to the crude oil market. It is essentially of course the
result of OPEC's restrictive production policy, i.e. its decision on production quotas, a
decision that was made as a result of the extraordinary low level of prices in 1998. The
high growth in demand has also played an important role and, to a lesser extent, the
weakness of the euro in relation to the dollar. That said, the other price components
should also be considered to see if there is any room for manoeuvre in those areas.

Against this background, it is also necessary to consider the impact of this rise and new oil
price volatility on growth and inflation in the European Union. If oil prices stay at around
$ 30 a barrel during the rest of the year the negative effect of the price increase on growth
would be 0.3% for the year 2000 and 0.5% for 2001. The increase in price would add 1%
to the inflation rate. A part of this impact was already incorporated for the forecast for the
spring. The final consequences would depend on the combined effect of oil price and
other components of growth and inflation. The impact of the price increase is, however,
more significant for developing countries, their economy being more strongly dependent
on oil.

Despite the concern caused by the increase in prices, the situation nevertheless needs to be
seen in relative terms. Looking at a long period, it can be seen that prices, including taxes,
have been higher during the last twenty years. In 1981, for example, the prices of diesel
and petrol, at constant prices for the year 2000, stood at 1092 and 1510 euros/1000 litres,
respectively, as compared with 908 and 1132 now. Diesel excluding tax was at 675
euros/1000 litres compared with 372 in 2000. In France, for example, at constant rates,
the average price paid by motorists at the pump has been FF 6.6 on average in 2000,
as against FF 5.9 in 1990 and FF 7.3 in 1985. There has also been a structural fall in
consumption per kilometre for a number of years.

The key problem which has confronted the Union since 1997 is the strong volatility of
prices. The fall in price to $ 10 a barrel, the increase in demand and the reactivation of the
OPEC cartel have produced a sudden reversal of price tendencies. At the same time, the
excessive price increase during 2000 may exercise too strong a pressure on certain sectors
of the economy and produce a deterioration of the economic climate.

The reduction in economic growth due to the increase in oil price also has an impact on
employment. Nevertheless, for both 2000 and 2001 the Commission expects a net increase
in employment, given the very favourable economic forecasts, even taken into account the
increased oil price.

The vulnerability of the European Union to the increased oil price which it has
experienced in recent months recalls the need for a policy of reduction in the energy
intensity of our economies. A stable and predictable level of fuel prices could give rise to
both economic and environmental benefits.

-3-

1.

Crude prices

Apart from brief respites during April and towards the end of July, the price of crude oil
now seems determined to stay around $30 (for a barrel of Brent-quality North Sea oil).
It reached that level in February 2000 following an interrupted rise since December 1998,
at which point it had bottomed out at $10 a barrel.

The slight fall in oil prices following the USA's decision to release a very small amount of
oil stocks (two days' consumption) should be interpreted prudently. The psychological and
speculative factors that explain the volatility of prices are just as important as the physical
reality of the balance between supply and demand.

The main cause of the trebling in prices during 1999 and the first half of 2000 has to be
sought in the restrictions on production adopted and actually implemented by a group of
oil-producing countries (OPEC and occasional allies). OPEC's behaviour, as a cartel, on
that occasion gave the lie to the view held widely since the mid-80s, namely that OPEC is
a cartel in name only and that we have entered a period of low, stable prices,
reflecting a market which has become competitive.

The major fall in price observed in 1998 to $ 10 a barrel with the possibility of reaching
$ 5 a barrel acted contrary to this judgement to increase the solidarity among OPEC
members, even if their long-term interests continue to diverge structurally, and some other
producer countries.

The economic environment was also extremely favourable. With a price level of $10 per
barrel at the end of 1998, oil companies saw their profits collapsing. The number of
exploration and production projects in some non-OPEC regions where production costs
are high, such as the USA, the North Sea and the Caspian Sea basin, fell sharply.

The financial crisis in Russia, which was made worse by the collapse of its revenue from
crude oil prospecting, and the rising public finance deficit in Saudi Arabia and some other
major producer countries were also worrying factors which caused instability.

The tightening of production quotas imposed by OPEC in a situation of lively demand
reduced oil stocks to a particularly low level in early 2000 and was the "physical"
component of the rise in prices.

In geopolitical terms, there have also been the recent difficulties in the peace process in
the Middle East, the embargo on Iraq and the uncertainty in developments as
regards Iran and Libya, though it is not possible to define exactly what influence they
have had on the behaviour of the OPEC members.

Lastly, one cannot ignore the financial impact of speculation brought about by the
increase in "paper" transactions in the futures market (International Petroleum Exchange
in London and New-York Mercantile Exchange in the USA).

Some of these factors are still enabling, and for the next year or two will probably
continue to enable, OPEC to retain a certain amount of control over the market and to
keep up the pressure on it by means of a production policy of holding stocks in the
consumer countries at a low level. However, the expansion of non-OPEC production,
notably in the Caspian Sea basin, which reacts sluggishly to price movements, could in

-4-

time complicate the equation for OPEC, like the situation following the oil crisis in the
1970s.

A major factor to be taken into account is OPEC's decision to introduce a price-band
concept centring on a "target price" of $25 per barrel, with a floor at $22 and a
ceiling at $28 (based on a composite OPEC barrel). If the OPEC price falls below the $22
floor for ten consecutive days or goes through the $28 ceiling for more than 20 days in
succession, the member countries have agreed to consult each other in order to adjust
their output levels. These consultations would lead to market intervention in the form of
cutting or boosting production by 500 000 barrels per day (1 million barrels per day = 50
million tonnes a year). A striking factor in this agreement is Saudi Arabia's support since,
shortly before, it had again expressed a preference for a price band of between $20 and
$25 per barrel for Brent quality, nearly $4 lower than the "OPEC price band".

