Examination of Witnesses (Questions 440-451)
SCOTTISH AND
SOUTHERN ENERGY
26 JANUARY 2005
Q440 Sir Robert Smith: There is still
more information to come, is there not, in that NGC have got to
get their procedures sorted out?
Mr Phillips-Davies: Yes. If you
started off with what you had in the power market and sort of
replicated it, there you go, why not do that? If the information
is available, why can you not replicate what you have in the power
market? It is a simple and easy question for you to ask somebody.
Q441 Chairman: We have discussed this
with a number of players and indeed energywatch have provided
us with indications that they think it should go further. I think
we will be comparing and contrasting in our report what is on
offer as the DTI-led consensus and the additional information
which people like energywatch are suggesting. Indeed I think it
is fair to say that we have not had any witness who has publicly
said that there should be no more information. Some have said
they are happy to go with the DTI, but I do not think there is
anyone who has disagreed that there should be more transparency.
Mr Phillips-Davies: They would
not at a public forum, I do not think.
Q442 Chairman: Well, equally, they probably
would not wish not to be part of a DTI consensus if it did not
go far enough. They are probably quite happy to take that. Maybe
I am being unduly cynical.
Mr Marchant: I think your cynicism
is well justified.
Chairman: It is not very often I get
told that by witnesses!
Q443 Richard Burden: In your memorandum
you talk about the non-linear relationship between capacity levels
and prices and you say that some things have a disproportionate
effect, particularly, an example you describe, the contractual
sterilisation of capacity utilisation back to the sub-terminal.
Could you say a bit more about that?
Mr Marchant: What we are trying
to say is that there is not a straight linear relationship between
demand and supply. The closer you get to a time of system stress,
the more acute the price signals become and because there is a
natural desire on the part of the Grid conservatively to make
sure the burners do not go out or the lights do not, they want
to hold some reserve margin, and, on the part of the energy supplier,
to make sure he has got his position covered, so the closer you
get to a time of system stress, the more you want to make sure
you have got enough gas purchased to cover your position. Then
any capacity withdrawal at that point in time, be it a sterilisation
of capacity or a field going off, has a much, much greater impact
than it would at a time, say, maybe the next day. It was a simple
point to say that the withdrawal of capacity at times of system
peak can have a very, very significant impact. Of course that
then feeds through if you are looking at an annual contract where
you are going to be paying a risk premium to cover those peaks,
and that is the point, made maybe in a very inarticulate way,
we were trying to get across. If things are not available when
you need them, that is when it really has an impact.
Q444 Sir Robert Smith: In a sense whilst
you are worried obviously about spikes in the forward market because
of the lack of liquidity, that risk premium in the forward market
is the market sending a signal that is encouraging the Norwegians
to build another pipeline, other people to invest in LNG and the
upgrading of the Bacton-Zeebrugge, so we have had the benefit
of the market giving us a competitive, cheaper supply, but presumably
these price signals are quite important?
Mr Marchant: Yes, they are, but
it feels to me that the forward price is over-sending those signals.
The new-entrant cost of LNG is probably around 20 pence a therm
plus or minus maybe 5 pence. For a new pipeline it is probably
similar, yet the forward gas curve in the next couple of years
is more like 40 pence on an annual basis, so the risk premium
or the lack of liquidity premium, and who knows which it is, is
causing prices to be significantly above that new entrant-type
of test.
Q445 Chairman: I think we have covered
most of the ground with you that we wanted to. Your answers have
been different in some respects from others'. I realise that you
have been the victims of the beneficiaries of your acquisitions
and, as you said, the unintended consequences. Do I take it from
what you have said that unless things change dramatically downwards,
you are probably going to have to confront price increases in
the near future?
Mr Marchant: That is correct.
What we said in September was that we would hold prices down until
at least the start of 2005, which we have succeeded in doing,
but we said that it was very unlikely we could continue that policy
beyond April, and that is still our position. The thing that concerns
me most is next winter's gas price which is sitting at a very
high level, and if that turns out to be correct, not only have
I got to move up to the pack, but then the whole pack will move
on again in around September time. That is in a sense my bigger
worry for my customers.
