Gas transit in Eurasia: transit issues between Russia and the European Union and the role of the Energy Charter1

Dr. Andrey A. Konoplyanik

Content:

1. Soviet/Russian gas supplies to Europe: contractual structure, its evolution & the role of transit:

a. Groningen model of LTGECb. Russian model of LTGEC

2. Three major components of transit risk in the cross-border gas value chain3. Zones of new transit risks – within and outside the EU - in gas value chain of

Russian gas supplies to Europe 4. New transit risks outside the EU: from political to market-based pricing within the

CIS (and to “European formulas”)5. New transit risks within the EU: Liberalization and enlargement of EU energy

market 6. What solutions for transit risks within Broader Energy Europe: GATT/WTO vs.

Energy Charter framework (ECT & draft Transit Protocol) a. Transit & transit risks & options to escape themb. GATT Article V “Freedom of Transit”c. ECT Article 7 “Transit” (Transit through fixed infrastructure)d. Strengthening ECT Article 7 through the draft Energy Charter Protocol on

Transite. Regulating transit of energy: GATT/WTO or ECT?

7. Key debated transit issues and draft solutions within Energy Charter framework:a. Definition of available capacity b. Domestic, import/export & transit tariffs c. Conciliatory procedure d. Congestion management e. Contractual mismatch

1 The basic part of the present paper was initially prepared by the author at the invitation and within the framework of the Program on International Energy Governance and Security of the then Center for Energy, Marine Transportation and Public Policy (CEMTPP) at Columbia University (New York, NY, USA) for the 31st IAEE International Conference (18-20 June 2008, Istanbul, Turkey). This material was allowed to be published/re-published and to be used in other author’s publications/presentations by the kind permission of the then CEMTPP (many thanks to the then CEMTPP Executive Director Mr. Albert Bressand and Mrs. Natasha Udintseva-Brenner who both initiated this work for CEMTPP). Major results of initial paper were first presented by the author at the Special Session on “Interconnection versus Integration: The Challenge of Transit Regimes and Jurisdictions for Eurasian Gas” of the above-mentioned Conference and then published in “Journal of Energy and Natural Resources Law”. The initial paper and its current redrafted version for his book are mostly based, inter alia, on the author’s publications and presentations that he made during his service through 03.2002-04.2008 as Deputy Secretary General of the Energy Charter Secretariat. All author’s publications and presentations, including all referred to in this chapter, are available from his website at www.konoplyanik.ru. Some of the questions debated in this paper were also presented by the author in his visiting lecturing courses in the Centre of Energy, Petroleum and Mineral Law & Policy (CEPMLP), University of Dundee (Scotland, UK), initially at the invitation of late Prof. Thomas Waelde, the Executive Director of CEPMLP, and currently – of his successor Prof. Peter D/Cameron, and also, most recently, in the Center of Energy Law, University of Aberdeen (Scotland, UK), under invitation of the Head of this Center Prof. Tina Hunter. This topic is also a regular part of the special lecturing course “Evolution of international energy markets and instruments of eergy protection/stimulation” at the Master’s Programme of the author at the Russian State Gubkin Oil & Gas University at the Chair “International Oil & Gas Business” which he has been teaching there since 2008, after he has returned from Brussels back to Moscow.

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f. Transit Protocol implementation inside the EU 8. Which transit risks ECT does not address and why so

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About 2/5 of the world’s production of oil, 1/5 of gas and 1/4 of electricity are being exported, i.e. are being sold with the crossing of at least one border. Only a limited portion of external trade in oil relates to transit supplies (which predetermines crossing of at least two borders) since the bulk of oil export is undertaken by sea in oil tankers. The role of transit in the trade of electricity in the global context is even less significant, though its transit might be crucial for some individual states (i.e. for the Central Asian states of the FSU in the Fergana Valley region – the result of straightforward electricity grids layout during the USSR times not paying attention to the then internal administrative borders within the USSR, between its Republics, the latter became sovereign states after dissolution of the USSR). At the same time, for gas export the transit component is of critical importance since until recently gas development worldwide took place mostly through pipeline infrastructure development. Transit accounts up to 40 per cent in international gas trade or about 7 per cent of global gas production. Gas industry is much more capital intensive in its transportation component (lower energy density of gas predetermines higher costs of increasing its pressure in the pipe to make transportation economical). Another crucial point is that cross-border gas transportation organized through immobile infrastructure.

For Russia, the problem of accomplishing the transit supplies of its energy exports (mostly destined for the European market) is more important than for any other energy-exporting country, including those that are competing with Russia in Europe, especially in gas. Direct supplies amount to only about 40 per cent in the case of Russia’s gas export compared to 2/3 in the case of Norway and 3/4 in the case of the Netherlands. The portion of direct supplies in Algerian gas export is only five percentage points higher than in the case of Russia, but Russian gas has a significantly higher portion of transit through the territories of two and more countries2.

The major market for Russian gas has been and will continue to be the EU which will stay increasingly dependent on external gas supplies (especially from Russia) through the forthcoming decades. That is why in this paper author will address specifically the transit issues in gas between Russia and the EU.

1. Soviet/Russian gas supplies to Europe: contractual structure & its evolution

Soviet/Russian gas export contract to EU countries (historically since 1968), to the former COMECON3 member states and to the CIS/FSU4 (following dissolution of COMECON and of

2 A.Konoplyanik. “Russian Gas to Europe: From Long-Term Contracts, On-Border Trade, Destination Clauses and Major Role of Transit to …?” – “Journal of Energy and Natural Resources Law”, 2005, vol.23, N 3, p. 282-307.

3 COMECON = Council for Mutual Economic Cooperation (рус.: СЭВ = Совет Экономической Взаимопомощи)

4 CIS/FSU = Commonwealth of Independent States/Former Soviet Union

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the USSR in 1991), have been based on a modernized Dutch (the so-called Groningen) concept of a long-term gas export contract (LTGEC).

a. Groningen Model of LTGEC

This concept was developed in the Netherlands in the early 1960s when the Groningen field – the then world’s largest gas field (now largest in Europe and the tenth largest in the world) – was discovered in 1959, subsequently lending its name to the concept itself. The concept was driven by the Dutch government’s desire to maximize the natural resource rent – or rather a specific part of such resource rent, the so called “Hotelling rent” – from the development of that uniquely sized field. This intend has its legal background in the international law. Legal background of the Groningen-type LTGEC is the well-known UN General Assembly Resolution 1803 of 14 December 1962 “Permanent Sovereignty over Natural Resources”, which was later reconfirmed, in new political environment of the 1990-ies, in regard to the energy resources, in the ECT article 18 “Sovereignty over Energy Resources”.

The key elements of Groningen LTGEC model were formulated in a statement made by the then Dutch Minister of Economy, Mr. Jan de Pous, in 1962 to the national parliament, establishing the main principles of a new government energy policy (the statement became known as the “Nota de Pous”). The intent of the new policy (which was fully reflected in the Dutch LTGEC concept) was to generate maximum revenue for the gas producing country in the long term obtaining maximum marketable price for gas through this period.5 This means – to maximise economic benefits for the resource owning state since Article 1 of the UN GA Resolution 1803 states that “The right of peoples and nations to permanent sovereignty over their natural wealth and resources must be exercised in the interest of their national development and of the well-being of the people of the State concerned”.6

The Groningen LTGEC is characterized by the following key elements (Figure 1) 7:

(Figure 1. Soviet/Russian & Groningen (Dutch) LTGEC Models: Differences & Similarities)

(а) it is based on a long term contract which secure lasting and stable demand for gas produced from the field whose development requires multi-billion investments. Such demand guarantees are needed to minimise noncommercial risks of investing in the upstream project (the larger the field the more numerous and larger the risks). The contract duration is a function of the need to: (i) secure lasting, predictable and stable cash flows from gas exports necessary to pay back the investment in the upstream project (field development, incl. related transportation infrastructure up to the delivery point which might be located thousand kilometers away from the well-heads, as has been the case of the USSR/Russia) and (ii) match the duration of guaranteed gas sales from the upstream project with the economically justified duration of this project life-time/cycle. This means that LTGEC where one of the parties is gas producer is, first of all, an

5 For more information see “Putting a Price on Energy: International Pricing Mechanisms for Oil and Gas”, Energy Charter Secretariat, 2007; Correlje A., van der Linde C. And Westerwoudt T., Natural Gas in the Netherlands: From Cooperation to Competition? (Oranje-Nassau Groep, 2003).

6 General Assembly resolution 1803 (XVII) of 14 December 1962, "Permanent Sovereignty over Natural Resources"

7 For more details see “Putting a Price on Energy: International Pricing Mechanisms for Oil and Gas”, Energy Charter Secretariat, 2007.

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investment tool/instrument, not just the trade deal like spot transaction or LTC between the buyer-reseller of the gas from the producer and his clients further down gas value chain;

(b) both domestic and export gas prices are pegged to gas replacement value (the price of gas substitutes for the end-user, i.e. “on the burner”). This allows the exporter to derive from its gas sales the maximum resource rent keeping the gas competitive to alternative energies within its specific consumption segment in a given consuming country. The market price for gas (equivalent to and competitive with the cost of replacing gas with alternative energies/”backstop technologies”) is calculated by a specific formula which serve as an integral part of any LTGEC. This means that in order to stay competitive the seller shall through the whole period of the LTGEC support the competitive price level (thus obtaining maximum marketable resource rent) which means that, contrary to the generally spread understanding within some European political circles, Groningen-type LTGEC from its very beginning were operating in competitive environment of inter-fuel competition;

(c) there is a special contractual clause on regular price review (both within the given contractual pricing formula as well as review of this formula itself) to reflect the changing price environment within competitive gas consumption areas. A regular price review is needed to reflect and adapt to price fluctuations of gas substitutes (replacement fuels) to maintain gas price on a competitive level;

(d) minimum pay obligations (known as “take and/or pay” or TOP obligation) which guarantee that the producer will market his minimum sales and will receive minimum guaranteed revenues from gas sales. On the other hand, the buyer will have a flexibility to decide whether to off-take all contracted volumes or only a part of them within the range allowed under the contract. The producer takes the “resource” risk associated with the upstream activities (risk of producing energy resources, geological risks inclusive, and of transportation of gas produced up to the delivery point), while the consumer assumes the “market” risk associated with the downstream activities from the delivery point to the end-user (risk of energy marketing and sale). Bearing in mind that the bulk of investment projects in oil and gas internationally are being developed by raising debt capital for significant portion of their capital expenditures, it is fair to notice that the presence of TOP-clause in the LTGEC is not only the requirement of the producers per se, but also or even mostly the demand of the external financiers to provide additional guarantees for pay-back of their money lend to the upstream producers;

(e) net back to the delivery point (gas replacement value for the end-user less transportation costs from the delivery point to this end-user). This clause (pricing principle) secures competitiveness of gas exports delivered to various markets via different routes. This clause also means that if gas is supplied from a single source (producer) to various export markets via one delivery point, the export price for such gas at such delivery point may vary significantly under the terms of different contracts due to varying end-use prices (gas replacement values) on such export markets and varying transportation distances to such markets from this delivery point;

(d) destination clauses whose appearance has been necessitated by the fact that gas exports through the same delivery point destined to different export markets thus with differing contract prices at this point. To rule out re-exportation of cheaper gas (purchased by the importer under one contract for a more remote market) at a higher price (specified in another contract for a closer market) at this closer market, gas resale restrictions are imposed – the so-called destination clauses, or territorial sale restrictions. Or profit-sharing clauses (if included in the LTGEC), which distribute incremental profit of the reseller at the closer market with higher price instead of selling it at contractual destination more distant market with lower price. Such clauses

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protect for exporter receipt of maximum possible marketable resource rent based on the competitive conditions in the consumer’s market and prevent the gas buyer (usually, wholesale buyer who acts as reseller- intermediary between the producer and the end user/retail market) from using in his favour price arbitrage to the detriment of the producer resulting in an undercut of producers’ resource rent.The Groningen model of LTGEC has provided the contractual framework for the evolution of existing European gas supply and transportation system. It should be considered as the backbone of the historical development of the European gas system. Over 250 BCM of gas is annually imported into Continental Europe under the terms of contractual arrangements based on the Groningen concept of LTGEC.

b. Russian model of LTGEC

Soviet gas supplies to Western Europe commenced in 1968 – six years after the Groningen model of LTGEC was first practiced – with shipments to Austria under the contract with OMV and with Baumgarten as a delivery point located far away from the USSR boundary. Groningen model had been developed for gas deliveries with rather small transportation distances within a politically homogeneous Europe. This model was adapted to the specific conditions of Soviet gas supplies to Western consumers located on the other side of “the Iron Curtain” in the then politically split Europe thousand miles away from the production gas fields in Western Siberia.

Based on the Dutch (Groningen) LTGEC concept, the contractual structure of Soviet/Russian gas supplies has proven to be viable and reliable at the times of confrontation between the two political systems in Europe during the Cold War era and through post-Soviet transformations of the political map of Europe within all 50-year-long period of its existence.

What are the specific features of the Soviet/Russian model LTGEC that differ it from the Groningen LTGEC model (Figure 1) 8:

• Contract duration : The Soviet model of long term “take-and/or-pay” contracts was distinguished by an even longer (the longest) duration because they served as the basis for financing of large-scale gas production (worldwide largest resources volumes of gas fields developed) and long-haul transportation projects (longest transportation distances). The reserves of West Siberian gas fields under development and the long distance of its export movements by far exceeded those typical of European fields in the Netherlands, United Kingdom and Norway or in Algeria from where pipeline supplies are destined to European end-users. As a matter of principle, long-term contracts have always been the basis for funding capital-intensive, long-distance and fixed infrastructure projects9. This is why TOP clauses have been always present in the LTGEC. Securing steady and long-term gas flows is requested by the financial community rather than producers because, as already mentioned, the majority of the upstream projects is funded with debt (project) financing. This type of financing provides up to 80-90% of the investment in such projects, calling for predictable in the long term and stable cash flows from gas sales to repay debt;

8 For more information see: А.Конопляник. «Российский газ для Европы: об эволюции контрактных структур (от долгосрочных контрактов, продаж на границе и оговорок о пунктах конечного назначения – к иным формам контрактных отношений?)». – «Нефть, газ и право», 2005, № 3, c. 33-44; № 4, с. 3-12.

9 For more details on long-term contracts as financial instrument for upstream development in oil and gas see, for instance: А.Конопляник. Развитие рынков газа, долгосрочные контракты и Договор к Энергетической Хартии. – «Нефтегаз», 2002, № 4, с. 25-33.

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• Delivery points locations : The delivery points for Soviet/Russian gas have been historically placed on the outer Eastern border of the “former” EU (EU-15) which means at the outer Western border of the COMECON. Such locations of delivery points stems from the fair distribution of gas supplier and buyer areas of responsibility within the cross-border value chain for securing reliable gas supplies. Geographical locations of the delivery points for Soviet gas exports were originally caused by the political split of Europe: the Soviet Union could assure uninterrupted supply within the area of its political influence, e.g. through USSR/COMECON to the Eastern border of the EU (Western Europe), while West European buyers could do so downstream of such points to their end-users. With all that, one delivery point for Soviet gas exports would serve several EU buyers/end users while it was not usually the case for gas exports originated from the European gas fields. Compared to LTGEC of Western European producers, delivery points in Soviet/Russian LTGEC were much more distant from both producer and end-user market;

• Pricing : Soviet/Russian gas pricing at given delivery points is defined as the replacement value at the end-use market in particular EU country less the cost of transportation to such market from this delivery points. This is the reason why there are different contractual levels of export prices for Russian gas destined for different markets in one and the same delivery point (e.g. in Baumgarten on the Austrian-Slovak border where there is a delivery point for Soviet/Russian gas export destined for Austria, Italy and France; in Waidhaus on the German-Czech border where there is one for supplies to Germany, France, etc.) 10;

• Regular price review and minimum pay obligations in Soviet/Russian LTGEC were similar to their Western European analogues (Groningen LTGEC model);

• Destination clauses : Due to geographical locations of delivery points for Soviet export gas sales, introduction of such clauses into LTGEC serves as a protection tool against price arbitrage which may be conducted by the buyers of Soviet/Russian gas to the detriment of the exporter in the absence of such clauses (Figure 2). For example, the export price for Russian gas destined for Austria in Baumgarten is higher than that for the Russian gas in the same delivery point but destined for Italy. In the absence of destination clauses, the buyer will be motivated to resell in Austria the gas purchased in Baumgarten for supply to Italy11. Such clauses also help to monitor price risks and enhance reliability of debt repayment because they made the contract price behaviour more predictable. Destination clauses acts as economically motivated and justified integral part of Soviet/Russian LTGEC to Europe. Since one delivery point of Russian gas export serves usually for few export contracts destined for different end-use markets located on bigger distances from these delivery points, destination clauses for Soviet/Russian LTGEC were much more important than for their Western European analogues. This is why forced elimination of the destination clauses from LTGEC post-2003, after Second EU Energy Package came in force with the proclaimed aim to develop single internal EU gas market with intended free flow of gas within the EU, had a strong detrimental effect for the

10 For more details see, for instance: M.Frisch. “The forced removal of destination clauses: European gas security of supplies implications”. - Presentation at the conference “Eurasian Natural gas: Opportunities and Risks”, organized by the Energy Charter Secretariat, 12-13 November 2003, Brussels; M.Frisch. “Can Price Review and Destination Clauses undermine gas security of supply in Europe?” – Presentation at the conference “NGas Summit”, organized by Informa IBC Energy, 1-3 July 2003, Paris.

11 Ibid.

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producers/exporters and created a legal conflict between the internal law of the EU (namely, competition law) and international law aimed at protection of the sovereign rights of resource-owning states. Forced elimination of destination clauses from LTGEC12 destroyed the earlier existing balance within such contracts between investment protection requirements and sovereign right of the resource-owning state for maximum marketable natural resource rent collection, protected by international law, in favour of freedom of trade, protected by EU law. This means that the balance in risk-sharing between trade and investment provisions of the contracts was moved in favour of trade by administrative means thus placing additional risks on the producers/exporters;

( Figure 2. Destination Clauses: Economically Motivated Integral Part of Soviet / Russian Export Schemes to Euro )

• Role of transit : The above-mentioned location of delivery points predetermined also the important role of transit immediately from the beginning of Soviet/Russian LTGEC history. During the Soviet era potential risks related to gas transit through the COMECON countries have been eliminated to zero level since all COMECOM states were under political and economic dependence of the USSR within the socialist system. Soviet state institutions such as Soviet sole gas trader - external trade association Soyuzgasexport (foreign trade has been the state monopoly in the USSR), had full operational control over Soviet gas transit flows within COMECON area and thus had not been facing any risks related to such transit flows. Prior to COMECON & USSR dissolution ( both in 1991) transit risks for Soviet gas exports did not exist in practice despite the fact that on its way to the EU Soviet gas crossed more state borders compared to gas supplies from its major competitors. After dissolution of the USSR and some former COMECON states in Eastern Europe (like former Czechoslovakia) the number of transit states on the way of Russian gas to its Western European consumers have further increased as well as the portion of transit gas in overall gas exports. The role of transit for Russian gas exports is much higher compared to its role in gas exports of major Russia’s competitors in the EU (Figure 3).