In fact, the "ideal price" from the producer countries' point of view must be a
compromise between their wish to maximise their short-term income and consideration of
the longer-term adverse effects of excessively high prices on that income (expanding non-
OPEC production and alternative energy sources, curtailing demand). Given the objective
differences in the situations in the producer countries (see section II.2.B), the "ideal price"
necessarily differs for the various categories of producer countries: the decision on the
range is therefore to some extent an unsatisfactory compromise (the "ideal price" in fact
being close to the ceiling for some and close to the floor for others).

There is nothing automatic about this mechanism. Its effectiveness in stabilising prices is
very relative. It should also be noted that it is extremely risky, if not impossible, to set
production quotas to achieve a target price. OPEC always fears that it might decide to
raise quotas too much, thus causing prices to plummet, as happened at the end of 1997
(that concern was indeed voiced once again by the Venezuelan Oil Minister at the end of
July). In conclusion, therefore, it can be said that, although the agreement on this
mechanism should make it possible to stop prices rising and staying above $35, it does not
guarantee stabilisation at the "target price" of $25, even in the long run.

Everything seems to suggest that we are moving into a situation where oil prices will not
in future fall back to the levels seen 18 months ago and will remain very firm over
the months ahead in the context of an extremely sensitive geopolitical situation:
troubled Middle East peace process, weak economies in some small producer countries,
difficult reform process in Russia.

Our economy and policies will have to adapt to this new situation.

The Commission considers that the objective must be the stability of oil prices at a level
neither too high nor too low. This level should be sustainable in the long term, responding
equally to the needs of the producing countries and to those of the consuming countries.

2.

Refining and distribution margins

The question motorists always ask when they see that the price at the pump has shot up is:
"Does the increase really reflect a rise in the price of crude?" As shown by the
appended graph comparing movement in average petrol prices in the European Union and
"Brent" oil prices, the answer is "yes" up to March 2000. It can be seen that in 1999 there
were two closely correlated trends, with the rise in petrol prices lagging slightly behind
that of crude oil. However, since March 2000 there has been a split, with petrol prices

-5-

rising more slowly than the price of crude during the spring of 2000. Very recently,
refining margins have therefore reached levels unprecedented since the Gulf War. It
should, however, be pointed out that the policies of vertical integration applied by the
national companies of several producer countries, in particular in the Middle East, and the
opening up of the European Union market had made it easier for these companies to
position themselves in the oil product storage and distribution sectors. Benefiting from
upstream preferential transfer prices, the margins recorded by these companies could be
significantly higher than those of competitor companies buying in on the market.

However, the main point to note is that there are major differences when comparing
consumer prices for oil products, exclusive of taxes and duties, between Member
States. For example, the price before taxes and duties of "Euro super 95" at the end of
May 2000 was
344 in the United Kingdom
€
(
346 in France), a difference of 31%. These differences, worrying as they are, existed
before the current price surge and therefore have no causal relationship with it.

452/1 000 litres in the Netherlands, but

€

€

In recent surveys of the application of the Community Regulation on the control of
concentrations, the Commission analysed the competitive situation in the fuel distribution
sector in a number of Member States. It was stressed that, while some cost factors might
vary between Member States, only oligopolistic behaviour and a lack of competition
in distribution can explain the price differences. For example, British and French
motorists benefit
from the competition produced by non-specialist distribution
(supermarkets).

On the basis of such an analysis, the question which obviously arises is whether or not
there has been an infringement of competition law, in particular whether there are
any cartels (pricing agreements). The national authorities in a number of Member States
have begun to investigate this. In Italy and Sweden, the competition authorities have
imposed sanctions on oil companies.

3.

Oil product taxation

The final price of oil products (to the consumer) includes a large proportion of taxes. These
taxes are of two kinds: excise duties, which are specific (fixed) duties, and VAT, which is an
ad valorem duty (proportional to the selling price of the product).

The proportion of tax in the price of oil products varies considerably from one country to
another. For example, the amount of excise duty on diesel for road haulage varies from
€
777/1000 litres in the United Kingdom, compared with a
245/1000 litres in Portugal to
minimum rate of
245. It can therefore be estimated that the total amount of tax on fuels
accounts for 50-60% of the consumer price in the countries with lowest taxes (Greece,
Luxembourg, Portugal, Spain) and up to 75% in the United Kingdom.

€

€

The sharp rise in the price of oil products has itself also increased the amount of tax. This
"snowball" effect is quite simply due to the fact that VAT is expressed as a percentage of
the selling price of the product. Oil price rises therefore result in an immediate increase in
VAT for consumers, with the advantage that it is easy to collect. Revenue from excise
duties, on the other hand, decreases if prices rise, as these duties are levied by volume.

-6-

II. MEDIUM- AND LONG-TERM PROSPECTS

1.

Key figures

Since it is linked to population growth (8 billion inhabitants in 2020 and 10 billion in
2050) and an annual growth rate in the world economy which will approach 3.5% over
the next two decades, world energy demand is expected to increase from 9.3 billion
tonnes oil equivalent (toe) in 2000 to 15 billion toe in 2020.

World oil consumption should be about 115 million barrels a day in 2020, as
compared with around 77 million barrels a day in 2000, an increase of 50%.

OPEC should cover 50% of this demand by producing about 55 millions barrels a
day, as compared with 32 million barrels a day in 2000. OPEC's willingness to produce
can be explained by the fact that production costs should remain extremely favourable,
even in a low-price scenario. OPEC production costs currently average around $2 per
barrel. High profit margins will provide an incentive which it will be difficult for it to
resist.

