Examination of Witnesses (Questions 305-319)
E.ON UK
26 JANUARY 2005
Q305 Chairman: Good morning, Dr Golby.
Welcome to the Committee. We have already had a number of players
in the market before us but I think you are the first of the electricity
participants. A number of the questions we are asking everyone
because we want to get their impressions of what the reasons are
for the difficulties that were encountered last year, if `difficulty'
is in fact the right word. It has been suggested by some people
that gas price rises are a temporarily blip; others have said
it is the start of a long-term trend. There is a kind of, you
might say, conventional wisdom; because of the decline in the
take from the UKCS and the increase in demand you could argue
that the days of cheap gas prices and, therefore, cheap electricity
policies are over but initially were you surprised at what happened
last autumn and do you think that this spiking is really a temporary
phenomenon or something we are going to see as a regular occurrence?
Dr Golby: Let me comment, if I
may, on the trend. I think it is a long-term trend. We have a
background where the United Kingdom has historically enjoyed much
lower prices than Europe as a result of the United Kingdom Continental
Shelf, and as we have now started to see both demand increase
and the Continental Shelf decline, we are going to see greater
convergence between the United Kingdom and European global prices
as we start to become a net importer of gas, so I see those things
moving together. In terms of the spike situation, what we have
here is a transitional period; as we go from an exporter to an
importer we have limited import capacity, and that does mean that
from time to time, until that capacity increases, the market is
more volatile than it otherwise might be, so in those situations
I think we could see spikes. Equally, if the infrastructure that
is planned to increase capacity into the United Kingdom goes into
place, one could see an overcapacity and therefore prices falling,
as well as spiking. But the long-term trend is we will see a convergence
to European and global prices and that the longer-term trend,
as we have to go further afield for gas, probably will be upwards
from there. So I think it is a long-term trend we are looking
at, not just a short-term spike.
Q306 Chairman: Would you be bold enough
to give us a guestimate as to where you would think the level
of pricing might settle? We saw a dramatic rise, 40-50%, and then
it came down a bit. How do you view the future trend? Have you
got any numbers?
Dr Golby: I do not think I would
be bold enough to suggest a number; I would be doing a different
job to the one I am doing if I could forecast in that way, but
I think the levels we are at today are broadly the levels that
we might expect to see in the future and we are going to see some
perturbations around those.
Q307 Chairman: If I can come back to
this point about the rise last year, there was never any suggestion
at any time that supply was interrupted so in many respects you
could argue that there was not an issue of a market responding
to an interruption in supply. Have your advisers, your market
analysts, come to any conclusions as to why this happened? I can
see the long-term trend and I can understand your reluctance to
forecast, but with the benefit of 20/20 vision that hindsight
affords can you come up with any clear reasons as to why you had
to pay so much money for gas and then understandably had to pass
it on to the consumers? I am not here this morning to castigate
you for the way in which you sell on electricity but rather to
try and establish what your views were as to how the market did
not seem to operate in the way that it had in the past?
Dr Golby: Chairman, the points
I made were about the long-term situation. We, as you have just
inferred, are a price taker; we have to buy this gas to supply
our customers; and in many ways we were as surprised as anybody
else at some of the peaking, the spiking here. Equally, arguably,
one can say this is a market working, that when supplies get tight
or are perceived to be getting tighter—
Q308 Chairman: But did they get tight?
This is the point.
Dr Golby: I have no precise information
on that, Chairman. There clearly was no interruption but I think
there was a perception in the marketplace that they were tightening
and could get tight, and the observation I can make is that sometimes
markets are driven by perception and that is the only explanation
I can really give in this case. I have no evidence to suggest—
Q309 Chairman: Rather convenient for
those who sell the gas. If they can scaremonger like that on a
regular basis—maybe not every year but every two or three
years—they could spend the rest of the time in the Caribbean
without having to worry about energy prices.
Dr Golby: I cannot comment on
those people. I am a price taker, and the price was volatile.
Q310 Chairman: However, really what I
am trying to get at is, in your view, was the market working as
it should have done and are the perceptions that you feel were
influential in forcing the prices up the kind of perceptions that
you could understand coming from the market-makers with whom you
have to deal?