(Figure 3. Role of Gas Transit for its Main Existing Exporters to Europe when ECT came in force (1999))

Historical location of delivery points of Soviet gas exports upstream to West European end-use markets predetermined existence of transit-legs for gas originated from the USSR/Russia both upstream from delivery points (though through USSR/COMECOM time Soviet gas transit through COMECON area can be called “virtual transit” due to factual limited sovereignty of the socialist countries of East Europe), as well as further downstream on its way from delivery points (where it change title of ownership) to end-users, i.e. within the EU, from the very beginning of Soviet gas supplies to Western Europe. So both Soviet/Russian producer and exporter and Western European wholesale buyers of Soviet/Russian gas has been facing transit problems both upstream and downstream from delivery points from the very beginning of Soviet LTGEC history.

12 for example, see the story of such elimination of destination clauses from ENI-Gazprom LTGEC (done under pressure from and with participation of the European Commission) and its consequences in: А.Конопляник. «Правовые аспекты процедуры недискриминационного конкурентного доступа к свободным мощностям транспортировки (ДЭХ, TAG и ЕСГ)», с.142-156. – in: Нефтегаз, энергетика и законодательство (выпуск 8 / 2009). Информационно-правовое издание топливно-энергетического комплекса России и стран СНГ (ежегодник). // Москва, «Нестор Экономик Паблишерз», 2009, 160 с.

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Prior to the late 1980-s/early 1990-s transit problems both in the Eastern and Western segments of the Soviet gas export value chain to Western Europe have been solved within vertical integration of the gas business in the West (western segment of the chain) and through the political control of the producer-state over the transit states in East Europe within the COMECON system (eastern segment of the chain). In the West, wholesale buyer of Soviet gas (vertically integrated company) usually owned/leased the transit pipeline. In the East, Soviet exporter (Soyuzgasexport) has operational control over the transit flows usually without (though with some few exceptions in late 1980-s) owning and/or leasing it but possessing transit system in its disposal through the COMECON mechanisms of the “socialist economic integration”.

Since late-1980-s/early 1990-s legal and economic environment for transit flows has been changing in both segments of Soviet/Russian gas export value chain upstream and downstream to/from delivery points:

- in the former COMECON/USSR area (in the countries upstream to Soviet/Russian gas delivery points) – due to political changes (dissolution of COMECON and USSR) that inspired radical changes in legal and economic environment in the gas transit states, due to appearance of new sovereign transit states, and due to the expansion of the EU when almost all former Eastern European COMECON states became in 2004/2007 the members of the EU. Former COMECON states received real (de facto) independence compared to a nominal (virtual) one during USSR time. FSU republics have risen to sovereignty (de jure and de facto) because of the dissolution of the USSR in end-December 1991. Since 1992 it was not any more Soviet Gas Ministry and Soyuzgasexport to be solely responsible (and possessing operational capacity to implement this responsibility) for reliable gas supplies through the gas value chain up to delivery points at EU-15 border. Since that time secure Russian gas supplies to Europe depends on a number of newly established (de jure and de facto) sovereign states between Russian border and these delivery points. Most of these states are now the EU Members-states who implies EU energy acquis due to their membership in the EU. Since 2006, a number of non-EU countries signed Energy Community Treaty with the EU thus obliged to imply EU energy acquis (competition and energy laws) within their territories non-dependent being non-members of the EU;

- in the EU area (in the countries downstream to Soviet/Russian gas delivery points) – due to evolution of internal legal and economic environment within the EU aimed at further integration (development of common internal EU gas market) and liberalisation (resulting, inter alia, in unbundling and implementation of mandatory third party access (MTPA)) of the EU gas market, and enlargement of the EU (thus with expansion of its acquis communautaire implementation area) to the East. The Russian gas delivery points which have been on the outer border of the “former” EU-15 (and not subject to the EU’s acquis) are now located inside the “new” EU-25/27/28. Moreover, considerable Russian gas volumes are now transitted across the EU (through the Balkans route with delivery to Turkey and to the former Yugoslav states and in the case of deliveries to Kaliningrad Oblast of Russia through Baltic States). This creates new transit risks for Russian gas within the EU, i.e. within the sphere of contractual responsibility of Russian exporter for secure gas supplies to the delivery points of Russian gas within the the EU.

The above-mentioned means that transit leg of Russian gas supplies to the EU have been increasingly dependent on the internal EU laws, rules and regulations.

Today Russia faces multidirectional transit of its gas supplies within expanding geography and more complex and comprehensive structure compared to other gas suppliers to Europe,

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on the one hand, and compared with possibilities for operational control over its gas transit in the previous years, on the other hand (Figure 4). This objectively and continually creates new legal risks entailing economic consequences for Russian gas supplies to the EU within the Russia’s area of contractual responsibility (i.e. up to the delivery points) for a reliable and uninterrupted gas exports. These risks are to be dealt with most effectively by the means of the international legal instruments.

(Figure 4. Russian Gas Export to/through the EU: On-border Sales and Transit Legs (from 1991 to post-2007))

2. Three major components of transit risk in the cross-border gas value chain

There are three dimensions/facets of (“levels in hierarchy” in) the incremental risks composition related to energy (gas) transit through the territory of any transit country compared to producer-consumer gas value chain without transit component in it (Figure 5).

(Figure 5. This author’s vision of the nature and three major components of transit risk in the cross-border gas value chain)

Firstly, the very fact of transit per se, non-dependent the name of the transit state, creates additional transportation risks both for the producer/exporter and for the importer since both bear supply obligations within the long-term gas export contracts (LTGEC) which usually shall be a long-term one for investment-protection purposes. But any sovereign state has its sovereign right to establish within its territory such (transit) regime as it considers appropriate for transportation operations through its territory, including establishment of different external limitations for transportation/transit operations. The latter can include, inter alia, introduction of: (i) an upper limit for the duration of transportation contracts, and/or (ii) quantitative quotas for the use of available capacity of transportation system within its territory, and/or (iii) such competitive procedures of access to transportation capacities which might not match investment-protection reasoning for the producers/exporters seeking such access in order to fulfill their supply obligations in the countries beyond the territories of transit states, etc. Major resulting risk is the risk of appearance of the so-called “contractual mismatch” problem (Figure 6). One supply export contract between producer/exporter and importer requires one or few transit/transportation contracts with the owners/operators of the transportation systems in the third countries between the exporting and importing states. In every such transit state (non-dependent its name) a “contractual mismatch” problem might appear. This very fact increases transaction costs of the gas value chains with transit component in it (additional contracts are needed, costly legal work with them, (lengthy) negotiations with transit TSOs for access to transit infrastructure if it is not a regulatory access regime that exists within the transit state, etc.). This means that both producer and consumer, the parties to LTGEC, faces the risk for security and stability of supplies beyond the contractual reach of these parties since such risk relates to the fact of existence of the third country(ies) between them and its sovereign regulatory rules of access to and utilization of transportation grid. This facet of transit risk reflects its legal (third country sovereign law) and regulatory (adequacy of transit regime to fulfillment of contractual supply obligations between parties to LTGEC from third countries) component.

(Figure 6. Contractual Mismatch Problem)

Secondly, since the transit component of the gas value chain is beyond the reach of the parties to LTGEC, this means that technical conditions of the transit system, which directly influence on

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the stability and reliability of supply, are also dependent on the third country, i.e. transit state and its transportation system owner/operator. Adequate maintenance of the transit system is key to the technical stability and reliability of transit. If such maintenance is not adequately provided, this creates technical risk from the third (transit) country of non-fulfilments of contractual supply obligations between (the companies of) producer and consumer states due to lower technical security and reliability of transit infrastructure. This facet of transit risk reflects its technical component.

Thirdly, political component of transit risk. If political relations between transit states and its neighbors (non-dependent whether the neighbor(s) are exporter, importer or another transit state in the gas value chain), this creates additional risk to secure, reliable, non-interruptible supply flow due to political developments up to interruptions of supplies of non-technical character.

In sum total, this means that contrary to most generally spread perception that transit risk is primarily a political problem (which has been intensively infiltrated into Western/international mass media in regard, for instance, to Russia-Ukraine past and present transit disputes), in this author’s view, basic element in the logical chain of multi-facet transit risk development is its sovereign component (legal and regulatory), then comes technical aspects of transit risk, and political component of transit risk is the element of last order in its hierarchy (see Figure 5).

3. Zones of new transit risks – within and outside EU - in gas value chain of Russian gas supplies to Europe

Where and when did the new transit risks start to arise in regard to gas supplies originated from Russia? Two areas and four phases (steps) of their occurrence may be distinguished.

Two main new transit risk areas along the value chain of Russian gas supplies to Europe include both the countries outside and inside the EU (Figure 7). The genesis of new risks in each of the two areas differs considerably.

(Figure 7. Russian Gas Supplies to Europe: Zones of New Risks for Existing Supplies Within Russia’s Area of Responsibility Under Its LTGEC)

First phase: The beginning of the first phase of transit risk occurrence (related to Russian gas transit to Europe) dates back to the late 1980s and the early 1990s. Following reunification of Germany and the dissolution first of the COMECON and then of the Soviet Union, new risks first arose in the “upper” part of the cross-border export gas value chain (between the gas delivery points and the western border of Russia as producing country), i.e. in the new independent states of the former COMECON and the FSU.

The “velvet” revolutions of the late 1980s and “sovereignty parades” of the early 1990s meant that new transit sovereign states (with real and not nominal sovereignty) emerged on the way from the producer (Russia) to West European consumers. When a new sovereign country (with its own – yet emerging – legislation and business regulation rules) appears on the way of gas supplies to the delivery point, the supplier retains the need to secure uninterrupted supplies within transit state, which is much more difficult to achieve in a sovereign rather than in a politically dependent transit country. For this reason, the supplier undertaking transit incurs additional risks: political, legal and, consequently, economic ones.

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This explains why in the 1990-ies Russian monopoly gas exporter Gazprom has been trying to enter into privatization processes within the former COMECON countries – transit states on the way of its gas supplies to the EU – with the aim to buy (preferably controlling stocks in) equity in Eastern European TSOs and thus to receive ownership control over the transit pipelines. By this means Gazprom tried to prolong the former management model, which he has been used to through the USSR time, of providing secure and reliable transit to the EU. So at this it tried to eliminate transit risks through ownership control mechanisms.

In addition, former COMECON member states and Russian suppliers immediately started to convert their contract relationships to the “European” model (to a modified Groningen LTGEC model); the declared accession of the former COMECON countries to the EU predetermined such a conversion. This also resulted in the occurrence of additional – although temporary – risks for Russian gas transit to Europe (as is known, any transition always brings new risks with it because it is the interphase stage in any process that is the least stable).

With the accession of the former COMECON countries to the EU (in 2004 and 2007), the risks to Russian gas transit did not go away – they are still there but their nature is different now (they were transformed to third phase risks – see below): from the risks caused by the transition stage of the transit country from its COMECON membership to its EU membership with the independent legal regime through the period in between, they transformed into risks caused by such East European country’s membership in the EU and thus application of the EU acquis in its domestic legislation.

Second phase: The beginning of the second phase dates back to 2002-2003 when the European Commission, Gazprom and several West European customers agreed to waive destination clauses in the relevant Russian LTGEC’s (first with ENI of Italy and OMV of Austria and then with Eon-Ruhrgas of Germany). In that phase, Russian gas encountered new risks in the delivery points which were still located – before the EU enlargement – on the external Eastern border of the “old” EU. Given the character of the agreements reached and their subsequent implementation, one may conclude that in the final analysis such agreements turned out to be unbalanced – and not to Gazprom’s advantage.13

For example, one of the key elements of the tripartite agreement among Gazprom, the European Commission and ENI of Italy balancing the potential losses of the seller (Gazprom) from the buyer’s (ENI’s) use of arbitrage (which was made possible because of the waiver of destination clauses from ENI-Gazprom LTGEC) provided for securing Gazprom’s expanded (compensatory) access to the market in the end-use country (Italy). To this end, the signed documents envisaged a capacity expansion of the transit TAG gas pipeline (Trans Austria Gasleitung) through which all Russian gas has been shipped to Italy14.

However, the bidding procedure for access to the TAG expanded capacity provided for prorated capacity allocations to all bidding companies irrespective of the fact whether or not they had gas

13 A.Konoplyanik. “Russian Gas to Europe: From Long-Term Contracts, On-Border Trade, Destination Clauses and Major Role of Transit to …?” – “Journal of Energy and Natural Resources Law”, 2005, vol.23, N 3, p. 282-307; А.Конопляник. «Правовые аспекты процедуры недискриминационного конкурентного доступа к свободным мощностям транспортировки (ДЭХ, TAG и ЕСГ)», с.142-156. – in: Нефтегаз, энергетика и законодательство (выпуск 8 / 2009). Информационно-правовое издание топливно-энергетического комплекса России и стран СНГ (ежегодник). // Москва, «Нестор Экономик Паблишерз», 2009, 160 с.

14 Commission press release on territorial destination clauses with Gazprom and ENI, IP/03/1345, 6 October 2003, Commission Staff Working Paper, ‘Energy Dialogue with Russia. Update on progress’, 28 January 2004, SEC (2004) 114, Annex 6.

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to ship (the bidding organisers did not consider nor have included in the bidding criteria the fact whether the bids have been secured with available gas volumes). As a result, Gazprom did not get an adequate share of the expanded TAG capacity. Their allocation neither corresponded to Gazprom’s declared willingness to secure with its gas 100% of the TAG’s additional capacity (the entire expansion volume) nor does this procedure compensated its losses caused by the waiver of the destination clauses. Moreover, company representatives have repeatedly told the press that immediately after the auction held in December 2005, Gazprom started to receive offers from other winner companies to sell Gazprom’s gas to them in quantities needed to fill their allocated capacity or proposing Gazprom to buy their access quota from them (at a totally different price)15.

Third phase: The third phase commenced in 2004 and continued through 2007 when a two-step EU enlargement took place. Additional risks in that phase appeared inside the EU - upstream to Russian gas delivery points and the Eastern border of the former COMECON countries which since that time became the EU member states. Such risks superseded the first-phase risks within the former COMECON member states. Such risks are also present downstream from delivery points of Russian gas supplies to the EU, e.g. in the area not of Russian supplier’s (Gazprom) responsibility, but rather that of Russian gas buyers (West European companies involved). The emergence of such new risks related to the transit of Russian gas inside the EU is a product of the EU enlargement multiplied by the effects of EU gas market liberalisation.

The major origin of such transit risks is Second EU Energy Package which introduced unbundling of the EU gas market into “commodity” (with supply contracts) and “capacity” (with transportation/transit contracts) markets and MTPA as an obligatory access rule to energy transportation infrastructure. This established permanent existence of the “contractual mismatch” problem for the term-contracts in the EU16.

Fourth phase: The fourth phase has occurred in 2009 with the implementation of the Third EU Energy Package which introduced a totally different architecture of the internal EU gas market. The variety of new transit risks within the EU has appeared due to the proclaimed aim of the package to expand (even by the means of the “positive discrimination” of the incumbents – the holders of historical LTGEC). Further EU liberalization has not diminished transit risks for the external suppliers to the EU which possess their delivery points within the EU. New risks to Russian gas transit within Europe still does exist17(Figure 8).

15 Фейгин В.И., Медведева Е.А. «Дьявол в деталях» европейской либерализации: вокруг аукциона по TAG». – Институт энергетики и финансов, «Экономическое обозрение», ноябрь 2006, № 5, с.37-39.

16 This author have been writing a lot on the consequences of the Second EU Energy Package on the supply risks to the EU for non-EU gas producers/exporters. See corresponding publications/presentations at www.konolyanik.ru, for instance: Протокол по транзиту к ДЭХ: на пути к согласию. Какой режим будет предоставлен российскому газу на территории стран ЕС? - «Мировая энергетическая политика», март 2003, № 3, с. 56-60; Russian Gas to EU Markets - 1: Thorny issues impede progress toward final Transit Protocol. – “Oil & Gas Journal”, October 20, 2003, vol. 101, N 40, p. 60-64; Russian Gas to EU Markets - 2: Compromise is best course for Russia, EU in Protocol negotiations. – “Oil & Gas Journal”, October 27, 2003, vol. 101, N 41, p. 68-75; Energy Charter Protocol on Transit: On the way to Agreement – What Kind of Treatment will be Accorded to Russian Gas in EU Countries. - “Oil, Gas & Energy Law Intelligence” (OGEL), Vol.2 - issue 1, February 2004; Stiff Competition Ahead – As Russia moots Ways to increase Presence on European gas Market. - “Oil, Gas & Energy Law Intelligence” (OGEL), Vol.2 - issue 1, February 2004; Transit Protocol progress. - “Petroleum Economist”, July 2004, p.34; Russia-EU Summit: WTO, the Energy Charter Treaty and the Issue of Energy Transit. – “International Energy Law and Taxation Review”, 2005, N2, p. 30-35; Russia-EU, G-8, ECT and Transit Protocol. - “Russian/CIS Energy & Mining Law Journal”, 2006, N3 (Volume IV), p. 9-12, etc.

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One important observation should be made in this regard. During my tenure in the Energy Charter Secretariat (ECS), in the course of technical consultations between the EU and Russian delegations (which continued through 2003-2007, after multilateral phase of negotiation on the draft Energy Charter Protocol on Transit was over and there were only few open issues left just between Russia and the EU), the stumbling block in moving forward was the issue of the so-called “REIO clause” (see below in more details). EU delegation has been repeatedly saying that after Second EU Energy Package (2003) has proclaimed the aim of creating internal EU gas market there is no more space for transit within the EU (though it was clear that unbundling of the energy markets and of vertically integrated companies and introduction of MTPA as a common regulatory rule has left the nature of transit risks inplace) . In the light of this on 30.06.2004 EU Gas Transit Directive18 was repealed19. Since that time the term “transit” is no more in use within the EU. All transportation within the EU now on is considered to be internal domestic transportation. Full stop.