The volume of non-OPEC production, which currently costs an average of $5 per
barrel, but with a marginal cost of more than $10, will be closely linked to price
movements since reserves will continue to be plentiful. Some oil production areas in
Russia and the Caspian Sea basin are extremely important for the European Union in this
respect. It is estimated that a crude oil price of about $20 should make it possible to
guarantee the investment in production in non-OPEC regions which will be needed
because of rising demand over the next twenty years.

The European Union is, and will continue to be, highly dependent on imports. This trend
will increase since energy dependence will rise from 50% in 2000 to about 70% in 2020.
Energy consumption, which currently exceeds 1 400 million tonnes oil equivalent (toe)
can be broken down as: 16% solid fuels, 42% oil, 21% natural gas, 50% nuclear energy
and 6% renewable energy sources.

If the current tendency continues in the absence of a strong policy of improving energy
efficiency, of promoting renewable energy sources and of structural changes in the sectors
that have the highest energy consumption, Gross domestic oil consumption in the
European Union will increase in a significant manner. Compared with 12 million
barrels a day (600 million toe) in 2000, it is likely to grow to 13.2 million barrels a day
(660 million toe) in 2020 even though it should develop four or five times less rapidly
than world demand. It should be stressed that 93% of this increase is likely to be
accounted for by transport. The European Union (2.6 million barrels a day) plus
Norway (3 million barrels a day) are expected to produce about 6 million barrels a day in
2020 as compared with 7 million barrels a day in 2000. With the prospect of the
enlargement of the European Union, the ratio between production and consumption looks
set to deteriorate considerably since none of the applicant countries, except Romania, is
an oil producer.

In terms of the structure of the final energy consumption of oil in the European Union
(402 million toe in 1995; 487 million toe in 2020), only the transport sector should see
a significant increase in consumption from 270 million toe in 2000 to 348 million toe
in 2020. This sector will therefore represent 71% of final demand for oil as compared
with 7% for industry, 8% for the tertiary sector and 14% for the residential sector. As far

-7-

as intermediate oil consumption by the electricity industry is concerned (75 million toe in
1995; 49 million toe in 2020), thermal power stations should not consume more than 7%
of our supplies in 2020. Non-energy consumption (80 million toe in 1995; 92 million toe
in 2020), mainly by petrochemicals,
should represent 14% of gross domestic
consumption.

There is a major potential for households to switch to natural gas. The present principle,
whereby the prices of natural gas are to a certain extent linked to the cost of oil, since
there is no real competition between gas suppliers, is likely to affect consumers in terms of
electricity and natural gas charges. Speeding up the completion of the internal market in
natural gas is therefore a major objective in this respect.

Furthermore, in order to avoid an excessive concentration of upstream supply on a few
exporting countries and therefore to strengthen competition in the long term, prominence
needs to be given to the increasingly important part which liquefied natural gas (LNG)
should be playing. However, this development will depend on the economies of scale
which can be achieved in this sector and continuation of the introduction of new
technologies, chiefly in the transport sector.

There is significant potential for substitution in the road haulage industry. In the short and
medium term, electrically powered vehicles will make a comeback in the form of a hybrid
electric car, with the use of NGV (natural gas for vehicles) meeting the highest
environmental quality standards for captive fleets, and biofuels for all types of vehicle.
Nevertheless it is necessary to take care that the global energy cycle and the balance of
greenhouse gas emissions are duly taken into consideration before adopting the most
appropriate technology and the consequent options in terms of fuels. Although biofuels
help to cut consumption of oil products, the fact remains that their energy balance is
negative at the moment. As they are relatively costly to produce, further research and
experimentation are needed so that production costs can eventually be cut to the point
where they are equal to the cost of oil, which will inevitably continue to rise. Lastly, the
direct use of hydrogen as a substitute fuel or its indirect use in fuel cells also offers
encouraging prospects.

2.

a)

Key factors to be taken into account

Environment

The European Union has set itself the target of reducing greenhouse gas emissions, under
the Kyoto Protocol, by 8% between 2008 and 2012 compared with the 1990 level. In
2010, CO2 emissions due to oil product consumption will account for more than 50% of
total emissions.

The transport sector will experience a particularly sustained increase in emissions. If no
voluntary action is taken, these are likely to increase by 35% by 2010 compared with
the 1990 level. Efforts therefore need to focus on this sector.

Furthermore, the problems in this area are not limited solely to CO2 emissions and climatic
change, but also include atmospheric pollution due to other harmful emissions, particularly
in the urban environment.

-8-

For all gaseous waste, transport is responsible for 12% of S02 emissions, 69% of nitrogen
oxide emissions, 64% of carbon monoxide, 49% of volatile organic compounds (VOC)
and 33% of particulates.

Although it is extremely difficult precisely to quantify the negative external factors due
to transport, it is clear that the main areas calling for government action are the use of
cars in towns and cities and long-distance road haulage.

The major effort that will have to be made in this area under the Kyoto Protocol will
require radical action as regards the choice of transport modes. These policies will
obviously involve reducing the consumption of oil products.

In addition, the growing environmental constraints in terms of the specifications for
oil products and the change in the structure of demand for fuel are leading to major
investment programmes in the refining industry which are likely to be reflected in a
moderate price increase for products to the consumer, chiefly in the transport sector.

Lastly, the maritime disasters in connection with the transport of oil products by sea,
the most recent being that of the oil tanker "Erika", have prompted the European Union to
plan for stricter regulation of ship standards.

b)

(i)

Security of supply

The geopolitical context

The European Union's dependence on oil imports, which is already particularly high at
75% of its oil supplies in 2000, is likely to increase yet further and exceed 85% by the
year 2020. In 1999, 43% of our oil supplies came from OPEC countries, 30% of these
from the Persian Gulf.

More than 70% of the world's oil reserves are in OPEC member countries. In 2020,
40% of the world's production will come from the Persian Gulf.

