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GdF faces a new order

Gaz de France must adapt to life as a publicly quoted company, cope with competition in the domestic gas market, take on Electricité de France in the French power sector and expand internationally. The next two years will prove a critical period in the company's history, writes Ayesha Daya

THE NEXT two years will prove decisive in shaping a reborn Gaz de France (GdF). Following last month's initial public offering (IPO), the firm must cope with a new cultural order – state-controlled since its inception in 1946, it is now open to market scrutiny and beholden to shareholder demands. More daunting, it must consolidate its share of the French gas market before full deregulation in July 2007 ends the monopoly it has long enjoyed.

IPO plans for GdF had been postponed since 2001 as the government yielded to pressure from France's influential trade unions. The no vote in France's May referendum on the European Constitution reflected, in part, popular fears that an economically liberal Europe would undermine that pillar of French socialism – les services publiques. That link was made in the public's mind because the privatisations were presented to the public as a European Union (EU) requirement, says Daniel Paccoud, managing director of the French Gas Association. Yet "nothing in European law says a company cannot be owned by the state. All it says is that the market must be open."

However, July's IPO showed the government's determination to stick to its economic restructuring plans. Electricité de France (EdF) is to be part-privatised later this year and nuclear-services company Areva in 2006.

Entering the electricity market

The priority for France's utilities is to secure their home markets as other energy companies begin to encroach on their territory. For GdF, this means diversifying into electricity as its share of the gas market declines. That will be no easy task because it will involve taking market share from its main competitor in France, EdF, which is three times the size (EdF employs 110,000 people in France, compared with GdF's 30,000) and familiar with GdF's 11 million customers at home.

The process will be helped by equivalent EU requirements for EdF to reduce its share of the French power market. But EdF will attempt to make up for lost market share in electricity by building its presence in gas supply, says Kelvin Beer, director of utilities at Ernst and Young. As joint-stock companies, GdF and EdF have been freed from their previous status that limited them to supply a single utility.

However, GdF is mainly focused on generating power from gas. It recently built an 800 megawatt combined-cycle gas turbine (CCGT) plant in northern France, adding to a 1.2 gigawatt plant in Spain. While such power plants are typical in many European countries, French national energy policy, with the second-highest nuclear percentage contribution in the world, strongly favours the development of nuclear power. Nuclear energy accounts for about 77% of total electricity generation in France, compared with the OECD average of 21%.

Diversification

Although using gas for power generation at home could be a way to diversify the nuclear-dominated energy mix for electricity production, in the short term, electricity produced from gas will be more expensive than nuclear and coal, says Jean-Pierre Favennec, director of the French Petroleum Institute. "CCGT plants give a good yield with relatively low pollution [compared with coal], but the high price of gas makes it too expensive for electricity generation."

The interest shown in next-generation nuclear plants, pioneered by EdF, reflect that internationally, the use of nuclear power is being reconsidered. Although gas' share in the global energy mix for electricity production is increasing (it was 15% in 2004) nuclear energy is growing faster and has risen by over five times between 1973 and 2004 to 16%, says EdF's head of international investment, Christian Stoffaës.

In a rapidly deregulating market, if GdF wants to succeed in becoming an integrated energy provider, it will need to find partners, says Jean-Marie Chevalier, director of Cambridge Energy Research Associates (Cera) in Paris. GdF is the fourth-largest gas supplier in the region – 49.7bn cubic metres a year (bn cm/y) in 2003 – after Gasunie (76.4bn cm/y), Eni (66.4bn cm/y) and E.On-Ruhrgas (54.4bn cm/y). But other gas companies, in particular, likely competitors of GdF, are branches of larger companies that have expertise in a variety of energy production, such as Distrigaz, an offshoot of French electricity, water and waste company Suez, and Ruhrgas, which has recently merged with power giant E.On. Gasunie, although still benefiting from being 50% owned by Europe's second-largest gas producer and largest gas exporter, the Netherlands, will probably face a similar task in the coming years if it wants to maintain its role as a key player in Europe's energy market.

If GdF's priority is to cling on to what it can from the deregulation process, its next aim is to consolidate its foothold in Europe and boost its own gas reserves. Jean-François Cirelli, GdF's chief executive officer, is planning an attack on three fronts to position GdF as an international competitor in various parts of the energy business: the company is building up its distribution assets in Europe; increasing its gas reserves through acquisitions; and diversifying into electricity. In total, it will spend around Euro17.5bn ($21.3bn) over four years.

GdF believes its best route to growth is by expanding outside France, especially because gas' share in the energy mix is lower in France than in other European countries. While the UK consumed over 90bn cm of gas in 2003 – almost 40% of total primary energy supply (TPES) – French consumption (42.5bn cm) accounted for around 14% of TPES – well below the European average, estimated by the International Energy Agency to be 23%.

Distribution acquisitions

GdF already has a presence in Europe, selling gas to countries such as the UK, Belgium and the Netherlands, which represented 89% of GdF's overseas sales in 2004. Its presence in distribution has been strengthened in central and eastern Europe by its acquisition last year of Distrigaz Sud, which operates a 13,425 km gas-distribution network in southern Romania and serves 0.9 million residential and commercial customers.