This de facto blocked the successful finalization of the Russia-EU technical consultations on the draft Transit Protocol and prevented then to bring this international treaty (additional to the ECT) to successful finalization in multilateral ECT framework20. Nevertheless, the new architecture of the internal EU gas market introduced by the Third EU Energy Package does not present the vision of the internal market as a homogenous structure or as a one single market zone. Instead, the EU Gas Target Model has presented the vision of internal EU gas market as a combination of market zones with the pipelines-interconnectors crossing the borders of the zones (Figure 8). All regulatory work undertaken by the EU gas community in 2010-2016 on preparation of the Network Codes to the Third Energy Package was aimed at creating operating rules for such non-homogenous domestic market. Which means that de facto transit within the EU does exist though the term ”transit” is not in formal/legal/official use within the EU anymore since 2004. This means that the substance of the “transit” problems within the EU (which is the problems of minimizing risks of the long-term supplies through cross-border capital-intensive immobile

17 This author have been writing also a lot on the consequences of the Third EU Energy Package on the supply risks to the EU for non-EU gas producers/exporters. See corresponding publications/presentations at www.konolyanik.ru, for instance: The 3rd Energy Package and the concerns of non-EU gas producers: An interview with Dr. Andrey Konoplyanik. – “Eurasia Energy Observer”, February 12, 2011, Европа - больше чем Европа. Третий энергетический пакет ЕС будет иметь последствия и за пределами Евросоюза. – «Нефть России», 2011, № 4, с. 56-61; № 5, c. 60-67; №7, с. 48-51; №8, с. 79-83; Third EU Energy Package: Regulatory Changes for Internal EU Energy Markets in Gas and Possible Consequences for Suppliers (Incl. Non-EU Suppliers) and Consumers. - “Oil, Gas and Energy Law” (OGEL), Provisional Issue, June 2011, 37 p.; “Russia and the Third EU Energy Package: Regulatory Changes for Internal EU Energy Markets in Gas and Possible Consequences for Suppliers (Including Non-EU Suppliers) and Consumers”. - “International Energy Law Review”, 2011, Issue 8, p. 24-40; Уменьшить риски и неопределенности Третьего Энергопакета ЕС. – «Нефтегазовая Вертикаль», 2012, №7, с. 79-88; Reducing risks and uncertainty of EU Third Energy Package. – “Energy Dialogue. Review of International Energy Policy and Security”, N3, 2012, p. 12-14; EU Quo Vadis: a theoretical exercise with an anti-Russian Flavour? // “Global Gas Perspectives”, 19 October 2017; Quo Vadis: оценка эффективности Третьего энергопакета ЕС или подготовка новой «линии Керзона»? // «Нефть, газ и право», 2017, №4, с. 42-53; №5, с. 47-56; №6, с. 51-59; etc.

18 Council Directive of 31 May 1991 on the transit of natural gas through grids (91/296/EEC)

19 https://eur-lex.europa.eu/legal-content/EN/ALL/?uri=celex%3A31991L0296

20 See author’s corresponding publications at www.konoplyanik.ru, including those mentioned under footnote 16.

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infrastructure) does not disappear and are still in place21. And the major one among those – is the risk of contractual mismatch.

Thus among instruments of international law, EU’s acquis communautaire is not diminishing, but creating new (additional) transit risks within EU area, at least for external suppliers to the EU (we will further discuss this issue in more details below). As for other multilateral international law instruments, it is GATT/WTO and ECT and its draft Transit Protocol that addresses the issue of transit of goods. WTO has broader geographical coverage, though some major gas producers within Eurasia are not WTO members yet (like, say, Turkmenistan, Iran). ECT, which incorporates in its trade section GATT/WTO rules, has more limited geographical coverage, though it is energy specific and includes (as member- and observer-states) all major gas producers in Eurasia.

4. New transit risks outside the EU: from political to market-based pricing within CIS (and to “European formulas”)

In a nutshell, the appearance of new transit risks outside the EU is the result of dissolution of the USSR and COMECON political system and it represents long-term economic consequences of this dissolution.

New former COMECON/FSU-related risks for Russian gas supplies to Europe reflect objective long-term economic problems of (soft !) transition from political pricing and supply obligations within unified political (and closely integrated economic) system of the USSR and COMECON to market-based pricing and supply obligations between independent sovereign states and their commercial entities based on the modified Groningen concept of LTGEC22.

Soviet/Russian Gas Supplies to COMECON/CIS states prior to dissolution of the USSR and COMECON were characterized by the following features. Export prices to COMECON states were defined on the basis of political (friendship) pricing - on a “cost-plus” basis rather than on “replacement value”-based principles used in international gas contracts in the trade between independent entities23. Transit tariffs were also defined on the political (friendship) basis and

21 These issues have been addressed in substance on the regular basis, inter alia, in the regular work of the Work Stream 2 “Internal markets” of the EU-Russia Gas Advisory Council since its inauguration in November 2011 and even earlier, since January 2010, within the framework of the Informal Russia-EU Consultations on EU Regulatory Topics (see: https://fief.ru/GAC.htm).

22 See in more details in: А.Конопляник. Российский газ в континентальной Европе и СНГ: эволюция контрактных структур и механизмов ценообразования. - ИНП РАН, Открытый семинар «Экономические проблемы энергетического комплекса», 99-е заседание 25 марта 2009 г. – Москва, Изд-во ИНП РАН, 2010 г., 102 с.; А.Конопляник. Экономическая подоплека газовых проблем в треугольнике Россия-ЕС-Украина и возможные пути их решения. - ИНП РАН, Открытый семинар «Экономика энергетики (семинар А.С.Некрасова)», 152-е заседание от 21 октября 2014 г. – Москва, Изд-во ИНП РАН, 2014 г., 132 с.

23 For more details on international gas pricing mechanisms see: “Putting a Price on Energy: International Pricing Mechanisms in Oil and Gas”, Energy Charter Secretariat, 2007. See also a further development of this study, especially in regard to former COMECON and CIS area, in a series of ECS presentations at the Workshops on International Pricing Mechanisms in Oil and Gas, organized with authors participation in 2007-2008 and beyond in some ECT member-states (available from www.konoplyanik.ru).

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were not “cost-of-the-service”-based (the latter is nowadays a commonly agreed, at least within ECT member-states, economic principle of transit tariffs methodologies24).

Political pricing and tariffication means that both the prices and transit tariffs were, firstly, notional by nature. Usually gas export prices for COMECON states and transit tariffs for transportation of Soviet gas through the territory of this or that COMECON state were calculated as arithmetic result to balance physical gas supplies to this COMECON state by gas transit payments to transit state “in kind” by exported Soviet gas. Thus inflow of gas into COMECON state consisted of two flows to cover its internal gas demand (defined on the basis of the physical gas balance within the centrally planned COMECON system): (a) inflow of gas that reflected payment “in kind” for the flow of Soviet gas transited through this COMECON state to the West, and (b) inflow of exported Soviet gas into this CONECON state.

Usually the same gas price was used in calculations of other parameters (volumes, transit tariffs) of both gas flows. That means that nor export prices, nor transit tariffs reflected justified economic values as to be used between the independent economic entities, but presented the function of pure arithmetic exercise. Both export prices and transit tariffs calculated by this mean were under-priced and reflected subsidized export prices and transit tariffs. Subsidized gas export price means that portion of (potentially marketable) resource rent was left to the importer in exchange on his political concessions (loyalty) to the exporter thus sharing USSR energy resources (which today are mostly Russian resources) within USSR and with COMECON countries. The availability of subsidized transit tariffs means that cross-subsidization took place and that Soviet net export price subsidy to the COMECON state was less than its gross arithmetic value.

Such economic cross-subsidization was possible since other elements of the broader COMECON economic system (political in its nature) were in place. Notional prices and tariffs were used as a basis for barter & quasi-barter deals. Transit payments were made by Soviet gas “in kind”, and Soviet gas export supplies to this COMECON state were balanced by counter-supplies of the goods and services from this state which were usually overpriced to neutralize the trade balance between USSR and this COMECON state. That is why COMECON transportation systems were designed in a simplified manner as an integral element of one common transportation system with the USSR, but not as separate transit systems. Export and transit supplies were nor physically, nor contractually separated within COMECON system. No transit existed within USSR prior to its dissolution.

After dissolution of the COMECON system and of the USSR, the former USSR-COMECON gas export-transit model was, nevertheless, de facto established in gas relations between Russia and the new sovereign transit states of the CIS – the republics of the former USSR, and has been implemented in this area until 2009 when overall sift to the Groningen-type LTGEC between Russia and other FSU countries, both those who acted as the importers of Russian gas (Ukraine, Belarus), as well as those who were acting as exporters of gas to Russia (Central Asian FSU states – Turkmenistan, Uzbekistan, Kazakhstan).

Evolution of Russian gas supplies to and through former COMECON and CIS states after dissolution of the USSR presents long and painful transition to contractual separation of transit and export supplies, to formation of separate pieces of legislation – for domestic transportation and for transit. Export and transit have been finally transformed from barter deals to cash

24 For more details on transit tariffs methodologies see: Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006.

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payments and thus from politically-subsidized to market-based pricing and prices, in relation both to transit tariffs methodologies and to market-oriented export pricing and prices.

Due to long historical tradition during the Soviet times of under-priced gas supplies to the former republics of the USSR, this transition from political to market-based export pricing and tariffication to be finally based on Groningen LTGEC concept and internationally accepted methodologies could not have been painless. It was to be painful “by definition”, especially since after long delays it was started to be implemented only after 2004 (when the then Ukrainian Presidential candidate Mr. Victor Yuschenko proclaimed in May 2004 in his Presidential campaign the political aim to convert from integration with Russia to Euro-integration and thus has appealed to move to “European formulas” in gas relations with Russia ). At that time the oil prices began to rise in a rocket-style manner25 and gas prices followed with some time-lag due to gas-to-oil indexation formulas in the LTGEC26. The level of acuteness of this transition depended to much extent on its timeliness. In this regard to choose the post-2004 timing for transition of Russian gas supplies to Ukraine and to Belarus (major transit states for Russian gas to Europe) to a market-based pricing was very unsuccessful since it reflected the highest and further growing values (through the whole post-Soviet period) of the Russian economic (resource) rent subsidized to both states through the historically existed political pricing mechanisms (Figure 9).

(Figure 9. Russian Gas Prices to the EU and the Countries along the Pipe)

But it was not possible to further escape the change of gas pricing systems within the CIS, since the gap between “political” and “economic” gas export prices became broader and broader27. It

25 For the explanation of the reasoning of such turbulent oil price dynamics in the 2000-ies, see, for instance: Бушуев В.В., Конопляник А.А., Миркин Я.М. и др. Цены на нефть: анализ, тенденции, прогноз. – М:, ИД «Энергия», 2013, 344 стр.

26 For more details see: “Putting a Price on Energy: International Pricing Mechanisms in Oil and Gas”, Energy Charter Secretariat, 2007. See also: A.Konoplyanik. “Gas Pricing: Indexation Versus Gas to Gas Competition (Chairman’s opening remarks to the Round-Table 2 Discussion)”. – Presentation at the European Gas Conference 2008, 23-25 January 2008, Vienna. 27 On more details on Russia-Ukrainian gas dispute and on the debate on “political” and “economic” pricing and prices in Russia-Ukraine gas relations, see publications of J.Stern and K.Yafimava (OIES) and/or this author’s publications, for instance: Russian – Ukrainian Gas Dispute: Prices, Pricing and ECT. - “Russian/CIS Energy & Mining Law Journal”, 2006, N1 (Volume IV), p. 15-19; Российско-украинский газовый спор: размышления по итогам Соглашения от 4 января 2006 г. (в свете формирования цен и тарифов, экономической теории и ДЭХ). – «Нефть, газ и право», 2006, № 3, с. 43-49; № 4, с. 37-47; Третейский газовый суд. – «Эксперт. Украинский деловой журнал», № 8 (106), 26 февраля 2007 г., c. 28-34; Андрей Конопляник: «Единственным вариантом обеспечения предсказуемости и прозрачности ценообразования между «Газпромом» и «Нефтегазом» может быть только формульный подход». – «Экономические Известия», 24 ноября 2008 г., № 212 (975), с.1, 3; Андрей Конопляник: «Газотранспортная система Украины и России всегда была единой». – «Экономические Известия», 24 декабря 2008 г., № 234 (997), с.1, 3; Andrey Konoplyanik: “A formula approach may be the only option for guaranteeing pricing predictability and transparency between Gazprom and Naftogaz of Ukraine”. - “Oil, Gas and Energy Law” (OGEL), Special Issue on EU-Russia relations, vol.7, issue 2, May 2009; Andrey Konoplyanik: “The gas transportation system of Ukraine and Russia has always been unified”. - “Oil, Gas and Energy Law” (OGEL), Special Issue on EU-Russia relations, vol.7, issue 2, May 2009; Andrey Konoplyanik: “Modernization and expansion of the gas transportation system will create positive macroeconomic effects for Ukraine”. - “Oil, Gas and Energy Law” (OGEL), Special Issue on EU-Russia relations, vol.7, issue 2, May 2009; Вхождение Украины в Договор об Энергетическом Сообществе ЕС со странами Юго-Восточной Европы: последствия для всех заинтересованных сторон. – «Нефть и газ», сентябрь 2010, №5, с. 20-22, 24, 26, 28, 30, 32, 33-36; «Газпром», Европа, Украина: о судебных исках, условиях контрактов и формуле ценообразования. Интервью с А.А. Конопляником, доктором экономических наук, профессором РГУ нефти и газа им. И.М. Губкина». – «Нефть, газ и право», 2011, № 5, с. 51-57; Эффект формулы (за что сидит Юлия Тимошенко?). – «Нефтегазовая Вертикаль», 2012, № 13-14, с. 18-23; Слезают с иглы. Российско-украинские газовые войны скоро канут в Лету — российский газ на украинском рынке медленно, но неуклонно теряет безальтернативность. - «Эксперт», № 38, 24-30 сентября

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also became clear that this transition would be even more painful after changes of political attitudes to Russia in some transit CIS states, firstly in Ukraine after “orange revolution”, which created much more negative environment for objectively more radical changes in gas price levels in the move to a market-based pricing principles based on Groningen LTGEC model. And furthermore, this transition, difficult by itself and, unfortunately, rather poorly explained to international public by both parties in dispute, was artificially politicized by the international media and anti-Russian politicians (like it was demonstrated in case of Italian gas supply problems in Winter 2005/06)28.

Figure 9 clearly explains economic background for different sensitivity of transition to market-based gas pricing and prices of Russian gas exports to former COMECON (Czech and Slovak Republics) and CIS (Ukraine and Belarus) transit states. That also explains why international public opinion has evaluated the risks related to energy transit through the above-mentioned states accordingly.

Of course, there were no internal motivation in all mentioned countries to move import gas prices from their notional level, which was closer to Russian internal “cost-plus” price levels, to the market-based prices based on “net-back replacement value” principles and indexed to world oil prices. But in case of former COMECON states it was strong external obligation (such as accession to the EU) to shift contractual relations to the “European formulas” which means – (in supply) to the Groningen LTGEC model with its pricing based on replacement values. There was no such obligation in Ukraine, nor in Belarus, especially until the trade-off (Russia’s economic subsidies in the form of “political” export pricing and prices in exchange for counter political and economic concessions in other, incl./mostly non-energy areas from the CIS states) took place between Russia and these CIS countries in 2006 and 2007 correspondingly (Figure 9).

Economic value of the issue in question much differed at the time of transition to market-based pricing for the above-mentioned countries. Price gap between market and political price for 2012 г., с. 52-54; Россия – EC - Украина: новый узел противоречий. – «Нефть России», 2014, № 6, с.16-21 (часть 1); № 7-8, с. 4-9 (часть 2), № 9, с. 4-9 (часть 3), № 10, с. 4-10 (часть 4) (in co-authorship with E.Orlova and M.Larionova); The Role of 'European formulas' in the Russia-Ukraine Gas Debate. – “European Energy Review”, 19 June 2014; The Role of 'European formulas' in the Russia-Ukraine Gas Debate (Part two: contractual offtakes vs reverse flows, contractual law vs EU acquis). – “European Energy Review”, 4 August 2014; The Role of 'European formulas' in the Russia-Ukraine Gas Debate (Part Three: How modernization of Ukrainian GTS changes the economics of bringing Russian gas to the EU). - “European Energy Review”, 25 September 2014; etc.

28 Analysis of real causes of undersupplies of gas to Italy during Winter 2005/06 showed the following. This winter was the coldest in previous 60 years. That increased demand for electricity in the neighbouring countries to Italy and electricity prices there went up. That in turn increased the margins in cross-border electricity trade and stimulated excessive depletion of Italian underground gas storages for export-oriented electricity production. When the temperatures went to the abnormally low levels, there was just not enough gas in the underground storage to cover the abnormally high peak demand for gas (to cover seasonal fluctuation in demand is the major reason gas storages are aimed for). The Russian-Ukrainian gas dispute came very timely in this regard since it enabled to shift the major flow of public critics from real internal cause (utilisation by corresponding Italian companies of their short-term trade benefits to the detriment of longer-term security of supplies of Italian end-users) to much exaggerated external events that did not have direct attitude towards the problem of undersupply of Italian gas consumers. (See, for instance: Marco Alverà. Securing Reliable Natural Gas Supply in the UNECE Region // UNECE Working Party on Gas - Seventeenth session. UNECE. Geneva. 23 January 2007). By contrast, in Germany and France major gas companies were criticized for non-market behaviour since they did not sell gas from underground storages to UK where the prices also went high and were the highest compared to the Continental Europe. The companies were criticized for not using the short-term economic benefits of price arbitrage. In respond the companies argued that their behaviour reflected not their potential short-term economic interests, but their existing longer-term contractual obligations. They did not have legal rights for utilizing price arbitrage since they have contractual obligations to hold corresponding volumes of gas in the storages to cover seasonable fluctuations in demand, and since this gas was contracted to cover specified needs of the particular end-users the companies were not entitled to use it for their own short-term trade benefit. So in this case in Continental Europe supply security and contractual obligations in favour of end-users dominated short-term economic benefits of the traders.

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Czech and Slovak Republics in 1998 was less than 10 USD/mcm, was at the historical lowest level (result of the second oil “anti-crisis” and its price collapse in 1997-1998 in result of Asian financial crisis) and was further diminishing due to oil market price trends (which were followed by gas prices) at that time. On contrary, at the time of transition from “political” to market-based pricing in Ukraine (Winter 2005/06) the price gap between “market” and “political” price was already about 160 USD/mcm and was further growing (compared to 15 USD/mcm gap in 1998 – at the time when Czech and Slovak Republics has moved to “European formulas”). In case of Belarus (Winter 2006/07), the price gap between “market” and “political” price was even bigger. It exceeded 170 USD/mcm and was also further growing (compared to 25 USD/mcm in 1998). This clearly explains comparative economic value and political sensitivity of the above-mentioned transition from “political” to market-based pricing and prices.

