Examination of Witnesses (Questions 120-139)
UK OFFSHORE OPERATORS
ASSOCIATION
25 JANUARY 2005
Q120 Linda Perham: It is our understanding
that Continental European gas prices tend to be linked to oil
prices, not to the crude oil price but to the historically much
more stable price of oil products, such as heavy fuel oil. For
those UK gas supply contracts that are linked to oil prices, is
the oil price in question linked to crude oil or oil products?
Mr Haywood: Taking the question
separately, yes I think the Continent generally is linked to oil
prices. It is linked to a combination of fuel oil and gas or diesel
prices. I would say that heavy fuel oil prices have traditionally
been less volatile and, therefore, less prone to go up in line
with crude but I would say that diesel gas oil prices have often
been just as volatile; in fact, in the current market, it is the
demand for transportation of fuels, including diesel, which have
given rise to some of that price increase. Fuel prices probably
move less than crude, diesel in line with and sometimes a little
bit more. Sorry, there was another part to the question?
Q121 Linda Perham: It was just about
the gas supply contracts which are linked to oil. Is the price
in question that of crude oil or oil products?
Mr Haywood: Generally, in the
UK, the traditional contracts are linked to UK inland prices of
products. In some of the potential new contracts, particularly
natural gas, the Global LNG market has been more traditionally
associated with crude prices I think as a reflection of the global
aspects.
Q122 Linda Perham: You are saying it
is oil products from the UK mainly?
Mr Haywood: In the main for North
Sea production coming in to the UK, yes.
Q123 Linda Perham: The price of heavy
fuel oil has barely risen though over the last year so how can
the linkage of oil prices explain any significant proportion of
gas wholesale prices?
Mr Haywood: I think where you
have a combination of both heavy fuel oil and gas oil you have
seen an increase. I think what that implies, also, is as we look
at something like the spot price for gas and in fact the forward
price for gas, we should remember that is only a proportion of
the gas which is coming into the UK. In fact, quite a lot of gas
which comes in has not exhibited that same level of volatility
and the same price increase.
Q124 Linda Perham: As far as BP is concerned,
I think you say in your evidence that consumers are placing an
increasing premium on price certainty. Does that mean that they
will look to the Continental model of long-term contracts linked
to oil product prices? What impact would that have on the UK gas
market?
Mr Haywood: Currently I am not
seeing any evidence from the industrial and commercial consumer
that they are moving to long term contracts, by which I mean contracts
of greater than two years' duration. What we mean in our submission
is that as people come into the pricing period, conscious of the
possibility of increased volatility as well as higher prices,
they may be looking to risk management products, such as fixed
prices or price caps which would give them a greater degree of
certainty; we are seeing more of that sort of activity.
Q125 Linda Perham: The impact on the
gas market in the UK?
Mr Haywood: I do not think it
has a direct impact on forcing higher or lower prices, it will
just give the consumer greater certainty.
Q126 Chairman: Can I ask, maybe Mr Haywood
or perhaps UKOOA or both of you, we have heard suggestions earlier
today that the UK gas market is not very competitive, how would
you describe the extent of competition among the UK gas producers
for gas contracts? I know there are some small players but how
many significant players are there in the market and how competitive
do you think it is?
Mr Webb: I was surprised to hear
somebody—when I was sitting at the back—saying today
that the HH index for gas suppliers was regarded as showing an
uncompetitive market. I do not know if there is more than one
index, I am sure there is not. We have done that research ourselves
and it shows it to be a very competitive market with a score below
1,000 which does indicate strong levels of competition. It is
true that there are some large players at the top of that list
with BP, ExxonMobil, Shell, Total, Centrica and others having
a significant share but there are a number of other significant
players and a number of new players coming into that market as
well. I heard today, also, that entry into this market was difficult,
well I do not believe it is, and I think there are lots of signs,
we have a lot of very interesting important new players coming
into this market; I am afraid we have a rather different view
of that. I would be happy, by the way, to share this with the
Committee and I will write to you with that information.
Q127 Chairman: That would be helpful.
