derogation, subsidiarity and the single market: the case of energy exploration and extraction under...

Journal of Common Market Studies Vol. 32, No. 2 June 1994

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Derogation, Subsidiarity and the Single Market

The Case of Energy Exploration and Extraction under the EC Utilities Procurement Rules

ANDREW COX University of Birmingham

1. Introduction

This article discuses the use of derogation from the Single Market rules and how this relates to the question of subsidiarity, in the context of the attempt by the European Commission (EC) to create an integrated Single Market providing for the free movement of goods, services, capital and people. The basic argument of this article is that, while subsidiarity may be politically necessary to ensure that Member States accept the further integration of the Community, if it is used incorrectly in the practical implementation of the Single Market rules it may undermine the search for a truly open, competitive and non-discriminatory economic structure in Europe.

This argument is developed by a detailed analysis of the Single Market rules which have been written to open up procurement practices by both public and private utilities operating in the energy sector. The article shows that, since the utilities procurement rules were drafted in 1990, there has been a successful counter-offensive by some Member States and their major energy production and extraction companies to win EC approval for national derogation from these rules. The European Commission has acquiesced in the case of France and is actively considering similar derogations in the case of Denmark, the Nether- lands, Germany and the UK. The article explains how this process of derogation has occurred, and argues that this is an example of the misuse of subsidiarity

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128 ANDREW COX

which will lead to the possible dilution of the Single Market rules. This will occur because the derogation from the rules may well lead to quite different procurement practices by national oil companies in each Member State. The result of this is likely to be the continuation of those problems of protectionism and national preference which the Single Market initiative was supposed to eradicate.

2. The Single Market Initiative for Energy and Utilities Procurement

Before we discuss the issues of subsidiarity in theory and its practical applica- tion in the case of energy extraction and exploration, we must first outline the basic goals of the Single Market initiative as they relate to the exploration and extraction industry in particular. We do this by first outlining the basic goal of the Single Market initiative as it relates to public and utilities procurement, and then indicate the major obstacles to trade in the EC oil production and extraction sector.

The Problem of Public and Utilities Procurement in the EC

The Single Market initiative has as its basic goal the removal of artificial barriers to trade amongst the Member States. It is the non-tariff barriers - such as non- commensurable taxation regimes, discriminatory states subsidies to producers and preferential procurement practices to favour national over foreign supplies - which have constituted the most effective barriers to free trade and an integrated market in Europe. These nationally determined purchasing practices can be seen as artificial barriers to trade which, if they were removed, would allow for a more open and competitive market structure in the EC. The hope amongst policy-makers in the Community is that by removing these artificial bamers to trade it will be possible to increase the competitive position of EC firms in the global economy, increase efficiency and, thereby, see an increase in output and employment, as well as a reduction in public expenditure through lower prices for publicly procured goods and services.'

Indeed the Commission has argued that if public procurement in the Community was liberalized and artificial barriers were removed for the award of supply, works and services contracts by the public sector and the utilities, there would be an increase in growth, the creation of up to 400,000 jobs and potential savings of between ECU 17-20 billion in public expenditure (Atkins, 1988, pp. 42-6). These savings were expected to be achieved through three mechanisms. First, it was argued the liberalization and freeing of nationally protected procurement markets would lead to a static price effect. Under this ' The basic goals of the EC in relation to public and utilities procurement are set out in CEC (1989) and CEC (1991).

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DEROGATION, SUBSlDlARITY AND THE SINGLE MARKET 129

process lower priced suppliers who are excluded from national markets by preference rules would win contracts and immediately expenditure costs would fall. Following from this there would occur a competition effect. The firms already in the market would face increased competition and, since they would lose protected markets, they would have to become more efficient and push down their own prices through increased productivity. Finally, there would be, in the long term, a restructuring effect. Since more efficient firms would now be allowed into domestic markets there would be an overcapacity problem. Eventually the more efficient would either acquire, merge with or destroy the least efficient and generate a rationalization of supply in the market place. This, i t was argued, would lead to larger producers, who would be able to achieve economies of scale, increase their productivity and compete as equals with the most efficient global producers (Atkins, 1988, pp. 8-10).

The way in which this process of rationalization might be expected to occur is presented in Figures 1 and 2.2 In any industrial sector in the EC we can argue

Hieh Natural barriers Low v

Quadrant A

Local services Strengths: Natural protection Weaknesses: Lack of scale Opportunities: Few Threats: Few

Effect of I992 very small Type of effect: Ownership

- Acquisitions - No additional new entrv

Quadrant B

Regulated local Strengths: Local expertise

Weaknesses: Lack of scale Opportunities: Broader horizons Threats: Competition

Effect of 1992: Uncertain Type of effect: Reorganization

natural protection

- Mergers, alliances, etc - Some new entry?