These rates, unfortunately, closely correlated in the (misguided) international public opinion with the level of as if permanent transit risks in the above-mentioned states and areas (former COMECON and nowadays EU member-states, on the one hand, and CIS states, on the other hand): low sensitivity in case of Czech and Slovak Republics, contrary to high sensitivity in case of Ukraine and even higher in case of Belarus (even highest, since both Russia and Belarus are the members of the Union State between them).

The compromise solutions finally agreed by Russia with transit states presented a soft and prolonged transition to a market-based pricing and prices. This transition period was to last for few further years. In case of Russia-Belarus agreement of December 31, 2006, it was defined that gas export priced at Russia-Belarus border will reach their net-back European value in 2011 (Figure 9). In case of Ukraine this time was to be flexible due to special organization of the gas export supplies to Ukraine29. According to Russia-Ukraine Agreement of 4 January 2006, the export flow of gas to Ukraine from Russia presented cocktail of both Russian gas (priced on Russia-Ukraine border on the net-back replacement value principle calculated from the end-user prices of European importers of Russian gas) and Central Asian gas (priced on the Russia-corresponding Central Asian state border on cost-plus principle, plus some premium, plus cost of transportation to Russia-Ukraine border). The use of intermediary – Russia-Ukraine joint venture RosUkrEnergo (RUE) as a sole exporter to Ukraine of gas originated both from Russia and Central Asia - enabled to implement “soft” export pricing for Ukraine (Figure 9), and use of another joint venture – UkrGasEnergo (UGE) as a sole supplier exclusively to the domestic Ukrainian market of gas purchased from RUE – to prevent re-export to Europe of cheaper gas imported from Russia (analogue of “destination clause” as contractual provision, but in case of UGE this norm – protection of the marketable resource rent of the exporter - was fixed in the establishing documents to prevent speculation of discounted gas supplied to the Ukrainian market to soften the burden on Ukrainian people of transition to new import gas pricing mechanism in the unfavourable international oil price environment)30.

29 On the broader picture of Russia-Ukraine gas developments and debates, problems and their draft solutions, see: А.Конопляник. Российский газ в континентальной Европе и СНГ: эволюция контрактных структур и механизмов ценообразования. - ИНП РАН, Открытый семинар «Экономические проблемы энергетического комплекса», 99-е заседание 25 марта 2009 г. – Москва, Изд-во ИНП РАН, 2010 г., 102 с.; А.Конопляник. Экономическая подоплека газовых проблем в треугольнике Россия-ЕС-Украина и возможные пути их решения. - ИНП РАН, Открытый семинар «Экономика энергетики (семинар А.С.Некрасова)», 152-е заседание от 21 октября 2014 г. – Москва, Изд-во ИНП РАН, 2014 г., 132 с.

30 For more details, see: A.Konoplyanik. “Russia-Ukraine Gas Trade: From Political to Market-Based Pricing And Prices”. - Presentation at the Conference “Reassessing Post-Soviet Energy Politics: Ukraine, Russia, and the Battle for Gas from Central Asia to the European Union” co-sponsored by The Harvard Ukrainian Research Institute & The Davis Center for Russian and Eurasian Studies, 7–8 March 2008, Center for Government and International Studies, Cambridge, MA, USA. See also: А.Конопляник. Слезают с иглы. Российско-украинские газовые войны скоро канут в Лету — российский газ на украинском рынке медленно, но неуклонно теряет безальтернативность. - «Эксперт», № 38, 24-30 сентября 2012 г., с. 52-54.

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In line with the change of pricing principles for the commodity (in gas supply newly established Gazprom-Naftogaz contract – based on Groningen LTGEC model) the transit tariffs for gas and their methodologies were adapted as well (based inter alia on the above-mentioned ECS study on transit tariffs 31). Transit tariffs for Russian gas through Ukraine were increased from 1.09 in 2005 to 1.6 in 2006 and then to 1.7 USD/mcm/100km in 2007. Negotiations on further adaptation of transit tariffs have been continued between Gasprom and Naftogas.

Different estimates for further increase in the transit tariffs were mentioned in the press in this regard at that time. Part of the debate reflected consideration that then current transit tariffs were still under-priced and its participants presented their figures of the “fair economic value” of transit tariffs32. Others proposed to link again transit tariffs and import prices and to establish direct correlation between the two: the higher the export prices – the higher the transit tariffs33.

Various technical, economic, financial, geographical, legal, regulatory factors may lead to different tariffs. Direct comparison of transit tariffs in different countries with different transit systems need to be done cautiously since at least four types of transit tariffs methodologies exist reflecting different types of transit systems and resulting in different values of the tariffs:

(a) postal: single fixed fee used for low-pressure distribution systems; (b) point-to-point: quoted for every entry-exit pair within the system;

31 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006.

32 According to one of the calculations, broadly presented in the press and within at least Brussels-based diplomatic circles and international organizations, in 2006 “economically proven” gas transit tariff through Ukraine territory was to be equal 5.25 and not 1.6 USD/mcm/100km, in 2007 – 7.48 and not 1.7, and in 2008 – 9.32 USD/mcm/100km. These figures were presented by the authors as if based on the Energy Charter transit tariffs methodologies. (А.Еременко. НАК «Нафтогаз України»: как заменить дефолт суперприбыльностью. - № 49 (678) 22 — 28 декабря 2007; Ю.Витренко. Экономическое обоснование расчета ставки транзита газа и стоимости импортного газа. – «Зеркало Недели» 21.01.2008; Yu. Vitrenko. Gas Transit and the Price of Imported Gas: Economic Justification. – “Zerkalo Nedeli”, # 2 (681) 19 — 25 January 2008). However, quick analysis of the methodology used by the authors of these figures has shown, that it is as minimum questionable and need to be at least double-checked. It seems that it was incorrectly economically justified by using at least once double counting in the evaluation of the full capital costs of the Ukraine transportation system in the calculation of “fair” transit tariffs through Ukraine: first time – by calculating full current replacement value (e.g. based on current costs) of the transportation system that was built more than 30 years ago (30 years is used in this calculations as amortization period of the system) and fully depreciated since that time, and second time – by adding full (accumulated) future depreciation value of this system calculated on the basis of its full current replacement value.

33 According to the comments of some Naftogas of Ukraine representatives in respond to the results of conversation of Russian and Ukraine Presidents D.Medvedev and V.Yuschenko in St.Petersburg early June 2008 regarding new gas export price for Ukraine which, according to D.Medvdev, might have increased two-fold since the beginning of 2009 due to increase of Central Asian prices for Gasprom on the gas further supplied to Ukraine. The then spokesman of Naftogas of Ukraine V.Zemlyansky stated that “price of gas depends on many factors, including of tariffs for underground storage in and transit through the territory of Ukraine”. Another source in Naftogas was quoted that “the company is ready for the market principles of work. In the given situation (further growth of import gas prices for Ukraine- A.K.) we are left only to undertake symmetrical measures – to increase transit tariffs for Russian gas to Europe”. (Кубометрическая система мер: Цена на газ для Украины вырастет почти в два раза. – «Газета», 07.06.08; "Нефтегаз Украины": Цена газа для Украины зависит от ставки его транзита и хранения. – “ПравоТЭК”, 07.06.2008). However, these views do not correlate with the general trends regarding decoupling of export and transit supplies and implementing different pricing principles and methodologies in establishment of export prices and transit tariffs, as it was shown in the following ECS publications (“Gas Transit Tariffs in the Selected ECT countries”, Energy Charter Secretariat, January 2006; “Putting a Price on Energy: International Pricing Mechanisms for Oil and Gas”, Energy Charter Secretariat, 2007) and further demonstrated in 2007-2008 during ECS workshops based on these studies in a number on ECT member-states, incl. CIS states and Ukraine in particular (see ECS presentations at: www.konoplyanik.ru).

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(c) distance-based: commonly used for gas transit in one direction with few off-take points – this is usually the case for transit through CIS and former COMECON (which are nowadays “new” EU) states; (d) entry-exit: suitable for highly meshed systems with many injection and delivery points – this is the case of the current EU internal gas market in the making (based on the Third EU Energy Package model) within the area of implementation of the EU energy acquis within and beyond (through the membership in Energy Community) its borders34.

The tariff methodology chosen must ensure financial sustainability of the system and avoid excessive profits. Contractual separation of transit and gas supply arrangements enable more transparency of tariffication and allow cost-reflective (means: cost of transportation service) tariffs.

Nevertheless, in some CIS transit states their – lower – transit tariffs were compared with - higher - transit tariffs inside the EU as proof for necessity to increase the tariffs in this CIS state to the “European” level. This was, in particular, the key economic motivation for Ukraine prior to and in the course of the 2004 “Orange Revolution” and beyond to move to Euro-integration. From this political appeals followed justified demand to move in gas to the (separated) “European formulas” (the EU gas market was unbundled since Second Energy Package as of 2003), both in supply (commodity market) and transit (capacity market). The key endeavor was to increase transit tariffs to their EU levels (to obtain high gain in capacity market increasing export earning for Ukraine). Instead, the result was an increase in import gas price (commodity market) since transition to “European formulas” with petroleum-products-indexation took place at the time when the shift to the new pricing formulas was based on the “reference periods” (previous nine months to the introduction of new prices based on new pricing methodologies) of high and increasing (shift since January 2006) and the historically highest (shift since January 2009) oil prices.

In March 2008 three Central Asian gas exporters (Turkmenistan, Uzbekistan, Kazakhstan) signed agreement with Gasprom that since 1 January 2009 on-border export prices of this states will be increased to the European levels less transportation costs (e.g. netted-back from European levels to Central Asian state-Russia border). According to some sources, it has reached 200-230 USD/mcm dependent on the country of gas origin (prior to this the price of Turkmen gas for Gasprom was equal to 140 USD/mcm, of Kazakh gas – 160 USD, and of Uzbek gas – 145 USD/mcm)35. It was agreed that contractual relations will be based on long-term contracts. With the continuous move of gas export pricing and prices to the internationally used formulas and economically justified levels the specific transit risks within the CIS related to the transition from the political to market-based pricing and prices, tariffication and tariffs have continued to diminish: the countries in question have been passing through “learning curves” of working on the basis of “European (Groningen) formulas”.

5. New transit risks within the EU: liberalisation and enlargement of EU energy market

In a nutshell, the appearance of new transit risks inside the EU is an objective pattern of the development of an integrated EU market, its further liberalisation and enlargement.

34 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006.

35 Кубометрическая система мер: Цена на газ для Украины вырастет почти в два раза. – «Газета», 07.06.08.

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The key elements of EU energy market liberalization are unbundling and mandatory third party access (MTPA) to energy infrastructure including energy transportation. Unbundling and MTPA within the EU inevitably creates new transit risks, both for the suppliers from the outside and from the inside of the EU to the EU market within the historically prevalent structure of this supplies and this market. This risks relates to possibility of non-renewal of existing transit contracts after their expiration if the duration of the import delivery contract (usually LTGEC) is longer than the duration of the corresponding transit arrangements (the so-called “contractual mismatch” problem) (Figure 6).

In the earlier days, when vertically integrated companies (VIC) in Europe had been developing energy infrastructure and have been using it afterwards (“own and operate” principle) for supplies of their own gas (produced/purchased by them), they possessed full control over the flow of gas that they owned through the pipelines that belongs to them, and for the utilization of this pipeline’s capacity. Under such conditions there was no need to accompany LTGEC (supply contract) by the corresponding transportation (transit) contract since VIC undertook both operations simultaneously within their own structure (within one company). A LTGEC was implemented by neighboring (responsible for production and transportation) departments of one vertically-integrated company. To provide adequate transportation facilities for implementation of existing and future supply contracts (to balance supply obligations with adequate transportations capacities) was an internal managerial issue of VIC. VIC could always reserve some throughput (now it sometimes called “to provide preferential treatment for their own gas”) within their temporarily unused (i.e. available) transportation capacities. Usually the driver for development of this or that transportation/transit capacity was the availability of long-term supply obligations and availability of proven reserves (for producers/exporters) or purchasing agreements with the producers (in case of wholesale buyers). Development and operation of transportation capacity was closely linked to the development of corresponding producing facilities. Long-term access to the pipe was requested by the financial community as an integral element of pay-back guarantees and of securitization of debt financing for development of integrated gas production and transportation projects.

Driven by the move to more competitive market, EU legislators have been continuously implementing unbundling into organisational structure of the EU energy market. Demand for unbundling became tougher and tougher: from operational (in first Electricity36 and Gas37 Directives of 1996 and 1998 – First Energy Package) to financial (in Second ones – of 2003 38 - Second Energy package) and to legal unbundling (in the Third Energy Package – Gas Directive of 200939). After unbundling was established as legal principle in Europe, starting with the first EU Electricity and Gas Directives/Package, and energy transportation facilities were (need be) separated from the production/supply facilities, any supply contract (LTGEC) need be accompanied by the corresponding transportation contract. To find a balanced solution and to match durations and volumes of both supply and transportation contracts became since then not an internal managerial task of VIC, but a result of negotiations between owner of the gas 36 European Parliament and Council Directive 96/92/EC concerning common rules for the internal electricity market.

37 Directive 98/30/EC of the European Parliament and of the Council of 22 June 1998 concerning common rules for the internal market in natural gas.

38 Directive 2003/54/EC of the European Parliament and of the Council of 26 June 2003 concerning common rules for the internal market in electricity and repealing Directive 96/92/EC; Directive 2003/55/EC of the European Parliament and of the Council (26 June 2003) concerning Common Rules for the Internal Market in Natural Gas and Repealing Directive 98/30/EC.

39 Directive 2009/73/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC.

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(supplier/shipper – former VIC) and owner/operator of transportation infrastructure - TSO. Supplier (shipper) lost his preferential access to the (former his own) pipe, unless it was specifically mentioned in the corresponding transportation contract.

Unbundling predetermined implementation of non-dicriminatory access to the now “independent” pipeline facilities (e.g. separated from the production operations) 40. There is no clear transit rules for internal EU gas market since EU Directive on Transit of 199141 was repealed in 2004 with introduction of the Second Gas Directive/Energy Package in 2003. Since that time EU treatment for gas transit is rather simple: no separate rules for transit, but common rules for all types of transportation (export, import, transit and domestic) within a single EU market. According to the Treaty of Rome since 1957 domestic transportation considered as free flow of goods inside the EU. “Free” in this regard means competitive. The rules of competition have been enforced through implementation of the third party access (TPA). Continuously strengthening TPA (first - negotiated TPA as a minimum standard in the First EU Gas Directive, then - mandatory TPA obligatory for all in the Second Gas Directive) diminished the right of pipeline owners on decisions for transit/transportation conditions independent of the ownership of the gas in this pipe. It also put on equal footing for access to the pipeline capacities the shippers with requests for short-term trading operations and long-term (usually investment-based) supplies. But in combination with unbundling, MTPA created the problem of contractual mismatch (long-term access to infrastructure for transit flows to match existing LTGEC supply obligations), which is nowadays one of the major risks for the long-term transit supplies, especially through the linear transit systems, i.e. for external gas supplies to the EU and for financing of their development (see below).

Trying to develop more liberalised and more competitive EU energy market, EU authorities have been trying to first increase its liquidity by stimulating short-term trade in gas. For this reasons Commission has been continuously and for long fighting against long-term contracts, despite the fact that LTGEC (not taking inconsideration their pricing mechanism) are still the backbone of the existing European gas supplies, thus opposing LTGEC as existing mature instrument of secure and reliable gas supplies, on the one hand, and spot markets with (virtual and to be liquid – according to Third Energy Package) gas hubs (liquid marketplaces) as emerging instruments of gas supplies still in their infancy if compared to US Henry-Hub or key petroleum exchanges such as NYMEX (New-York) or ICE (London), on the other hand.

Philosophies of creating liquid marketplaces with frequently changed directions of contractual gas flows within highly meshed internal EU gas market being developed as a pool system, demanded prohibition of long-term access to the pipe for a one (few) large external supplier(s) since that prevented competition if the latter is understood as synonym of liquidity and measured by the Herfindahl-Hirschman index (HHI) as increased number of gas traders (sellers and re-sellers of purchased gas). Contrary to this philosophy, fixed directions of long-term contracted transit supplies through the linear transit systems requested long-term access to the pipelines of gas producers/exporters with their large volumes and directed flows of long-term transit supplies.

It seems that in this fight between protection of the interests of the producers/suppliers of gas into the EU market (protection of secure transit flows to guarantee upstream investments), on the one hand, and of the re-sellers of this gas within the EU market (creation of liquid and competitive internal market), on the other hand, the second group has been temporarily winning. Item 25 of the 2003 Second EU Gas Directive states: “Long-term contracts will continue to be an 40 Author considers that the term “non-discriminatory access” to the pipe within the pipeline systems owned by independent system owner/operator and by vertically integrated company has different economic meaning.

41 The Council of the European Communities. Council Directive of 31 May 1991 on the transit of natural gas through grids (91/296/EEC) (No longer in force since 30.06.2004).

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important part of the gas supply of Member States and should be maintained as an option for gas supply undertakings in so far as they do not undermine the objectives of this Directive and are compatible with the Treaty [of Rome, 1957, establishing the EU], including competition rules.”42 This was repeated in Item 42 of the 2009 Third EU Gas Directive43. This means that in the EU (short-term) competition rules yet considers to be the higher priority that long-term security of supplies which inevitably creates new transit risks within the EU. That is why unbundling plus mandatory TPA as major elements of increased liberalization and competition in EU energy markets have resulted in contractual mismatch problem which creates new transit / transportation / investment risks for external and internal gas suppliers to the EU.

This aspect regarding substance of the transit risk issue within the EU was multiplied by its geographical aspect.

Prior to 2004 no Russian gas (which means the gas on which the title of ownership belonged to Russian companies) was transited inside/through the EU – across individual EU member-states. Before 2004, as long as the EU included 15 member states, the Russian gas delivery points were located on the outer (Eastern) border of the EU. In May 2004, the EU outer border moved farther on to the East, with the Russian gas delivery points now located inside the EU. Russian gas transit appeared virtually in its aggregate supplies to Western Europe because the main Russian gas flows to Europe cross Slovakia, the Czech Republic, Hungary and Poland which became EU members in May 2004. The year 2004 saw appearance of transit via the EU as REIO (Russian gas supplies to Kaliningrad Oblast across the Baltic states and to the former Yugoslavia via Hungary). With the accession of Bulgaria and Romania to the EU in January 2007, transit through the EU as REIO grew considerably due to onshore Russian gas supplies to Turkey (Figure 4). This means that the area covered by EU regulation (acquis communautaire) with the incurred risks for transit flows has been expanding upstream from the delivery points of Russian gas to the EU. Moreover, these risks are generated within the segments of the gas value chain which are within Russia’s area of contractual responsibility for stable and secure gas supplies to Europe.

