State Regulation of Natural Gas Transportation and Sales

Outline of the Legal Framework of the Industry

Currently, the Federal Tariff service of the Russian Federation regulates the following gas transportation tariffs:

·       tariffs for services of gas transportation through trunk gas pipelines for independent organizations;

·       tariffs for services of gas transportation through gas distribution networks;

·       tariffs for gas supply and distribution services provided to end users by gas suppliers (if gas is supplied at regulated wholesale prices).

The principal regulation in the sphere of gas transportation and sales is Resolution No. 1021 of December 29, 2000 of the Russian Federation Government «On State Regulation of Gas Prices and Tariffs for Services of Gas Transportation on the Territory of the Russian Federation,» which approved the «Main Provisions for Formation and State Regulation of Gas Prices and Tariffs for Services of Gas Transportation on the Territory of the Russian Federation.»

Currently, these tariffs are determined using the following procedures developed and approved by the Federal Tariff Service and the Federal Energy Commission of the Russian Federation:

1. «Guidelines for Regulating Tariffs for Services of Gas Transportation Through Gas Distribution Networks» approved by Resolution No.88-e/1 of October 28, 2003 of the Federal Energy Commission of the Russian Federation (in the version of Resolution No142-e/1 of October 26, 2004 of the Federal Tariff Service of the Russian Federation).

State regulation of gas transportation through gas distribution networks is based on the same legal framework as gas transportation through trunk gas pipelines. One of the salient features of state regulation of gas transportation through gas distribution networks is the legislative rule prescribed by the Federal Law «On Gas Supply» and approved by Resolution No.335 of May 3, 2001 of the Russian Federation Government «On Establishment of Special Surcharges to the Tariffs for gas Transportation by Gas Distribution Organizations for Financing Gasification Programs,» which regulates the procedure of determining special surcharges to tariffs for gas transportation by gas distribution organizations for financing gasification programs. Apart from that, in contrast to gas transportation through trunk gas pipelines regulated by the Federal Tariff Service of the Russian Federation, ample materials have been worked out for gas transportation through gas distribution networks and published as Guidelines^[1].

2. «Procedure for Calculation of Tariffs for Services of Gas Transportation Through Trunk Gas Pipelines» approved by Resolution No.338-e/1 of August 23, 2005 of the Federal Tariff Service of the Russian Federation.

Apart from that, regulation of gas transportation through pipelines uses the method of price regulation, the method for identifying consumers with the right of mandatory attendance, and the method for determining the minimum level of their attendance in case the requirements of such consumers for the product produced or sold by the natural monopoly subject cannot be fully satisfied.

Thus, the following regulatory documents are added to the list of regulations for gas transportation and sales:

§       «Regulation on Access of Independent Organizations to the Gas Transportation System of OJSC Gazprom» approved by Resolution No.858 of July 14, 1997 of the Russian Federation Government; and

§       «Regulation on Access to Organizations to Local Gas Distribution Networks» approved by Resolution No.1370 of November 24, 1998 of the Russian Federation Government.

The main points of the access regulations are as follows:

§       access is granted for ensuring supplies to consumers in the Russian Federation (the issues of gas supplies outside the customs territories of the Russian Federation are not considered);

§       access may be granted to any organization (producer, consumer, or supplier of gas);

§       gas transportation contracts are concluded if free gas transportation capacities and technical possibilities of gas supply to the gas transportation system or gas withdrawal from it are available and gas satisfies certain standards[2];

§       free gas transportation capacity is defined as the technical capacity of the gas transportation system to receive and transport the required volume of gas in addition to the volumes of gas transported for organizations of OJSC Gazprom and independent organizations under current gas transportation contracts;

§       disputes and discrepancies are settled by the Commission of the Russian Federation Government for the use of trunk oil and gas pipelines and pipelines of oil products.

It should be mentioned that the availability of free capacities in the gas transportation system is determined by OJSC Gazprom. The liability of OJSC Gazprom, as the owner of the Unified Gas Supply System, for a failure to grant access or failure to grant timely access to the gas transportation system when free capacities are available is not defined. All this makes users of the gas transportation system dependent on the owner of this system, which was confirmed at several meetings of the Commission of the Russian Federation Government for the use of trunk oil and gas pipelines and pipelines of oil products dedicated to the cases when access to the trunk pipelines of OJSC Gazprom was not granted.