Quadrant D

Open market industries Strengths: Already Competitive Weaknesses: Little Opportunities: Growth of EC Threats: Increased attention

Effect of 1992 slight Type of effect: Growth

- Continued cornpetition - Some entry by non-EC firms

Quadrant C

Protected national champions Strengths: Little Weaknesses: Overcapacity Opportunities: Wider market Threats: New entrants

Effect of 1992: Massive Type of effect: Rationalization

- Restructuring, closures - Entry by non-EC firms - Highly competitive

Figure 1. Matrix of EC sectors and barriers after I992 Source: Adapted from CBI ( 1 990) p. R4

Low

Art if cia1 barriers

High

Much of this discussion is based on the approach adopted in CBI ( I 990) pp, 77-R6. 0 Basil Blackwell Ltd 1994

130

1 ef

ANDREW COX

Hieh Natural barriers Low

Quadrant A

Intc 1 ef

Quadrant D

Quadrant C

ded 2 ct

2 0 w

rrtifcial jarriers

ligh

Figure 2. The intended Single Market effect

that there are both natural and artificial barriers to the free movement of goods and services. By natural barriers we refer to physical and geographical or logistical difficulties which make it difficult for producers and suppliers to compete effectively against local companies. The Channel and the North Sea, for example, can be seen as natural barriers which would still make it difficult for firms from certain sectors to compete on equal terms with domestic UK suppliers. The costs of supplying drinking water from the Continent to the UK, or vice versa, would be a classic case of an irremovable natural barrier to trade, even if there were no artificial national barriers in operation. It is however the artificial barriers to trade which the Single Market initiative is directed towards eradicating.

As Figure 1 reveals, however, the process of framing EC-wide rules which will ensure a relatively level playing field for all potential suppliers in the public and utilities procurement markets of the Member States will not necessarily lead


DEROGATION, SUBSIDIARITY AND THE SINGLE MARKET 131

to lower prices, rationalization or more efficiency in all EC industrial or service sectors. Whether or not such open market rules will achieve the three price effects which were outlined above depends upon the type of industrial sector firms are operating within. As Figure 1 demonstrates, we can differentiate between industrial sectors in terms of whether they experience high or low artificial and natural barriers to trade. We can see there are some sectors (quadrant A) which may be characterized as local services industries. These are sectors in which there are high natural barriers to trade and where the scale of operations is normally low but where there are already few artificial barriers to market entry. In these sectors, (and hairdressing would be a useful example of this), theeffect of removing artificial barriers to trade would be relatively small.

Quadrant B refers to what can be called a regulated local sector. In these industries (and the professions in the Member States are good examples of this), there are both high natural barriers and high artificial barriers. For UK solicitors, for example, the combination of the artificial barriers of a regulated professional qualification system and the natural barriers of the UK common law system and the use of the English language militate against easy market access for compet- itors outside the indigenous country. The removal of artificial barriers in the form of EC rather than national qualification systems might create opportunities for competition and market entry for non-nationals in the long term, but there would still be a number of artificial and natural barriers in the medium term due to custom, practice and consumer obduracy.

Quadrant C industries, orprotected national champions, are those sectors in which the EC expects to see the greatest changes as a result of the creation of Single Market rules which remove artificial barriers to trade and competition. In these industries there are few natural barriers to trade and the reason local suppliers dominate national markets arises primarily from preferential and discriminatory contract awards and national protection. The procurement practices of the utilities and public agencies in the Member States are seen as a major cause of such artificial barriers and a significant goal of the Single Market initiative is the framing of rules to end discriminatory procurement to bring about the three price effects outlined above. By so doing it is expected that there will be considerable rationalization, especially in the utilities supply industries of energy, transport, water and telecommunications.

Finally, within the EC there are quadrant D, or open market industries, which are characterized by a lackof natural or artificial barriers to trade. These markets are normally already fully competitive and there is unlikely to be any significant change in market structure or prices as a result of the Single Market approach, The overall intended effect of the Single Market initiative is demonstrated in Figure 2. As this figure shows, the overall aim is to reduce the number of artificial barriers to trade by framing rules which force those on the demand and

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132 ANDREW COX

supply sides of the market to operate in competitive and non-discriminatory ways. In effect the aim is to shift quadrant B industries into quadrant A and quadrant C industries into quadrant D.

The Specijic Barriers to Trade in the EC Oil Production and Exploration Sector

We do not have the space here to discuss all of the industrial and service sectors within the EC but confine our discussion to the oil production and exploration sector. By locating the oil sector industries in terms of our matrix of artificial and natural barriers, we will be in a better position to understand what the EC is trying to achieve through procurement rules in this sector, and how the recent decision to permit a measure of subsidiarity, by allowing for derogation in energy exploration and production, may undermine the overall goals of an integrated Single Market.

In the oil industry adistinction must be made in terms of both the demand and supply sides of the market, and the upstream (exploration and production) and downstream (refining and distribution) sectors. The demand for oil for the public and industrial consumers occurs at the downstream end of the process. The major suppliers are the large publicly quoted oil companies which have integrated exploration, production, refining and distribution structures. These industries are internationally competitive and the EC Single Market initiative is, therefore, unlikely to have a significant effect on these operations since there are low natural and low artificial barriers to trade in operation. Downstream operations are clearly within quadrant A of our matrix outlined in Figure 3.

Insofar as artificial barriers to trade exist in oil, these are to be found almost exclusively within the upstream energy extraction and production sector. Since this article focuses on this particular sector it is worth emphasizing in more detail the nature of these artificial barriers. Most of the exploration and production of oil within the EC occurs within the UK and the Netherlands. Norway is also a major source of supply and, although a member of EFTA, has agreed to operate utility procurement rules from 1 January 1995 under the European Economic Area (EEA) agreement (DTI, 1992, p. 8). Exploration and production also take place in Denmark, Germany, Spain, France, Greece and Italy. It is however negligible in Belgium, Ireland, Luxembourg and Portugal.

