Examination of Witnesses (Questions 372-379)
CENTRICA ENERGY
26 JANUARY 2005
Q372 Chairman: Good morning, Mr Clare
and Mr Ulrich. Perhaps we could start with a few background points.
You are major players in these markets. Could you give us some
idea of what your share is of the domestic and industrial markets
in the UK for gas?
Mr Clare: We have around 12 million
gas customers in the UK but just under 60% of the market for domestic
customers. We have around six million electricity customers, which
is just under 25% of the domestic market, and we are a relatively
small player in the commercial market. We have around 800,000
customers.
Q373 Chairman: What percentage of the
non-domestic market is it?
Mr Clare: The non-domestic market
is probably no more than 10%.
Mr Ulrich: It is less than 10%.
Q374 Chairman: The reason we are here
today is the volatility of the prices over the last 16 months.
Do you think that the market is operating normally or are the
spikes that we have seen just an example of dysfunction? What
would be your view of this?
Mr Ulrich: I am not sure I would
use the word `dysfunction'. The market is working but there are
not as many participants as I think we in the rest of the industry
would like to see. If you look at the recent price rises from
2002-03 and 2003-04 they are roughly similar to the price increases
in oil. We certainly see 2005 and onward, where oil prices have
stabilised, that prices this year still look substantially above
last year as far as gas goes. That increase in oil prices has
had some impact on why things are higher now. Secondly, as explained
by the last witnesses, we have seen a drop-off in physical supply
at the beach and yet if I add up the physical supply at the beach,
all the storage that is currently available and the amount of
gas that can flow through the Interconnector, we are still comfortably
above what has been the peak day so far this year. We have used
408 million cubic metres this year and we have the capacity for
something like 475 or 480 million cubic metres on a peak day,
so we have not approached that. Even last year when we had some
fairly cold days I think we got up to around 430 million cubic
metres, so there is enough capacity there. The issue is what someone
said was the expectation of prices going forward and there were
some articles that we found very unhelpful quoting the people
who had predicted the warm summer saying we were going to have
a Siberian-type winter and giving specific weeks when it was going
to be extremely cold, so there is a mismatch in the forward market.
We have a lot of buyers who want to fix prices, who want price
security, who will fix them on the forward market, and we do not
have the level of sellers now in this market. Between 2002 and
2004 we estimate that the liquidity in the futures market has
gone down by about 40% based on public trade information, so you
have people trying to fix prices and a lot of producers who are
not selling forward. It is not as liquid as it needs to be.
Q375 Chairman: We were told yesterday
that there were something like 60 players selling in the market,
that there were probably about five who controlled nearly 60%.
Then in the afternoon we were told by people who are wanting to
purchase gas that they could maybe only get one quotation, that
there was a stickiness there. You have also said to us that even
allowing for this stickiness the gas that we buy is less expensive
than what we would have in Europe. Can you explain this because
some of our industrial consumers who came in yesterday have suggested
that this is not the case.
Mr Clare: Certainly in the residential
market the price a UK customer will pay is substantially lower
than pretty much anywhere else in Europe, so we still benefit
from lower gas and electricity prices. In the commercial market
the prices are much closer. We do not supply customers in the
rest of Europe directly so we have not got direct comparisons,
but from the data we have we believe that UK prices are similar
to European prices and very much reflect the underlying commodity
cost. Of course, if you look at September and October last year
when we had the substantial price spikes, if there was a commercial
customer fixing into a long term contract at that stage they almost
certainly would have seen a substantial increase. Since that point
we have seen prices fall back more closely in line with the European
prices.
Mr Ulrich: If we used the DTI
information that was released in January and goes through from
last October, gas prices were very similar for a British buyer
on average and for a European buyer. Electricity prices were still
somewhat lower, on a range of 9 or 10%. As Mark said, on the residential
side, even including the most recent round of price increases,
we are still 30-40% lower than the continental prices on average.