Considering the aspects of granting access to the gas transportation system, it is necessary to point out that requirements for connecting facilities (fields, gas processing facilities, etc.) of independent gas producers to the pipeline transport of OJSC Gazprom are set by OJSC Gazprom[3]. OJSC Gazprom coordinates the technical conditions for connecting facilities of independent gas producers. However, coordination of technical conditions for connection by OJSC Gazprom is necessary but not sufficient for getting access to the pipeline transport (as, for example, in the case of the Beregovoe field developed by ITERA).

All this leads us to the conclusion that many important issues of using the gas transportation system are not regulated. To develop mechanisms ensuring truly non-discriminatory access to the gas transportation system and establishing civilized rules regulating access to the gas transportation system, it is necessary to introduce essential changes into the existing «Regulation on Access of Independent Organizations to the Gas Transportation System of OJSC Gazprom» and the law «On Gas Supply.»

Access to local gas distribution networks is regulated by Resolution No.1370 of November 24, 1998 of the Russian Federation Government «Regulation for Access of Organizations to Local Gas Distribution Networks.» The terms and procedure of access to local gas distribution networks prescribed by this document are similar to the terms and procedure of access to the gas transportation system of OJSC Gazprom and have the same shortcomings.

Practical application of this resolution of the Russian Federation Government is explained in the «Regulation for Consideration of Issues Related to Access of Organizations to Local Gas Distribution Networks» approved by Resolution No.6/1 of February 19, 1999 of the Federal Energy Commission of the Russian Federation.

The following prices and rates are currently regulated in the sphere of purchase and sale:

§       wholesale prices of gas (natural gas, associated petroleum gas, and stripped dry gas), except the prices regulated by gas producers that are not affiliated companies of the open joint-stock company Gazprom and the joint-stock companies Yakutgazprom, Norilskgazprom, Kamchatgazprom, and Rosneft-Sakhalinmorneftegaz;

§       rates for supply and distribution services provided by gas suppliers to end users (with regulated wholesale prices of gas); and

§       retail prices of gas sold to the population and the domestic household sector.

The main regulation here is Resolution No.1021 whose provisions are reflected in the following regulatory documents:

§       Procedure for Determining the Rates for Supply and Distribution Services Provided by Gas Suppliers to End Users» approved by Resolution No.8/9 of February 6, 2002 of the Federal Energy Commission of the Russian Federation; and

§       Guidelines for Regulation of Retail Prices of Gas Sold to the Population» approved by Resolution No.194-e/12 of November 23, 2004 of the Federal Tariff Service of the Russian Federation.

The rate for supply and distribution services provided by gas suppliers to end users is added tp the regulated wholesale price of gas. Regulated wholesale prices and rates for supply and distribution services do not apply to gas produced by organizations that are not affiliated companies of the open joint-stock company Gazprom and the joint-stock companies Yakutgazprom, Norilskgazprom, Kamchatgazprom, and Rosneft-Sakhalinmorneftegaz. That means that according to Resolution No.1021 of the Russian Federation Government, regulation of wholesale prices and rates for supply and distribution services does not apply to independent gas producers. This is important, because establishment of the rate for supply and distribution services by the Federal Energy Commission of the Russian Federation resulted in an actual increase of wholesale prices regulated by the state and expanded the geographic scope of economically efficient regions for independent gas producers.

The price of gas for end users at the line separating gas distribution networks from end user networks is based on the regulated wholesale price of gas, tariffs for gas transportation in gas distribution networks, and rates for supply and distribution services. If end user networks are directly connected to the trunk gas pipeline system, the price of gas for end users at the line separating trunk gas pipelines from end user networks is based on the regulated wholesale price of gas and the rate of supply and distribution services. If several organizations take part in gas supplies to end users, the regulated rate for supply and distribution services paid by end users is distributed among these organizations as agreed between them. Apart from that, if a holding structure takes part in gas supplies, the regulated rate for supply and distribution services is set by the companies engaged in immediate gas sales and the parent company^[4].

Retail prices of gas are regulated as prescribed by Resolution No.239 of March 7, 1995 of the Russian Federation Government «On Measures for State Regulation of Prices (Tariffs)» adopted in fulfillment of Decree No.221 of February 28, 1995 of the President of the Russian Federation «On Measures for State Regulation of Prices (Tariffs).»