Exploration and production are undertaken by the large publicly quoted, international oil companies operating in concessions regulated by laws operated by the individual Member States. These concessions are discretionary and within the gift of governments, who have thereby been able to impose obligations on the international oil companies in the subsequent award of supply, service and works contracts when they begin exploration and production. The



Natural barriers

Low Quadrant D

Oil distribution and refining

992 effect

Quadrant i C

Oil exploration and production

.ow

Afcial iarriers

ligh

Figure 3. The energy sector and the Single Market initiative

major oil companies operating such concessions normally award contracts to private sector supply and service companies. There are many companies in the market but the largest tend to be US owned, operating through local subsidiaries incorporated within the Member States. There are also however a number of multinational firms of EC origin, and numerous smaller local indigenous supply companies. The market could be as equally competitive as downstream operations, but for the fact that there is evidence of national preference and artificial non-tariff barriers in the award of contracts (CEC, 1989, pp. 29-30).

The major artificial barriers to trade are:

1. There are discriminatory concession awards in many Member States (especially Greece, Portugal, Spain and Ireland) where national economic development considerations apply.

2. Dutch concessions are undertaken by the Minister for Economics who normally requires applicants for licenses to give information about their previous and their intended future contribution to Dutch industry. Dutch firms (NAM, Petroland and DSM) also dominate concessions and the

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134 ANDREW COX

state normally takes up to a 50 per cent stake in production and installa- tions.

3. The UK has around 40 concessionaires in the North Sea (including 8 major oil companies, 17 US companies, 5 EC companies and 7 private UK companies). BP, Shell and Esso have 50 per cent of all concessions for exploration and production between them. National preference in supply and service contracts has traditionally operated through the Offshore Supply Office (OSO). OSO has normally required information from concessionaires on the anticipated UK share of their expenditure, and in the past has altered the applicants’ list of suppliers as it wishes. Twice a year the OSO can inspect expenditure and the award of supply, works and services contracts by concessionaires to ensure compliance with its original objectives. As a result the OSO was able to ensure that between 1973 and 1987 contracts from concessionaires to UK suppliers rose from 25 per cent to 87 per cent.

4. There are also numerous national regulations on working conditions, technical and safety standards and pollution controls which may favour local suppliers.

Overall therefore, while there are numerous potential suppliers in the market, the EC found considerable evidence in upstream contract awards of discriminatory behaviour favouring local suppliers. This occurred either as a direct consequence of national governmental agencies forcing concessionaires to behave in ways which they would not if they were left to their own devices; or through national and publicly owned oil companies favouring national over foreign suppliers. Since the heaviest procurement expenditure in the industry is to be found in the upstream as opposed to downstream activities (see Table 1) the EC argued that the removal of artificial barriers ought to have a significant impact on efficiency and prices in the industry (CEC, 1989, pp. 32-3). In effect upstream energy activities can be placed in quadrant C of our matrix.

As we can see from Figure 3, a substantial proportion of the activities of the upstream oil sector prior to the Single Market initiative was located within the high artificial barrier quadrant of our matrix. This shows clearly why it was that this sector was seen by the Commission as a prime candidate for action under the 1992 reforms. It was hoped that by framing rules to remove artificial barriers, these industries could be moved from quadrant C into quadrant D. The EC expected to make substantial quantitative gains in this sector through more open procurement rules. This was because supplies and works contracts for extraction and production account for around 77.5 per cent of all the supplies and works contracts in the oil industry as a whole (CEC, 1989, p. 3 1). If artificial

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Table 1 : Oil company investments in the EC (ECUm 1986)

Exploration1 Refining Distribution production

Germany Spain France Italy Netherlands UK Rest of EC

Total

270 455 200 900 1600 3900 875

8200

150 60 120 340 500 470 I20

1760

100 85 50 50 250 I35 I00

770

Source: CEC (1989) p. 31

barriers to trade in the upstream industries would be removed, then substantial quantitative gains were expected to be made.

The question which this article poses is why it is that, given this background, the EC decided, first, to incorporate these upstream energy industries within the Single Market rules for utilities procurement and, then, allow them to derogate from these rules? Furthermore, one must also ask why, while a case for derogation can be supported in general terms when the market is already competitive, it is that the EC has allowed the industry itself in some countries to draft its own derogation rules, even though the suppliers of equipment and services are not fully competitive? The answer to this conundrum is clearly the need for the EC to ensure political support for the integration project as a whole, even though this may undermine the search for a Single Market in practice. This approach is clearly based on a growing belief in the need for subsidiarity and the political influence of mainly privately owned oil companies. This article will argue that the type of derogation to be described here for upstream energy companies is however not a proper use of subsidiarity and that, if subsidiarity comes to equate with what is happening in this industry, then the Single Market initiative will be fundamentally flawed.