Already the second-largest company in Europe in terms of customers – after E.On-Ruhrgas – GdF aims to treble its client base for gas and electricity in Europe to 15 million by 2007 (and to increase it from 11 million to 12 million in France). This would involve an increase in GdF's share of the European gas market from 10% to 15%.

Around 45% of the proposed investments aim to increase GdF's equity gas from 10% (5.2bn cm/y) to 15% of its total supply. "GdF has an impressive customer base and supply infrastructure, but it lacks upstream capacity," says Mark Hughes, PricewaterhouseCoopers' leader of European utilities.

However, one effect of gas-market liberalisation in Europe has been to strengthen links between gas companies and buyers in the form of partnership agreements, says Patrice de Vivies, gas director at the French commission for energy regulation (CRE), making it more difficult for new entrants to secure supplies. "More than 90% of gas supply is tied up in long-term contracts, mostly with Russia or Algeria, which want to maintain good relations with their historic buyers. They don't want to jeopardise their portfolio," says de Vivies.

Cera's Chevalier says increasing its own reserves is an important objective for GdF because it will give it greater flexibility when negotiating contracts – increasing its bargaining power with large buyers. A Standard and Poor's risk-assessment of GdF agrees. While production activities are "intrinsically higher risk, access to own gas reserves, in combination with a flexible liquefied natural gas (LNG) fleet, provides a competitive advantage and reduces exposure to the more volatile spot markets," it says.

To increase its reserves, GdF is operating in the Netherlands, Germany, the UK, Algeria, Libya, Egypt, Kazakhstan and Norway. It also hopes to increase its LNG imports, from 16.4% of its natural gas supply in 2004 to 30% in 2007, with supplies from Egypt and Norway adding to existing deliveries from Algeria (see Table 2).

GdF is already the second-biggest LNG importer in Europe, and the fifth largest in the world. Its two regasification terminals in France have a combined capacity of 17bn cm/y. Last year, the terminals imported just 7.63bn cm – less than half of their capacity, as cargoes were diverted to the US and Asia to take advantage of arbitrage opportunities. Its influence in global LNG markets is set to increase later this year. Under a 20-year contract, GdF is contacted to receive the entire output of the first train at Egypt's 2bn cm/y ELNG plant, which started up in May. However, construction of a new receiving terminal at Fos Cavou, in which GdF is the majority shareholder, is behind schedule meaning it does not have the capacity receive the Egyptian LNG. GdF is looking for buyers and BG has agreed to take two cargoes a month until the end of 2006)

Since July 2004, all non-residential customers – 70% of the gas market in France – have been free to choose their electricity and gas distributor. Residential customers (who will receive the same choice when the market opens fully in 2007) – and industrial clients that have chosen not to switch to market prices – continue to receive gas from GdF and 22 local suppliers under government-regulated tariffs.

Despite market liberalisation, GdF remains in a strong position because of its former monopoly. Although the country's infrastructure is theoretically open to third-party access, it continues to own and operate 96% of distribution lines, 100% of entry points to the country and 75% of the high-pressure transmission system. It already has the longest transport network in Europe, with more than 30,000 km of pipelines in France transporting 60.8bn cm in 2004. Including storage and international transmission and distribution, GdF's infrastructure accounts for over 70% of its overall income.

"GdF has also used the weapon of public services," says Chevalier. "It has lobbied to include in French law the idea that storage belongs to the public. Consequently, GdF has managed to keep a greater part of its storage capacity." With 83% of the country's capacity (9bn cm), it is Europe's second-largest operator of storage facilities, ensuring it continues to play a critical role in national supply security.

But the main reason that GdF retains 80% of the market is that market prices are unable to compete with regulated tariffs. Around 37,000 eligible sites – accounting for more than 40% of gas consumed by all the eligible sites – had switched from buying gas at regulated tariffs to market prices as of 1 June. Of course, this was in areas where the market price was more attractive. However, only 17% of these customers chose to leave GdF for a new supplier: the rest simply negotiated new contracts with GdF at rates lower than the regulated tariff.

Price-setting power

Fixed prices are, therefore, frustrating for GdF, industry experts argue. Where market prices are lower than fixed tariffs, they must negotiate rates that are more competitive than the already low fixed tariffs to retain customers. Higher prices would ensure better returns. Government interference eroding GdF's price-setting power is unlikely to please the markets. While high gas prices persist, however, it is likely that the French government will maintain fixed tariffs. As a result, Chevalier says gas and electricity competition will not flourish. In France – as well as in Austria, Germany and the Benelux countries – long-term take-or-pay contracts are still prevalent, he says. "The price of gas is linked to oil prices. So the final price of gas – the commodity plus transport plus the efficiency of the operator – remains high."

CRE's de Vivies is more optimistic. He blames high prices on a shortage of supply and infrastructure, as new investments were halted when prices were low at the beginning of the decade. "Now, as reserves are in decline, prices are rising because of worries over shortages. The opening of the European market coincides with this rise in price." However, new pipelines and LNG terminals go on stream around 2007, and Spain, northern Europe and Italy are expected to benefit from a gas bubble. Consequently, "as new supply comes on stream in 2007, the price of gas relative to crude will decrease."

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