Recent events on the oil market tend to prove that, while OPEC is sometimes described as
a weak, heterogeneous cartel, centralising forces are prevailing at the moment, even if
Saudi Arabia, Venezuela, Iran and Kuwait appear to have had most influence on
decisions taken over the last
the interests of, and the
two years. The fact
constraints on, the sovereign States which make up OPEC are multiple and complex, and
to a large extent diverging if not contradictory.

is that

Although some of the member countries are in favour of maximising prices in the short
term as they have low reserves, a large capacity for absorbing oil revenues and a high
degree of production capacity utilisation or a relatively low GDP, such as Algeria,
Venezuela or Iran, others, such as Saudi Arabia and other Persian Gulf producers, prefer
to vary prices over the longer term as they have abundant reserves, a low absorption
the
capacity and often surplus production capacity. They therefore wish to prevent
emergence of substitute energy forms and at the same time to maintain oil's position on
the world energy scene in the medium and long term, together with their market share.

In the light of the above, it was no coincidence that Venezuela was one of the countries in
favour of cutting production quotas in early 1999, when the price of crude fluctuated
around $10 per barrel, that Iran and Algeria were particularly reluctant to relax the

-9-

production quotas agreed by OPEC in March 2000 and that Saudi Arabia discreetly
released further quantities onto the market in order to reduce prices.

Geopolitical factors have also played a part in these developments. The differences of
opinion within OPEC which emerged just as the Gulf War began, the internal tensions
regarding the oil embargo against Iraq, the uncertainly surrounding developments as
regards Iran and Libya as well as the common position of the Arab countries on the
Israeli-Palestinian conflict are equally factors which do not
facilitate the smooth
functioning of the oil market.

Iraq's role in the years ahead is also a major unknown factor. During 1999, Iraq managed
to increase production to 2.8 million barrels a day and achieve just over $5.2 billion in
oil exports as authorised by the United Nations Security Council resolutions under the
"Food for Oil" programme. It can be estimated that, if the sanctions were lifted and with
the assistance of foreign investors, production could relatively quickly rise to 3 to 4
million barrels a day.

Although there is no reason to fear a physical shortfall in the foreseeable future, it is not at
the same time possible to anticipate OPEC's behaviour as a cartel and the political
concerns which may occasionally affect its attitude. However, several factors stand out
which are likely to have a decisive effect on price levels, namely the importing
countries' growth rates, the progress made in curbing demand, the addition of new
reserves and the tightening of environmental protection standards.

In the long term, taking account of the concentration of reserves in the OPEC countries, it
is technological developments which will pose the principal threat to OPEC, namely new
production technologies
in difficult areas, using non-conventional oil, and the
development of new substitute fuels and the associated technologies, chiefly in the
transport sector.

The role of the countries of the former USSR may also prove to be particularly
important for the European Union since, in 1989, they were still the world's leading oil
producers with production of more than 11 million barrels a day. Production in this region
could double over the next 20 years from 7.8 billion barrels a day in 2000 to 14 million
barrels a day in 2020. The known oil reserves in the Caspian Sea basin (25 billion
barrels) are about equivalent to those in the North Sea and the USA. Potential reserves
could exceed 200 billion barrels, i.e. 25% of known reserves in the Middle East.

With regard more especially to the European market, the high degree of penetration of
natural gas - a potential substitute for oil - should be an incentive for the European
Union to cooperate more closely with the two main natural gas suppliers (Russia and
Algeria) by providing support for gas extraction and transmission. At the same time, it
should keep to its priority objective of diversifying sources of supply, in particular by
means of LNG imports.

(ii)

Strategic reserves

An event, such as a political and/or military incident, in an oil-producing or transit region
could disrupt a major proportion of the world's oil supplies at any time. Emergency
stocks and crisis measures, as provided for in the framework of the International
Energy Agency and under Community legislation, are a partial response to this type of
threat. Work in this area must be continued if not stepped up.

-10-

The role of the International Energy Agency

The key points as regards strategic stocks were laid down in 1974 by the signature of the
"Agreement on an International Energy Programme", which created the IEA. At the
moment, all EU Member States are IEA members.

One of the main commitments of IEA member countries is to maintain a level of stocks
equivalent to 90 days' net imports of oil and/or oil products which can be used in the event
of a supply crisis to replace all or part of the shortfall in supply.

The 1974 Agreement also establishes a mechanism for an interdependent, coordinated
reaction in the event of a supply crisis. The main features of this mechanism, which is
based on the principle of "equal misery", are:

– a "trigger" threshold at 7% of supply disruption;

– a uniform obligation for all member countries to reduce consumption (percentage

reductions predefined according to the level of disruption);

– a centralised, predefined procedure for activation of stock disposal and allocation of

available oil among member countries.

The essence of the mechanism is that, once it has been activated, the rights and obligations
of each country are automatically calculated in accordance with predefined procedures.

In 1984, another crisis mechanism, referred to by the acronym CERM (Coordinated
Energy Response Measures), was developed within the IEA. This mechanism is much
more flexible than the 1974 mechanism: it can be activated below the 7% threshold and
does not include a mechanism for allocating oil among states. It more simply involves
each state making an equivalent effort to restore the market balance. The specific nature
of the effort (reduction of consumption, stock disposal, raising of indigenous production,
a combination of these) is decided by each member state.

European Union legislation

Community legislation in this field consists of the following:

1)

Directive 68/414/EEC, as amended by Directive 98/93/EC

These Directives impose an obligation on Member States to maintain a level of stocks
equivalent to 90 days' consumption for each of the three main categories of petroleum
products for energy use (stocking crude oil instead of products is authorised provided
certain rules are complied with).

Directive 68/414/EEC provides that the Commission arranges for consultation with the
Member States before they reduce stocks below the 90 days' limit.