3. Subsidiarity and Derogation in the Single Market

Subsidiarity in Theory

The issue of subsidiarity is a complex one and, as the article by van Kersbergen and Verbeek in this issue shows, subject to a variety of interpretations, This article cannot hope to deal with this topic but confines itself to a discussion of


136 ANDREW COX

two of the more basic interpretations of the concept.3 On the one hand there is a liberal view. This interpretation holds that subsidiarity means that all decisions should be taken whenever possible by the individual actors within a community. The collective should only have precedence when the individual cannot make a decision or cannot effectively enforce the implementation of that decision. This view has been taken up by opponents of the federalist and intergrationist approach to the future development of the EC. This school of thought argues that the EC should be allowed to intervene in the actions of the Member States only when there is clear evidence that the EC is in a better position to achieve the aims of policy than the Member States. Such an approach is fundamentally opposed to the creation of a supranational federal EC structure and seeks to use the concept of subsidiarity to limit the role of the EC in relation to Member States. It is an approach which reifies national sovereignty at the expense of suprana- tionality and which, when taken to extreme, may lead to the rejection of the very thing subsidiarity seeks to achieve. This is the maintenance of a supranational sovereignty between Member States which is superior to national sovereignty in the pursuit of agreed common objectives.

There is however an alternative interpretation which may be referred to as a supranational view of subsidiarity. As Jacques Delors has argued:

Subsidiarity, because it assumes that society is organised into groups and not broken down into individuals, rests strictly speaking on a dialectic relation- ship: the smaller unit’s right to act is operative to the extent, and only to the extent (this is forgotten very quickly) that i t alone can act better than a large unit in achieving the aims being pur~ued.~

Under this interpretation national sovereignty is clearly more circumscribed than under the liberal view. Here subsidiarity implies that the supranational body ought to have the right to determine policy. Furthermore this right should only be replaced by national autonomy when there is clear evidence that the aims being pursued can only satisfactorily be achieved by so doing. In this view the presumption is in favour of the supranational bodies’ superior competence, as opposed to the liberal view which holds that the presumption of superior competence is in favour of national sovereignty. To put it starkly the liberal view holds that the EC has to make and prove a case to be allowed to interfere in the affairs of a Member State. The alternative supranational view holds that the presumption is in favour of the EC institutions, and it is the Member States which have to make and prove the case for autonomous action.

’For a recent discussion of the issues, see EIPA (1991 ). This quotation is taken from McKenzie, ‘Issues Relating to EC Security Directives’. Paper presented to

ajoint meeting of the ESRC Single Market Initiative Group and the European Policy Unit of the European University Institute, Florence. Italy, 25-27 February 1993, p. 1 1 . See also Delors. ’The Principle of Subsidiarity: Contribution to the Debate’ (EIPA, 1991) pp. 7-18. 0 Basil Blackwell Ltd 1994


In some sense this is a sterile debate because the real test of whether the EC institutions or Member States should be the competent body to make and implement policy rests, not on any a priori assumption about rights, but on whether or not the agreed aims of policy are best achieved by supranational rather than national action. In this interpretation both viewpoints may be right and both may be wrong. One cannot say in advance which of these should be upheld; it depends ultimately upon the issue at stake and the constraints which policy-makers are attempting to overcome. Thus in some circumstances, national policy-making and implementation may be in order; in other supranational action may be the only way forward. This interpretation, which may be termed an instrumental view, rejects an a priori approach whether it is liberal or supranational. The real test of subsidiarity (or allowing national governments to make and enforce rules) is whether supranational or local bodies are able to achieve the aims of policy. Which institutions are competent to act in any given situation should be determined by the test of efficacy not the test of sovereignty. In fact the whole point ofeffective policy-making is that there should be achoice of alternative policy instruments and policy approaches to achieve the agreed aims of policy. The failure of subsidiarity in policy-making occurs when either the aims of policy are overtaken by the desire to defend constitutional rights about sovereignty, or supranational and national institutions are used to main- tain discriminatory national behaviour against other Member States.

As we shall argue here, the use of Art. 3 derogation for the energy sector in the utilities procurement rules is a misuse of subsidiarity. Art. 3, as interpreted in practice by the Commission, allows the Member States to draft rules which undermine the search for an open and competitive Single Market in energy exploration and extraction. While the rights granted to Member States under this Article certainly conform with the view of subsidiarity held by supranational theorists, in this particular case however the possession of these rights must be amisuse of subsidiarity because they can be operated in such a way as to subvert the search for a Single Market. We develop this argument below by first outlining the utilities procurement rules and the likely impact of these on the Single Market initiative. We also outline the derogations from the utilities rules allowed by Art. 3 of the Directive. This is followed by a discussion of the way in which this example of subsidiarity in practice appears to be operating in France and the UK.

The Utilities Procurement Directive and the Single Markel

The EC has been involved since I985 in an extensive programme of legislative drafting for public and utilities procurement. This has led to the adoption of four directives covering public supply, public works, public services and utilities works and supply contracts. There have been two further directives adopted to 0 Basil Blackwell Ltd 1994

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create a legal remedies structure for infringement of the new rules in public and utilitiescontracts awarded. Finally, the EC adopted new rules to cover the award of utilities services contracts in August 1993 (Arrowsmith, 1992, 1993, 1994; Cox, 1993; Cox and Lamont, 1993). Generally speaking the EC has attempted to create aregime for public and utilities procurement which ends the abuses and anomalies which had been experienced under the procurement rules which had been in operation since the 1970s. The 1971 public works rules and the 1977 public supply rules were often ignored by public purchasers because there was no effective remedies system for aggrieved suppliers. Furthermore, attempts by the EC to use the European Court of Justice to endorse the rules proved slow and cumbersome (Arrowsmith, 1992).

