APPENDIX 11
Memorandum by the Energy Intensive Users
Group
1. EIUG represents the energy intensive
sectors of UK manufacturing industry such as steel, chemicals,
paper, glass, ceramics, aluminium, etc, that compete in international
markets and depend on secure, competitive energy supplies to remain
in business.
2. Energy supplies represent a significant
proportion of our members' operating costs—especially the
variable costs. Energy purchases account for around 25% of production
costs for steel and paper, 40% for aluminium smelting and certain
chemical processes and up to 70% for the production of certain
industrial gases. The bulk of these costs, typically around 75%,
are attributable to the wholesale cost of gas and electricity.
3. Energy intensive industries in the UK
currently purchase around £1.3 billion gas and £2.8
billion electricity per annum. We estimate that the dramatic increase
in wholesale prices over the last year and a half, once fully
reflected in new contracts, will have added around £0.5 billion
and £1 billion respectively to the annual cost of industrial
gas and electricity supplies.
4. Industry tends to be concerned with relative
energy prices (ie the extent to which UK prices differ from our
competitors) because of the potential impact on competitiveness.
The absolute level of energy prices, rightly a concern for the
economy as a whole and especially for the fuel poor, is less of
an issue for industry than often assumed.
5. Forward wholesale market prices for the
year ahead have risen by around 75% for gas and 50% for baseload
electricity in the UK over the last year and a half. Prices are
dynamic and volatile, so it is not easy to quote a more precise
figure. Forward prices are particularly significant as they are
used by suppliers as the basis of their quotations for industrial
supply to consumers who wish or need to fix their fuel prices
for the year ahead.
6. Some industrial consumers opt to receive
gas supplies at a floating rate by buying their gas indexed to
day-ahead prices, often at lower average cost than can be obtained
through fixed price deals. Other types of flexible contracts allow
consumers to fix at the market price at any point during the contract
period. However, these methods of purchasing entail a significant
degree of additional risk to the consumer. Indexed prices are
inherently more volatile and may turn out to be higher than would
have been available under a fixed price deal. Such deals are not
therefore suitable for all businesses.
7. Continental European consumers do not
benefit from liberalised gas markets like in the UK, but the price
of gas tends to be much more predictable and competitive with
their immediate neighbours. Industrial consumers in these markets
typically buy gas at prices indexed on a lagged basis to the price
of oil products—generally heavy fuel oil, sometimes gas
oil—ie substitute fuels. In contrast to dollar-denominated
crude oil, which has recently hit record highs, the prices of
euro-denominated heavy fuel oil has barely risen over the last
year. High oil prices have not therefore caused a surge in continental
gas prices, so they cannot be an explanation for the dramatic
rise in gas prices in the UK.
8. In recent months the forward price for
UK gas has become substantially more expensive than the (oil product
indexed) price in continental Europe—by as much as 30% for
the year ahead. Yet the UK supposedly benefits from a liberalised
gas market and remains, on an annual basis, a substantial net
exporter of gas.
9. Wholesale electricity prices in the UK
are sensitive to the price of gas—there is a strong correlation
between movements in gas and electricity prices. Around 40% of
generation is gas-fired—much of this is marginal plant whose
operating costs can directly affect the market price. Other factors,
especially the advent of EU emissions trading in 2005, are also
driving up forward electricity prices but in recent months the
growing price of UK gas has become the dominant factor. There
is no evidence that the market price reflects a tightening of
supply margins. The margin of excess generating capacity above
peak demand is higher for the coming winter than last year, and
in any case the UK has one of the highest supply margins in Europe.
Forward electricity prices for 2005 are now around 30% higher
in the UK than for major EU competitors such as France and Germany.
10. Industrial consumers in the UK are therefore
facing a substantial competitiveness gap in the cost of both their
gas and electricity supplies. Energy intensive industries are
most at risk if this competitiveness gap is allowed to persist.
11. EIUG is disappointed that Ofgem, having
spent almost a year working on their report into the surge in
UK gas prices, was unable to explain why the majority of the price
increase had come about. Ofgem's analysis showed that "oil
price" rises explained less than 30% of the increase in gas
prices. We are also disappointed that Ofgem, having identified
a "knot of contracts" that might have been a factor,
and promised a swift decision as to whether further action is
required, has yet to make any further comment on this matter two
months later. We agree with Ofgem that the lack of liberalisation
in continental markets could be part of the problem and indeed
have been involved in lobbying the Commission ourselves on this
matter since 2001. However, we are sceptical about whether there
is any realistic prospect of full market opening being achieved
in the medium term. We also believe that there are serious problems
within the UK wholesale gas market, including a concentration
of market power, an inequitable access to market information and
a fragmentation of regulatory responsibilities which remain to
be addressed. We have therefore called for a comprehensive investigation
of the wholesale gas market, to be carried out by the Competition
and/or European Commission, ie a body with the appropriate onshore,
offshore and/or international regulatory powers, and would hope
that the TISC would also consider the case for such a referral.
12. EIUG and the Chemical Industries Association
commissioned a report from Europe Economics on the impact and
possible causes of the rise in wholesale gas prices, a copy of
which is appended to this submission. The report identifies areas
of concern regarding the structure and regulation of the UK gas
market and makes recommendations for further investigation and
reforms to policy and regulation, which we endorse. In addition,
EIUG would draw particular attention to the need for seamless,
independent market regulation to replace the current fractured
regime under which DTI is charged with an uncomfortable dual responsibility
as sponsor and regulator of the offshore gas industry.
13. EIUG opposes the idea of imposing a
windfall tax on gas producers in response to the high gas prices.
If the problem is essentially one of market failure, then that
is the issue which needs to be addressed. Raising taxes would
not address the problem of uncompetitive industrial energy prices
and would discourage future investment in North Sea production
on which the security of our energy supplies depend.
14. EIUG believes that the impact of uncompetitive
wholesale gas and electricity prices, should they persist, will
need to be taken into account when reviewing the UK's climate
change policies, especially measures such as the Renewables Obligation
(the escalating subsidy to encourage uneconomic renewable generation)
and the Climate Change Levy, which add to the competitive burden
on the UK's energy intensive industries.
25 November 2004
| 