Note also that some Member States currently hold more than 90 days' stocks, which can
be released before any Community consultation (see the attached table).

2)

Directive 73/238/EEC

-11-

This Directive has two aims. Firstly, it obliges the Member States to be ready to act, i.e.
to provide themselves with intervention plans, appropriate bodies and powers in particular
to enable stocks to be released onto the market, to restrict consumption, to safeguard the
supply of priority consumers and to regulate prices. Secondly, in the event of a crisis, the
Commission is instructed to arrange for consultation among the Member States for
coordination purposes.

The USA's Strategic Petroleum Reserve

This initiative goes back to 1975, two years after the first oil crisis. The Energy Policy and
Conservation Act (EPCA) provided for the holding of strategic stocks of some 1 billion
barrels of oil for use in the event of war or major disturbances leading to the disruption of
supplies. The logical site for this reserve was in the Gulf of Mexico (Louisiana and Texas)
where there are more than 500 salt mines.

This reserve currently contains 571 million barrels, an investment of about $20 billion at
today's prices. For the record, the USA recently decided to release 30 million barrels from
this reserve, just under two days' consumption, in order to make up for an excessively low
level of product stocks which might lead to a shortage of heating oil during the coming
winter.

These mechanisms have all been developed to deal with a serious disruption of supply, but
not as a means of responding to market factors such as high or volatile prices. However, it
should be noted that the USA's intervention last week had a marked influence on the
psychology of the market.

III. POSSIBLE ACTION

Relations with producer countries

While it is in the interest of both producer and consumer countries to see where prices are
heading, these prices have to find their level in a competitive market and not through a
group of producers intent on maximising monopoly revenues. Any other approach would
be to be benefit neither of consumer countries, who would be obliged to step up
investment into substitute products ahead of time, nor of producer countries, who would
be faced with a long-term stagnation of prices due to falling demand. Furthermore, in the
short term it is not in the interest of producer countries to jeopardise world growth, a
possible outcome of their current production policy.

At political level it is important for the European Union to pursue its dialogue with OPEC
and its principal member countries. As a major economic power and the second world
consumer of oil, the European Union has to make its voice heard so as to obtain greater
price transparency and, in the longer term, stable prices.

Our message to producer countries must emphasise the vulnerability of the world
economy to the high prices that would result from irrational management of the world's
natural resources and thus the need to start a constructive dialogue on how the market
might operate better and how to achieve greater transparency.

Finally, the European Union should continue to focus on and lend support to countries
on the Caspian Sea, in particular by way of the Community's INOGATE (Intergate Oil
and Gas Transport to Europe) programme of technical assistance. A watchful eye needs
to be kept on the Russian Federation's interest in the potential of the Caspian Sea

-12-

basin and its transport infrastructure. This is why it has asked to play a greater part in
this programme.

Rehabilitation and optimisation of the oil and gas networks of the former USSR,
thereby freeing the resources of Russia and the Caspian Sea basin, should help in the long
term to improve the oil supply of an enlarged European Union.

2.

Competition policy in the oil sector downstream (refining - distribution)

It is essential to promote a more open and competitive structure in the fuel distribution
sector. A critical factor lies with the development of a real internal market for refined
products (in the wholesale market) to make for ready and competitive supplies to all
distributors, including those which are not national refineries.

To this end a systematic comparison of the prices of oil products in the Member States
would highlight disparities between them.

The Commission will maintain its contacts with national competition authorities in order
to exchange experience and views in this area. The meeting that it organised on 29
September made it possible to examine how competition policy can help to make the fuel
sector more competitive. This meeting clearly showed that the competition authorities (at
National and Community levels) are ready to intervene immediately when the market
operators appear to wish to exploit the sitaution by anti-competitive behaviour. The
Commission will also continue to be vigilant in applying the merger control rules in this
sector, as in the cases of BP/Amoco and TotalFina/Elf. Any abuse of a dominant position
should be severely punished.

3.

Use of tax instruments on oil products

Given the massive proportion of tax in the price paid by consumers, a fairly widespread
idea, and one taken up by OPEC, is to offset the price of oil products by lowering
taxes. Capitulating on this front would amount to transferring tax revenue to the
member countries of OPEC and encouraging them to keep their rates artificially high since
the effect of crude increases on consumer prices would be offset by tax reductions.

Utilisation of
orientations and the commitments made in terms of budgetary consolidation.

instruments must be compatible with political and economic

fiscal

Piecemeal tax cuts are not fully compatible with European law, even if the latter is far
from achieving genuine harmonisation of excise duty and VAT rates.

The sixth Directive on VAT provides that oil products should be subject to the "standard"
minimum rate of 15%. Member States may not introduce lower levels of VAT into
their national taxation laws for certain uses of oil products. Only the reduced rates
that existed in 1991 may be retained as part of transitional measures.

In terms of excise duty Community legislation provides only for a very low minimum
rate compared with the average levied, these level decided in 1992 have not been
subject to re-evaluation since then. On the other hand, several special arrangements
allow Member States to waive or reduce excise duty on oil products. Several exemptions
or reductions are expressly provided for by Community legislation. A good example is the

-13-

total exemption of excise duty on fuel used for commercial air navigation (kerosene)
and commercial navigation in Community waters.

Community law also allows Member States to submit a particular request to the
European Commission for applying exemptions from, or reductions in, excise duties
other than those expressly permitted by Community legislation. Several Member States
have recently announced reductions in excise duty on diesel fuel for road haulage. Some
of these are covered by exemptions up to the end of the year 2000, others are not. The
Commission is currently re-examining these requests with a view to preparing a
proposal to submit to the Council, which has to give a unanimous decision.
Although these derogations can be justified by very short-term factors they are not
consistent with the European Union's objectives in terms of environmental, energy
or transport policy.