Wholesale prices and rates for supply and distribution services are regulated by the Government and federal executive authorities of the Russian Federation. Prices of natural gas sold to the population and domestic household cooperatives are regulated by executive authorities of constituent entities of the Russian Federation.

Regulation of retail prices of natural gas sold to the population^[5] and rates for supply and distribution services^[6] provided by gas suppliers to end users is exercised in accordance with the guidelines approved by the Federal Tariff Service of the Russian Federation in coordination with the Ministry of Trade and Economic Development of the Russian Federation.

In the legal framework regulating relations in the gas industry, the main legislative enactment is Federal Law No.69-FZ of March 31, 1999 «On Gas Supply in the Russian Federation.» This law is the only and primary legislative enactment regulating relations in the gas industry and requires detailed analysis.

Despite the continuous arguments about the necessity of development and adoption of a unified industry law «On Oil and Gas» that would take into account all salient features of the oil and gas industry, Russian legislators followed the path of including separate reforms in the oil and gas industry into general legislative enactments and regulations. The main issues in the oil and gas industry that require state regulation are as follows:

§       issues of subsoil use (in particular, definition of fields of federal importance, aspects of license agreements, etc.);

§       issues of taxation and customs regulation (in particular, rental payments);

§       issues of property and ownership;

§       issues of access to the infrastructure;

§       issues of export directions, etc.

A closer look reveals that most of these issues are already reflected in one way or another in the currently effective legislation, or are in the stage of development and adoption (such as, for example, the draft law «On Pipeline Transport»).

The history of development and adoption of the law «On Gas Supply» shows that it is a clearly political law oriented, first of all, to protection of the principles of and approaches to functioning and regulation of the gas industry used by the management of OJSC Gazprom at the moment of its adoption. For example, the law states that separation of the Unified Gas Supply System is impossible and its owner (OJSC Gazprom) may only be liquidated by a special federal law. In addition to the fact that the legislative prohibition of separation of the Unified Gas Supply System makes it difficult to separate the spheres of natural monopoly from potentially competitive spheres, the provision that OJSC Gazprom may only be liquidated by a special federal law contradicts the Civil Code of the Russian Federation that provides a complete list of cases when a legal entity may be liquidated and cannot be expanded, including liquidation of legal entities by adopting a special federal law.

The essence of the law «On Gas Supply» is that

§       OJSC Gazprom is inseparable;

§       the state must own at least 35% of shares of OJSC Gazprom;

§       nonresidents may own no more than 20% of shares of OJSC Gazprom; and

§       state regulation may take the form of regulation of transportation tariffs or regulation of wholesale prices and transportation tariffs for independent gas producers.

Today, a number of provisions of this law check the development of the gas market in the country. Interestingly, in 2001, a special commission created at the presidential Executive Office at the request of V.V. Putin, President of the Russian Federation, that took inventory of the entire legislation of the Russian Federation, came to a conclusion that the law «On Gas Supply» is meaningless, and proposed to abolish it.

Most provisions of the law «On Gas Supply» do not contain mechanisms of their practical implementation. Many concepts used in it are not explained and have no criteria for their clear definition. Many provisions of this law repeat provisions of other laws or refer to provisions that do not ensure the necessary level of legal regulation.

For example, the law says that state regulation of tariffs for gas transportation services, classified by the Federal Law «On Natural Monopolies» into the sphere of activities of natural monopolies, should be exercised by the federal authority for regulation of natural monopolies, which in fact repeats the corresponding provision of the Federal Law «On Natural Monopolies.»

Law of the Russian Federation No.948-1 of March 22, 1991 «On Competition and Limitation of Monopolistic Activities on Commodity Markets» and Federal Law No.147-FZ of August 17, 1995 «On Natural Monopolies» classify pipeline transportation of gas into the sphere of activities of natural monopolies.

The law «On Gas Supply» applies the antitrust legislation to the problem of access to gas transportation facilities and obliges all organizations conducting business on the territory of the Russian Federation to ensure non-discriminatory access to free capacities of their gas transportation and gas distribution networks in accordance with the procedure prescribed by the Russian Federation Government. The term ‘free capacities» has no legal definition.