Before we leave it, what share of the market is accounted for
by the majors, the big players?
Mr Haywood: My understanding is
that the big five players have something just short of 60% of
the market.
Mr Odling: The top five have 58%
of the production. I think we must emphasise we are talking about
production. I do not know whether there was any confusion earlier
which part of the chain was being talked about.
Q128 Sir Robert Smith: Is that gas production?
Mr Odling: Gas production, yes.
Q129 Chairman: I think we are going to
have to explore this issue. We are getting conflicting evidence
here.
Mr Webb: We would be happy to
share this with you.
Chairman: We will go back to certain
people and ask them for their sources as well as your own. As
I say, we just want to do that.
Q130 Sir Robert Smith: A lot of the concern
has come from the way the forward market prices went, especially
in September, and concern about the liquidity of the forward market.
One of the suggestions for the price increase being so high is
there is an unwillingness to sell gas on the forward market because
they feel it is risky. People still want to buy because they want
certainty for their investors and for their customers. Was it
your experience that people were unwilling to sell gas on the
forward market?
Mr Haywood: Certainly I would
reflect that there was nervousness on the part of the sellers
reflecting the nervousness on the part of the buyers. As we are
talking about forward markets and we are thinking, particularly,
for instance, of the price of gas in January but doing this in
October, that is a period of significant uncertainty for producers
as well as consumers. Therefore I think when we saw a market sentiment
which was unclear on what the supply/demand balance would be and
perhaps unclear on whether the shortfall would be covered by the
Interconnector pipeline or might be in excess of that capacity,
certainly there was a nervousness which was reflected perhaps
in a lack of offers at the time. People who still had gas were
waiting until they had greater certainty before they sold it,
not sure whether they would have enough gas for their demand.
Q131 Sir Robert Smith: Was that production
companies being uncertain or the shippers?
Mr Haywood: I think it is a combination
of the two but I would really say it is the shippers separate
from the production companies. In a sense that is why Steve and
I sit here separately as a shipper of gas and a marketer of gas.
I am unclear exactly what we are going to have from our own production
side.
Q132 Sir Robert Smith: It has been suggested,
also, maybe another problem with the forward market is to do with
taxation and accounting rules, in particular transfer pricing
rules and the Accountancy Standard 39 on the reporting of derivatives,
and that these factors may be deterring producers from selling
their output on the forward markets. Is that your understanding?
Mr Haywood: Certainly we are aware
of those new standards and we are trying to understand what they
mean. I think when we are talking about the shorter term contracts,
again the ones of less than two years' duration, personally I
do not think it is going to have a huge impact. These are the
sorts of deals which we were comfortable already to understand
the financial implications of and were accounting for accordingly.
Where we have the much longer term contracts—perhaps five,
ten, 15 years—then I think there is a need for a greater
understanding of the implications of that, and we are not clear.
But, of course, it was not five, ten, 15 year contract pricing
which took the forward price up, it was the much shorter duration.
Q133 Sir Robert Smith: A lot of other
witnesses were very sceptical how everyone could be so frightened
of a one in 30 winter. Is a one in 30 winter going to hit the
price on such a scale that forward price reflects it? There was
a dramatically higher price.
Mr Haywood: Obviously you have
to ask all the players and get the total picture. Let me express
a personal opinion which is it did seem an extraordinarily high
price and when one thinks it implies a price would have to be
at that level for a great number of days that, in my opinion,
did seem somewhat extreme. Nonetheless, as a company what we would
do is reflect the collective wisdom of the market and collectively
the market said there is a possibility. It turned out that possibility
did not materialise. I think we have seen one day this winter
where prices have got to something like 70p but it has been a
relatively mild winter and field reliability has been good. People
will remember higher prices in the past so it is possible but
I would say that insurance premium, with hindsight, does look
a little extreme.
Q134 Mr Clapham: Can we have a look at
the transparency of the markets, briefly, because is sufficient
is made available if the wholesale market is not working properly?
I understand some of your members have started to negotiate making
more information available. Could you tell us where we are with
that and what further information is going to be made available
and how that might assist the market?
