APPENDIX 30
Supplementary memorandum by the UK Offshore
Operators Association
This supplementary information from UK Offshore
Operators Association (UKOOA) responds to requests and comments
made by the Trade and Industry Committee during the recent hearing
held at the House of Commons. It addresses the following:
— market competitiveness;
— oil price movements over the
last decade;
— the relationship between oil
and gas prices; and
— the likely impact of a windfall
tax.
COMPETITIVENESS OF
THE UK WHOLESALE
GAS MARKET
— Over the course of the inquiry,
the competitiveness of the UK gas market has been questioned by
various parties. UKOOA's members are responsible for the exploration
for and production of gas offshore and its delivery to Transco's
National Transmission System for wholesale in the markets. UKOOA's
remit does not extend into the downstream aspects of the gas supply
market.
— UKOOA has 31 member companies
and there are more than 20 non-operators who share ownership in
offshore production. Typically, gas (and oil) fields in the UKCS
are jointly owned by several companies. Whilst one company is
responsible for operating the field, each company sells its share
of gas (and oil) production separately, via individual sales contracts.
— Over the last five years there
has been a steady increase in the number of new operators in the
UKCS who are gradually acquiring producing assets from many of
the traditional operators. These new entrants include Tullow,
Caledonia, Gaz de France, Apache, Nexen, Paladin, RWE Dea and
Perenco. This transfer of assets to new operators will continue
to promote a yet more commercially competitive environment in
both gas and oil.
— At UKOOA's request, ILEX has
made an independent assessment of the competitiveness of gas production
in the UK by calculating the Hirschmann-Herfindahl Index (HHI),
a commonly used measure of the degree of concentration in any
sector or industry.
— ILEX concluded that 15 offshore
producers in 2003 accounted for 92% of total UK gas production,
with the top five accounting for 58%. They calculated an HHI for
the sector in 2003 of 866, indicating a highly competitive market.
[46]ILEX
also noted that this had improved slightly compared with 2002,
when the HHI was 950. These figures compare, for example, with
those for mobile phone networks and power generation of 759 and
936 respectively (using the most recent figures we could identify
for these two industries).
— UKOOA expects that the supply
of gas will become even more competitive as new imports of LNG
and pipeline gas begin to feed the market alongside indigenous
gas, thereby enhancing both the diversity and security of supply.
This new and expanded infrastructure will increase the connectivity
between the UK, European and world gas markets, expanding the
size and liquidity of the overall market.
RELATIONSHIP BETWEEN
GAS PRICES
AND OIL
PRICES
— In its previous written submission,
UKOOA agreed with Ofgem and ILEX that the fundamental driver behind
increasing gas prices had been the increase in oil price, because
of the linkage to the oil-indexed continental gas market from
the time when the Interconnector was commissioned in late 1998.
— On top of that underlying effect,
there were uncertainties about the UK's supply-demand balance
during this winter and next, and market sentiment was reflecting
that.
— It has been questioned whether
gas prices demonstrate a stronger linkage to prices of crude oil
or oil products (Gasoil and Low Sulphur Fuel Oil (LSFO)). As a
result, UKOOA has asked ILEX to examine the correlations between
the various prices.
— ILEX has reviewed data between
1997 and 2004 to establish trends. They have found that oil product
prices in Europe follow crude oil prices very closely: for Gasoil
the correlation is 0.98 and for LSFO 0.91, although the link between
crude oil and LSFO weakened in 2004, perhaps as a result of tighter
environmental regulations reducing demand for LSFO. [47]
— Changes in gas prices tend to
lag behind changes in oil prices by a few months owing to the
way in which long-term continental gas contracts are indexed,
typically to 50% Gasoil + 50% LSFO. Allowing for the time lag,
ILEX has found that gas prices measured in US$ have shown a correlation
to 50% Gasoil + 50% LSFO, between Q1 1997 and Q3 2004, of:
— 0.91 in Europe (a very high
correlation); and
— 0.77 in UK (a high correlation).
— Over the same period, UK and
European gas prices measured in Euros have shown a correlation
to one another of 0.82 (still high), even though this includes
summers when the Interconnector was flowing at maximum export
capacity, thus reducing the correlation. [48]
— Over the same period, the UK
gas price in sterling terms continues to show a correlation of
0.77 to 50% Gasoil + 50% LSFO (in US$) and of 0.80 to European
gas (in Euros), again high figures.