Since the new risks have appeared – solutions to them need to be found. Since transit involves at least three states, best compromise decisions (i.e. balanced and long-term) are those that include all the parties, i.e. instruments of multilateral character.

6. What solutions for transit risks: WTO vs. ECT & draft Transit Protocol

a) Transit & transit risks & options to escape them

In operational terms four types of organization of pipeline transit systems can be identified: - Pipeline crossing sovereign territory and carrying transit gas without any connection

to the gas supply system of the transit country (Moldova, Algeria/Morocco lines);

42 Directive 2003/55/EC of the European Parliament and of the Council (26 June 2003) concerning Common Rules for the Internal Market in Natural Gas and Repealing Directive 98/30/EC.

43 Directive 2009/73/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC

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- Transit pipeline owned by a separate entity, predominantly used for gas transit, but also used to supply gas of the same origin to the transit country (most Russian transit pipelines, plus TAG, WAG, MEGAL, TENP);

- Transit pipeline system integrated into the domestic supply system and owned and operated by the main national transmission operator, where the transit gas flow can still be traced (Ukraine, Belgium);

- Systems where transit volumes commingle with a highly meshed national grid (UK, Germany and France)44.

In legal terms – according to the definition of “transit” given in Article 7 “Transit” in the Energy Charter Treaty (ECT)45 - there are three different options for carrying out supplies of energy materials and products (EMP) from the territory of one Contracting Party (say, from point A located within the CP2 Area) to the territory of another Contracting Party (say, to point B located within the CP3 Area) if there is at least one more Contracting Party (CP1 Area) in between them (Figure 10).

(Figure 10. Transit is not the only option …)

Option 1 - without transit at all : In this case on-border sales will take place at delivery points C and D (Figure 10), at which points both the title of ownership for the pipeline and for the gas in this pipeline is transmitted from one legal entity to another. No cross-border sales (in legal terms) will take place in such case. A chain of on-border sales can be in principle organized within multi-state cross-border gas transportation thus escaping gas transit at all. Usually it is either producer or consumer who prefer to escape transit risks by favouring on-border sales on its border. Producer state will not face transit and related transit risks when it sells its gas on its own border though he will (might) not receive the higher price that he would have obtain at the end of the transit chain (trade-off between lower risk and risk premium). In its long-term gas purchasing agreements with Turkmenistan, Uzbekistan and Kazakhstan Russia buys the gas produced in these states on their border. In this case, it is Russian buyer who transit Turkmen gas through Uzbek and Kazakh territory, and Uzbek gas through Kazakh territory. Transportation of this gas through Russia can not be considered as transit, but only up to Russian border 46. Turkmenistan sell on its border its gas destined to China. In this case Chinese buyer transit Turkmen gas through Kazakh territory. On-border sales are also an integral part of the Algerian supply schemes to Italy (transit through Tunisia by Italian buyer) and Spain (transit through Morocco by Spanish buyer).

Another opportunity to escape transit is to by-pass the neighbouring states with pipelines layout through the international waters where it is possible. This task was solved historically, for 44 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006.

45 For the text of the ECT see www.encharter.org.

46 Let’s consider situation that existed up to beginning of this decade within CIS: legally speaking, after selling Turkmen gas to Russian company (Gasprom) at the Turkmen-Uzbek border this gas was no more “Turkmen” but only “originated in Turkmenistan” since the title of ownership was passed on to the Russian company on the border and it was considered further to be as “Russian” gas (i.e. belonging to the Russian company Gasprom). This gas was further transited through the Kazakh territory – now as already “Russian” (to put it more precisely – as Gasprom’s) gas. Then it was transported to Russia-Ukraine border, where next delivery on-border point was located and where this gas again changed the title of ownership. Since delivery points in the chain of physical supplies of Turkmen gas to Ukraine were located on the consecutive state borders, this gas chain (from Turkmenistan to Ukraine) – in legal (contractual) terms - can be considered as holding “transit” segment between Turkmen-Uzbek and Russia-Kazakh borders. Transportation of this gas from Russia-Kazakh to Russia-Ukraine border can not be considered as transit in legal terms. Similar considerations – in regard to supplies of the gas of other Central Asian states through Russian territory to Ukraine and/or other CIS states.

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instance, by the “Blue Stream” pipeline which directly connects Russia with Turkey through the Black Sea (an alternative to supply Turkey with Russian gas via Ukraine, Moldova, Romania and Bulgaria). Nowadays “Nord Stream 1” pipeline connects Russia with Western Europe (Germany’s Baltic coast as entry point) through the Baltic Sea. “Nord Stream 2” pipeline (the same as “Nord Stream 1” and in the same corridor) is in the making, as well as “Turkish Stream” (a successor of the “South Stream” pipeline) in the Black Sea. But this opportunity can be searched for only when new transportation routes are to be developed with the aim either to address growing market, or to escape transit risks, or both.

Option 2 - transit through the pipe that is owned/leased by the shipper of gas : Under this scheme the gas originating from Russia and destined for France has been shipped by Gas de France from the delivery point at Waidhaus on through the territory of Germany to the French border; or gas destined for Italy has been shipped by ENI from the delivery point at Baumgarten on through the territory of Austria through the TAG pipeline partly owned by ENI. A similar scheme is used in supplies of Norwegian gas to France through the pipeline leased by the Norwegian supplier. Gazprom has been implementing the same approach throughout the 1990s in the FSU and Central Europe, trying to purchase stocks in the pipeline companies of the countries that historically have been acting as transit states for Russian gas supplies to Europe. In some cases Gasprom failed to become a stake-holder in the transit pipeline system, like in Ukraine, where finally the special law was passed prohibiting privatization of the state gas transportation system47. In some case it won, like in Poland, where the new pipeline was built partly owned by Gasprom, or in Belarus, where Gasprom bought a half of the country’s existing pipeline system48.

Option 3 - transit through the pipe that is not owned by the shipper of gas : Since Second EU Energy Package (2003) this option is a dominant one within the EU as a consequence of liberalization of EU gas market which resulted, inter alia, in the unbundling of vertically integrated energy companies and implementation of mandatory third party access (incl. to the energy transportation facilities). In some non-EU countries where unbundling is not legally binding, this option might be in place since transportation system is a state property by law (like in Ukraine) or due to unsuccessful attempts of the external shipper to privatize it (like in Belarus until end 2006).

Option 2 is certainly a more costly than option 3 for organization of transit through this or that pipeline transit system. This is why international law can be the most effective instrument (in “cost-benefit” terms – i.e. the cheaper solution for the same result) to minimizing transit risks. Since transit usually involves at least three (more than two) Contracting Parties, it is most effectively to be addressed by the multilateral legal instruments. Bilateral instruments are not as effective in solving transit issues.

Among multilateral instruments of international law dealing with transit are: Article V of GATT/WTO “Freedom of Transit”, Article 7 “Transit” of the ECT and draft Energy Charter Protocol on Transit worth to be analyzed.

47 After long-term debates on establishment of the international gas transportation consortium on the basis of the Ukraine gas transportation system, on 6 February 2007 Verkhovnaya Rada (Parliament) of Ukraine (with 430 votes from the registered 439 deputies) has passed the law which prohibited alienation of the property of national joint-stock company “Naftogas of Ukraine” and of gas transportation system of Ukraine, including reorganization, merger, acquisition, transformation of the state enterprises of gas-main pipeline transportation, and their privatization. («Вектор ТЭК», 6-13.02.07).

48 In a package deal of December 30, 2006, when the portion of the Russian gas export price formula increase for 2007-2011 period was partly paid by the shares of Beltransgas (the Belarus state company – the owner of this state gas transportation system) (Figure 9).

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b) GATT Article V “Freedom of Transit”

The basic idea of the principle of Freedom of Transit is to enable trade without undue restrictions when the goods are crossing transit countries. The concept of freedom of transit originated in the Barcelona Convention and Statute on Freedom of Transit of 1921and is embodied in Article V of GATT (1947), providing for transit via most convenient routes with no distinction based on the place of origin, departure, entry, exit or destination, or relating to the ownership of goods or means of transport. One of the most important elements of freedom of transit is its exemption from customs duties or other charges, except charges for transportation or those commensurate with administrative expenses or with the cost of services rendered. Furthermore, all charges and regulations with respect to transit are required to be reasonable. Finally, transit cannot be subject to any unnecessary delays or restrictions.

Article V of GATT emphasises on comparative characteristics of transit compared to other means of transportation of goods to their final destinations and not on regulation of transit per se within/through the transit state. Moreover, the GATT transit provisions were negotiated in the 1940-ies when most goods traded among Contracting Parties were transported by “mobile” carriers such as vessels, trucks, trains, etc., rather than through fixed (“immobile”) infrastructure such as pipelines and electricity grids. At that time trade operations presented mostly discrete transactions of single volumes of goods, that can be placed in a discrete packages or separate capacities (f.i. for oil: barrels, tank-trucks, tank-wagons, oil tankers, etc.) adequate to the dimensions of selected carrier within the broad nomenclature of the discrete volumes of different mobile carriers (f.i. for oil tankers: Aframax, Panamax, Suezmax, VLCC, ULCC, etc.), rather than the processes of the continuous flows of traded goods through the fixed throughput capacity of the fixed infrastructure that link together production and trade/transportation processes into one indissoluble technological chain. GATT Article V does not therefore address some pertinent issues linked to transit per se, especially through fixed (immobile) infrastructure, i.e. through oil and gas pipelines and electricity grids.

c) ECT Article 7 “Transit” (Transit through fixed infrastructure)

Transit tied to fixed infrastructure (pipelines, electricity grids) has special characteristics which have to be addressed in addition to the generic rules of GATT Article V:

(a) necessity for high upfront investment into energy infrastructure. Costs are mostly dominated by investment and it financing, while operational costs of throughput are minor; thus economic viability requires predictable long-term high level of utilization of transit/transportation capacity. Moreover, in case of creating fixed infrastructure which is aimed to link new oil and/or gas deposits, which are usually located in undeveloped or underdeveloped areas, with the existing/new markets, the specific energy infrastructure costs are further increased by adding to them the general costs of economic development of any undeveloped area. In such cases specific costs of fixed energy infrastructure usually incorporate additionally imputed costs of general economic infrastructure which make up-front investment even higher;

(b) need of a fixed infrastructure connecting entry and exit points, requiring lining up of corresponding rights of way. In theory, the alignment of rights of way could be negotiated

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with all land owners; in practice, however, the legal institute of “eminent domain”49 is needed to avoid possible blockades. That cost item further increase the upfront investment into transportation/transit capacity;

(c) pipelines have clear-cut capacity constraints which can only be overcome by investment and construction phases of combined duration of up to several years, and frequently exceeding ten and more years. So investment is not a short-term solution to congestion;

(d) there is a range of possible physical and commercial interactions with the transit country’s system: at one pole are pool-like systems (which can also serve as a market place, typically for electricity, but also for highly meshed gas systems – this is the case since 2009 in the EU when the Third Energy Package has introduced new architecture of the internal EU gas market structure based on such “pool” principle – see Figure 8); at the other pole are dedicated linear systems (typically for oil, but also most large gas export systems)50.

In pool like systems, energy flows may change at short notice depending on optimization of production and consumption decisions within the system and such optimization deals usually with internal flows of the system. In these systems production levels of individual domestic producers (and thus individual traded flows) are usually much less then (non-comparable with) combined consumption level of the whole system.

Linear systems are typically used for the transfer of resources from a single (usually – rather big, external and sovereign) source to a specific market area over a long time and thus usually by LTGEC. Optimization of this system deals with externalities, including sovereignty issues. Individual energy flows in this system are usually relatively high (and comparable with or even exceeding the) combined consumption level of the whole system, and can not be changed at short notice.

The ECT-1994/1998 51 applies by reference the rules of GATT-1947 (and WTO-1995 by the Trade Amendment-199852) to Energy Materials and Products (EMP) which include by definition those EMP that are being traded/transported/transited only through fixed infrastructure, like electricity53, or through both mobile and fixed infrastructure, like oil (tankers/trains/trucks and/or pipelines), gas (LNG/compressed gas carriers and/or pipelines) or coal (trains/trucks/ships and/or coal slurry pipelines). The ECT Contracting Parties felt however that additional disciplines are

49 "Eminent domain", also called "condemnation", is the power possessed by the state to appropriate private property for "public use" (may also be named “public interest” or “public convenience and necessity”). In some jurisdictions, the state delegates its eminent domain power to certain public and/or private companies, typically utilities, so that they can bring eminent domain actions to run telephone, power, water, or oil and gas lines. With respect to energy transportation infrastructure, when the state (and/or regional processes) finds that a proposed project is in the public convenience and necessity or is needed to address transportation bottlenecks of national (or sometimes cross-border) interest, the designated entity has the right to acquire the property for that project by eminent domain even if the owner does not wish to sell the property or where the landowner and the pipeline investor cannot agree on the compensation to be paid for the land.50 See: Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006, Chapter 3.4

51 Signed in 1994, came in force in 1998. For more details on ECT see, for instance, the most fundamental study: Centre for Petroleum & Mineral Law & Policy, University of Dundee, ed. by T.Waelde. European Energy Charter Treaty: An East-West Gateway for Investment & Trade. (International Energy and Resources Law & Policy Series). – London-The Hague-Boston: Kluwer Law International, 1996, 700 p.; or the more condensed one: A.Konoplyanik, T.Waelde. Energy Charter Treaty and its Role in International Energy. – “Journal of Energy and Natural Resources Law”, November 2006, vol. 24, No 4, p. 523-558.

52 Amendment to the Trade Related Provisions of the Energy Charter Treaty, April 1998

53 Thus ECT considers electricity to be a “good” rather then “service”.

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needed to clarify specific issues related to energy transit, especially to energy transit through fixed infrastructure.

ECT Article 7 “Transit” addresses explicitly energy transit by fixed infrastructure, as defined in this Article. It stipulates to facilitate transit of EMP (inclusive of placing “no obstacles in the way of new capacity being established, except as may be otherwise provided in applicable legislation”54) based on non–discrimination principle. Other major points covered are definition of transit area, securing established transit flows, non-interruption of transit flows in case of disputes and a special dispute resolution mechanism (conciliatory procedure).

d) Strengthening ECT Article 7 through the draft Energy Charter Protocol on Transit

Most decisions on transit of EMP needing fixed infrastructure are long term since they are usually linked to the supply decisions with LTGEC. Spare capacity in fixed infrastructure is expensive and, therefore, usually of a temporary nature. In case of bottlenecks and congestion, existing capacity may be allocated through non-discriminatory congestion management mechanisms. Congestion can in principal be overcome by investment into additional capacity, but only taking into account the time necessary for planning, authorization and construction.

As ECT Article 7 does not address in detail the implications of these issues and other aspects, there was a wish of ECT member-states to detail them in a special Transit Protocol. Major issues addressed in the Energy Charter draft Protocol on Transit are:

– obligation to observe transit agreements; prohibition of unauthorized taking of EMP in transit;

– definition of available capacity in energy transport facilities used for transit;

– negotiated TPA to available capacity (mandatory TPA is excluded except for the areas where MTPA is a legal obligation);

– facilitation of construction, expansion or operation of energy transport facilities used for transit;

– transit tariffs shall be non-discriminating, objective, reasonable and transparent, not affected by market distortions, and cost-based including reasonable rate of return;

– technical and accounting standards harmonized by use of internationally accepted standards;

– energy metering and measuring strengthened at international borders;

– co-ordination in the event of accidental interruption, reduction or stoppage of transit;

– protection of international energy swap agreements;

– implementation and compliance;

– dispute settlement.

54 ECT Article 7.4. This does not mean that any request to build a new transit capacity is to be implemented by the potential transit state. There are at least 5 levels of decision-taking where sovereign and potentially transit state can provide argumented objection and refrain from building a new transit capacity (А.Конопляник. Есть только один путь к ратификации ДЭХ. Чтобы договориться, надо понять возражения противной стороны. - «Нефть и капитал», 2001, № 3, с.8-10; А.Конопляник. Договор к Энергетической Хартии: «Ратифицировать надо, но не сегодня…». - «Промышленный мир», 2001, № 2, с. 44-48; A.Konoplyanik. “We must ratify Energy Charter Treaty – but not yet”. – “Oil & Capital. Russia & CIS Energy Magazine”, April 2001, p.6-8).

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Negotiations on the draft Energy Charter Protocol on Transit (TP) started in 2000 and in two years have resulted in considerable progress in further elaborating certain provisions of Article 7 by, for instance, providing a definition for available capacity and establishing the principles of transit tarification55. It was expected that successful finalization of Transit Protocol and its implementation will diminish risks related to transit, improve financing terms of projects with transit component, increase competitiveness of transit supplies, and improve energy security within its tri-lateral integrity of security of supplies, of demand and of infrastructure.

At the Energy Charter Conference in December 200256, all 51 Member States agreed on a text of the draft Transit Protocol 57, however, subject to a solution of three issues which stayed open between the EU and the Russian Federation: two issues relating to transit per se and one broader (non-transit-specific) issue stemming from the specificities of the EU as a Regional Economic Integration Organisation (REIO). The points of substance that remained open concerned:

(i) non-discriminatory use of available capacity and the rules of handling congestion implied in the discussion of cost-reflectiveness of transit tariffs if established at auctions;

(ii) the issue stemming from the longevity of transit decisions. Originally it was labelled as Right of First Refusal (which reflected one of the debated solutions, broadly used outside of the EU, of the contractual mismatch issue), later – as avoidance of contractual mismatch (which reflected the issue per se), e.g. a need for correlation in terms of timing/duration and volumes/throughput capacities between transit contracts providing access to transportation capacities, on the one hand, and underlying supply contracts (usually LTGEC), on the other hand;

(iii) the EU-specific issue of the application of the draft Transit Protocol inside the EU. The point is whether to apply definition of “transit” to crossing of the EU entire territory as REIO, as proposed by the EU in the draft Transit Protocol (Article 20), and thus to narrow down definition of “transit” as made in the ECT, or to apply definition of “transit” both to crossing of each single EU member country and/or of the EU as a single area, as defined in the ECT (Article 7). This issue stems, inter alia, from the fact that each EU member-state has signed/ratified ECT in double-capacity: as individual ECT Contracting Party and as a member-state of the EU which, in turn, is itself a separate Contracting Party of the ECT.

Further to this three open issues related to the draft Transit Protocol, Russian Federation has been continuously raising its concerns regarding different (from the EU) or unclear interpretation of some key transit-related provisions of the ECT regarding:

(i) implementation of mandatory third party access (MTPA) within the ECT area,

(ii) correlation between tariffs for transit, export, import and domestic transportation (ECT Art. 7.3),

55 For detailed description of the development of Transit Protocol negotiations and consultations see the author’s publications and presentations at www.konoplyanik.ru, including those mentioned under footnote 16.