Q376 Sir Robert Smith: It is important
to point out maybe for people outside that the residential market
price is more dampened because there are more overheads for distribution,
bill handling and everything else, and therefore probably our
competitive supply market makes the difference in terms of those
costs.
Mr Clare: That is absolutely right.
If you look at a major industrial user, probably almost as much
as 90% of the price they pay will be the commodity, whereas for
a domestic user it is probably only 50%, so you certainly have
that effect.
Mr Ulrich: Just to add one thing
to Mark's point earlier, I was with a group of large industrial
buyers in October to discuss this phenomenon and these issues,
and anyone who did fix their price during that period of time
would have paid substantially more than a European buyer, again
because of the biannual contracting nature of it.
Mr Clare: One of the things that
we have introduced for our industrial customers is the concept
of a short term contract so if they did not want to fix it at
that stage then there was encouragement for them to fix it for
perhaps a much shorter time, so they still had access to the supplies
they needed but they were not having a contract for a full year
at that peak, and that is something we have introduced which has
been quite successful.
Mr Ulrich: To encourage people
we will give them monthly a floating price and allow them a trigger
when they can decide what period they want to lock into and how
long they want to lock in for, whether it be three, six or 12
months.
Q377 Linda Perham: You have talked about
and identified in your evidence a number of reasons for the recent
increases in wholesale gas prices being so steep. Mr Ulrich, you
talked about reduced liquidity by 40% in the forward trading market.
Is there anything that can be done to encourage more liquidity
in the forward market?
Mr Ulrich: That is a very difficult
question. Who is left basically is the American players, the Enrons,
the Dynergys, TXU, Reliant, El Paso; I could go on and on. Those
were market makers that did not generally have large upstream
positions but they both buy and sell. We have a polarisation now.
We have a lot of buyers, including ourselves, and some sellers.
I do not know how we move them on. I think we will see increased
liquidity because people who want to be active in the market obviously
could have sold at some very high prices in October and November.
Bringing on more sources of supply and more diversity and bringing
the overall volatility down will counteract that lack of liquidity.
Mr Clare: The other key action
that we are encouraging and that was in our evidence is the need
for more transparency. As Jake has already said, we certainly
experienced what I would call anxious buying in the back end of
last year and I think if there was more transparency those buyers
would have understood that there was enough gas to meet demand
and therefore there was no need to lock into contracts when prices
were increasing quite dramatically. We think transparency is a
key part of the solution, but we think the transparency needs
to go further than just the UK market. We think it needs to look
into Europe. We need to understand, as we become more reliant
on the connections with Europe and European gas supply, that we
have access to that information also.
Q378 Linda Perham: Yes, that has been
raised by a number of witnesses about transparency and availability
of information. You mentioned interconnection. Do you have a view
about why the Bacton-Zeebrugge gas interconnector failed to respond
to the market signals in 2003?
Mr Ulrich: That is an interesting
case and we do not have any real information. There is no real
transparency on the continental side, but October I think was
the coldest October in 10 years and so I believe that what you
saw was a number of continental players making sure that they
had topped-up storage. I think it was a concern for security of
supply amongst the continental players, so gas did not flow even
though on an economic basis you would think it would have moved
into the UK. Generally this is a problem only during the shoulder
months, and again I think that is related to storage. When we
see the winter develop we see a full pipeline from Europe to the
UK and in the summer we see a very robust export from the UK to
Europe, which is what you would expect, so we do anticipate potentially
some inefficiencies or mismatch during those shoulder periods
of September/October, March/April.
Q379 Linda Perham: Are the outages in
UKCS production facilities becoming more frequent, more prolonged,
less predictable, or all three of those as time goes on?
Mr Ulrich: Our view is that as
the kit gets older and production gets pushed in this high
price environment we will see more breakdowns. I am not privy
to the spending of the other upstream players. We spend a lot
of money trying to make sure that South Morecombe can maintain
its plateau of buy-ins. Last summer there were a number of small
breaks and interruptions that did make the market a little bit
nervous.
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