One-off measures must also be assessed as to whether they constitute State aid within the
meaning of Article 87 of the EC Treaty, which can distort competition and thus erect
barriers to the completion of the internal market.

tax rates between Member States

Upward harmonisation of
therefore
unavoidable. And this is what the Commission is proposing in its draft directive on the
taxation of energy products, which has been before the Council of Ministers since 1997.
This recalls the need to evolve towards the qualified majority for certain aspects of
decision making with regard to indirect taxation at the IGC.

is

In this way, the temptation to offset prices by tax cuts should be discouraged. It is
precisely the opposite approach that is needed, with genuine harmonisation of excise duty
on fuel.

The only conceivable adjustment mechanism relates to VAT. A decision could be taken to
stabilise VAT revenue in the event of significant fluctuations in oil prices.

4.

Achieving a balance between modes of transport

Transport is the largest consumer of oil products, more than 80% of which are consumed
by road haulage. With economic growth boosting transport demand, this trend can only
increase. By the year 2010, freight traffic is projected to grow by 38% and passenger
traffic by 19%; this trend will be characterised by a growing imbalance at the expense of
rail traffic. While in 1970, road haulage represented less than half of traffic, it now
accounts for 80%.

Faced with the congestion of our main road routes and town centres, along with the
environmental consequences of this, we must break this vicious circle and work towards a
new balance between modes of transport, by:

– Revitalising the railways, notably by modernising public services and opening up to

competition; Encouraging the development of short sea shipping.

– Reviewing the conditions for access to the road haulage profession and tightening up
the enforcement of social and safety regulations. Over-capacity in the EU road haulage
industry is estimated at 30%, so it should be restructured through social measures, not
tax cuts.

-14-

– Infrastructure investments to avoid the bottlenecks in the rail networks and to develop
financial solutions, e.g. using

the European rail network. This requires novel
investment funds fed by tolls on the competing road routes.

Finally, rationalising the use of private cars in city centres and promoting clean urban
transport are also priority objectives. The question also has to be raised as to the
competitive conditions between certain modes of transport, in particular air against high-
speed rail connections, especially in the context of tax-exempt aviation spirit. The
proposed directive concerning the taxation of energy products, on the Council table since
1987, would permit taxation of aviation fuel at Community level.

5. Making Europe's economy less oil-intensive

Europe's oil intensity has already been reduced by half compared with 1973 (thus
making Europe's economy less susceptible to the recent price rises than during the oil
crises of 1973 and 1979-80), even though in the past this reduction was due more to
economic factors than to any deliberate action by the public authorities.

Developments on the energy markets show that in all sectors government influence on
supply is constantly diminishing, whether in terms of opening up energy markets to
the impact of
competition, globalisation of companies, geopolitical
speculation on the oil market. Taking action on demand can be the only basis for a real
energy policy.

influences or

The new context of high oil prices, which in large measure elude the policy-makers of
consumer countries in terms of supply, heightens the need to develop a new strategy for
demand geared to the gradual substitution of oil by other sources of energy, greater
use of renewable and alternative sources of energy, demand management, greater energy
efficiency and energy saving, particularly in buildings. These measures should help both to
protect the environment (in particular in respect of the problem of greenhouse gases)
and to lessen the vulnerability of the European economy to energy supplies from
outside. Unless the European Union can reverse the current trends in energy use and in
transport, especially in cities, it will not be able to deliver on the undertakings it gave in
Kyoto.

By the end of the year the Commission will be proposing regulations on energy saving in
buildings, to replace the simple, relatively ineffectual incentive measures so far taken at
Community level. It also plans to propose a programme, together with quantified targets,
on the number of clean vehicles in Europe (as a percentage of the number of automobiles)
and on fuel substitutes for petrol and diesel (as a percentage of total consumption). It is
not unreasonable to imagine that a substantial percentage of petrol and diesel consumption
could be replaced by 2010.

In the key sector of transport, managing fuel demand also implies redressing the balance
between modes of transport, particularly for freight, in favour of rail and short sea
shipping as well as more rational use of private cars in city centres and the promotion of
"clean" urban transport.

These policies form an integral part of the Commission's strategic objectives for
2000-2005 and will be adopted shortly in a new White Paper on transport.

-15-

Fresh initiatives will help to reduce Europe's dependence on oil supplies, a weakness
that had been forgotten over the past fifteen years.

IV. OUTLINES OF A STRATEGY

The current situation highlights the danger of too great a dependence on a form of energy
whose production is concentrated in a limited number of countries. Moreover,
the
volatility of the market has revealed that it lacks transparency and pricing mechanisms.
The European Union cannot allow its economy to be undermined on a permanent basis by
rises and volatility in the price of a raw material on which it is overly dependent. It is
against this backcloth that:

– The Commission intends to present a plan at the European Council in Gothenburg to
save energy and diversify sources, both by improving energy efficiency, particularly in
buildings, and by providing support for the development of a new generation of
vehicles. This will focus on two priorities with precise targets for 2010.

On the vehicle front, technological developments will help to improve the fuel
efficiency of conventional vehicles and to progress towards more efficient electric and
hybrid vehicles as well as battery-driven vehicles. In terms of fuel, on the other hand,
measures have to be stepped up in favour of fuel substitutes to make for greater
use of natural gas in vehicles and, in the longer term, hydrogen and biofuels which the
proposed directive on energy products envisages to exonerate from excise duties. In
addition to the advantages of biofuels in terms of security of supply, they also open up
new economic prospects for the world of agriculture.

