Examination of Witnesses (Questions 400-420)
CENTRICA ENERGY
26 JANUARY 2005
Q400 Chairman: Does that mean then if
you were to go and ask for a price that you would get twelve different
prices or is that a segmented business?
Mr Ulrich: No, if you were to
go out, depending upon the quantity of gas you buy, as a large
customer looking for a quote, it would invariably be based on
the forward price, so given the forward price, it would be plus
some incremental margin. We are talking very small amounts, pence
per therm, so the quotes will all be very similar. We find it
very difficult to compete in that market.
Q401 Chairman: So maybe there is not
that much incentive for people to be in it, is there?
Mr Ulrich: Well, it is different.
That is the approach for an industrial commercial buyer and you
are looking at what is the forward market consensus. If you are
a large producer, the issue is whether you want fixed prices or
to let them float. If you are a seller and you believe that prices
could get higher, there is very little incentive to lock in.
Q402 Chairman: Do you think that this
market would benefit from, say, some regulatory regime? It has
been suggested that the kind of light rein that is afforded by
the DTI is in some respects almost compromised by the fact that
they have both the promotion of the industry and a notional regulatory
role which they have not usually exercised in any economic sense.
Do you have a view as to whether or not the regulation should
extend beyond the beach, as it were, and, if so, who should be
doing it?
Mr Ulrich: That is one where we
do not have a strong view. We have talked about it. The DTI, from
our perspective, has done a very, very good job, especially on
issues around HSE and project development. I do not think, whether
you have one, two, three or however many regulators you have,
that this current situation would have been significantly changed.
You cannot force people to sell in a forward market and you cannot
force people to develop and bring on more gas. The only solution
is to bring more gas to the UK.
Mr Clare: I think the key role
of DTI and Ofgem is that it should really be focused on the European
scenarios that we talked about. I think in the UK that if we had
more transparency in the traded markets we have, then of course
if there was abuse, it would be obvious and, therefore, there
would be authorities that would be able to investigate. We do
have a market that is a proper traded market, but with transparency
I think we would see it working that much better. Certainly our
preference would be for DTI and Ofgem—and they are both
very much involved in this and have been very helpful—really
to focus their attention on Europe which I think is, if you like,
the medium-term challenge that we will have and we must not really
be too fixated by the short term in the UK.
Q403 Chairman: As I understand it, the
Government has been very proactive within European Councils in
promoting the whole argument for liberalisation, but a number
of our Continental partners have been rather slow in moving towards
this, and it has to be said that the one which is the biggest
obstacle is the one which has most to gain and that is Germany.
Although we are told there is going to be legislation, it is moving
at a near-glacial speed towards getting the Act on the statute
book. There is not really an awful lot we can do; we cannot quite
march into Poland or something like that! What can we do or what
more can be done apart from naming and shaming, and they seem
to be indifferent to that?
Mr Clare: I think we can continue
to lobby the state regulators to ensure that the proper structures
are put in place, as we heard from Paul Golby this morning, in
Germany, for example, but once those structures are put in place,
they properly enforce the sort of liberalisation and openness
that is required for a competitive market. I think we have made
a lot of progress in that respect. If we go back three or four
years, then we see a situation where most European countries,
some of the larger countries, really did not see the need and
had not really engaged in what this meant, and I think what we
see now is a situation that is much improved. There are still
instances where we are not making enough progress and, therefore,
I do believe, and we know, that Ofgem has now put more effort
into this area and Sir John Mogg, I know, has taken that on as
a key issue and we have had a lot of support from DTI. You are
right that in the end we have to do it through persuasion and
argument, but coming from the UK market where it has clearly been
liberalised, we can show the benefits of competition to customers.
We think they are very powerful arguments and we need to continue
to make them.
Q404 Sir Robert Smith: Earlier, Mr Ulrich,
you mentioned, in answer to a question from Mrs Perham, the importance
in the UKCS of encouraging new entrants. Do you think a windfall
tax would encourage them or discourage them?
Mr Ulrich: Well, I think it is
self-evident and maybe I am wrong, but I do not think a windfall
tax would encourage increased UK productivity. I think if we drive
more of the producer community out or we delay development or
work on existing fields or even new drilling, all that means is
that we are going to have to import more gas in the future, so
I think, if anything, I would ask to look at some tax incentives
for new development, new field reclamation-type work. We pay 70%,
as it is, on our production, so there is not a lot of incentive
to look here, although we are, but it is a very difficult environment
right now.
Q405 Chairman: Of the 30% that is left,
in the light of the experiences of the spiking and things like
that, have you increased your plans to spend more of your 30%
on the kind of programmes you have identified?
Mr Ulrich: Well, we have identified,
as Mark said earlier, the need to be more fully integrated and
have more vertical integration. We announced last year that we
are going to spend £5 billion on upstream projects, so we
are—
Q406 Chairman: When was that announced,
what month?
Mr Ulrich: That was last July.
Q407 Chairman: So that was before the
spike?
Mr Ulrich: Before the spike, yes.
Q408 Chairman: So are you going to increase
it even more in the light of the spike?
Mr Ulrich: No.
Q409 Chairman: So the spike makes no
difference and a windfall tax on the profits that were made during
the spike will in fact not affect your investment plans at all?
Mr Ulrich: It will not for us.
Q410 Sir Robert Smith: But the new entrants
that you wanted to encourage would be frightened off?
Mr Ulrich: Maybe, yes.
Q411 Chairman: They might not be if it
is a one-off. The point about a windfall tax is that it is designed
to deal with a specific problem in the sense of the problem of
people making money almost by doing nothing.