The document applying the provisions of the law «On Gas Supply» to regulation of access to gas transportation facilities is Resolution No.858 of July 14, 1998 of the Russian Federation Government «On Ensuring Access of Independent Organizations to the Gas Transportation System of the Open Joint-Stock Company Gazprom,» which approved the «Regulation on Access of Independent Organizations to the Gas Transportation System of OJSC Gazprom.»

As to construction of private gas pipelines, Mikhail Fradkov, Prime Minister of the Russian Federation, said on June 21, 2004 at the briefing in Tallinn that «the issue of private pipeline construction is not on today’s agenda.» Earlier, the Prime Minister of the Russian Federation spoke against the idea of privatization of pipelines: «This is our infrastructure and our competitive edge, and we have to attend to it.» Mr. Fradkov stressed that access to pipelines, as well as to any resources,  should be free.

Acknowledgement of separation of competitive and natural monopoly sectors as the generally accepted strategy of economic development would simplify and facilitate state regulation in the gas industry. In his speech on February 14, 2003 at the meeting dedicated to celebration of the 10^th anniversary of OJSC Gazprom, V.V. Putin, president of the Russian Federation, said that «the state, as the largest stakeholder of Gazprom, will insist on cutting costs and raising the performance efficiency of the company but will not support any plans for its separation …» This statement froze the concept of gas market development in the Russian Federation, which implied separation of gas production and gas transportation activities. Nevertheless, the issue of reforming OJSC Gazprom by separation of its different activities is still on the agenda, said A. Sharonov, Deputy Minister of Trade and Economic Development of the Russian Federation, because «natural monopolies should be reformed by separating their competitive and natural monopoly activities.»

Taxation

Apart from the general taxation system, which is the same for all businesses and enterprises in the Russian Federation and does not need special discussion for that reason, there are specific taxes for organizations in the gas industry that should be discussed in greater detail.

After cancellation of the gas sale excise on January 1, 2004, the only specific tax levied in the gas industry is the mineral extraction tax.

The mineral extraction tax was imposed in accordance with Federal Law No.126-FZ of August 8, 2001, which added the article on introduction of the mineral extraction tax into the Tax Code of the Russian Federation. The mineral extraction tax replaced all previous taxes, including the tax for rehabilitation of mineral resources.

The object of taxation (produced mineral resource) is the product of the mineral extraction industry contained in the mineral raw materials (rock, liquid, or other mixture) actually produced (extracted) from subsoil (wastes, losses) the quality of the former meeting the standard of the Russian Federation, industry standard, regional standard, international standard, or in the absence of such standards for a certain produced mineral resource, organization (enterprise) standard. This formulation of produced mineral resources makes it difficult to determine the mineral extraction tax for gas condensate mixture produced directly from the well. For this very reason, natural gas and gas condensate should be considered as types of mineral resources liable to the mineral extraction tax.

The taxation base of the mineral extraction tax is independently determined by the taxpayer for each type of produced mineral resources. The taxation base for production of associated gas and combustible natural gas from all types of hydrocarbon fields is determined as the amount of produced mineral resources in natural units.

The taxpayers that prospected and explored the fields of mineral resources developed by them at their own expense and the taxpayers that have fully compensate to the state all expenditures for prospecting and exploration of the corresponding amount of these mineral resources and exempted, as of July 1, 2001 according to the federal legislation, from the tax for rehabilitation of mineral resources during the development of these fields, pay the mineral extraction tax for the mineral resources produced in the corresponding license area with a correction coefficient equal to 0.7.

The tax rate for gas condensate is of the added value type and equal to 17.5% of the value of produced mineral resources. The tax value for natural gas is of a specific type and equal to 147 rubles per 1000 cubic meters of natural gas.

Chapter 26.4 of the Tax Code of the Russian Federation establishes the procedure for calculation and payment of the mineral extraction tax during execution of production sharing agreements. The latest amendments to the Tax Code of the Russian Federation and the law «On Production Sharing Agreements» made this procedure economically inferior and non-competitive in comparison to the usual standard procedure.

One of the main companies considered by the state for sales of the state-owned part of gas produced under production sharing agreements is OJSC Gazprom.

Article 13 of the Tax Code of the Russian Federation implies levying a tax for additional income from production of mineral resources. Currently, however, proposals for imposing and determining this tax are in the stage of formation.