– The future of and relationships between the different sources of energy (oil, coal, gas,
nuclear, renewable) are the subject of a Green Paper on security of supply due to be
adopted by the Commission by the end of the year. It will propose an overall strategy
designed to bolster the security of internal and external supplies and will address the
issue of the European Union's growing energy dependence on the outside, in the dual
perspective of an enlarged European Union and commitments under the Kyoto
Protocol to reduce greenhouse gas emissions.

– Special efforts are required to redress the balance in favour of rail and short sea
shipping by a substantial improvement in the economic effectiveness. The inevitable
restructuring of the road haulage industry requires social rather than fiscal measures.
The Commission will present a White Paper on transport policy by the end of the year.

– The European Union must set up an ongoing dialogue with producer countries,
especially OPEC, to make for maximum market transparency and help establish stable
prices. Attention must also be paid in this context to the hopes of certain producer
countries in the light of political developments in the Middle East.

– As regards market transparency, producer countries and market and industry players
should be encouraged to improve pricing indicators, based notably on a global index
reflecting the whole market.

– We must resist the temptation to offset rises in oil prices by cutting taxes. Doing so
would run counter to our environmental objectives, notably under the Kyoto protocol,
and would amount to transferring tax revenue to the member countries of OPEC. Such
an approach would also be incompatible with the orientations of economic policy and

-16-

with the commitments of the Member States in terms of budgetary consolidation. It
would also be desirable to develop a common approach and to examine its translation
into the broad economic guidelines. We must make sustained efforts to harmonise
excise duties between Member States, mainly by raising the minimum rates as
envisaged in the proposed directive on taxation of energy products, on the Council
table since 1997.

– The Commission will look into the possibility of linking the alignment of fuel taxes
with the higher rates (structural component) with a Community mechanism to help
stabilise VAT revenue in the event of major fluctuations in oil prices (cyclical
component).

– Greater

cooperation is needed to rehabilitate production and transport
installations in Russia and to capitalise on the prospects opened up by oil and gas
from the Caspian Sea basin, in particular under the INOGATE programme.

– The Commission will actively develop, in cooperation with Member States, the scrutiny
of the competition rules in the sector of oil product distribution. It will examine the
compatibility with Community law of the contingency measures taken by Member
States to lessen the impact of the recent increase in prices in certain sectors of activity.
It is also important to ensure proper functioning of the oil sector "upstream".

– The increase in oil price strongly affects those levels of the population which are on the
threshold of poverty and so risk to be further excluded in economic and social terms.
The Commission intends to facilitate the exchange of experience on the appropriate
means of alleviating the effects of the oil price increase for those who are most
dependent on it and to reduce the risk of social exclusion in line with the conclusions of
the Lisbon Summit.

– The Commission will look at ways of increasing strategic oil stocks by bringing their
use into the Community framework. To combat speculation ways need to be found,
like on the money markets, of limiting price volatility.

-17-

ANNEXES

Graph 1:

International price quotations of crude oil

Graph 2:

Trends in oil stocks

Graph 3:

Cost of production of the world supply in oil

Graph 4:

Cost of OPEC oil production

Graph 5:

Cost of non-OPEC oil production

Graph 6:

Comparison of prices, excluding tax, of Eurosuper 95 petrol

Graph 7:

Comparison of trends in average petrol and crude oil prices

Graph 8:

Structure of energy consumption in the EU (1998)

Graph 9:

Price of crude oil (OPEC basket price (1970-2000))

Graph 10:

Level of oil stocks in the European Union

Table:

Excise duties and VAT rates on motor fuels

-18-

Crude oil - International price quotations

30 US$/barrel

l
i
r
a
b

/
$
S
U

38

37

36

35

34

33

32

31

30

29

28

27

26

25

24

23

22

21

20

19

t
û
o
a
-
8
1

t
û
o
a
-
9
1

t
û
o
a
-
0
2

t
û
o
a
-
1
2

t
û
o
a
-
2
2

t
û
o
a
-
3
2

t
û
o
a
-
4
2

t
û
o
a
-
5
2

t
û
o
a
-
6
2

t
û
o
a
-
7
2

t
û
o
a
-
8
2

t
û
o
a
-
9
2

t
û
o
a
-
0
3

t
û
o
a
-
1
3

t
p
e
s
-
1
0

t
p
e
s
-
2
0

t
p
e
s
-
3
0

t
p
e
s
-
4
0

t
p
e
s
-
5
0

t
p
e
s
-
6
0

t
p
e
s
-
7
0

t
p
e
s
-
8
0

t
p
e
s
-
9
0

t
p
e
s
-
0
1

t
p
e
s
-
1
1

t
p
e
s
-
2
1

t
p
e
s
-
3
1

t
p
e
s
-
4
1

t
p
e
s
-
5
1

t
p
e
s
-
6
1

t
p
e
s
-
7
1

t
p
e
s
-
8
1

t
p
e
s
-
9
1

t
p
e
s
-
0
2

t
p
e
s
-
1
2

t
p
e
s
-
2
2

t
p
e
s
-
3
2

t
p
e
s
-
4
2

t
p
e
s
-
5
2

t
p
e
s
-
6
2

t
p
e
s
-
7
2

t
p
e
s
-
8
2

DatedBrent

-19-

M o nthly trend s in o il sto cks (cru d e oil + o il p ro du cts)
E ur 16 = E ur 15 + N o rw a y

s
e
n
n
o
T
n
o
i
l
l
i

M

163

161

159

157

155

153

151

149

147

145

143

141

139

D ec

Ja n

Feb

M ar

A p r

M ay

Jun

Jul

A ug

Sep

O c t

N ov

D ec

E nd of m o nth po sitio n

1 9 97

19 9 8

19 9 9

2 00 0

-20-

C ost of production of w orld supply in oil

)
l
e
r
r
a
b
/
$
(

t
s
o
C

14

12

10

8

6

4

2

0

10

20

30

40

50

60

70

80

90

P roduction (m illion barrels/day)

