Select Committee on Trade and Industry Minutes of Evidence


Memorandum submitted by BG Group

Recent Increase in the UK Gas Spot Price and the Operation of the UK/Belgium Gas Interconnector

  BG welcomes the recent decision by the European Commission—at the suggestion of the Trade and Industry Secretary—to launch an inquiry into the operation of the UK/Belgium Interconnector.

  We believe it is important to clear up some misunderstandings surrounding higher UK gas-prices and the operation of the Interconnector. BG is, therefore, grateful for the opportunity to submit this note for inclusion in the debate.


  1.  Over the past 12 months, the wholesale price of gas in the UK has risen by over 100 per cent. BG believes that the increase in the UK spot price are due principally to the formal link that exists between oil-prices and gas-prices in Continental Europe. That link—which did not exist in the UK spot market but is now impacting upon it—has seen oil-prices hit a five-year high, pulling up gas-prices with them.


  2.  Other key factors contributing to higher prices include:

    —  Growth in demand for gas;

    —  Barriers created by the trading conditions in Belgium for shorter term transactions, making access to their grid—and the rest of Europe—very difficult;

    —  Higher entry costs to the market plus added risk and uncertainty as a result of the introduction of the Entry Capacity Auction regime;

    —  Additional costs due to regulatory intervention under the Reform of Gas Trading arrangements.


  (i)  BG is both a shareholder and a user of the UK/Belgium Interconnector.[1] The company, Interconnector (UK) Ltd, was established to build and operate the Interconnector. It acts purely as an operator of the pipeline and of its compressors to provide capacity to its "Shippers"—companies which wholesale gas through the Interconnector.

  (ii)  It is the shippers, who, individually "nominate" their gas inputs and outputs to Interconnector (UK). The company then aggregates all such "nominations" to determine how much gas physically flows and in which direction.

  (iii)  Shippers base their "nominations" of the levels of input and output on their own commercial judgements. Interconnector (UK) Ltd seeks to accommodate these "nominations" but has no influence on them.

  (iv)  However, Interconnector (UK) does not allow shippers to see other shippers' "nominations"—with the exception of the Belgian national gas company, Distrigas, which receives the information to enable it to feed into the Belgian Grid.

  (v)  There are currently 16 shippers. Not all are shareholders. Shippers meet Interconnector (UK) Ltd regularly to discuss shipping arrangements and modifications to improve flexibility and trading of capacity.

  (vi)  It is understandable that the operations of the Interconnector—which opened as recently as late 1998—should require some adjustments over time. BG is hopeful that two alterations to existing arrangements, currently under discussion, can be agreed. These should increase capacity trading and inventory flexibility and reduce turnaround time—the time it takes to switch the flow of gas through the Interconnector. However, the difficulty of reaching consensus between 16 parties should not be underestimated, especially when there are one or two entrenched positions.

  (vii)  Shareholders meet twice a year to agree budgets and approve the annual accounts. Now that the Interconnector is operational there is significantly less Shareholder involvement.

  (viii)  Gas can flow both ways through the Interconnector and some capacity is known to be reserved for the delivery of gas to Continental buyers under long-term contracts, agreed prior to the start-up of the Interconnector. Large volumes of UK gas have been exported to the Continent, with gas-buyers attracted by our low prices. But gas is also imported into the UK and we shall discuss the implications of that below in a section on the link between UK and Continental gas-prices.

  (ix)  There have been some suggestions that the Interconnector operating rules governing the time taken to switch the flow from exporting gas from the UK to importing gas to the UK, and vice-versa, may have created market price-"spikes".

  (x)  After a couple of years of operational experience, amendments are now being considered to reduce the turnaround time. However, at present, there is only compression equipment on the UK side of the Interconnector and, unless and until compression is installed at Zeebrugge as well as Bacton, a minimum time will always be needed to effect a switch of direction.

  (xi)  Whilst any decisions on, for example, the construction of compression equipment at Zeebrugge would be made by Interconnector shareholders, they would act only when shippers agreed to underwrite the investment by signing up to long-term agreements to pay for capacity, whether or not it is used.

