This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 MADRID 000649 
 
SIPDIS 
 
DEPARTMENT PASS TO EUR/WE 
 
E.O. 12958: N/A 
TAGS: EPET ENRG PGOV SP
SUBJECT: SPAIN: GROWING PAINS IN LIBERALIZED NATURAL GAS 
MARKET 
 
REF: A. 04 MADRID 04241 
     ¶B. 05 MADRID 00393 
     ¶C. 04 MADRID 04613 
 
¶1. SUMMARY: Rapid growth in domestic consumption has made 
Spain the world's fifth largest natural gas market.  Market 
liberalization, combined with growing demand and 
environmental concerns, has given rise to potential supply 
problems that could jeopardize Spain's energy grid.  Spain is 
strengthening its natural gas infrastructure to prevent 
distribution problems and to lower prices, and Spanish 
companies are pursuing development opportunities with new 
suppliers.  However, neither effort will likely impact the 
long-term problems that Spain currently faces.  Alternate 
fuels are not feasible due to political or technological 
reasons and it appears that the GOS will likely have no 
choice but to raise current ceilings on natural gas prices. 
This could cause difficulties for the Socialist government, 
as higher natural gas and energy prices would negatively 
affect their social agenda and have an inflationary impact on 
the Spanish economy. END SUMMARY 
 
MARKET OVERVIEW 
--------------- 
 
¶2. Spain has been undergoing a steady privatization of its 
energy sector over the past eight years, with the goal of 
attaining full liberalization by 2013.  Meanwhile, energy 
consumption has skyrocketed due to strong economic 
development, causing Spain to search for additional 
inexpensive energy sources.  At the same time, Spain is 
struggling to meet its EU and Kyoto Protocol commitments to 
reduce CO2 emissions.  Spain's emissions in 2004 were 45 
percent over 1990 levels, which is three times Madrid's quota 
under the terms of the Kyoto Protocol.  This situation has 
necessitated the use of cleaner fuels.  As a result, Spain 
has increasingly relied on combined-cycle electricity 
generators, which are fueled by natural gas.  At this time, 
there are twelve such generators in Spain, with ten new 
plants projected to come on-line in 2005.  This increased 
demand has caused Spain to become the world's fifth largest 
market for natural gas. 
 
¶3. Natural gas provides more than 15 percent of Spanish 
energy, already surpassing coal, and consumption increased by 
16.8 percent in 2004, to a total consumption of 321,617 GWh. 
Of that total, 248,434 GWh was sold in the 
industrial/household/commercial market, an increase of 8.39 
percent over the previous year.  However, power generation 
was the market with the strongest growth, consuming 67,497 
GWh.  This figure represents a growth of 68.5 percent over 
2003 and accounts for 21 percent of the total natural gas 
consumption in Spain. 
 
¶4. Spain imports 98.3 percent of its natural gas, with total 
natural gas imports experiencing an increase of 15 percent 
over 2003.  Spain's largest supplier is Algeria, which 
accounted for 51.5 percent of imports in 2004, down from 58.5 
percent in 2003.  The Persian Gulf countries of UAE, Qatar 
and Oman have emerged as Spain's second largest suppliers, 
providing 19.4 percent of imports.  Of note, Persian Gulf 
imports increased from 29,227 GWh in 2003 to 61,700 GWh in 
2004, an increase of over 111 percent.  Nigeria is Spain's 
third largest supplier at 16 percent of total imports, with 
Norway rounding out the main suppliers with 10 percent. 
 
¶5. The GOS plays an important regulatory role in the energy 
sector.  Government regulations dictate that no one country 
can provide more than 60 percent of Spain's natural gas 
imports and that energy suppliers must maintain a thirty-day 
reserve supply of fuel.  The government also sets a cap on 
energy and natural gas prices that is reviewed on a monthly 
basis.  In 2004, the Spanish government imposed a decrease of 
one percent in consumer gas prices in April, and increases of 
2.6 percent each in July and October.  A separate 
governmental institution, the National Energy Commission 
(CNE), maintains the responsibility to ensure that the 
industry is in compliance with government regulations by 
conducting inspections, preparing sector reports and engaging 
in dispute resolution.  In addition, the Ministry of Industry 
has established a ten-year plan, effective from the years 
2000 through 2011, which sets goals in regard to the sources 
of final energy consumption.  The plan calls for average 
annual increases of 9 and 10 percent in natural gas and 
renewable energy, respectively, and a 3.66 percent average 
annual decrease in the use of coal. 
 