Mr Ulrich: Well, that may or may
not be true, but it is not only the upstream community. As I said
before, the fact that this is fed into generation prices, British
energy is making much greater profits due to this also because
the wholesale electricity price increased, so should indirect
participants in the market also be taxed?
Q412 Chairman: Well, that is something
that would have to be examined. We are testing this hypothesis
out on various people and, as I say, you are one of the almost
unique groups that has benefited and then has had this painful
task of explaining to people that, because another part of your
organisation has been forced by daft stories about whether to
increase their prices and their profits, sadly you have got to
increase the prices throughout. You could have maybe had a wee
bit of vertical integration in your handling of the profits, could
you not? You could have maybe taken the profits from one side
and given it to the other and kept the gas prices down.
Mr Clare: That is exactly what
we do. We do—
Q413 Chairman: Not very much. You have
lost 900,000 customers.
Mr Clare: That is because we are
the market leader and the biggest brand and of course the media
does pay particular attention to the largest brand. The reality
is that we have passed on less than the full costs. We took advantage
of our own supplies, the fact that they gave us a slight cost
advantage. We also, as you know, restructured our organisation
to take costs out and we have passed that through, but of course
in the end the increase in commodity prices that we were paying
the third party was so large that it still resulted in a very
large price increase, so we are integrated in terms of the way
we price to customers.
Q414 Chairman: So, on reflection, if
you had hammered them even harder, you would not have lost very
many more customers?
Mr Clare: I think, as we are primarily
a downstream company, our focus is always on how we improve our
customers' experience and having to put prices up to the extent
we did last year clearly was unlikely to improve that experience.
Q415 Chairman: What was the contribution
to your profits in 2002-03 and 2003-04 from upstream and downstream?
Mr Clare: The majority is made
by upstream still.
Q416 Chairman: So you are not really
a downstream company. Your shareholders will not give a damn whether
you call yourself upstream or downstream if the profits are coming
from upstream in terms of their dividends.
Mr Clare: In terms of the number
of employees that we employ and the activities of the group, they
are very much focused on the downstream and I think the reference
to just being a downstream company is that we have upstream assets
to support our downstream business. It is exactly the same model
in North America and we buy upstream assets to support our customer
base there and that is why we talk about ourselves as a downstream
business rather than the producers of course who are all upstream
and do not have a customer position at all.
Q417 Chairman: Yes, but the point I am
really getting at is that I understand that somebody has got to
have this painful job of selling gas to domestic and industrial
consumers and you have reluctantly carried on that responsibility,
but you are making rather more money out of the other bit and
you are passing on these costs at levels which may be lower, but
so far your consumers have not really shown much gratitude, have
they? They have deserted you in great numbers.
Mr Clare: I think that is back
to the fact that, as the market leader, we were the first to move
and we know that all but one of our competitors have followed
us and there are signs that that competitor will probably follow
as well, so this is a cost that every supplier has had to bear.
As the market leader, we do take a disproportionate hit when we
change our prices and that is one of the negatives of being the
market leader. Our real focus of attention is to try and ensure
that our customers are protected as much as they can be, but the
real challenge we have is to make those investments that we talked
about earlier, to bring the new gas to market and that will enable
market prices, we believe, to reduce from the highs that we saw
in that peak time. The more gas that we bring into the UK, the
more we will get into a balance with supply and demand, the better
that is for our customers, so I guess we move very, very rapidly
from the short term, dealing with the impact on customers today
and we have invested more to try and help those that are in need,
to trying to ensure that all of our customers have adequate sources
of supply at lower prices as a result of the investments we are
making.
Q418 Chairman: How much have you invested
in helping your disadvantaged customers?
Mr Clare: Over and above the energy
efficiency commitment, which costs about £130 million a year,
we spend about £30 million over a three-year period, so we
are putting about £10 million a year into our Help the Aged
Programme, into our trust fund and into our charity partners through
Here to Help.
Q419 Chairman: The additional sums of
course have been sort of brokered with the Government, have they
not, in the sense that the Government has said they would look
to you to make a contribution here? Is that not the case? It is
not quite obligatory, but it is almost.
Mr Clare: We have had lots of
discussions with regulators, consumer bodies and government. I
think we have, by and large, felt that we have led the way in
terms of the schemes that we put in place and I do not feel that
we have been put under enormous pressure to do more. I think we
have often been acknowledged as the one that is probably leading
the way. Once again, as the brand leader, we would expect to take
that position.
Q420 Chairman: What proportion of your
profits are accounted for by this sort of activity, or setting
your profits down as a percentage of them, how much would that
be?
Mr Clare: If you take a percentage
of just the downstream profits, the customer profits, rather than
including the upstream, one of the challenges we have is that
our profits are very, very volatile in the downstream, but it
could vary between 15% one year to 5% another because what we
have seen over the last three years of reported results is that
our margins have moved around quite a lot. We consider the investments
that we are making to be more appropriate given our size, but
I think we have to continue to look at other innovative schemes
to help consumers who are in difficulty. The challenge is how
to spend £130 million a year more effectively back to back
and I can get far more benefit from making that work harder than
I can by necessarily just putting more money in from shareholders.
Mr Ulrich: I think the other very
important point is that it is very much a long-term view that
we take on pricing and on customers. In two or three years our
percentage, if we are not successful in buying other assets, will
be well below 20%, so we will become increasingly dependent on
the downstream customer margin which means that losing customers
at this stage is not good for the long-term viability of the company.
We will announce our results in February and I can assure you
that the major question amongst all the analysts who follow us
and the subsequent meetings with our major investors is about
what we are doing to stem customer losses, what we are doing to
stabilise the business, so it is the downstream, the customer
end, that our investors and analysts follow.
Chairman: Well, thanks very much for
your time. We might get back to you about one or two additional
points. Thank you very much.
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