56 Energy Charter Conference is the supreme authority of the member-states of the Organisation comprising 51 states in Europe and Asia plus the EU as the only institutional party to the Treaty (as the so-called Regional Economic Integration Organisation - REIO). Prior to 2005 hold its meetings twice a year (usually in June and December), since 2005 – once a year at its end.

57 The draft Energy Charter Protocol on Transit in its version as of December 2002 (at the end of the first multinational phase of negotiations) is available from the Energy Charter website (see at www.encharter.org/fileadmin/user_upload/document/CC251.pdf)

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(iii) conciliatory procedure of transit-related dispute settlements (ECT Art. 7.7),

(iv)role of long-term contracts which are fundamental for long-term transit solutions.

The above-mentioned demands of the Russian Federation to address its transit-related concerns regarding interpretation of the ECT Article 7 and other transit-related issues of the ECT were not included by the Energy Charter Conference into three open issues between Russia and the EU since they related to the ECT and not to the draft Transit Protocol, though it was proposed to solve these issues in the course of finalisation of Transit Protocol (legal status of Transit Protocol allows such scenario).

It was always understood that after clarification of the open bilateral issues between Russia and the EU, the draft Transit Protocol would be again discussed within the whole ECT multilateral community based on the principle that “nothing is agreed until everything is agreed”. This means that all transit-related issues need to be agreed upon by all the ECT member-states, at least by all the states important for current and future energy transit - in order to make Transit Protocol a really operational instrument of international energy transit. That is why clarification of Russia’s concerns regarding transit-related provision of the ECT, though not initially included into three open issues between Russia and the EU, had strong practical impact on prospective finalisation of the Transit Protocol per se and for international energy transit in general. It was expected by international ECT community to also have strong operational consequences for the then prospective Russia’s ECT ratification: it was clearly stated by the Russian State Duma (lower Chamber of Russian Parliament) in 2001 that no ECT ratification would have been possible without fair clarification of Russia’s concerns regarding transit provisions of the ECT 58.

e) Regulating transit of energy: GATT/WTO or ECT?

Further to Russia-EU debate on transit issues within bilateral consultations on finalisation of the Energy Charter Protocol on Transit, the energy transit-related group of issues emerged during the Russia-EU bilateral negotiations on Russia’s accession to the WTO in October 2003 as part of six items introduced by the EU in the so-called “Lami package”59 (Figure 11). At that time, it caused a very sharp public response from the then Russian President Vladimir Putin during his meeting with the then German Chancellor Gerhard Schröder in Yekaterinburg (many remembered Putin’s rhetoric about “European bureaucrats”) related to Russia-EU Autumn 2003 Summit.

(Figure 11. “Lami Package” (October’2003 EU Commission’s six demands on Russia under energy agenda in EU-Russia WTO accession negotiations))

However, it was not only Putin’s statements that aroused interest in the way the transit issues were debated prior to and at this Summit within WTO agenda. The prospects of multilateral negotiations on the ECT Transit Protocol depended on this debate as well. “Lami package” showed that EU delegation interpreted transit issues differently according to its demands to Russia based on WTO rules within bilateral WTO-related talks, on the one hand, and according to ECT and its draft Transit Protocol rules as they were debated within the multilateral Energy

58 А.Конопляник. Договор к Энергетической Хартии: «Ратифицировать надо, но не сегодня…». - «Промышленный мир», 2001, № 2, с. 44-48; A.Konoplyanik. “We must ratify Energy Charter Treaty – but not yet”. – “Oil & Capital. Russia & CIS Energy Magazine”, April 2001, p.6-8.

59 Named by Pascal Lami - then the Head of the European Commission’s Directorate on Trade and key EU negotiator within Rusia-EU bilaterals on Russia accession to WTO; afterwards – General Secretary of WTO.

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Charter discussions, on the other hand. Thus two negotiating processes overlapped both in timing and, more importantly, in substance.

In December 2002 the multilateral phase of the ECT Transit Protocol negotiations was provisionally finalised by the ECT member-states. Three issues had been unsettled by that time on which there were differences between the Russian and the EU delegations only. That is why the multilateral negotiations were temporarily transformed into the format of bilateral consultations between Russia and the EU until the two will agree on this three outstanding issues and their draft agreement on these issues will be returned to the multilateral level of negotiations. The two parties’ negotiators compromised on the text of the Transit Protocol in June 200360, immediately prior to the 12th regular meeting of the Energy Charter Conference.

However, before Moscow and Brussels could approve the achievements made by their respective negotiators within the Energy Charter process and present it to the Energy Charter Conference at its next 13th regular meeting in December 2003, the above-mentioned “Lami package” emerged in October 2003 as part of the other - WTO-related - negotiating process involving both parties on Russia’s accession to the WTO. “Lami package” presented by the EU within the WTO debate included transit requirements for Russia that differed from the approaches on the same issue as debated and provisionally agreed (pendant on the approval by the capitals) by the delegations of Russia and the EU within the Energy Charter process (both processes included even the same negotiators from both sides). In response, the Russian Government stated in December 2003 that as long as both ECT and WTO negotiating processes overlapped with contradicting EU demands to Russia on the same issues within two processes, completion of the negotiation on the Energy Charter Protocol on Transit was out the question61. And in both processes EU delegation (though consisting mostly of representatives from different Directorates: of Trade – in WTO and of Energy and Transport – in Energy Charter processes) based their demands to Russia on transit issues based on its own interpretation of WTO rules.

In some cases, EU demands to Russia within the “Lami package” were based, according to EU, not only on (EU interpretation of) WTO rules, but also on provisions of EU acquis communautaire and on EU practice as well. One of the most striking cases was item 5 of “Lami package” requesting Russia to introduce equal prices for transit of (transit tariffs on) gas for domestic users and for exports. This was one of the issues of Russia’s concerns regarding ECT (its Art. 7.3). EU argued that this demand – reflecting its reading of ECT Art. 7.3 - was based on (i) WTO rules, (ii) EU acquis and (iii) EU practice. To clarify this issue and to address substantiated concern of Russian delegation, the Energy Charter Secretariat undertook special study on Transit Tariffs in which it has proved that in the ECT member-states, both outside and (sic!) within the EU, transit tariffs usually exceed domestic tariffs62 which means that this demand of the EU delegation to Russia – as if based on WTO rules, EU acquis and EU practice - was not substantiated.

The key issue of Russia-EU debate was whether the GATT’s Article V on freedom of transit applied to network infrastructure facilities (pipelines, electricity grids, etc.). If yes, what was the

60 For more details see, for instance: A.Konoplyanik. Russian Gas to EU Markets - 1: Thorny issues impede progress toward final Transit Protocol. – “Oil & Gas Journal”, October 20, 2003, vol. 101, N 40, p. 60-64; Russian Gas to EU Markets - 2: Compromise is best course for Russia, EU in Protocol negotiations. – “Oil & Gas Journal”, October 27, 2003, vol. 101, N 41, p. 68-75.

61 That reflected comparative importance of two processes and two international organizations (WTO and Energy Charter) for Russian leadership: WTO clearly prevailed over Energy Charter.

62 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006, table 6.2 (p.67).

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dominant rule to regulate transit issues: GATT Article V “Freedom of Transit” or ECT Article 7 “Transit”? Both parties’ official documents avoid this question63. This means that WTO rules does not provide at least one and the same understanding of some key issues regarding transit of energy materials and products, though it proclaim “freedom of transit” in GATT Article V and “Lami package” contained demand to Russia for “free transit” though without clear description of this claim (Figure 11).

Firstly, it is necessary to “decode” the term “freedom of transit”. It needs to be clearly understood that there is no unlimited “freedom of transit”64. The term “freedom of transit” will remain an empty phrase without clearly defined restrictions to “freedom of transit”. In other words, “freedom of transit” requests legally binding and unambiguous definitions of economically proven instruments of state regulations of transit in correlation with other types of operations in regard to utilization of energy transportation infrastructure (grids) which, in turn, takes into consideration economically proven interests of the shippers, owners of the transportation facilities, investors, the producer-, consumer- and transit-states.

From my view, under GATT/WTO this backbone term in relation to energy grid-bound systems is not followed by the detailed interpretation of all appropriate, mutually acceptable and agreed upon constraints to unlimited “freedom of transit” which in their totality only provide this rule for appropriate implementation in practice (make transit being effectively operational) with least risks due to clear and unambiguous interpretation. GATT/WTO rules does not describe access to and does not provide definition of available capacities, nor does they describe a number of other important issues needed to secure energy transit. GATT Article V and ECT Article 7 each have a different subject matter.

ECT and its instruments are the only international law documents in existence today that are recognised both by members as well as by non-members of WTO. It is only ECT and its draft Transit Protocol that in details defines on the legally-binding basis and in practical terms what does “freedom of transit” mean, taking into consideration the realities of the current state of development of the energy markets in all rather heterogeneous ECT member-states. In particular case of Russia, ECT takes into consideration that Gasprom is a company which is both a gas producer and a gas transportation capacity owner (though that is the case not only for Russia within the ECT area) and that it is for the sovereign decision of ECT member-state to define organizational structure of its energy sector: whether to unbundle vertically-integrated companies (as in the EU) or not (as in Russian gas). It is the ECT and its draft Transit Protocol that introduce definition of “available capacities for transit”, define access to available capacities (MTPA is not implemented in the ECT65), formation of transit tariffs, etc. Without this type of legal clarifications (constraints) implementation of the term “freedom of transit” would become absolutely hollow and will result in higher transit-related risks both for investors and the states due to the possibility of its ambiguous interpretation, different in different transit states within the cross-border gas value chain.

Secondly, does one of the demands in the “Lami package” to Russia – i.e. that all types of transportation tariffs (for transit, export, import, domestic transportation) need to be equal –

63 For more on this debate see: A.Konoplyanik. Russia-EU Summit: WTO, the Energy Charter Treaty and the Issue of Energy Transit. – “International Energy Law and Taxation Review”, 2005, N2, p. 30-35.

64 This was also a matter of concern of the Russian President expressed in Yekaterinburg in late 2003 in regard to Russia-EU WTO debate and repeated since then by a number of high-ranking Russian officials in regard to the debate on ECT ratification by Russia as if “unlimited free transit” was authorised by the ECT.

65 It is explicitly stated in ECT Understanding IV(1)(b)(i) that “The provisions of the Treaty do not … oblige any Contracting Party to introduce mandatory third party access”.

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really mean that that is a correct legal interpretation of the WTO provisions? Or was it just a tactical negotiating tool of one of the two contracting parties? Or it as just lack of knowledge of business practice within the EU? It is clear, that within the EU, where since establishment of the European Community by the Treaty of Rome in 1958 the notion of “free movement of goods” is in effect, all types of transportation tariffs need to be equal (though they are not, as was shown in the ECS study 66). But, up to my mind, that is due to the Treaty of Rome, and not due to the WTO rules.

Though Russia-EU bilateral WTO-related negotiations are finished and Russia has acceded to WTO in 2012, it looks like transit issue between the two parties still stays in the ‘grey’ zone within WTO agenda. So the question is still open on the legal and economic background of transit tariffs demands to Russia (and to other non-EU WTO members?) in the “Lami package”.

Lack of clarity in regard to transit issue between Russia and EU was of no profit to both parties both within WTO and ECT processes67 (though now it has lost its sensitivity since Russia has entered WTO in 2012 and has withdrawn from provisional application of the ECT in 200968). Transit Protocol would have implemented in practice the principle of ‘freedom of transit’ in the energy sector which is just proclaimed in the GATT Article V. Therefore, it would have been quite logical that the ECT and its Transit Protocol may and must operate in the areas where it is not yet clear how the GATT/WTO will operate.

66 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006, table 6.2 (p.67).

67 See: А.Конопляник. Многосторонняя Энергетическая хартия не должна становиться заложником двусторонних переговоров. – «Ведомости», 24 октября 2006 г.

68 This author has been considering Russian withdrawal from provisional application of the ECT and following nonparticipation in the Energy Charter activities as a big mistake of my country which has been resulting in the increasing material losses from its not being a Contracting Party to the Treaty. For more details, see this author’s publications: Энергетическая хартия: Мифические угрозы. – «Ведомости», 5 июня 2006 г., № 100 (1627), с. А4; Борьба с мифами. О мнимых выгодах и угрозах Договора к Энергетической Хартии. – «Политический журнал», 13 июня 2006 г., № 21 (116), с. 32-36; Россия, ЕС и Энергетическая хартия: что дальше? – «Время новостей», № 210 (2092), 13 ноября 2008 г. с. 8; Энергетическая хартия и российская инициатива. Что делать с правовой базой международного сотрудничества. - «Время новостей», 28 апреля 2009 г.; A Common Russia–EU Energy Space: the New EU–Russia Partnership Agreement, Acquis Communautaire and the Energy Charter. - “Journal of Energy and Natural Resources Law”, vol. 27, #2, May 2009, p. 258-291; Energy Сharter and the Russian initiative - Future prospects of the legal base of international cooperation. – “Oil, Gas and Energy Law” (OGEL), Special Issue on EU-Russia-EU relations, vol.7, issue 2, May 2009; A common Russia-EU energy space (The new EU-Russia Partnership Agreement, acquis communautaire, the Energy Charter and the new Russian initiative). - “Oil, Gas and Energy Law” (OGEL), Special Issue on EU-Russia relations, vol.7, issue 2, May 2009; Russia: don’t oppose the Energy Charter, help to adapt it. Russia should improve the Energy Charter process, not abandon it, says Andrey A Konoplyanik. – “Petroleum Economist”, July 2009, p. 2-3; Энергохартия-плюс. Россия должна возглавить процесс модернизации ДЭХ. – «Время новостей», N°125, 16 июля 2009; Energy Charter Plus - Russia to Take the Lead Role in Modernizing ECT? - “Oil, Gas and Energy Law” (OGEL), vol.7, 5 August 2009; Russia remains a signatory of the Energy Charter Treaty. – “Financial Times” (Comments/Letters to the Editor), 26 August 2008, p. 6; Энергохартия и Россия: мифические угрозы оказались сильнее реальных выгод? – «Время Новостей», № 21, 17 ноября 2009 г.; Выход России из временного применения ДЭХ: мифические угрозы оказались сильнее реальных выгод? – «Нефть и газ», ноябрь 2009, № 9, с. 32-35; Энергетическая Хартия: почему Россия берет тайм-аут. – «Международная жизнь», 2010, № 1, с. 27-44; Why Is Russia Opting Out of the Energy Charter? – «International Affairs», 2010, vol. 56, № 2, p. 84 -96; Россия и Энергетическая хартия: долгий и извилистый путь навстречу друг другу. – «ЭКО: Всероссийский экономический журнал», декабрь 2010, № 12 (438), с. 114-132 (часть 1); Энергетическая хартия: отменить нельзя модернизировать. - «ЭКО: Всероссийский экономический журнал», февраль 2011, № 2 (440), с. 118-136 (часть 2).

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7. Key debated transit issues and draft solutions within Energy Charter framework

The quest for balanced solutions has been continuing that would satisfy both competition and investment considerations of all the participants of the cross-border gas value chains, inclusive of requests for development of common internal gas market within the EU and for providing security of transit gas supplies to the EU within LTGEC originated both from the outside and inside of the EU. Multilateral debate on these issues within the Energy Charter framework is based on common interests identified among all the players along the cross-border energy supply chain: producers, consumers, transit countries and their companies.

After the multilateral phase of negotiations on the draft Energy Charter Protocol on Transit was temporary suspended and the debate was continued on the bilateral basis between Russia and the EU, obvious progress has been achieved on many points within the informal consultations of the experts of the two parties:

(a) on the three open issues of the draft Transit Protocol that were left by the Energy Charter Conference for the draft settlement by the two parties, as well as

(b) on some other issues of Transit Protocol that were raised in the course of this bilateral debate, and

(c) on the transit-related issues of the ECT that had raised substantiated concerns of the Russian delegation and have been continuously mentioned by Russia as one of key obstacles for ECT ratification by this country prior to its withdrawal from provisional application of the ECT in 2009.

a. Definition of Available Capacity (draft TP Article 1.2)

Energy Charter documents are not dealing with the “free access to the transportation infrastructure” as this documents are sometimes criticized for. This documents regulate the rules of access to the “available capacities” of the transportation facilities. This was one of the key and the most debated issues within the multilateral phase of negotiations on the draft Energy Charter Protocol on Transit. The draft solution on definition of “available capacity” (Article 1.2 of the draft TP – CC25169) was the last point agreed before multilateral debate was suspended in December 2002.

Definition of “available capacity” excludes, inter alia, capacities reserved for implementation of existing long-term contracts (incl. LTGEC) and for future supplies of hydrocarbons from the fields the licenses on which belongs to the owner of the transportation system (Figure 12). The latter deduction was the most debated issue within the multilateral negotiations on the definition of “available capacity”. The reason for the appearance of this clause was the fact that in a number of gas producing ECT states (namely in Russia, Kazakhstan, Ukraine, etc.) gas-producing company owns gas transportation system as well (like Gasprom in Russia, Naftogas in Ukraine, Kazmunaigas in Kazakhstan) and unbundling of vertically integrated gas companies is not requested by domestic legislation of these countries70. The economic reasoning for these clauses was to secure existing LTGEC (it was the time of the peak debate within the EU on and the pressure of the Commission against the LTGEC) and access to the pipeline for the upstream

69 See at www.encharter.org/fileadmin/user_upload/document/CC251.pdf.

70 Ukraine as a member of the Energy Community has been reforming its gas sector in line with the requirements of the EU energy acquis.

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projects being developed but not yet brought to the production stage by the VIC acting as producer and owner of transportation system.

(Figure 12. Definition of Available Capacity)

These clauses means, that if, for instance, there is no free capacity (“available capacity”) in the Gasprom’s (Naftogas’, Kazmunaigas’, etc.) pipelines since all of them are booked (reserved) forward by the existing supply contracts (LTGEC) and/or for future production of Gasprom (Naftogas, Kazmunaigas, etc.) itself – nobody can press Gasprom (Naftogas, Kazmunaigas, etc.) in its own pipelines to make room to other shippers to the detriment to its own supply obligations for which capacity are reserved. But this information on available capacities need be public and reliable.

In the course of the informal meetings of Russian and EU experts within the bilateral consultations between the two parties, EU delegation has proposed a clarification to this definition reflecting demand for the unbundling and MTPA within the EU territory. This clarification relates to one of the four deductions from the volume of “physical capacity” which results in the volume of “available capacity”, namely to the infrastructure owners own transportation needs (Figure 12).