THE MAJOR PLAYERS 
----------------- 
 
¶6. The main players in the Spanish natural gas market are Gas 
Natural, Repsol YPF, Cepsa, and Enagas.  Gas Natural is the 
largest supplier of natural gas and, prior to liberalization, 
it controlled nearly all aspects of the natural gas market. 
Repsol YPF and Cepsa also maintain strong market shares, 
although they both primarily operate in the petroleum market. 
 Enagas is the main Spanish company responsible for 
transport, regassification and storage of natural gas.  It 
also holds sole responsibility for the distribution of 
natural gas, coordinating transportation of natural gas 
supplies among access points and storage sites.  As is common 
at the intertwined commanding heights of the Spanish economy, 
Repsol YPF holds a 30.8 percent share of Gas Natural, while 
Gas Natural maintains a 26.1 percent share of Enagas.  The 
CNE has intervened in this aspect of the natural gas market, 
issuing a decree that limits the economic holdings of any one 
company in Enagas to 5 percent.  Gas Natural sold off 12.5 
percent of its share in the grid operator in 2004, with 
further reductions planned to bring the company in 
compliance. 
 
¶7. The Spanish banking sector maintains a strong interest in 
the energy market, maintaining significant holdings in 
natural gas providers: Repsol YPF (17.8 percent), Cepsa (45.5 
percent) and Gas Natural (39.8 percent); as well as 
electricity suppliers: Endesa (13.6 percent), Iberdrola (14.7 
percent) and Union Fenosa (30.3 percent).  The dominant banks 
in this area are La Caixa, which maintains 12.5 percent of 
Repsol YPF and 33.8 percent of Gas Natural, and Santander, 
which maintains 45.5 percent of Cepsa and 23.3 percent of 
Union Fenosa. 
 
INFRASTRUCTURE 
-------------- 
 
¶8. Spain imports its natural gas via boat and pipeline, with 
each accounting for approximately 50 percent of imports. 
Liquid natural gas arriving in Spain via boat is processed in 
one of four regassification centers: Barcelona, Cartagena, 
Bilbao, and Huelva.  New centers are currently being built in 
Ferrol, Sines and Sagunto, while existing centers in Huelva 
and Cartagena underwent significant upgrades to their storage 
tanks and increases in their distribution capacity in 2004. 
In 2005, Spain plans on increasing the storage tank capacity 
in both Cartagena and Barcelona, while improving distribution 
capacity in Huelva and Barcelona. 
 
¶9. In 2004, Spain put 1,267 km of new pipelines into service, 
mostly to strengthen the internal distribution system.  Gas 
arriving in Spain via pipelines used one of two existing 
systems: the Lacq-Calahorra pipeline, which connects Spain 
with France and facilitates the arrival of natural gas from 
Norway; and the Mahgreb pipeline, which connects Spain and 
Algeria by transiting through Morocco.  In 2005, the GOS 
anticipates that approximately 1,000 km of new gas pipelines 
will be put into service and that two new compression 
stations (Cordoba and Crevillente) will become fully 
operational. 
 
¶10. On 23 January 2005, Europe's newest gas pipeline was 
completed connecting Bilbao, Spain and Lussagnet, France. 
The 500 km long pipeline has a capacity of 500 million cubic 
meters of natural gas per year.  It will primarily operate to 
export natural gas from Africa via Spain to the rest of 
Europe.  The pipeline was a joint project between Gas de 
Euskadi (Spain) and Gaz du Sud Oest (France).  It cost EUR 23 
million, with the EU providing five percent of funding. 
 
¶11. In 2006, construction will begin on the Medgaz pipeline, 
which will directly link Spain with Algeria.  The pipeline 
will be 747 km long, with the capacity to move approximately 
10 billion cubic meters of gas per year.  Investors include: 
Cepsa (Spain) and Sonatech (Algeria) with a 20 percent share 
each; and Total (France), BP (Britain), Gaz de France, 
Iberdrola (Spain) and Endesa (Spain) with a 12 percent share 
each.  The pipeline will cost an estimated EUR 1.1 billion 
and is due to be completed in 2009.  Currently, the EU is 
studying the possibility that it could partially finance the 
project, as it would help alleviate the energy problems in 
other parts of Europe. 
 
