Select Committee on Trade and Industry Minutes of Evidence

Memorandum by the Lattice Group plc


  1.  Transco, the Lattice Group's biggest subsidiary, is the owner and operator of the National Transmission System (NTS), which transports around half of the country's primary energy. The related commercial arrangements and information systems operated by Transco provide the basis for the liberalised competitive gas market. This infrastructure plays a key role in maintaining gas supply security.

  2.  Lattice welcomes the opportunity to present evidence to the House of Commons Trade and Industry Committee in respect of its inquiry into Energy Policy. Alongside the Performance and Innovation Unit's Review of Energy Policy, Ofgem's final consideration of how appropriate investment in the gas infrastructure network can be encouraged through incentives on Transco's System Operator, and the House of Lords inquiry into EU Security of Supply, a review of related issues by the House of Commons is welcome and timely.


  3.  Given the increased dominance of gas as an energy source, the medium term supply/demand outlook for UK gas supplies is an important consideration when developing policy measures to deliver a range of objectives, in particular those relating to security of supply and environmental considerations. On 31 October 2001, Transco published its Ten Year Statement, setting out the detailed supply/demand forecasts that are expected to form the basis of its investment plans in the NTS.

  4.  The main relevant points from the Ten Year Statement and other published forecasts are:

    —  Around one third of the UK's gas demand will need to be met from imports by 2010. Some forecasts[1] place this figure as high as 90 per cent by 2020.

    —  Although there are ample supplies of gas worldwide, there is increased uncertainty regarding the medium to long-term source of future imports (Norway, Russia, Algeria, LNG or others) and their precise entry points to Transco's NTS.

    —  Continental gas prices tend to be heavily influenced by international oil prices. Consequently, the gas Interconnector to Europe has had a marked impact on the pattern of UK supply and demand, both in terms of the increased uncertainty presented by the coupling of UK and continental markets, and in a changed demand pattern on the NTS.

    —  Up to 9GW of nuclear electricity generating plant is expected to close in a 5-15 year time to horizon. This represents around 12.5 per cent of currently installed electricity generating capacity, and is against a background of continued annual electricity demand growth of 1-2 per cent per annum[2].


  5.  Lattice believes that the future outlook for gas supply and demand gives rise to a number of policy implications. In our various submissions to Ofgem as part of Transco's Periodic Price Control review and our submission to the PIU's Review of Energy Policy, we have generally restricted our comment to tackling these issues directly.

  6.  Our submission to the PIU is attached as Appendix 1 to this evidence, and provides a more detailed reflection of our views on specific regulatory issues. In the following answers to the specific questions put by the Trade and Industry Committee, we have sought to address some of the wider regulatory and public policy issues.

  Q:   Given the imminent dependence of the UK on energy imports, how can the UK maintain a secure energy supply? What mix of fuels would maximise security?

  7.  Lattice believes that there is fundamental incompatibility between the use of competitive markets, and diversity and security of supply. However, there is a significant question as to whether the foreign markets on which the UK will increasingly depend are themselves sufficiently liberalised to provide diverse, reliable and accessible sources of energy. In the case of gas, future supplies will almost certainly need to be sourced from the continent, and in part, across the continent from Russia. This points to two key areas for consideration—the impact of slow European liberalisation and the ability to gain access to the European gas network in order to source future supplies from Europe's eastern borders.

  8.  The extent and pace of European gas liberalisation is a principal consideration in formulating future policy. If the UK maintains a philosophy of being driven principally by competition and market mechanisms, with few administered safeguards against exceptional circumstances, this is less likely to deliver a range of policy objectives as the proportion of the market supplied from less liberal regimes increases.

  9.  As liberalisation has developed, the UK has dismantled many of the institutions and safeguards that still exist in its likely future supply source markets. As the relative proportion of UK demand met by these markets increases, the risk of adverse consequences from administrative constraints and political intervention may also increase.

  10.  As a comparison with other fuels, and largely arising from historic supply shocks, oil producers are required to keep up to 90 days of oil stocks, and the Secretary of State can mandate minimum levels of fuel stocks at power stations[3]. In the absence of any similar requirements in gas, the transfer in the generating fuel mix from coal to gas has effectively depleted electricity generating fuel reserves.

  11.  In order to safeguard against possible future administrative and political intervention outside UK control, Lattice believes the following measures should be adopted:

    —  As a principal policy, continued advocacy of a pan-European gas liberalisation model, featuring in particular:

    the mandatory separation of monopoly transportation from gas supply

    open access and non-discriminatory access to transmission, transit and storage facilities.

    the development of large, liquid, gas trading hubs across Europe

    the removal of practical barriers arising from differences in gas quality and operating practices

    given the likelihood of future dependency on Russian supplies, the adoption of consistent security standards across Europe, and consideration of inter-governmental agreements with other EU Member States to avoid diversion of transit supplies to interposing domestic markets in times of supply shortages.

    —  In the UK the application, though licences, of specific security standards that deliver a desired level of supply security. In practice these should:

    Adopt a precautionary approach to network investment that recognises the need to build an adequate level of capacity and resilience into the infrastructure networks, both to allow network flexibility to cater for supply shocks and to allow more effective facilitation of competition.

    Consider placing minimum storage inventory obligations on gas suppliers similar to those that exist in oil and for Coal-fired generation.

    —  An urgent review of the vulnerability of the UK gas market given the likely continued slow pace of liberalisation in Europe.