Multilateral phase of Transit Protocol negotiation was suspended (in December 2002) before Second EU Gas Directive came in force (in June 2003). That is why EU delegation has proposed during a series of informal EU-Russia experts meetings in 2006 its clarification to this clause (Figure 12) to reflect requests of the then newly introduced internal EU legislation (second EU Energy Package) and to put in line definition of “available capacity” within EU territory with requirements of acquis communautaire.

b. Domestic, import/export & transit tariffs (ECT Article 7.3)

In the course of the ECT ratification procedure (in end-1990-ies/early-2000-ies) the Russian Federation has come to the conclusion that some provisions of ECT Article 7, namely two of them - Art. 7.3 on transit tariffs and Art. 7.7 on conciliatory procedure did not exclude such interpretations that might lead to huge economic losses for Russia:

- regarding Article 7.3: if interpreted in a way that transit tariffs need to be equal to export, import and domestic tariffs,

- regarding Article 7.7: if interpreted in a way that provisional transit tariffs established by the conciliator would not be recalculated to the final tariffs agreed by the parties in dispute for the period when provisional tariffs were applied71.

This would have violated the principle of not-worsening existing economic conditions for the individual state by any new treaty entered into by this state and would also have violated the key ECT principle of non-discrimination in relation to this particular sovereign state. Russian State Duma (Lower Chamber of the Parliament) has then stated that this would have prevented ECT ratification by Russian Federation unless these transit-related provisions are clarified at minimum not to the detriment for the Russian Federation (at best, they need to be clarified in such a way which provide the clear economic benefits for every ECT member-state concerned: not a “zero-sum” game, but a “win-win” approach). 71 For more details see, in particular: А.Конопляник. Договор к Энергетической Хартии: «Ратифицировать надо, но не сегодня…». - «Промышленный мир», 2001, № 2, с. 44-48; A.Konoplyanik. “We must ratify Energy Charter Treaty – but not yet”. – “Oil & Capital. Russia & CIS Energy Magazine”, April 2001, p.6-8.

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Such the then position of the Russian Federation on ECT ratification (dependent on clarification of ECT transit-related issues) has been explicitly and continuously expressed by Russian authorities since at least 2001, but was not supported by the EU (as have been continuously expressed by the representatives of the Commission on behalf of the EU). EU delegation on the official level has been insisting that ECT ratification and draft Transit Protocol finalisation are to be two separate issues, until in 2006 the breakthrough came at the expert level when EU experts within the informal consultations with their Russian colleagues have agreed to discuss the substance of Russia’s transit-related concerns regarding provisions of the ECT after publication of the ECS study on transit tariffs72.

First transit-related concern of Russia in regard of the ECT related to Article 7.3 and reflected the possibility to interpret this Article in such a way that all transportation tariffs – for domestic transportation, export, import and transit – need to be equal within the ECT area.

Interpretation of ECT Article 7.3. as if requesting equality of all types of tariffs, has been constantly presented by the EU delegation within the negotiations and consultations both within Energy Charter and WTO frameworks (see above) and by EU officials in their public presentations. That is why such interpretation has been broadly circulated in the international press and became the general understanding of the “real meaning” of the ECT on this issue. It led to the strong opposition to the ECT from Russian officials based on a possibility to interpret this ECT article in the above-mentioned way. In Autumn 2006 Russian Presidential Aid responsible for Russia-EU bilateral relations Mr. Sergey Yastrzhembsky has stated “We can not bear with the fact, that tariffs for transit of energy resources for external and internal consumers need to be equal”.73 But they need not.

The formula voiced by the then Russian Presidential Aid was only one of the possible, but not the only possible interpretation of the ECT Article 7.3. EU supported this formula making reference to requests of its own legislation and the WTO. But as was shown above, WTO (GATT Article V) does not deal with this issue. Moreover, as it was shown in the ECS study, domestic and transit tariffs are not equal in the EU itself, both in “new” and “old” EU member-states analyzed.74

Why this clause was so sensitive for Russia? Third paragraph of Article 21 “Regulation of gas prices and tariffs for services on gas transportation” of the Russian Law “On gas supply in the Russian Federation”75 states: “With a view to implement accounts between organisations being part of the gas supply system, the organisation-owner of this system (i.e. Gasprom – A.K.) determines internal expected prices for gas and internal expected tariffs for services on gas transportation”. This means that in order to consolidate net profits of its affiliates in the centre of profit within Gasprom in the head office of the company, Gasprom can establish (and have been doing so) subsidised tariffs for domestic transportation of his affiliated companies. Article 21 of the law “On gas supply” does not apply to the shippers which are not subsidiaries of Gasprom. But Gasprom was concerned that if EU interpretation of ECT Article 7.3 dominates in the legal practice that will oblige Gasprom to provide “free” access to its transportation system 76 for

72 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006.

73 А.Мернье, А.Конопляник. Энергетическая Хартия: проигравших не будет. – «Нефтегазовая Вертикаль», 2007, № 3, с. 26-29.

74 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006, table 6.2 (p.67).

75 Law N 69-FZ of 31.03.1999.

76 This is also not requested by the ECT, as was explained in the paragraph above relating to definition of “available capacity” and also to implementation of MTPA.

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competing gas suppliers to the EU from Central Asia with their cheaper (to produce) gas at low transit tariffs (equal to “internal expected” tariffs that Gasprom establish for its subsidiaries) 77.

But nor less valid and substantiated is another interpretation of this Article according to which transit tariffs need not be necessarily equal to the tariffs for domestic transportation and can be compared only with export and/or import tariffs. And this need to be the general rule at least within ECT area outside the EU (Figure 13).

(Figure 13. Russia-EU Debate on Tariffs (ECT Art. 7.3))

It is clear, that what is legally binding for EU states according to the EU legislation, is not legally binding - according to the ECT - for non-EU ECT member-states (except for the members of the Energy Community). ECT is not an instrument of exporting emerging EU legislation to the non-EU countries. In some cases it is clearly clarified in the Treaty itself (like in the case of implementation of MTPA which is not requested by the Treaty78), in some cases – it is not (like regarding correlation between export, import, transit and domestic transportation tariffs).

ECT provides common and mutually acceptable for all ECT member-states minimum standard of behaviour. That is why individual ECT states can go further than others in developing their domestic energy markets more open and competitive than ECT provisions requested. But they can not demand this “upper standard” from other ECT member-states. However, availability of the space for interpretations creates risks for other states and their companies – in this particular case, for Russia and Gasprom – and requests practical mutually acceptable solution to this justified concern of the Russian side.

Taking this into consideration, ECS has undertaken its study on transit tariffs in ECT member-states79. It has proved that at least within four EU member-states among six analyzed transit tariffs exceed domestic transportation tariffs for gas. This was the reason to introduce the wording of the draft Understanding to the Transit Protocol (similar to the Understanding to the ECT in regard to the MTPA implementation) that was in principle accepted at the informal expert level both by the EU and Russian delegations pendant to the agreement of all other open issues. The substance of this draft Understanding is that transit tariffs need not be necessarily equal to the tariffs for domestic transportation.

c. Conciliatory procedure (ECT Article 7.7)

ECT Article 7.7 describes mechanism of conciliatory settlement which ECT member-states and/or their companies, involved in transit disputes, can use80. If this mechanism will not allow

77 For more detailed analysis related to the debate on the issue of correlation between transit and domestic tariffs and other concerns of Russia regarding ECT ratification, see: А.Конопляник. «Ратификация ДЭХ Россией: прежде всего необходbмо развеять добросовестные заблуждения оппонентов». – гл. 22 (с. 545-614) в кн. «Договор к Энергетической Хартии – путь к инвестициям и торговле для Востока и Запада» (под ред Т.Вальде – англ.изд. и А.Конопляника – рус.изд). – М.: Международные отношения, 2002, 632 стр.

78 According to ECT Understanding IV.1.(b)(i) “The provisions of the Treaty do not oblige any Contracting Party to introduce mandatory third party access”.

79 Gas Transit Tariffs in the Selected ECT countries, Energy Charter Secretariat, January 2006.

80 For more detail see: В.Сорокин. Энергетическая Хартия: развитие многостороннего режима транзита энергоносителей. - гл. 21 (с. 526-544) в кн. «Договор к Энергетической Хартии – путь к инвестициям и торговле для Востока и Запада» (под ред Т.Вальде – англ.изд. и А.Конопляника – рус.изд). – М.:

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the parties in dispute to reach an agreement, the conciliator appointed by ECS General Secretary can take intermediary decision, which the parties in dispute are obliged to follow within 12 months if the dispute will not be settled earlier (Figure 14). In order to address substantiated concern of Russia regarding conciliatory procedure of transit disputes settlement, a clarification was proposed by the experts during informal Russia-EU experts meetings in 2006 (in the form of Understanding to the draft Transit Protocol) that interim transit tariffs, established by the conciliator for the period of the dispute, shall be restituted at the end of this dispute to the level of transit tariffs, finally agreed by the parties in dispute, inclusive of interest at a commercial rate established on a market basis.

(Figure 14. Conciliation (ECT Art. 7.7))

Conciliatory procedure has not been used yet by ECT member states. It was first proposed to the disputed parties during Russia-Ukraine (Winter 2005/06) and Russia-Belarus (Winter 2006/07) gas disputes in case they would not have reached bilateral agreements.

Gas disputes between Russia and Ukraine (both of January 2006 and of January 2009) regarding export supplies to and transit of gas through Ukraine has attracted strong international attention and provoked numerous commentaries81. One of the aspects of the dispute, namely the transit one, was related to the role of the Energy Charter instruments in diminishing risks of transit interruptions in energy supplies. In the course of this dispute representatives of both Russia and Ukraine appealed to the provisions and principles of the Energy Charter as the basis for finding solution. According to the Treaty, ECT member-states are obliged to facilitate energy transit consistent with the principle of freedom of transit, not to interrupt nor to reduce transit flows in the event of dispute, etc.

On January 3, 2006, the Secretary General of the ECS sent the letter to both parties 82 in which he reminded that the Treaty possess dispute settlement instruments, including special conciliatory procedure of transit dispute settlement, and proposed to use them in case if bilateral agreement is not reached. It was only second working day of ECS Secretary General in this capacity after being elected to this post, but his proposal was well substantiated: the Secretariat has carried out all the preparatory work necessary to implement conciliatory procedure, including preliminary agreement of both parties at the top level to enter this procedure if needed and their no objection to the candidacy of the potential conciliator. Secretariat’s proposal was not called for since next day, on 4 January, 2006, Gasprom and Naftogas of Ukraine signed bilateral agreement putting an end to this dispute. 83

Similar development took place during transit disputes between Russia and Belarus in gas (December 2006) and in oil (January 2007). General Secretary of the ECS has again made statements on December 30th and January 8th 84 and appealed to both parties to follow transit provisions of the ECT, including on providing freedom of transit and continuity of existing

Международные отношения, 2002, 632 стр.

81 Among such commentaries, from this authors view, most substantiated were publications of the Oxford Institute for Energy Studies (OIES), incl. publications of J,Stern and K.Yafimava.

82 It is available at the Energy Charter website at www.encharter.org.

83 On more details on this agreement between Russia and Ukraine see: А.Конопляник. Российско-украинский газовый спор: размышления по итогам Соглашения от 4 января 2006 г. (в свете формирования цен и тарифов, экономической теории и ДЭХ). – «Нефть, газ и право», 2006, № 3, с. 43-49; № 4, с. 37-47.

84 Available at www.encharter.org.

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transit flows. General Secretary has again paid attention of the parties on possibility to use ECT conciliatory procedure for transit dispute settlement in case the dispute is not settled bilaterally. Fortunately, this proposal was not again called for since the parties has reached bilateral agreements on gas and oil on 31 December and 1 January correspondingly.85

d. Congestion management (draft TP Article 10)

One of the three outstanding issues that remained in the draft Transit Protocol (Document CC 25186) concerns auction-based access to transportation capacity for transit (Art. 10).

Article 10.3 of the draft Transit Protocol declares cost-reflectiveness as a principle of establishing transit tariffs by saying that “transit tariffs shall be based on operational and investment costs, including a reasonable rate of return”. Understanding 11 of CC 251 declares that congestion management mechanisms may include auctions and that transit tariffs determined by auctions should be cost-reflective. However, auctions will in general not be cost-reflective but will create an extra income above the level of cost-reflectiveness. It should therefore be avoided that auctions and the underlying congestions are perpetuated, blocking the transit of extra volumes and increasing the costs of transit.

In the course of their lengthy and intensive informal consultations, not only did Russian and EU experts find a mechanism to resolve this peripheral issue, but they also proposed a solution to a more general problem. A non-discriminatory competitive procedure was developed to allocate available capacity of energy transporting infrastructures (Figure 15).

(Figure 15. Capacity Allocation and Creation)

In a world of increasing energy demand it is important to allow for the necessary expansion of the existing energy transport infrastructure including for the purposes of transit. Depending on their duration, congestion can be overcome by investment or other measures if shippers are willing to cover the extra costs incurred. The period in which auctions are applicable as a mechanism to manage congestion and access to the network should therefore be restricted to the period necessary to implement measures to relieve this congestion. To avoid an incentive to perpetuate congestion, extra revenue beyond cost recovery should be used to relieve congestion or to reduce tariffs.

For the issue of transparent and non-discriminatory congestion management, the wording of detailed principles was agreed between the EU and the Russian experts in 2006 and confirmed to the ECT community in 2007, subject to an overall agreement. The text addresses the time span for which congestion mechanisms should apply before capacity increases can be implemented and principles of non-discriminatory capacity allocation in case of congestion, based on the idea of open seasons.

In case capacity requests exceed by volume and/or duration the available capacity (capacity congestion), there are two options to consider. It is possible to:

continue allocating the existing capacity in a non-discriminatory and transparent manner through conceiving one or more capacity allocation mechanisms (pro-rata, auction, other);

85 А.Мернье, А.Конопляник. Энергетическая Хартия: проигравших не будет. – «Нефтегазовая Вертикаль», 2007, № 3, с. 26-29.

86 See at www.encharter.org/fileadmin/user_upload/document/CC251.pdf.

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opt for an investment decision to create new capacity (Figure 15).

Capacity allocation mechanisms for the existing capacity will allow an immediate but temporary solution to the congestion problem. Investment decisions, on the other hand, require long lead-time to be realised; therefore, cannot serve as a prompt instrument to address capacity problems.

Creation of new capacity is addressed by Article 9 of the draft TP, which has already been provisionally agreed by all member states, subject to overall finalisation. An open question is who is entitled or obliged to invest into developing transit infrastructure, which depends strongly on the regulatory model chosen by the respective country (regulated access (MTPA) with Transit System Operators - TSOs in the EU vs. negotiated access in non-EU).

In the case of a single system operator and regulated access, an obligation to create transit capacity by the TSOs is necessary to avoid obstacles to transit. This should not be an undue burden in view of cost reflective tariffs.87

In the case of negotiated access, when everybody including those seeking transit is allowed to invest in new transportation, the necessary rights of way have to be secured by the company investing in new transportation. Without the right of eminent domain transit projects will be difficult to realise when the transit route crosses many private pieces of land.

The draft Transit Protocol addresses various aspects related to the creation of new transport capacity through either expansion of existing lines or construction of new lines:

new Article 10bis developed by the experts from the EU and Russia requires taking all reasonable measures to mitigate the congestion (Figure 15);

Article 9 stipulates objective, transparent and non-discriminatory (as to origin, destination and ownership of energy) authorisation procedures and legislation on creation of new capacity in Energy Transportation Facilities (ETFs);

Article 9 also requires non-discriminatory authorisation procedures and legislation between ETFs used for transit and those used for internal transport.

Prior to a decision for allocating existing capacity or new investment for additional capacity, an “Open Season/Open Subscription” process may be initiated, which will help determine market demand with respect to additional capacity. As required by the draft Transit Protocol above, such procedures must be based on objective, transparent and non-discriminatory principles.

In the specific case where congested capacity is allocated by auctions, the resulting tariffs are determined by demand and so, by definition, do not meet the test of cost-reflectiveness. Therefore, the use of extra revenue of auctions beyond cost recovery should be restricted to avoid any economic interest in the perpetuation of congestion.

Draft capacity allocation procedure agreed by the EU and Russian experts included the use of surplus revenues from auctioning the available capacity so that the owner and/or operator of the pipeline system would have no incentive to raise transit tariffs for the purpose of enrichment.

87 This approach was used in developing Network Code on Incremental Capacities to the Third EU Energy Package (two experts from Russia/Gazprom Group were invited to participate within the group of six Prime Movers in preparation of this Code) based on the provision of Article 13.2 of the Third Gas Directive saying that “Each transmission system operator shall build sufficient cross-border capacity to integrate European transmission infrastructure accommodating all economically reasonable and technically feasible demands for capacity and taking into account security of gas supply.” This factually means that “if there is market demand for the capacity - TSO shall invest” (Directive 2009/73/EC of the European Parliament and of the Council of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC). See also: А.Конопляник. Третий энергопакет ЕС: как избежать дефицита мощностей в рамках 10-летнего плана развития газотранспортной инфраструктуры? – в сб. «Газовый рынок Европы: направления развития». Материалы международного семинара «Развитие рынков газа в Европе». – М.: РГУ нефти и газа имени И.М.Губкина, 2012, с. 23-49.

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Additional revenues accumulated by the owner and/or operator of the pipeline/transit system from auction-based access transit tariff-setting in excess of “reasonable” profit (because auction-based tariffs are not cost-reflective) are to be used to debottleneck available capacity or reduce “excessive” tariffs paid by shippers through the auction-based access arrangement.

e. Contractual mismatch problem (draft TP Article 8)

The contractual mismatch problem means that transit gas flows need long-term access to infrastructure that corresponds in terms of time (duration) and volumes to the supply obligations under a LTGEC. If such requirements are fulfilled in regard of the transit time (including the opening and closing dates of such a contract) and transit volumes, there is no contract mismatch problem.

As an integral part of performing supply obligations, a mismatch of the opening/closing dates and volumes between the LTGEC and transit/transportation contract creates a risk of transit/transportation contract non-renewal for the producer/supplier and, consequently, a risk of non-performance of its supply obligations under the LTGEC. The key object is to guarantee the producer’s/supplier’s access to the relevant transportation capacity for the entire term of the existing LTGEC and all the contracted volumes thereunder (Figure 6).

Due to their longevity, most hydrocarbon (and some dedicated electricity) export deals are based on long-term commitments of markets, resources and the transportation infrastructure in-between (including transit), whose durations have to match each other to make the project workable and especially bankable. Exporters will not conclude a long-term export contract without secured transportation/transit and, vice versa, not commit to build or book long-term transportation capacity without having a long term export contract.

It should be recalled that the typical size of most long distance gas and oil export projects to justify a new pipeline is in the order of at least 10 billion cubic meters per year for gas and 10 million tonnes per year for oil and that the project duration is usually not less than 10 years, with 20 – 25 years being most common. Banks will require proof of sufficient reserves, market outlet and corresponding transportation arrangements linking production and market, to finance such projects. Competition for transit is predominantly competition between such large projects.