The basic goals of the new rules are to provide for greater transparency in the award of contracts by providing for earlier and more comprehensive information, lower threshold levels, the harmonization of technical standards, sensible time limits for the awards procedure, clear criteria to govern decision-making and common rights to enforcement and remedies for non-compliance in all of the individual Member States. The basic goal is the eradication of national preference in favour of more open and competitive structures. Furthermore, the rules are written so that all relevant public and private bodies are incorporated in the regime. At the same time previously excluded contracts and sectors are also brought within the rules. From 1993 all service contracts are included in the rules alongside supply and works contracts.

It is, however, the incorporation of the formerly excluded or utilities sectors covering energy, water, transport and telecommunications which is the most revolutionary step in the Single Market initiative for procurement. As we saw earlier in our discussion of the energy sector, much of this sector was located in the national preference and high artificial barrier quadrants of our matrix. The same conclusion can be made for the other three sectors of water, transport and telecommunications. In each of these sectors there is considerable evidence of national protection and abuse of monopoly and oligopoly trading rights by public and private ‘national champion’ operators. On the other hand the Commission clearly intended that eventually the new rules should encourage industrial restructuring and the development of larger and more efficient utilities companies.

Whether or not these goals will be achieved is difficult to say. It will take some time for the rules to have any concrete effect in either the public sector in general or the utility sectors specifically. What is already clear however is that there is a considerable difference between the procurement rules operating in the public sector as a whole and those applying to the utilities sector. It can be argued that these differences, which provide for far more loopholes in the utilities regime than in the public sector rules, are likely to reduce the impact of



the rules and limit the quantitative gains anticipated. More worryingly, the exclusions, exemptions and easements granted in the utility rules, may ensure that the overall integrationist goals of the Single Market initiative and the idea of a level playing field for procurement suppliers within the Community will be subverted.

The major differences between the public sector and utility regimes are that there is considerably more evidence of the use of subsidiarity in the utilities than in the public sector rules and there are far more specific exemptions and easements for the utilities than for public sector purchasers (Cox, 1993). The major easements and exemptions are as follows:

1 . The utility rules, which came into force in the original nine Member States on 1 January 1993, do not apply at all in Spain until 1 January 1996 and in Greece and Portugal until I January 1998. This is a considerable exclusion because one might have expected the supply industries in these countries to be candidates for early and radical restructuring through market openness.

2. The threshold levels for utility supply and services contracts are set at ECU 4O0,OOO in the transport, energy and water sectors and ECU 600,000 in telecommunications. The works contracts threshold is ECU 5 million. The works threshold is set at the same level as in the public sector rules but the supply and service threshold in the general rules is much lower at ECU 200,000. This further limits the impact of market openness.

3. Under Art. 29 bids for utility supply contracts which have less than 50 per cent local content in them can be rejected. Bids for utility supply and works contracts from non-reciprocating countries can also be rejected if they are 3 per cent lower than bids from other EU countries. Under Art. 37 of the proposed utility services directive it will also be possible for EU utility purchasers to suspend or restrict the award of service contracts to non-reciprocating third country firms, their affiliates located in the EU or EU firms submitting bids which include services originating in the third country in question, These combined powers provide a bargaining tool for the EU in the GATT negotiations, but they also limit the market liberalization of the new rules by extending rather than reducing artificial barriers to trade.

4. There is a range of specific exclusions for particular sectors from the rules. These exemptions include radio and broadcasting services, bus transport services to the public and telecommunications services when they operate under competitive conditions, private bodies supplying gas, heat, drinking water and electricity primarily for their own purposes,


140 ANDREW COX

water authorities when they purchase water and for utilities awarding contracts for the supply of energy or for fuels for the production of energy. Finally, there are specific and, in some quarters, contentious exemptions for carriers of passengers and providers of services by air or sea.5

5. The awards procedures are much more flexible for utilities when compared with public purchasers. There is far less emphasis on open and selective contract awards procedures and far less onerous reporting rules after contracts have been awarded. The utilities are not obliged to provide notices in the Official Journal and can comply with the rules simply by providing periodic indicative notices or announcing a competition for pre-qualification. Furthermore, the utilities have far greater scope to use negotiated and single source contract awards without any prior calls for competition. There are also further easements from competition when framework agreements are used.

All of these easements and exemptions potentially weaken the impact of the Single Market initiative because they either retain or, in some cases, extend artificial barriers to trade. In so doing they ensure that the degree to which the Commission will be able to move the utility sector industries from national preference to more open market competitive practices in contracts awards will be limited. The reasons for the decision to weaken the impact of this regime clearly owe more to politics than to economics. As we saw the economic case for including the utilities in the procurement rules is transparent. There are a massive number of artificial barriers to trade in these sectors. The decision to provide easements and exemptions from the rules obviously derives from the need of the Commission to win support from the Member States and the private sector firms, which are now to be incorporated within the rules for the first time. In the past, the fact that there were many private and semi-private companies operating in the utilities sectors ensured that these sectors would be excluded from the earlierprocurement rules. In the wave of enthusiasm for the eradication of artificial barriers enshrined in the Single Market initiative, the Commission was however able to convince the Council of Ministers of the need to incorporate public and private utility providers in the rules.

Despite this there was considerable political opposition to this move and, in order for the Commission to achieve its ultimate goal of extending the rules to the utilities as a whole, many concessions had to be made to Member States and to the private companies affected. The delays in extending the rules to Spain,

’ Inshore and river ferry services are included in the rule but sea ferries are not. The Economic and Social Committee in particular was opposed to these exclusions and exemptions. ‘Opinion on the proposals for a Council Directive on the procurement procedures of entities providing water, energy and transport services’ (OJC 139/23) (5/6/1989).