  (xii)  These rules were originally agreed in 1998 prior to the start-up of the Interconnector. At that time, no-one anticipated the need to change direction more than once or twice a year. In fact, within two months of opening for business, the Interconnector went into reverse-flow to allow cheaper European gas to enter the UK.

  (xiii)  At the time the rules were agreed there was no operational experience of what would happen and therefore a cautious approach was adopted.

  (xiv)  It is worth recalling that the Interconnector was originally conceived as an export pipeline to help ship out "surplus" UK gas. What has changed over the years is level of UK demand.

  (xv)  Between 1995 and 1999, UK gas-consumption, excluding exports, increased by 32 per cent. In the first three quarters of 2000, consumption was 5.5 per cent up on the same period in 1999.

  (xvi)  It is important, however, that no-one should be under any illusions about the impact on gas-prices of operational changes to the Interconnector. Neither installing compressors at Zeebrugge nor the other operational adjustments for which Interconnector (UK) is seeking to gain shipper agreement would be likely to have anything more than a marginal effect on prices. Extra compression equipment might iron out some short-term price-"spikes" currently occurring. It is unlikely that it would do much more than that.


  4. (i)  From this analysis of the operation of the Interconnector, it should be clear that any allegations of profiteering levelled against Interconnector (UK) Ltd are simply groundless. The Interconnector handles capacity but Interconnector (UK) does not benefit from the price of the gas it handles.

  (ii)  In the broader case of BG Group, the company is not active in either the retail or domestic markets and sells the majority of the gas it producers from the UK Continental Shelf under long or medium term contracts.

  (iii)  Only about 10 per cent of BG Group's UK gas production is sold into the spot market, and the majority of that during the lower priced summer months.


  5. (i)  So, the operational procedures of the Interconnector do not on their own explain why UK spot-prices have risen so sharply without an understanding of the impact of Continental gas-prices on UK gas-prices.

  (ii)  The UK is now widely accepted as having the most competitive gas-market in the world. all gas consumers in Great Britain can now choose their supplier from a significant number of companies, in competition with one another.

  (iii)  Approximately 85 per cent of gas production is sold via long-term contracts with the remaining 15 per cent sold directly on the wholesale spot market.

  (iv)  However, liberalisation of gas-markets and real competition have not been embraced as enthusiastically across the rest of the EU. The open spot market which exists in the UK is not replicated in the rest of the EU. Other member states do not enjoy a competitively trading market against which to index their gas.

  (v)  A key factor in recent prices-rises has been the juxtaposition of an open, transparent and liberalised UK gas-market with a Continental market in which most long-term gas contracts are directly indexed almost 100 per cent to oil-prices.

  (vi)  The levels to which oil-prices have risen in late 1999 and throughout much of 2000 have, therefore, impacted heavily upon gas-prices on the Continent. Continental gas-buyers wanted to purchase UK gas because of its cheapness but there was another effect: UK gas shippers and suppliers had the choice of selling gas at low prices at home or at significantly higher prices on the Continent.

  (vii)  That led to tightened demand in the UK and, over time, bumped up the price on the UK spot market to levels close to that in Europe. It is important to understand in this context that Interconnector (UK) does not initiate switches of gas-flow but responds to the requests of shippers.

  (viii)  The picture could have been very different, had there been full liberalisation of gas-markets in other EU member states and/or the historic link between oil and gas-prices on the Continent did not exist.

  (ix)  In fact, UK consumers need not have suffered such sharp increases, had the practices of the UK gas-markets been replicated on the Continent. Clearly, the liberalisation of markets in other EU states cannot come soon enough.

  (x)  The almost 100 per cent link between oil and gas-prices on the Continent did produce low gas-prices when the price of oil was low. Unfortunately, the opposite is true when oil-prices are high.


  6. (i)  There is a further complicated factor. Quite simply, gas-trading in Belgium is not as "liquid", as easy or as open as in the UK. The Belgian gas company, Distrigas, has chosen to establish a trading hub at a point removed from where the Interconnector is landed in Belgium.