Q446 Chairman: You have mentioned the
September date and we have been asking a number of people and
there is nothing magical about it. Our adviser was able to tell
us after yesterday's session that in fact it is just a hangover
from the old British Gas days when they liked to get things smoothed
out for twelve months at a time, but now people in more volatile
circumstances want it to be smooth for everyone.
Mr Marchant: If you have got gas
contracts, which we have, it is the end of the contract year,
so your annual squaring up of volumes and the resetting of prices
for the next year tends to happen around that time, so whilst
it was lost in the mists of time, that time of the year has a
disproportionate influence because a lot of contracts are coming
up. The other issue that you have got in the electricity market
is that the biggest contract round for industrial commercial customers
is in October. The October round is significantly bigger, so people
are signing contracts for power through the summer into September
and if they think they can leave it, they will leave it as late
as they can, and most of the people selling the industrial contracts
will want to back the power off and some of that power comes from
gas, so there is a pressure to sign up and buy some gas. The reason
why I think gas got to 83 pence was that those two things together
with the fact that most of the liquidity is provided by banks
whose job it is to create capital markets and when they see a
market moving one way, they help it in that way because they can
make money as a sort of one-way bet for them, it got ahead of
itself and then the speculation was that it was a one-way bet
coming down, so those same physical effects will be around this
September also in terms of pricing before a winter, so there is
a whole series of things that come together in that.
Q447 Chairman: What you are really saying
is that this is a market which is not working. You can explain
why it is working, but the explanations may not necessarily be
acceptable. Would you see this as a market which should be subject
to some form of regulation and, if so, should it be the FSA, which
is responsible for commodities markets, or should it be Ofgem,
which has responsibility for energy? That is assuming you would
want to have the market regulated.
Mr Marchant: I think there are
three things that need to happen in the gas market: increased
transparency, which we have talked about; looking at market structure
to improve liquidity; and regulation. Those are the three things
that I would want to see done and I never thought I would be at
the point where I argued for an increase in power for the regulator,
but I think that is probably the answer in the sense that if you
think about the energy business having four bits of value to it—upstream,
downstream, gas and power—they regulate three of those four
bits and not one of them, the wholesale gas market, so I think,
therefore, it is more logical to put the responsibility on Ofgem
than, say, the FSA who are looking much more at market abuse.
They do not mind what the price is as long as there has not been
abuse, whereas Ofgem worry about the absolute level of price and
what the new entrant levels are and things like that. Therefore,
reluctantly, I conclude that probably Ofgem are the best.
Q448 Chairman: Mind you, the cynic might
say, "Well, you would say that because you don't have any
upstream activities".
Mr Marchant: Yes, you could indeed
say that. Maybe I would have a different answer if I had upstream
activities, but what you have to remember about a company like
SSE is that we are a customer-focused organisation and what matters
to us is keeping the lights on and keeping the burners on for
our customers. We own generation stations because we have customers.
We have taken the view that we should not own offshore production
for two reasons: firstly, we thought we could buy it; and, secondly,
the whole technical and tax issues would be new to us and we have
taken the view that we should not do that. The market at the moment
is making it more difficult for me to hold that line, but I am
perfectly happy to have my activities regulated wherever they
are.
Q449 Sir Robert Smith: What happens to
the price of your hydroelectric generation then in a market like
this?
Mr Marchant: Generally, like nuclear,
the production costs are fixed, so higher prices mean higher profits.
More rainfall—and, as you know, it has been particularly
wet in Scotland this year—means higher profits and that
again was part of the influence on our decision not to put prices
up in an attempt to share some of that literal windfall with customers.
Q450 Chairman: What proportion of your
generation capacity derives from hydro?
Mr Marchant: About 10% of our
capacity, just over a gigawatt at 97, which is just over 10%.
Q451 Chairman: Well, thank you very much.
For the record, can I also thank you for responding to what was
a fairly late request. I think you came in place of another witness
at fairly short notice, but thank you.
Mr Marchant: We are always happy
to help this Committee.
Chairman: Thank you very much.
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