APPENDIX
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.
INTRODUCTION
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.
KEY FACTORS
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.
3. THE UK/BELGIUM
INTERCONNECTOR
(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.
HIGH PROFITS
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.
THE IMPACT
OF CONTINENTAL
GAS-PRICES
ON UK PRICES
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.
THE BELGIAN
"EFFECT"
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.
HIGH GAS
DEMAND
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".
OTHER FACTORS
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.
CONCLUSIONS
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
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