Portugal and Greece are testament to the role of national political bargaining in the policy process. The French government was also particularly successful in ensuring that the threshold levels for supply contacts in telecommunications should be raised to ECU 600,000 from ECU 400,000. This was clearly due to the French concem that liberalization should not fundamentally endanger the viability of its own national champion firms in this sector. Similar concerns can be found behind the local content and reciprocity clauses. The Commission feared that, because the Community has a liberal attitude to the rights of establishment for third country suppliers, the opening up of utility procurement might give them a massive advantage in EU markets. Furthermore, it was also felt that the freedom granted to third country suppliers might not be reciprocated in their own countries for EU suppliers. The reciprocity rules were written therefore to provide the Community with a bargaining counter to try to force third countries to open their markets to EU suppliers.

All of the easements to the rules outlined above mean that the utility procurement market will be less open, and contract awards less transparent and subject to more national preference, than in the EU public sector as a whole. More worrying than this however is the potential that exists in the utility rules for national governments and utility undertakers to abuse subsidiarity to undermine further the scope and coverage of the procurement rules and, thereby, the goals of a Single Market.

Subsidiarity in Practice: The Art. 3 Derogation for Upstream Energy Activi- ties

Under Art. 3 of the Utilities Procurement Directive the Member States can ask the Commission for an additional exemption from the rules for public and private entities involved in the exploration for, or extraction of, oil, gas, coal or other solid fuels.6 If the Commission grants approval, these entities are allowed to operate under a system which looks like subsidiarity in practice. Under Art. 3 Member States can apply their own rules to upstream exploration and extraction activities so long as the following national conditions are satisfied:

1. there is competition when initial authorization to exploit is granted;

2. the technical and financial capacity of all competing entities is established prior to evaluation;

3. any contract award is based on prior publication of non-discriminatory and objective criteria about the method of extraction;

4. there should be similar prior publication of objective and non-discriminatory criteria relating to the operation and termination of any contract to

Directive 9O/EEC, (OJL 297/1) Art. 3. 0 Basil Blackwell Ltd 1994

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explore or extract. This should include provisions on operating obligations, royalties and participation in the capital or revenue of the entities;

5 . any amendments must be non-discriminatory, but operating obligations need not be established until immediately before authorization.

If these criteria are complied with, all reporting and compliance rules on contract awards can be determined nationally and contract awarding authorities do not have to report on their contracts to the Commission. The national government has the obligation to enforce the rules and must provide reports, but only after prior discussion with the Commission over the content and form of these reports.

Clearly this approach to upstream activities is a classic example of what supranational theorists of subsidiarity have argued for. The Member State should be granted the power to act only when it has demonstrated that it is in a better position to implement the rules and to achieve the fundamental aims of policy than the supranational body. The basic principle of Art. 3 is that, if the Commission believes that the Member Stales are competent to police and enforce non-discriminatory behaviour in this sector, they should be allowed to derogate from the utility rules and operate their own system. In so doing Art. 3 is explicit that the Member State must first satisfy the Commission of its capacity to achieve the basic aims of policy - transparent, non-discriminatory contract awards which dispense with artificial barriers to trade - by an altema- tive mechanism or regime. This is a classic example of supranational subsidiarity because it forces the Member States to draft legislation which the Commission has the right to comment on and approve.' A liberal view of subsidiarity would clearly operate the other way around. The supranational body would propose legislation which the individual Member State would have the power to veto and amend before approving the scope for EU action. Normally then the supranational body would have reserve powers only.

Whether or not the liberal or supranational approach is the correct way forward for the future constitutional and legislative structure of the Community is of less importance here than whether or not either approach is the best way to achieve the goals of policy for utilities procurement. As we argued earlier, one cannot decide this topic in advance. There may well be cases when the liberal approach to subsidiarity is best and others when the supranational approach should be used. In the case of upstream energy exploration and extraction, it appears that the supranational approach to subsidiarity adopted by the Commis- sion suffers from grave weaknesses and that these would have been compound- ed if a liberal approach had been adopted.

' I would like to thank Tom Rose, Chief Legal Counsel for Schlumberger Sofitech SA. for this insight.



The major reason why subsidiarity may not work in this sector is that the goal of policy is achievable only if there are common and enforceable rules which ensure that all contract awarding bodies act in a non-discriminatory manner. While the Commission clearly has the power to decide whether or not to allow Member States to derogate from the rules, i t cannot ensure that the Member States or the national awarding bodies implement the rules in a non-discriminatory manner. This being the case, i t cannot ensure that the goal of policy in an integrated Single Market is achieved. This arises because in this sector the aim of policy is to eradicate national preference in the award of oil, gas and coal concession contracts and also the subsequent award of supply, works and services contracts by the public and private concession companies. To achieve this, the EC needs to be sure either that the new utility rules are applied or that any national derogation ensures transparent and non-discriminatory behaviour. The problem is that the way in which the Commission appears to be operating indicates that there will be tremendous scope for the continuation of national preference by unscrupulous contract awarding bodies.