-21-

C o st o f O P E C o il p ro d u ctio n

)
l
e
r
r
a
b
/
$
(

t
s
o
C

6

5

4

3

2

1

0

9

14

19

24

29

34

P roduction (m illion barrels/day)

-22-

C o s t o f n o n -O P E C o il p r o d u c tio n

)
l
e
r
r
a
b
/
$
(

t
s
o
C

1 4

1 2

1 0

8

6

4

2

0

0

5

1 0

1 5

2 0

2 5

3 0

3 5

4 0

4 5

5 0

P r o d u c t io n ( m illio n b a r r e ls /d a y )

-23-

C o m p ariso n o f p ric es , ex clu d in g tax es , E u ro su p er 95 (J u n e 20 00 )

Increas e A pril 1 999-June 2000

A pril 1 999

s
e
r
t
i
l
0
0
0
1
/
o
r
u
E

500 .00

450 .00

400 .00

350 .00

300 .00

250 .00

200 .00

150 .00

100 .00

5 0.00

0.00

N L

L

D K

S

G R

B

I

A

P

F IN

IR L

U K

F

E

D

-24-

Comparison of trends in the price of Eurosuper 95 in the EU and the price of crude oil (dated Brent)

Petrol price: difference
compared with March
1997

Crude price: difference
compared with March
1997

s
e
r
t
i
l
0
0
0
1
/
o
r
u
E

180

160

140

120

100

80

60

40

20

0

-20

-40

-60

-80

avr-97

juin-97

août-97

oct-97

déc-97

févr-98

avr-98

juin-98

août-98

oct-98

déc-98

févr-99

avr-99

juin-99

août-99

oct-99

déc-99

févr-00

avr-00

juin-00

août-00

-25-

Structure of energy consumption in the EU (1998)

100%

80%

60%

40%

20%

0%

A

B

DK

FIN

F

D

EL

IRL

I

L

NL

P

E

S

UK

Solid fuels

Oil and oil products

Natural gas

Nuclear power

Renewable sources

-26-

P ric e o f c ru d e o il ( O P E C B a s k e t P ric e )
1 9 7 0 - 2 0 0 0 ( J A N - A U G )

l
e
r
r
a
b

/
$

3 6

3 3

3 0

2 7

2 4

2 1

1 8

1 5

1 2

9

6

3

0

7 0

7 2

7 4

7 6

7 8

8 0

8 2

8 4

8 6

8 8

9 0

9 2

9 4

9 6

9 8

2 0 0 0
(J A N -
A U G )

N o m in a l p ric e

C o n s ta n t p r ic e 1 9 7 3

-27-

LEVEL OF OIL STOCKS IN THE EUROPEAN UNION

DERNIERE INFORMATION MENSUELLE DISPONIBLE - LAST AVAILABLE MONTHLY DATA

Sur base de la
consommation de
1999
On the basis of
1999consumption

au/at:29/09/2000

CATEGORIE/CATEGORY I

CATEGORIE/CATEGORY II

CATEGORIE/CATEGORY III

TOTAL

Days of consump.

Jours consommat.
(1)

1000 t

Days of consump.

Jours consommat.
(1)

1000 t

Days of consump.

Jours consommat.
(1)

1000 t

Days of consump.

Jours consommat.

1000 t

31/7/2000
31/7/2000
31/7/2000
31/3/2000
30/6/2000
31/7/2000
31/7/2000
30/6/2000
31/7/2000
30/6/2000
30/6/2000
30/4/2000
31/5/2000
30/6/2000
31/7/2000

B -
DK -
D -
EL -
E -
F -
IRL -
IT -
L -
NL -
P -
UK -
A -
S -
FIN -

EUR-15

101
157
116
78
105
107
94
99
149
154
132
96
144
106
101

109

659
649
9413
690
2576
4147
362
4434
230
1587
751
4241
719
1176
512

32146

83
141
118
70
92
97
93
93
150
103
80
92
94
105
133

101

2702
1393
20647
1291
7114
12954
1022
6449
612
2788
1085
6649
1417
1862
1708

69693

223
503
226
133
152
176
112
122
214
5505
121
338
213
353
145

171

933
576
3006
1090
3080
2106
634
6623
3
1167
1297
1518
851
1633
647

25164

99
172
123
87
104
104
98
104
150
148
105
102
124
140
128

112

4294
2618
33066
3071
12770
19207
2018
17506
845
5542
3133
12408
2987
4671
2867

127003

(1) Obligation de 90 jours pour les trois catégories de produits / 90-day obligation for the 3 product categories
CATEGORIE/CATEGORY I - Essences auto et carburant pour avion de type essence/Motor spirit and aviation fuel of gasoline type.
CATEGORIE/CATEGORY II - Gasoil, diesel, pétrole lampant et carburéacteur de type kérosène/Gasoil, diesel oil, kerosene and jet-fuel.
CATEGORIE/CATEGORY III - Fuel oils.

-28-

Excise duty and VAT rates on motor fuels

Excise duty
gazoline

Euros/1000
litres

Excise duty diesel

VAT rates motor fuels

Euros/1000 litres

Minimum
Directives EU

Belgium

Denmark

Germany

Greece

Spain

France

Ireland

Italy

Luxemburg

Netherlands

Austria

Portugal

Finland

Sweden

United Kingdom

287

507

518

562

291

371

589

378

520

372

596

414

289

559

529

777

15 %

21 %

25 %

16 %

18 %

16 %

19,6 %

21%

20 %

15 % (gazoline 12 %)

17,5 %

20 %

17 %

22 %

25 %

17,5 %

245

290

344

378

246

269

391

330

381

252

351

289

245

304

345

777

-29-