Examination of Witnesses (Questions 277-279)
ENGINEERING EMPLOYERS
FEDERATION
25 JANUARY 2005
Q277 Chairman: Good afternoon, Mr Temple.
Perhaps you would introduce your colleagues. We know you of old.
I am not sure if we have had either of your two colleagues here
before.
Mr Temple: Good afternoon. On
my left is Stephen Radley, Chief Economist, and on my right is
Trevor Sikorski, who is a Senior Energy Analyst who has been working
with us but he works for Global Insight.
Q278 Chairman: You have suggested in
your evidence that manufacturers have found it difficult to adjust
to the new gas and electricity price regime. You say that this
was because it was rapid and unanticipated, but it has to be said
that it is not altogether a surprise surely because people have
been saying that we are going to be ceasing to be self-sufficient
in gas, that there is a sense in which the UK's ability to control
prices internally—should this not have been anticipated
by someone, either yourselves or other people?
Mr Temple: I think it has been
a very confusing picture and I think that the whole scenario around
gas price increases has just not been fully explained at all.
We saw a situation with prices for January 05 gas contracts rising
from just over 30 pence per therm in March to around 80 pence
per therm in October and falling back to 40 pence per therm more
recently. Explanations like, "We are out for summer",
which happens every year, do not satisfactorily explain extremely
dramatic changes in the level of gas prices. Indeed, Ofgem's own
study on this really covered, I would say, only about 50% of the
debate in terms of fairly hard facts. The rest was somewhat more
speculative. There is certainly a case for the DTI to drive the
gas companies much harder to explain that, because if it is such
a dramatic increase it must be explainable in much more tangible
ways. What we had over that period of time were problems explaining
what was going on. We had a market in gas that was not reacting
to the market fundamentals. We also had, in terms of anticipating
the changes, emissions trading coming in where again we were not
sure exactly how that would work out, so there was no doubt that
there was confusion at that time. The DTI themselves were telling
us they thought that gas prices were not going to increase significantly.
They had an ILEX report which was saying in the context of emissions
trading that they did not see dramatic changes. Around that time
we were questioning quite strongly whether or not there would
be significant increases. Our hunch was that there would be but
we were being told all round that this was not going to be the
case. We still are massively concerned about the problem of explaining
why these gas prices have increased and I will ask my colleagues
to comment a little bit on why we think it does not match the
market fundamentals.
Mr Sikorski: What we saw in 2004
was gas trading for the first quarter of this year at around 40p
a therm. That was pretty stable and higher than we had probably
seen last year but it could be explained by what we call market
fundamentals, that is, a tightening of the supply in demand balance
on the UK. Most analysts were looking at this and thinking that
this was a fairly reasonable explanation for what was happening,
including ourselves. The reasons they were as high as that are
linked to things like the oil indexation, gas prices on the continent,
the seasonality in UK prices and so on which I am sure you have
heard a lot about. What happened in the fall was that we saw prices
above 50p a therm for 50 days and above 70p a therm for six days.
The prices did that and they went back down to the level that
everyone expected them to be at. If you look at most commodity
markets this is called a price excursion. A price excursion that
you can explain is an efficient market. A price excursion you
cannot explain is market failure, and I use the words very carefully
here. This was without doubt a market failure. Why we had a market
failure is open to debate and there are a number of different
explanations, of which one could be market abuse, but there have
been other explanations as well put forward for why that has happened.
I do not know why we had a market excursion. I am not in a position
to say why we had a market excursion or a market failure, but
what it does drive home is that this is a very big question. When
you have market failure in a commodity market this has a lot of
knock-on problems for the market as a whole because it takes confidence
out of the market and when you get market confidence waning you
get liquidity going away. What does liquidity going away mean?
It generally means higher prices for the market as a whole because
you do not have as many people trading and it becomes more expensive
to close out market positions and makes it harder to compete.
There are a number of big reasons why having these market excursions
is a really big problem for the UK and something which needs to
be looked at very closely.
Q279 Mr Hoyle: Obviously, manufacturers
do suffer from volatile markets in raw materials, industry has
to put up with that in manufacturing; we suddenly see the price
shoot up with no real explanation and then eventually it comes
back down. Can industry not cope when this happens in energy prices?
Mr Temple: Have we other alternatives?
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