POTENTIAL PROBLEMS 
------------------ 
 
¶12. Increasing demand has led to problems in the Spanish 
energy market.  A possible weakness in the natural gas system 
was exposed in December, when Enagas was forced to reduce the 
gas supply to various petrochemical factories and three large 
electricity suppliers: Endesa, Iberdrola and Union Fenosa. 
The reduction lasted from December 13 through December 18 and 
was attributed to damage to a gas compression station in 
Algeria, combined with a seasonal spike in demand.  The 
companies affected have contracts with Enagas that afford 
them lower gas prices but which permit a justified 
interruption in service.  The Spanish government became 
directly involved in this issue, chairing meetings between 
Enagas and the electricity suppliers.  Ministry of Industry 
officials told Econoff that there had not been an emergency 
and that the situation had been over-publicized, despite the 
resulting brownouts that affected various portions of the 
country.  Ministry sources further commented that the 
situation had been exacerbated by the closure of a nuclear 
power plant for renovations during that time period. 
Finally, they expressed confidence that renovations scheduled 
for 2005 will reduce the likelihood of a reoccurrence of the 
problem. 
 
¶13. Market liberalization has also created a potential 
problem in regard to Spain's natural gas supply.  The GOS 
sets a ceiling on the price of natural gas and electricity in 
Spain.  With the privatization of the sector, Spanish natural 
gas importers are now free to pursue other markets for their 
products.  An increasing amount of liquid natural gas, which 
could be delivered to Spain, is being diverted to the United 
States and Japan where companies can obtain higher profits. 
Ministry of Industry officials told Econoff that the amount 
actually being diverted is not sufficient to have a large 
impact on the Spanish market. 
 
POTENTIAL SOLUTIONS 
------------------- 
 
¶14. Spanish companies, such as Repsol YPF and Gas Natural, 
are attempting to develop new markets that could increase the 
supply of gas to Spain.  In December, the two companies 
signed an agreement to conduct joint exploration and 
production of additional natural gas sites in Algeria. 
Combined with the future opening of the Medgaz pipeline, this 
move could help ease the developing supply problems by 
providing additional inexpensive sources.  In addition to 
Algeria, Repsol YPF is currently in negotiations with Gazprom 
(Russia) for joint ventures to include: supplying natural gas 
to Spain, cooperation in exporting liquid natural gas to the 
United States, and joint development projects in third 
nations.  Currently, Spain does not receive natural gas from 
Russia, the country with the world's largest reserves, due to 
the lack of sufficient capacity in existing European 
pipelines combined with the high cost of transportation 
across Europe.  At this time, the two companies have created 
a working group to study concrete initiatives for joint 
operations.  Finally, Repsol YPF has won the rights for 
exploration and development in Liberia, in the first tender 
ever run by the Liberian government to accept international 
bids.  Of note, Repsol YPF did obtain the right to develop 
another block of Liberian territory in the summer of 2004, 
through direct negotiations with the Liberian government. 
 
COMMENT 
------- 
¶15. Rising demand and market liberalization are likely to put 
pressure on the Spanish government to take further action. 
The government will have two options in this situation: they 
can turn to other methods of supply or steadily increase the 
price ceiling on natural gas prices.  Spain does have other 
options to provide energy, namely nuclear and coal, but both 
are politically undesirable.  Nuclear, although clean and 
potentially sufficient for Spain's energy needs, is 
politically untenable due to strong public opinion against 
its use (see reftel A).  Coal, abundant in Spain and 
relatively inexpensive, results in high pollution levels that 
would cause Spain to move further away from its Kyoto 
obligations (see reftel B and previous).  The Kyoto Protocol 
mandates that Spanish CO2 emission levels are 15 percent over 
1990 levels by 2012.  By the end of 2004, Spanish CO2 
emission levels were actually running at 45 percent over 1990 
levels.  Spain's Socialist government is determined to 
re-orient the country towards Europe, and making serious 
efforts to implement the Kyoto targets are widely viewed as a 
central part of the "return to Europe" strategy.  In part due 
to Kyoto-related pressure, The GOS is encouraging the 
increased use of renewable energies, such as wind and solar 
power, but the technology is not sufficient at this time to 
meet market demand (see reftel C).  These problems, combined 
with growing Spanish investment in natural gas infrastructure 
and power plants, indicate that Spain will increasingly rely 
on natural gas for its energy needs.  As a result, the 
government will likely have to raise the price ceilings on 
natural gas in order to compete with other national markets. 
However, this solution will likely encounter strong 
resistance from Second Vice President and Minister of Finance 
Pedro Solbes, due to the resulting inflationary influence 
that it would exert upon the Spanish economy.  This energy 
issue will likely evolve into a high profile problem that the 
Socialist government will have to address; balancing their 
social agenda with fiscal responsibilities and environmental 
obligations. 
MANZANARES