Special Procedure of Supplies of Fuel and Energy Resources to Certain Categories of Consumers

Resolution No.364 of May 29, 2002 of the Russian Federation Government «On Ensuring Stable Supply of Gas and Electric Power to State Security Organizations Financed from the Federal Budget» and Resolution No.1 of January 5, 1998 «On the Procedure of Cutting Off or Limiting Supplies of Electric Power, Heat and Gas to Consumer Organizations in Cases of Failure to Pay for Supplied and Consumed Fuel and Energy Resources» prescribe a special procedure for supplying fuel and energy resources to certain categories of consumers.

Cutting off or limiting supplies of fuel and energy resources to strategic facilities is forbidden within the framework of limits of guaranteed payment from the federal budget. The list of strategic facilities for which cutting off or limiting supplies of fuel and energy resources beyond the limits established for them is fairly clear and concrete.

A special regime of cutting off and limiting supplies of fuel and energy resources is established for socially important categories of consumers where failures in supplies of fuel and energy resources may endanger human lives or entail environmental harm. The list of consumers of special social and economic importance falling within the ambit of the privileged regime of cutting off and limiting supplies of fuel and energy resources is not clear and concrete.

Entrance of New Consumers to the Market

The general procedure for entrance of new consumers to the market (for using gas as fuel) is determined by Resolution No.832 of October 29, 1992 of the EFG «On Determining the Type of Fuel for Enterprises and Fuel-Consuming Installations,» the law «On Gas Supply,» and the «Rules of Using Gas and Providing Gas Supply Services in the Russian Federation» developed in accordance with this law and approved by Resolution No.317 of May 17, 2002 of the Russian Federation Government. These rules, in particular, establish that for using gas the customer must have a permission issued either by state executive authorities or by local executive authorities in coordination with OJSC Gazprom. Technical requirements for connection to the gas transportation system are issued by a gas transportation organization or gas distribution organization, respectively, according to the permission issued by state executive authorities or by local executive authorities. This regulation grants unjustified and ungrounded gas supply advantages to OJSC Gazprom over gas consumers.

Summary

1.     The central document in the legal framework of the gas industry is the law «On Gas Supply in the Russian Federation.» A new law «On Pipeline Transport» may be adopted in near future.

2.     Access to the infrastructure is divided into the following procedures: connection of fields to the gas transportation system, connection of consumers to the gas transportation system, signing a contract for gas transportation in trunk pipelines, signing a contract for gas transportation in gas distribution networks, signing a contract for gas storage services, signing a contract for access to a trading site, and permission of OJSC Gazprom for selling gas.

3.     The current provisions of the legal framework regulating access to the infrastructure are not efficient.

4.     Currently, tariffs for gas transportation services, wholesale gas prices of OJSC Gazprom, and the size of payment for supply and distribution services (for gas of OJSC Gazprom) are regulated. The basic regulation is Resolution No.1021 of the Russian Federation Government. The regulation procedure is defined by methods.

5.     The key requirements to gas sales are established by the gas supply regulations.

6.     The only specific tax levied in the gas industry is the mineral extraction tax. The tax value for natural gas is specific and equal to 147 rubles per 1000 cubic meters of natural gas.

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[1] Resolution No.88-e/1 of October 28, 2003 of the Federal Energy Commission of the Russian Federation «On Approval of Guidelines for Regulation of Tariffs for Services of Gas Transportation Through Gas Distribution Networks»

[2] The main requirements of OJSC Gazprom to gas supplied into its gas transportation system are: low humidity of gas and requirements for the content of higher hydrocarbons in gas.

[3] Resolution No.200 of September 3, 2003 of OJSC Gazprom «On Approval of the Procedure of Providing Independent Producers of Gas and Liquid Hydrocarbons with Technical Requirements for Connecting to the Pipeline Transport Systems of OJSC Gazprom»

[4] Resolution no.93-e/13 of December 18, 2002 of the Federal Energy Commission of the Russian Federation established the rate for supply and distribution services of Mezhregiongaz LLC equal to 6.69 rubles per 1000 cubic meters.

[5] Resolution No.42-e/3 of October 29, 2003 of the Federal Energy Commission of the Russian Federation «On Approval of Guidelines for Regulating Retail Prices of Natural Gas Sold to the Population.»

[6] Resolution No.8/9 of February 6, 2002 of the Federal Energy Commission of the Russian Federation «On Approval of a Method of Determining the Rate for Supply and Distribution Services Provided by Gas Suppliers to End Users.»