  12.  Turning to fuel mix, Lattice does not believe that a pre-defined percentage fuel mix would enhance security of supply. Continued market liberalisation supplemented by safeguards to cover against severe supply circumstances is likely to be the best way to create diversity and security of supply. In practice, many fuels are subject to similar potential for political and administrative intervention. Consequently, the key question is not so much the fuel type, but the impact of an increasing proportion of supply being sourced from markets that are relatively non-liberalised when compared to indigenous supplies.

Q: What scope is there for further energy conservation?

  13.  Lattice does not have any detailed research in this area to put forward. However, we would simply note that gas-based technology solutions are amongst the most energy efficient means of providing domestic space heating, for example modern condensing gas boilers and the newly-emerging Micro-CHP schemes.

Q: What impact would any changes have on industrial competitiveness and on efforts to tackle fuel poverty?

  14.  There is little doubt that industrial competitiveness has been improved by the lower prices resulting from the introduction of competition into the gas and electricity markets. To the extent that measures to enhance security standards compared to the status quo involve additional cost, there may be a marginal effect on industrial competitiveness. However, any widespread supply failure would have serious implications for industrial competitiveness, and this assertion is borne out by the experiences of a number of industries following the electricity supply crisis in California. Consequently, a suitable combination of incentives and obligations to provide supply cover against exceptional circumstances would involve small relative additional cost, but provide insurance against the serious consequences of supply failure.

  15.  In tackling fuel poverty, low energy prices clearly play an important role. However, the introduction of wider objectives into Energy Policy could place upward pressure on prices, and run counter to measures to relieve fuel poverty.

  16.  Specifically in the gas industry, extending the gas network and providing gas burning equipment as a means of relieving fuel poverty cannot, in many cases, be justified solely on economic grounds, even once social and environmental benefits have been monetarised and factored in. Consequently, additional explicit funding is needed and the issue then becomes one of social policy for government. To effect cross-subsidy by implementing measures in the gas industry would run counter to using competition as the primary means of protecting consumer interests. It would also put further upwards pressure on prices, thereby working against the grain of relieving fuel poverty. Consequently, Lattice believes that, where cross-subsidy is needed to tackle measures such as relieving fuel poverty, this should take place in a way that does not unnecessarily distort the effective operation of the competitive market. In practice this may mean raising funding through public sources, rather than introducing changes to the operation of the competitive energy markets.

Q: Is any change of government policy necessary? How could/should the government influence commercial decisions in order to achieve a secure and diverse supply of energy?

  17.  Competition and market mechanisms have delivered many benefits to the UK energy industry. Prices have fallen, all consumers have choice of supply in both gas and electricity and CO2 emissions have reduced significantly. Whilst acknowledging these benefits, it is becoming increasingly clear that future energy policy entails a more pluralist set of objectives.

  18.  Many of the consequences of widespread supply failure would be social and environmental, as well as entailing knock-on effects throughout the economy. Much of the resultant cost would not fall to those participating in the energy market. Consequently, individual market participants are unlikely to invest in the extra capacity needed to secure against infrequent but severe supply/demand scenarios as the consequential costs of failure are not their own. Even where market participants are directly confronted with a potential cost consequence, they may not be willing to insure voluntarily against unlikely events in the face of short-term competitive pressures. Similarly, social and environmental objectives are only partly served by the increased use of competition.

  19.  Lattice believes that direct Government influence over individual commercial decisions should be minimised if competition is to continue to deliver the many benefits that have arisen since its introduction, including a diverse and secure energy supply. However, it is important to recognise the boundary between markets on the one hand and public policy on the other. For example, markets may work well in delivering supply security standards but should not be left on their own to set those standards. Consequently, Government should set a regulatory and public policy framework that delivers a desired level of security, leaving competition and markets as the primary means of delivery.

  20.  Where Government can and should play an important role is in examining and, if necessary, redefining the framework of regulatory institutions, their duties and obligations. This should be done with a view to ensuring that the institutions have suitable duties and objectives, and the necessary tools to deliver a wider set of objectives without unduly distorting the operation of the competitive markets. Given the increasing importance of Europe for future UK energy supplies, this examination should also consider the international perspective of UK regulation, with a view to ensuring sufficient duties, obligations and tools to participate fully in the development of European competition.


  21.  In summary, Lattice believes that Government policy should:

    —  Continue to promote competition as the primary means for meeting consumer demand for energy.

    —  Recognise that, due to a number of externalities, competition and market mechanisms cannot be exclusively relied upon to meet wider policy objectives, such as security of supply as well as social and environmental objectives.

    —  Set a regulatory and public framework that delivers a desired level of security, leaving competition and markets as the primary means of delivery.

    —  Examine the institutional framework, its duties and obligations with a view to ensuring they can deliver a wider set of policy objectives.

    —  Ensure that, in delivering a wider set of policy objectives, any required cross-subsidies are introduced in a way that avoids distorting the operation of competitive markets.

    —  Continue to push for increased liberalisation in Europe. At the same time, to recognise the likely continued slow pace of European liberalisation and undertake an urgent review of the resultant vulnerability of the UK gas market.

    —  Investigate the feasibility of introducing minimum storage inventory obligations on suppliers, similar to those that exist in the oil industry and for coal-fired power stations.

Lattice Group

October 2001

1   Ref: Running Short of Gas: The outlook for UK and Irish Gas Markets. A Multi-client Study. (Wood MacKenzie, September 2001.) Back

2   Ref: National Grid Company plc Seven Year Statement 2001. Back

3   Ref: Electricity Act 1989, Section 34 & 35. Back

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