Since the utilities directive was adopted there have been a number of applications from Member States for derogation under Art. 3. So far only France has been granted a derogation from the rules, and it is clear that the Commission has pursued a fairly rigorous supranational approach to subsidiarity in this case.8 The French government applied for derogation as early as 10 April 1992, but only for the extraction and exploration of oil and gas and not for coal and other solid fuels. In July 1992 the Commission requested that the French government make substantial changes to the national laws and regulations covering contract awards in these areas before it would grant derogation. The Commission also placed a notice in the Official Journal asking interested parties if the national rules applying to exploration and extraction in France were discriminatory. There was no reply alleging discrimination and this led to negotiations between the EC and the French government in the Autumn of 1992 over the inclusionof a text into the French law transposing the utilities directive. This discussion outlined the principles of non-discriminatory and competitive procurement which should apply in oil and gas exploration and extraction from 1 January 1993. This derogation was however granted for only one year.

On the face of it the Commission has pursued an effective and closely controlled exercise in supranational subsidiarity. It has received legislative drafts from the French government and has passed opinions on these and requested redrafting so that the legislation is compatible with the aims of the original utility directive. How can one then argue that subsidiarity will not work in this case? The conclusion presented here has nothing necessarily to do with the bureaucratic efficacy of the Commission in drafting or monitoring rules; it

Commission Decision, 93/18/EEC (23/12/1992), OJL 12/19. 0 Basil Blackwell Ltd 1994

144 ANDREW COX

is based more on an analysis of the likely impact of the derogated rules on the behaviour of oil and gas companies operating in France. The Commission appears to have closely monitored and supervised the setting up of a national non-discriminatory approach in France. The reason one may doubt the efficacy of this approach derives not from the lack of legislative and administrative effort by the hard working staff at the Commission, but more from the fact that the alternative French regime was written by the firms in the domestic oil industry and provides for even more easements from the utilities rules, which we argued were, in any case, a substantial retrograde step when compared with the general rules applying in the public sector.9

Under the French alternative regime the rules are even more lax than those provided for in the utilities directive. French contract awarding bodies do not have to specify when or if open, selective or negotiated contract awards should apply because any of these approaches can be applied. No time limits are specified for the sending of bids or for participation in pre-qualification tender lists. The phrase ‘sufficient’ time is the only specification which is allowed for. There are no rules on the use of technical specifications and awarding bodies can do what they wish so long as it is non-discriminatory. Frenchentitiesdo not have to provide prior indicative notices, contract award notices or notices setting out to whom they have awarded contracts in the Ofjicial Journal. The French system does provide for three types of contract award procedure. In general none of these provides for open competition in any way at all. The three procedures are through prior indicative notices when restricted (selective) or negotiated awards may be made; through pre-qualification notices when restricted or negotiated awards may be made; and through negotiated awards when there is no requirement for a prior call for competition. As can be seen, none of these procedures enshrines open competition as a central pillar of procurement practice in this sector. Indeed one might argue that this system is no system at all since the awarding bodies are under few obligations. Apart from the legislative commitment to support non-discrimination it is not clear how the derogated French alternative system will be enforced or implemented satisfactorily. It is clearly a regime written by the French oil companies to minimize bureaucratic interference by either the EC or national government.

Why should one worry about this, given that there is a commitment in the French law to support transparency and non-discrimination? The major reason is that there is likely to be a significant difference between the willingness of some contract awarding entities in this sector to implement non-discriminatory

For further details see the relevant laws: Lois No: 92-1282 du I I dbcembre 1992 (Journal Officiel de la Ripubliyue Francaise, 12 December 1992) and Ministkre de L’lndustrie et du Commerce Extbrieur, Am& du 15 decernbre 1992 Definissant le RCgirne d’Attribution des Marches de Fournitures et de Travaux par Entitis Titulaires d’ Autorisation de Prospecter. d’Extraire ou d’Exploiter des Hydrocarbures Liquides ou Gazeux (Journal Offiriel de la Repuhliyue Francaise. 14 January 1993). 0 Basil Blackwell Lid 1994

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procurement rules than others. There is also likely to be a difference in the attitude of the national governments of the Member States as to how the national derogated rules they apply are drafted. We saw that the French oil companies were allowed by their government to write their own rules. It is unlikely however that the British government will allow UK oil companies the same degree of latitude when the UK rules on derogation are written, The same may or may not be the case in those other Member States -Germany, Denmark and the Netherlands - which have asked for derogation. The significant point here is that because the latitude given to oil, gas and coal companies will vary in each of the Member States, the rules which will apply are likely to be non- commensurable. This implies either that there will be different rules in each of the Member States or no rules at all if the utility companies have their way, as they appear to have had in France.

There is also a related point which is linked to the attitude of the companies which will have to apply the rules. Some utility and oil companies are publicly owned, some are semi-publicly owned and some are wholly privately owned. Similarly the upstream oil and gas market is characterized by relative oligopoly amongst concession companies, even if their own supply markets are relatively competitive. One might hypothesize that there will be a direct correlation between the degree of public ownership and oligopoly and the resistance to the writing of open and competitive procurement rules in this industry. The attitude of BP to the topic of derogation brings this point out quite forcefully. It is clear that while BP would welcome some derogation from the rules by the British government related to time-scales and bureaucratic costs, it would not wish to ignore the opportunities for more efficient procurement practices which the new utilities directive encourages. l o

The reasons for this very different approach by BP to that being practised by the French oil companies is obvious. BP has recently suffered through a combination of low price and worldwide recession, coupled with some strategic errors in corporate decision-making which led to the company reporting its first ever annual loss in 1992. In recent years the company has refocused on hydrocarbon activities in a drive to improve margins and has replaced a subjective, engineer and technology-driven procurement system with an objective, rules-based approach based on criteria related to profit, quality and closer partnerships with suppliers. This has been necessary because BP must reduce costs and become more efficient to survive in the market.