OIL PRICE
MOVEMENT OVER
THE PAST
DECADE
— The two graphs show oil price
movements since 1990 in $/barrel and £/barrel and the $:£
exchange rate, prices in the left hand graph being in money of
the day and in the right hand graph in 2004 money, ie adjusted
to take account of inflation.
— US Dollar and Sterling oil prices
have been volatile over the period, reflecting a pattern of uncertainty
that has been acknowledged since the early 1970s. When the impact
of inflation is allowed for (right hand graph), the change in
oil prices since the mid-1990s is much less pronounced. This is
even more the case when considering the Sterling price of oil
which has remained fairly constant over this period, particularly
when inflation is taken into account.
— Exchange rate fluctuations have,
therefore, had a significant impact. This has been demonstrated
most recently in 2004 with the Sterling price of oil rising 30%
less than its Dollar equivalent. In this context, it should be
noted that UKCS costs are mainly (approximately 80%) in Sterling.
UPDATED EUROPEAN
GAS PRICES
— We have updated the chart of
gas prices in various countries in Europe which we included with
our original, written evidence. It now includes January 2005 prices
and continues to show that for small, medium and large industrial
and commercial users the UK remains among the lowest cost countries
for gas in the EU. One point of interest, for which we do not
have an explanation, is that Germany is the most expensive country
for small and medium users, but the cheapest for large users.
This updated chart is attached at the end.
GAS PRICE
MOVEMENTS
— Producers totally refute any
allegations of collusion or market manipulation which is both
illegal and subject to severe penalties. No evidence of such behaviour
has ever been found in various enquiries, investigations and a
public consultation over the past four years by Ofgem, the European
Commission (regarding the Interconnector) and the DTI.
— In recent evidence to the European
Parliament, RWE Npower's director of UK markets was reported as
stating that "Liberalised markets will have high volatility"
and that predictions of a cold winter and potential shortages
had caused suppliers to buy enough to ensure that their customers
would not be affected (a comment which is consistent with ILEX's
analysis). He added that he had not detected any collusion on
the part of upstream producers: "As a gas buyer, I have found
them falling over themselves to compete to sell me gas—and
that doesn't sound like collusion." (Ref UK Gas Report, 7
February 2005).
— UKOOA remains convinced that
the forward price of gas for this winter, during the summer and
early autumn of 2004, was driven by three main factors:
— the price of oil, through indexation
of gas prices in continental Europe;
— concerns about the supply-demand
balance in the UK; and
In this, we are in agreement with Ofgem and
ILEX. However, the out-turn this winter has been benign, because
of very mild weather and a good supply—spot prices have
been around 30 p/therm.
— Nonetheless, it should not
be forgotten that last winter two events showed the significance
of a tight supply-demand balance and market sentiment:
— in late January 2004, the Rough
storage field suffered a technical failure at a time when very
cold weather was forecast, with the result that the spot price
of gas jumped to 80-100 p/therm within a day;
— the Interconnector flowed at
full import capacity (ie gas flowing into Britain) for several
consecutive weeks which had never happened before (when it is
full, or shut, the link between the two markets ceases and prices
will move apart); it seems to UKOOA, as we stated in paragraph
31 of our original submission, that the market was expecting the
same to happen again this winter—a reasonable assumption
given a slow decline in UKCS supply and none of the new import
projects being onstream—and, therefore, forward prices were
pushed upwards above continental ones, in significant part because
of a capacity constraint imposed by a full Interconnector; this
significant point about the role of the Interconnector seems to
UKOOA to have been missed by many who have commented on the market's
behaviour.
— There are a number of new projects
in hand which will bring large quantities of gas supplies to the
UK within the next few years. Indeed, the earliest of these will
be complete by the end of 2005 which should help next winter's
supply. We have updated the table (attached) which was with our
original submission, with some corrections and revised timings.
Overall volumes of gas remain the same, though.
— While UKOOA believes that the
market has generally been working and evolving well, it is worth
considering whether it has signalled the need for these new projects
in as timely a manner as is required to meet the UK's needs, given
the long lead times inevitably involved. If, for example, one
or two of the earlier projects had been 12-18 months ahead of
their current timings, it is much less likely that we would have
seen the type of prices which occurred in the forward markets
during the summer and early autumn of 2004.
CORRECTION: "DRY"
GAS V
"ASSOCIATED" GAS
— With regard to our oral evidence,
at the top of page 63, and our letter of 7 February, we must apologise
for creating confusion regarding the proportion of gas which is
"dry", or is "associated" with oil or natural
gas liquids. We have now done a thorough check and the correct
figures are 45% dry and 55% associated (the error in our letter
arose because the 30% given only took account of dry gas in the
southern North Sea).