  (ii)  This creates obvious difficulties and barriers to overcome. Short-term transit access to the Belgium grid is very difficult, further discouraging trading. Other obstacles include the fact that there are different operating regimes between the UK and Belgium. The UK operates a daily gas balancing regime, while Belgium operates hourly balancing. There are also issues around gas quality. It is, therefore, not just the price that is the consideration when trying to trade across the Interconnector.


  7. (i)  It is also the case that a contributory factor to higher prices has come from the fact that UK gas supplies have become increasingly attractive. Clean, efficient and reliable, gas is seeing demand rise in the domestic, industrial and commercial sectors, not to mention in electricity generation.

  (ii)  There have also been increased exports to Ireland as well as the effect of cold weather.

  (iii)  Out-flows from the UK/Belgium Interconnector steadily increased from December 1999, but significantly increased in April 2000 and then remained high into the summer. This trend was further accentuated by offshore routine maintenance.

  (iv)  UK prices did then fall in the second half of the summer of 2000, as supply was considerably greater than demand. With the start of the new gas year in October 2000, with increasing demand, prices moved back into line with continental prices and have remained in step ever since.

  (v)  Continued economic buoyancy in the UK has also contributed to this surge in demand.

  (vi)  The combination of these factors has tightened the supply/demand position, with the result that the UK, which had been forecast just a few years ago to become a net importer of gas in 2007, is now forecast to do so earlier—in 2003.

  (vii)  Consequently there is a "perceived" tightening of supplies within the market that will increasingly produce price-"spikes".


  8. (i)  BG is generally in agreement with ILEX's recent report[2] to UKOOA, and is supportive of the view that the Current Entry Capacity Auction regime has increased costs (significantly for BG) and created additional risk and uncertainty.

  (ii)  The entry capacity auction created significant concern in the market as the clearing prices reached record levels and players scrambled for entry capacity to ensure they could get gas into the system, leaving Transco with a significant over-recovery compared to the pre-auction regime.

  (iii)  The changes from intervention under the Reform of Gas Trading arrangements are also, in our view, adding further additional costs and creating inappropriate signals to market participants.


  9. (i)  BG believes strongly that the high UK gas-prices experienced at present are principally as a result of the juxtaposition of an open, liberalised UK market with a Continental market yet to be liberalised and where gas-prices are linked to oil-prices.

  (ii)  The solution to this problem for the British consumer is not the short-term approach of reverting to protective practices but for strong pressure to be applied by the Commission and the UK Government to other EU member states to match our openness and transparency.

  (iii)  There are other elements in the equation that could have an impact on pricing. Lower prices could be brought about to some degree by changing the Entry Capacity auctions regime and by reducing to a minimum regulatory intervention. Improved trading conditions in Belgium could also contribute.

  (iv)  It is hoped that changes currently being discussed amongst Interconnector shippers will result in more flexible trading and operating conditions and quicker turnabout times.

  (v)  However, all of these factors pale into insignificance alongside the problems posed by the impact of Continental gas-prices on our market.

  Interconnector (UK) Ltd shareholders:

  BG Group 20 per cent; BG North Sea Holdings Ltd 5 per cent; BP 10 per cent; Conoco (UK) Ltd 10 per cent; Distrigas S.A. 10 per cent; Elf Aquitaine Gas UK Ltd 10 per cent; OAO Gazprom 10 per cent; Ruhrgas UK E&P Ltd 10 per cent; National Power 5 per cent; Amerada Hess Ltd 5 per cent; Snam International Ltd 5 per cent.

(NB: The views and opinions expressed in this note are those of BG Group (BG) and do not purport to represent those of the UK gas industry or any other Interconnector Shareholder or Shipper.)

12 February 2001

1  A list of other shareholders is at the end of this document. Back
2  "What Influences Gas Prices in the UK and Why Have They Increased Through 2000", January 2001. Back

previous page contents

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2001
Prepared 6 March 2001