Long-term export decisions can be based on deep liquid markets (as for oil in general and for gas in North America and the UK) or on long term (gas) contracts which are so far the dominant feature outside the UK and North America88. In any case, a long-term commitment to export resources by a fixed infrastructure to a specific market needs secured access to that infrastructure for the duration of the delivery commitment (the typical case being the duration of a long term gas export contract needing secured transportation/transit for that duration).

The contractual mismatch problem existed within the CIS countries (mostly between Russia and Ukraine, Belarus) since transit arrangements with CIS transit states (providing for implementation of Russian LTGEC supply contracts with EU buyers) had been usually signed on an annual basis. In CIS countries and other non-EU states there is an all-purpose arrangement to resolve a contractual mismatch if such a problem seems unavoidable. This arrangement is called the “right of first refusal” (RFR) 89. This mechanism is well known and broadly used world-wide.

88 See “Putting a Price on Energy: International Pricing Mechanisms for Oil and Gas”, Energy Charter Secretariat, 2007, chapter 4.1.

89 As a general concept, right of first refusal is defined as a contractual right granted by the owner of something, that gives the holder of the right an option to enter a business transaction with the owner according to specified terms, before the owner is entitled to enter that transaction with a third party (Wikipedia,

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RFR is a common concept in the US, introduced by FERC Order 636 in 1992, and applied since then without negative impacts on competition or on non-discriminatory treatment. In 2009 Russian Gazprom and Ukrainian NAK Naftogas has signed both 10-year long gas supply and gas transit contracts thus eliminating risk of “contractual mismatch” problem.

The discussion on alignment of duration of transit and supply contracts was originally addressed in Article 8.4 of the draft TP (as in CC 251) by providing for a RFR to the existing user, i.e. the incumbent supplier.

RFR enables any long-term firm transportation customer to continue receiving that firm service by agreeing to pay up to the maximum rate and matching the length of contract term offered by another customer who wants and values the service. If the pipeline owner/operator is willing to discount the transportation rate for competitive reasons, the pre-existing customer may retain the capacity by matching the highest rate, up to the maximum, offered by a competing bidder. The existing transportation customer agrees to match the longest contract term offered by another customer interested in receiving the service. Thus, if a competing bidder offers to pay the maximum transportation rate for a term of 20 years, the existing customer cannot retain the capacity by agreeing to pay the maximum rate for some shorter term.

Concerning the applicability of RFR within the European system, one should clearly understand the structural differences in the US and European gas markets and transportation infrastructures. Most European oil and gas transits (except those within a common market) take place through pipeline systems driven by specific upstream projects from a single supplier and usually constructed and owned by this supplier/project company. Therefore, there is often only one contractual arrangement allowing the use of the entire/most transit capacity by one supplier/project company. In the US system, however, there typically exist multi-transport agreements within one pipe and major parts of the capacity are not used exclusively by one supplier. That is why the RFR concept raises concerns in the Eurasian context.

The EU interprets such all-purpose arrangements for the provision of access to capacity for the entire duration of a supply contract (LTGEC) as being in conflict with the EU legislation on competition. EU considers that RFR accords preferential access rights to the incumbents. This, in EU view, discriminates against new prospective shippers. RFR forces them to resort to a more capital intensive solution such as the construction of a new transit infrastructure. This clearly deteriorates the newcomers’ competitiveness at the end-use market and contributes to the existing monopolisation and/or high market concentration in the industry. For this reason, the EU asserts that the RFR is unacceptable for implementation inside the EU to resolve contractual mismatch problems where these are unavoidable.

The expert discussion suggested that the underlying problem addressed by draft Article 8.4, is how to avoid mismatches between the duration of delivery obligations and the duration of the corresponding long-term transit arrangements and that the RFR was only one of the possible instruments to address it.

In principle, there should be no restriction to the duration of a bona fide request for capacity booking backed by credible long term payment commitment. This was also addressed by the corresponding interpretative note of the European Commission90. To avoid discrimination, newcomers should have the same access to available capacity or to construction of additional capacity, which will enable them to have the same opportunities to implement export projects as

http://en.wikipedia.org/wiki/Right_of_first_refusal).

90 See at: http://ec.europa.eu/energy/gas/legislation/doc/interpretative_note/sec_2007_822_en.pdf

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incumbents. On the other hand, realisation of projects by those coming first or by incumbents should not be prevented from securing the transit services they need simply because of a desire to reserve an option for newcomers to join later. The state of the art approach to transparent and non discriminatory (long term) capacity booking for the time span economically needed is to call for an open season to give everybody interested a time-limited opportunity to join on a non-discriminatory basis91.

There were concerns that some countries may wish to limit the duration of transit arrangements, clearly, below the duration needed for the corresponding long-term export contracts. Reasons for such restrictions could be of a technical nature (which could be overcome) but also a wish to give a free option to newcomers. Inside the EU, there are considerations to foster competition by limiting the duration of EU internal transportation contracts which are, however, of a different nature compared to transit linked to import contracts.

There was concurrence among the experts about the need for long-term import contracts as an important instrument for security of supply and the need to have corresponding transit arrangements. However in many countries – and the EU is not exception in this regard – authorities are biased against the provision of suppliers with long term access to energy transportation infrastructure. In the event of mismatch between transit and supply contracts on at least one parameter (most frequently, the term of the transit contract is shorter than the duration of the supply contract) a contractual mismatch is unavoidable. Then there is the risk of non-renewal of the transit/transportation contract and the threat that the supplier will not perform under its energy supply contract (usually LTGEC) for reasons beyond its control. Nonetheless, it is the supplier that will be liable for such non-performance because it is his liability for any breach of LTGEC within its area of contractual responsibility, inclusive the transit segments of gas supply chain, i.e. up to the delivery points.

In the course of unofficial EU-Russia expert consultations on draft Transit Protocol it became clear that it is necessary to reflect in more details interrelations between owners (operators) of transit capacities and their existing and potential users with due consideration, that durations of supply contracts (LTGEC) and transit arrangements which are used or planned to be used for fulfillment of these LTGEC, do not correlate in many cases thus creating “contractual mismatch” problem.

It is only owner (operator) of transit capacities, who can possess full information about existing contracts/agreements with the users and who can collect in advance information about newly appeared demands in using his transit capacities. This owner (operator) will act according to the rules/regulations acting in his state (ECT Contracting Party). For collection and analysis of this information transparent procedures need be in place. Well-founded applications for using the capacity need be entertained, first of all, those that are confirmed by corresponding supply contracts. In this case, the owner (operator) of transit capacities can in advance identify potential shortages of available transit capacities compared to the integral forthcoming demand for them.

EU experts stated that in this case (if prospective shortage of transit capacities is identified) the necessary development of these capacities will be provided to cover all well-founded requests for transit capacities within the EU territory. Such approach will exclude the very fact of appearance of “contractual mismatch” problem within the EU (supply contracts and transit arrangements will always be matched).

91 See: А.Конопляник. К вопросу о равнодоступности (о так называемом равном доступе к трубопроводам). – «Нефть, Газ и Право», 2008, № 5, с. 39-44; А.Конопляник. Правовые аспекты процедуры недискриминационного конкурентного доступа к свободным мощностям транспортировки (ДЭХ, TAG и ЕСГ), с.142-156 – в: Нефтегаз, энергетика и законодательство (выпуск 8 / 2009). Информационно-правовое издание топливно-энергетического комплекса России и стран СНГ (ежегодник). – Москва, «Нестор Экономик Паблишерз», 2009, 160 с.

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For other Contracting Parties, who are not the EU member-states, an option is left not to take by themselves stringent obligations to develop transit capacities. For this countries initial principle is left as an option – to provide to the incumbent user of the transit capacities the right to be the first to accept the new transit conditions after his existing transit contract will come to an end. At the same time it is clarified, that this rule is acting if incumbent user of the transit system possess the supply contract with duration exceeding termination date of his transit contract (i.e. RFR to be implemented only within the duration of valid LTGEC).

It was not possible within the time frame of the expert meetings to concur on a joint wording on this issue.

f. Transit Protocol implementation inside the EU (The “REIO Clause” - draft TP Article 20)

A definition for a REIO (Regional Economic Integration Organization) is provided in ECT Article 1. It is undisputed that the EU is a REIO under the ECT.

The EU member-states has signed ECT in two capacities: as each individual EU member-state and as the EU as a whole (as a REIO) – that is why ECT had at that time 51 member-states but 53 Contracting Parties (The EU and EURATOM). That created a potential problem and conflict of interests for the EU and its member-states related to definition of the “area” – in the current case to definition of the “area of transit”: whether it is the area of the individual EU member-states or of the EU as a whole.

The discussion over the draft Transit Protocol’s Article 20 concerned the application of the draft Transit Protocol inside the EU with respect to transit through single EU member countries (calling Article 20 of the draft Transit Protocol a “REIO clause” looks like a misnomer!). While ECT Article 7 clearly defines transit through single EU member states as transit, and its provisions are fully applicable to such cases, Article 20 of the draft Transit Protocol would have restricted its application, to the extent it is more specific than the ECT, to the EU as a single area. This would have reduced the application of the draft Transit Protocol to the EU to very few cases of small significance, e.g. gas transit to Switzerland or Russian onshore supplies to Kaliningrad oblast or to Turkey (Figure 16-17).

(Figure 16-17. Possible Scenarios of Hydrocarbon Supplies Destined For and/or Transported Through REIO Territory)

It is the political aim of the EU to create a single competitive energy market. On the other hand, long-term supply contracts are still considered a major instrument of security of gas supply. When their delivery point is inside EU this will require to allow long-term transit arrangements inside the EU to support long-term supply obligations. The corresponding Interpretative Note by the European Commission92 provided for the possibility of long-term booking of capacity93, indicating that the idea of avoidance of mismatch for import contracts and corresponding transportation arrangements across single EU countries seems in line with the EU Acquis, 92 http :// ec . europa . eu / energy / gas / legislation / doc / interpretative _ note / sec _2007_822_ en . pdf 93 which was just the first step. After all, the EU Network Code on Incremental Capacity entered into force in April 2017 provided to book access to transportation capacities of up to 20 years in special cases (up to 15 years within the ordinary procedures)

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although not part of it. The draft Transit Protocol would have gone beyond the EU Acquis by requiring solutions to the mismatch issue, both within and outside the EU.

A difficult issue seems to be the relation within the EU between the Acquis and the draft Transit Protocol as an international agreement. For instance, the dispute resolution mechanism under the draft Transit Protocol when applied to single EU member states would risk bringing disputes between EU member states to a judicial instance external to the EU system (ICSID, UNCITRAL, SCC), which would jeopardize the Acquis94.

But it seems that by signing and ratifying the ECT by the EU as a whole as a 52 nd ECT Contracting Party, the EU seems to agree to the common principle of international law that the rules of international agreements to which the EU is a party need to dominate over its internal laws (in this case – over the EU’s Acquis).

When looking for possible solutions, it is also useful to distinguish between electricity and hydrocarbons: for electricity a pool-type system is established in the EU and in any case in line with the physics of electricity. Net imports of electricity into the EU are minor (hovering around 2 % during the last 20 years) compared to gas net imports which have grown to 75%. A major part of imported gas is not delivered at the EU border any more, but at borders inside the EU (Baumgarten, Waidhaus, Frankfurt/Oder). For gas, the transit through single EU member states can be and, in view of taxation, is registered separately as opposed to national transportation or imports or exports of gas. Electricity transit is not traced for single member states inside the EU in view of the pool system established. Thus it was considered by the experts to differentiate between transit of electricity and of oil and gas, because the draft Transit Protocol would not lend itself to application to single EU member states for electricity. Such approach did not solve the issue of application of Transit Protocol within the EU as a legal issue but rather did not address it due to its insignificance in case of electricity.

There was from the EU side that long-term supply contracts and related long-term transportation contracts within the EU gas market would be an obstacle to competition in the EU. However, transportation within the EU for import EU purposes is just a portion of much longer transportation chains linked to development of production sites mostly external to the EU. It thus covers cross-border transportation systems with significant portion lying outside the EU jurisdiction and is not comparable with transportation for EU internal market purposes when the whole transportation system is lying within the EU and its jurisdiction.

In this regard one of the then proposals of Russian side95 to find solution to the issue of Transit Protocol implementation within the EU, was the following: to implement Transit Protocol within the EU only within limited space – until the delivery points of LTGEC from the external suppliers, i.e. from the outer EU border until the first point of changing title of ownership of the gas in the pipe (Figures 16-17). However, this idea was not supported by the EU experts.

At its 18th meeting on 7th December 2007 the Energy Charter Conference adopted the following conclusion: “The Energy Charter Conference recalls the importance of transparent, non-discriminatory and operational legal frameworks for energy transit, for the benefit of consumers, producers and transit countries. In this context, it reaffirms if support for finalization of the negotiations and adoption of the Energy Charter Protocol on Transit to expand upon the existing provisions of the Treaty.

94 see: У.Руснак, А.Конопляник. Эволюция модели энергобезопасности. Россия и ДЭХ: не остаться на обочине. – «Нефтегазовая Вертикаль», 2015, № 10, с. 4-12.

95 I would like to remind that this took place before 2009 when Russian Federation has withdrawn from ECT provisional application.

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The Conference resolves to ask the Group on Trade and Transit to hold multilateral consultations on the draft Transit Protocol during 2008. At the end of 2008, the Chairman of the Group on Trade and Transit shall report to the Conference on the outcome of these consultations, including an assessment of the possibility to fix areas of consensus in a form that could be considered for adoption by the Conference, and, where this assessment is positive, recommendations on modalities and procedures for further work”.

Unfortunately, it was not possible to successfully finalize the draft Energy Charter Protocol on Transit. Now it is on hold with low prospects of its finalization ever, mostly due to the fact that the party most interested in it – Russian Federation – has withdrawn from provisional application of the Treaty.

8. Which transit risks ECT does not address and why so

One of the key elements of criticism from Russian authorities towards the Energy Charter both in and/or after the Russia-Ukraine gas transit crises of January 2006 and January 2009 were the informal but publicly stated claims from different politicians that Energy Charter did not prevent appearance of these transit crises per se, which means that it has not prevented the unauthorized takings of the gas from the transit flows and has not prevented interruptions of such flows. From their views, this demonstrated that Energy Charter was not a useful instrument in regard to transit since it has not managed to prevent its interruptions by one of the ECT Contracting Parties. So they (began to) treat ECT as an instrument of the guaranteed prevention of any transit crisis to appear rather than the instrument of the quick and effective solution in case transit crises appears.

In respond to this claims I can say, that any instrument is effective/workable within the area of its predetermined implementation. It cannot act beyond the areas of its “competence/validity” and beyond the areas where it was aimed to be enforced at the stage of negotiations on this instrument. At the stage of negotiations on the ECT it was not possible even to imaging by the future Contracting Parties that transit can be interrupted by purpose. The whole philosophy of the ECT in its “transit” section (Article 7) was based on the overall perception of the negotiating parties that transit flows would continue under any unfavorable development and the dispute between the parties on transit can occur only on the value of transit fees/tariffs. This is why the whole methodology of the Article 7 “Transit” of the ECT was aimed at the quick and effective amicable solution on the mutually appropriate transit tariffs value. It was based, to some extent, on the same/similar approach as has been used historically within long-term supply contracts in regard to possibly appearing different views of the parties to the contract on the price levels of the contractual commodity: the well-known “price review clauses” in LTGEC are aimed at redetermination of the price without interruption/cancellation of the gas flows. The same approach – redetermination of transit tariffs (the “price of transit service”) without interruption/cancellation of transit flows – is the base principle incorporated into ECT Article 7 “Transit”. So one cannot accuse a treaty for the absence in it of this or that provision that was not incorporated in it by the negotiating parties at the stage of negotiations either by purpose or because the issue (possibility to interrupt transit by purpose) was beyond the imagination of the negotiating parties.

There are two ways how to deal with possible transit disputes96:

96 See, inter alia: A.Konoplyanik. Transit risk minimization instruments for Russian gas supplies through Ukraine to the EU: arguments of the resource-owning sovereign state – and the motives of the opponents. // Presentation at the 21st WS2 GAC meeting / 28th round of Consultations, Gazprom export, St.Petersbourg, 21.10.2016

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(1) to settle transit dispute/crisis after/in case it occurs. International law instruments (ECT Article 7) are aimed at minimization of negative consequences of the dispute/crisis in case the latter is already in place (it was perceived that it might happen by accident and not by purpose). But availability of mutually agreed rules does not preclude that they will/might not be violated (like transit crises of January 2006 and/or January 2009), especially if there is no mechanism of inescapable punishment for violation of the mutually agreed rules. Such international rules are oriented mostly on goodwill of the parties (sort of “idealization’ of international law). In the post-Cold War 1990-ies nobody can even imagine, after more than 30 years of stable and non-interruptible transit from the USSR to the EU through the Cold War era, that transit flows can be interrupted by purpose. So even under such rules the risk that transit dispute/crisis will occur still remains;

(2) to prevent (to exclude/decrease probability of) the very fact of transit dispute/crisis occurrence. Under such option two sub-options can be mentioned: (i) diversification of routes (“multiple pipelines” concept) leading to liquidation of transit monopoly of the state(s) located at the single transit route and thus leading to diminishment of transit risks, and/or (ii) full abandonment from transit routes by moving (where technically possible and economically justifiable) to non-transit bypasses to the destined markets (escaping third countries on the delivery route, if/when/where possible). This leads to nullification (total liquidation) of transit risks.

So to criticize Energy Charter for its incapability to prevent transit crises means to criticize it for what it was not purposed for by the ECT Contracting Parties at the stage of negotiations on ECT. To add value to the ECT in this regard on the issue that was identified after it came into force, means to initiate, to prove to other parties, and to open new multilateral negotiations on the issue which one of the parties (in this case Russia) considers to be lacking from (absent in) the ECT. A good opportunity for such initiative was opened by the signing of the International Energy Charter (IEC) in 2015 (which ceremony my country did not attend and thus did not sign IEC). Now the work is underway on the adaptation of the ECT itself which opens new possibilities to incorporate into ECT new provisions which would reflect the areas which Contracting Parties/Signatories consider appropriate to be improved. Instead, my country has decided to withdraw from ECT provisional application in 2009 and since then has de facto withdrawn from the practical activities within the Energy Charter process, including its non-participation in the current activities on further improvement of the legal force of the ECT. I still do hope that my country will reassess its policy towards the ECT and will sooner or later return to the ECT family.

(www.fief.ru/GAC; http://www.konoplyanik.ru/speeches/161021-Konoplyanik-WS2-transit%20UA%20risks.pdf)

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