IMPACT OF
ANY WINDFALL
TAX ON
INVESTMENT
— UKOOA would like to close by
reflecting on the very public discussion regarding the potential
imposition of a windfall tax on the industry. Recent experience
has shown that the increase in taxation in 2002, with a 10% supplementary
charge on Corporation Tax (SCT), did much to damage investors'
confidence.
— It is also clear that the industry
and Government have benefited from higher revenues during this
past year, just as both suffered in 1998-99. We believe that our
industry's role is to run profitable, efficient, long term businesses
that can attract investment capital from around the world, ensuring
the production of secure and reliable sources of energy for the
nation, providing the infrastructure to facilitate imports of
energy as that becomes necessary and creating wealth for society
and our members' shareholders which include many people's pension
funds.
— The UKCS is a mature oil and
gas province, struggling to remain competitive in the face of
rising costs and declining reserves. Most, if not all, of the
large discoveries have been made; the average size of each new
field has fallen from several hundred million barrels of oil (and/or
its gas equivalent) to around 25 million.
— From the late 1990s, the number
of development wells drilled had been falling steadily, with exploration
and appraisal (E&A) drilling exhibiting similar trends; neither
of these was improved by the imposition of SCT. By the end of
2003, the number of drilling rigs stacked and reduced activity
within the supply chain demonstrated the size of the challenge
which the industry was facing.
— Through the combined efforts
of industry and Government, investors' confidence is now gradually
returning to the UKCS and positive results are beginning to be
seen. The most recent activity survey by UKOOA confirms, for the
first time in four years, an improvement in the production outlook,
accompanying a trend of rising investment which is estimated to
increase by 10% to £3.8 billion in 2005. Furthermore, a 30%
increase in E&A expenditure, rising to £0.6 billion,
is anticipated this year.
— Our capital expenditure makes
us the largest industrial investor in the UK. In recent years,
the industry has consistently accounted for 17-20% of total industrial
investment per annum.
— Set against all of this, global
competitiveness remains the over-riding issue. Operating costs
are up by over £0.5 billion per year, equivalent to an increase
of 15% per barrel of production, and are on a rising trend. Research
by energy consultants, Wood Mackenzie, has shown the difficulties
for the UK in remaining competitive in new E&A opportunities
when compared with other oil and gas provinces worldwide, where
the potential rewards are much larger.
— Investors already face substantial
geological and technical risks in the UKCS, not to mention the
many regulatory requirements imposed in recent years. Most of
the new entrants are much more mobile than traditional oil and
gas companies. A windfall tax would further raise the risk of
doing business, reduce investment and recovery of reserves, hasten
import dependency, cost thousands of jobs and, ultimately, diminish
the Treasury's revenue.
UKOOA
February 2005
New Import Projects
| Name of Project |
Target Date(s) | Capacity (bcm/year)
|
Langeled Pipeline
(Ormen Lange) |
2006 and 2007 | 23 |
Bacton Interconnector*
Upgrading | Phase 1 2005-06 Phase 2 2006-07
| 8 8 |
BBL Pipeline
| 2006-07
| 10-15 |
| Isle of Grain LNG | Phase 1 2005
Phase 2 2008
| 4 10 |
| Qatar Petroleum/ExxonMobil LNG (Milford Haven)
| Phase 1 2007-08
Phase 2 2009-10 | 10 10
|
Petroplus LNG
(Milford Haven) | Phase 1 2007
Phase 2 2010-12
| 6 6 |
| Totals | | 61-100**
|
| * Existing import capacity of Interconnector = 8.5 bcm/year.
|
| ** Current demand in the UK is 100+ bcm/year.
|
| Revised February 2005—amendments underlined in red.
|
| |
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46
The Hirschmann-Herfindahl Index (HHI) is a commonly used index
to measure the degree of concentration in any sector or industry.
An HH Index below 1,000 is generally taken as an indication that
a market is relatively un-concentrated (very competitive). An
HHI between 1,000 and 1,800 is considered moderately concentrated,
while and index greater than 1,800 is generally considered highly
concentrated. Back
47
A correlation of 1 implies a perfect relationship between variables
and a value of zero indicates no relationship. Back
48
European and UK gas prices will diverge from one another when
the Interconnector is either full or shut. "Exports"
through the Interconnector are from UK to Europe and "imports"
vice versa. Back
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