Dr Golby: I have no reason, no
evidence to suggest that the market was not working. The market
was very volatile: we saw some sharp movements: there was a lot
of commentary at the time about some of these movements, but this
does sometimes happen in competitive markets. It is the other
side of the coin, I guess, of having a competitive market so that,
when sentiment comes into play, prices can move in quite a volatile
manner. But I have no evidence to tell me why that should have
happened.
Q311 Chairman: Let me just put this in
context. How much electricity do you generate and what is your
share of the United Kingdom market, in rough terms?
Dr Golby: In rough terms we have
approximately 22% share of the United Kingdom market in terms
of electricity generated.[1]
Q312 Chairman: So you obviously do not
just depend exclusively on gas for the fuel for your electricity
generation, do you?
Dr Golby: No, we do not. We have
a balanced portfolio so we have a substantial element of coal
in our portfolio: we have gas; we have oil and we also have renewables.
Wind energy, for example.
Q313 Chairman: What is the share you
have, say, between coal and gas?
Dr Golby: Probably 55% of our
total mix is coal; 35% is gas, and then the balance is oil, wind,
etc.
Q314 Chairman: And do you run the coal-fired
stations all the time, or are they a reserve capacity?
Dr Golby: We change these, as
you would expect. We run those stations which are economic first,
so during winter when gas prices historically are high we run
our coal stations flat out, and the gas stations come in at the
margin as demand goes up; during the summer months the reverse
has traditionally been the case. We will be running our gas stations
because historically in summer months gas prices are low and cheaper
than running the coal stations. So it is an optimisation process
and I have not done it justice in describing it in such a simplistic
manner there, but we do flex between the two.
Q315 Chairman: I realise that your company
has gone through various incarnations of late and several owners—
Dr Golby: Just two owners.
Q316 Chairman: Okay, but the low gas
prices in the 90s ushered in the `dash for gas', but we are now
looking at the prospects for future generation capacity. How do
you think you will accommodate that as far as the medium to long
term? You have indicated that the days of cheap gas are probably
over. How do you anticipate accommodating the new economics, as
it were?
Dr Golby: Well, if I can put this
into context, our view is that the United Kingdom will require
probably about 20 gigaWatts of new plant over the next decade,
mainly to replace the closure of the ageing nuclear fleet and
also the coal plants, many of which of course are under increasing
environmental pressure with the Large Combustion Plants Directive
and carbon trading, and our estimates, not just of the construction
of generation plant but the total infrastructure needed in the
energy area, is probably of the order of £40-50 billion over
the next decade, so some very sizeable investments indeed for
the United Kingdom. My view is that at present the CCGT, combined
cycle gas plant, is the new plant of choice; these will be the
plants that will come in to replace both nuclear and coal, and
it would need quite a substantial shift between gas prices and
coal prices to put clean coal technology at the moment in
front of building conventional, albeit high technology, gas power
generation plants.
Q317 Chairman: And you would not want
to get involved in nuclear rebuild, if that were an option?
Dr Golby: As you know, Chairman,
we are not a nuclear player in the United Kingdom and at this
point in time, whilst the Government has left the option of nuclear
open, I think no decisions have been made so we do not have a
position.
Chairman: Thank you.
Q318 Linda Perham: Dr Golby, you did
just mention coal prices and obviously there has been a lot of
media interest in the effect of increasing gas prices on the cost
of generation and, therefore, on electricity prices, but there
has been less publicity on the quite significant increase in coal
prices. How much have the coal prices for generation risen recently?
Dr Golby: Putting both of those
into context, on the numbers I have—and these are basically
between January and November of last year—wholesale gas
prices increased by just over 70-71%, and international coal prices
increased by 55%, so of a similar order although slightly less
increases for coal than gas.
Q319 Linda Perham: And why have those
rises been so high?
Dr Golby: Probably the one simple
word is China. There have been very substantial imports into China
which have impacted both the commodity price, the price for coal
itself, and also international freight rates because massive imports
into China, not just commodities but steel and other factors,
have pushed international freight rates up to very high levels,
so they are the principal drivers behind the coal price increase.
1 Note by witness: In fact, we have approximately
10% share of the UK market in terms of electricity generated. Back
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