The EU rules are now considered by BP as a key lever in improving profitability. BP sees the utilities procurement rules as a guide to best practice

'OThisdiscussion is basedon apresentation on BP'sresponsetothenew utilities procurement rules by John Jolly of BP Exploration at Schlumberger Sofitech SA. Brussels on 9 March 1993, andcorrespondence with George Bain, European Procurement and Logistics Manager, BP Exploration.

0 Basil Blackwell Lld I994

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and is using these to reshape its internal procurement structure. Nor should this be surprising because the utilities rules are aimed directly at the eradication of many of the national preference rules which militated against efficient procurement by BP. We saw earlier that the Offshore Supplies Office (OSO) in the UK imposed a memorandum of understanding on energy concession companies about where they should place supply, works and service contracts. This tended to impose UK suppliers on BP rather than those suppliers which BP would have preferred. This practice is replicated in many Member States when supply, works and service contracts are awarded for oil and gas exploration. Under the utilities rules this practice is outlawed and BP, and all other concession companies, will be free to award contracts to anyone they like, subject of course to the provisos of the local content and reciprocity rules.

The attitude of BP appears to be different to that of the French oil companies and it is also at variance with many other UK oil companies who believe, misguidedly, that the utilities rules are an unwarranted infringement of their private affairs. There is clear pressure from the privately owned UK oil companies to encourage the government to derogate from the rules in a major way. It is clear that the primary reason for this is that the oil and gas companies are concerned about the additional administrative burdens the rules will impose upon them and they are politically opposed to government interference, even when it may be for their own good. It is also likely that the press.ure for derogation from publicly owned oil and gas companies in the other Member States stems partly from these concerns and also is partly due to the desire to continue with national preference in supply relationships.

The problem which arises from this analysis of the very different attitudes of BP and the French oil companies is that it is clear that the request for derogation can only be driven by a desire to avoid the proper implementation of the utilities rules. BP sees less need for derogation because it wants to create a procurement regime which allows it to compete efficiently and at the lowest price possible in the market. These are the very goals towards which the Single Market initiative is ultimately supposed to be working. It is unclear therefore why it is that the Commission appears to be willing to agree to derogation at all. If the analysis presented here is correct then, insofar as the Commission allows derogation under Art. 3 of the utilities rules, it must be acting as an accomplice in the emasculation of the very rules it has created. The only explanation for this must be the effective political power or private interests being exerted on the Commission through the Member States.

The fact that the Commission is taking its time over the approval of further derogations and has granted France only a one-year experiment, is perhaps evidence that there is some disquiet in the Commission over this act of subsidiarity. It does demonstrate however that subsidiarity is a difficult concept


DEROGATION. SUBSIDIARITY AND THE SINGLE MARKET 147

for the Commission to implement in practice. In this case it is clear that even the adoption of the supranational approach to subsidiarity which Jacques Delors favours may be detrimental to the achievement of the goals of the Single Market. A more liberal approach to subsidiarity which granted national oil companies and governments even greater autonomy would reduce the scope of the utilities procurement rules further.

This being so it may well be that the Commission will have to withdraw derogation it if wishes to ensure a level economic playing field for utilities procurement. The fact that derogation was written into the rules in the first place indicates however that political considerations are equally as important as economic goals in the framing of Community decisions.

References

Arrowsmith, S. (1992) Public Procurement in the EC, Volume 2: Guide to the Procurement Cases of the Court of Justic (Winteringham: Earlsgate Press).

Arrowsmith, S. (1993) Public Procurement in the EC, Volume 4: Remedies for Enforcing the Procurement Rules (Winteringham: Earlsgate Press)

Arrowsmith, S. (1994) Public Procurement in the EC, Volume 5: Remedies for Enforcing the Utilities Procurement Rules (Winteringham: Earlsgate Press).

Atkins, W.S. ( 1 988) The Costs of Non-Europe In Public Sector Procurement (Luxem- bourg: OOPEC).

Commission of the European Communities (1989) ‘Public Procurement in the Exclud- ed Sectors’. Bulletin ofthe EC, Supplement 6/88, (Luxembourg: OOPEC).

Commission of the European Communities (1991 ) The Large Market of I993 and the Opening-Up of Public Sector Procurement (Luxembourg: OOPEC).

Confederation of British Industry (1 990) Marketing to the Public Sector and Industry (London: Mercury Books).

Cox, A. ( 1993) Public Procurement in the EC, Volume I : The Single Market Rules and the Enforcement Regime After I992 (Winteringham: Earlsgate Press).

Cox, A. and Lamont. F. ( 1 993) Public Procurement in the EC: Volume 3: The Texts of the Community Directives, Recommendations, Proposals, Decisions, Resolutions and Communications in Force (Winteringham: Earlsgate Press).

Cox, A. and Watson, G. (1994) The EC and The Utilities (Winteringham: Earlsgate Press), forthcoming.

Department of Trade and Industry ( 1992) The Single Market: The European Economic Area (London: DTI).

European Institute of Public Administration ( 199 1’) Subsidiarify: The Challenge of Change (Maastricht: EIPA).


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