Mr Webb: Yes. That was one of
the first things I encountered when I came to UKOOA a year ago.
In March last year an agreement was reached between UKOOA—all
its members involved in that supply—the DTI and Ofgem for
the provision of further information. Information fell into two
categories: further confidential information regarding forward
development plans and a second category of information relating
to actual and forecast flows on an aggregated basis onshore the
UK. There were four categories of that information which it was
agreed should be provided. As we stand today I think two of those
categories have been provided and are available to the market,
two have yet to make their way into the market but that is nothing
to do with my members, if you will forgive me, it is that Transco
have encountered quite a challenge in handling that information
and getting it into the market. We expect the last of that information
to be in the market in the third quarter of this year and it is
our belief that information is going to greatly inform the market
and be a positive good.
Q135 Mr Clapham: You said it will greatly
inform the market, is it possible to go a little further and say
what kind of impact you expect it to have on shippers and suppliers
in them making their purchasing within a more rational framework?
Mr Webb: Maybe I should turn to
my guest experts on the shipping side and on the production side.
Mr Odling: The two perhaps most
pertinent categories, Chairman, are, first, physical flows close
to real time into the national transmission system are going to
be provided. That is the category that is causing the longest
time and has the most work for Transco in getting the systems
up and running to do that. The second category which is yet to
come is forecast flows into the national transmission system ahead
of and hourly through the day. That is expected to be made available
during this current quarter of this year. The other two things,
one of which relates to maintenance plans and the other of which
provides after the day flows into the national transmission system,
that is already available on Transco's website. Completely outside
of that, which Malcolm referred to, is the forward planning information
which goes to Transco alone and it is updated annually. We are
just coming round to the season when that will be updated so that
helps them with their overall forward plans but does have some
highly confidential aspects to it.
Q136 Mr Clapham: If this information
is going to make the market work better, why did we not approach
it in this way earlier?
Mr Odling: I think we have to
say that although the market here has been going for some time,
it is still—relatively speaking—a young and evolving
market. Where we are today is totally different from where we
were five years ago. A lot of things have happened in that period
of time. The agreement that was struck last year was an extension
of discussions which had started two or three years ago. There
was a consultation that the DTI did back in 2001-02 on this whole
subject and everybody contributed. This is very much an evolving
market and I think this is a fairly natural part of that evolution.
Q137 Mr Clapham: Do you want to add anything?
Mr Peacock: Yes. I need to add
that we are full supporters of what is happening at the moment
by way of information disclosure or information getting through
to the market. We firmly believe that if you describe the full
spectrum of long term forecasts, medium term forecasts, day ahead
forecasts updated hourly, real time flows on the day and then
information the day after, surely it will address the market issues.
We have done some, we have a schedule to implement the rest and
we need to see what benefit that has.
Mr Webb: I would re-emphasise
the delay in getting that into the market this year has nothing
to do with UKOOA or its members.
Q138 Mr Clapham: Can I move on to maintenance
problems: why is it that so many companies chose to shut down
their production facilities for maintenance at the same time during
the summer of 2003?
Mr Peacock: It is not a 2003 issue,
it is a well established pattern in the industry that the facilities—the
platforms, the pipelines, et cetera—do need maintaining,
not just so they maintain their efficiency of production but for
safety reasons as well. Periodic maintenance of the facilities
is a perfectly natural part of safely and efficiently producing
oil and gas. The best time to do that from a couple of aspects,
both the best in terms of efficiency and in terms of minimising
impact on the supply, is in the summer. It is in the summer when
the weather is kinder so you can get boats and helicopters out
to do the additional work and it is the time of the year when
you are not in this high demand winter period. I think it is a
natural thing to do. Summer is the natural time to do it.
Q139 Mr Clapham: Nevertheless in 2003
it had a greater emphasis than previously, it was much more noticeable
in 2003.
Mr Peacock: I think, as far as
I am best aware, for us it is always in the range of five to 6%
of our total production which is probably down at some period
over the summer. I am not aware it was significantly outside that.
Mr Webb: We were not aware that
it was significant in the summer.
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