Examination of Witnesses (Questions 506-519)
DEPARTMENT OF
TRADE AND
INDUSTRY
1 FEBRUARY 2005
Q506 Chairman: Good afternoon, Mr O'Brien.
Perhaps you could introduce your colleagues and then we will get
started?
Mr O'Brien: Good afternoon, Chairman,
it is a pleasure to be here. On my immediate right is Joan MacNaughton,
who is the Director-General of Energy at the DTI, and on the further
right is Tera Allas, who is the Director of Energy, who is an
economist. We will be very happy to answer your questions.
Q507 Chairman: Thank you very much. Before
we go any further, you provided us with a welter of information,
but somewhat inconveniently it all seemed to stop at about September
2003, which is roughly about the time the price spikes started.
Do you think it would be possible to give us some more up-to-date
information for the record, because it does seem that the graphs
that we have got all seem to peter out just when it is beginning
to get interesting?
Mr O'Brien: I think that is a
very good idea, Mr Chairman, and I think Tera has got some information
on that.
Q508 Chairman: I am sorry; do not give
it to us now. The last thing you must do in the middle of a class
is give out pieces of paper which will be read to the exclusion
of everything else, so we will take them and read them as homework,
if that is okay with you?
Mr O'Brien: That is fine, yes.
Some of it is graphs of previous prices but some of it takes it
forward.
Q509 Chairman: It is just that the information
you gave us, and I appreciate that it was some time ago that you
sent it to us, if you could give us an update that would be helpful?
Mr O'Brien: Certainly.
Q510 Chairman: We know that we have had
spikes and we know there has been volatility. Do you think we
are entering into uncharted seas, where we could expect to see
obstacles and difficulties of this nature occurring frequently?
What is the Department's view on this?
Mr O'Brien: As far as gas and
electricity prices are concerned, we have seen an increase in
those prices as a result of the changes in the situation in the
United Kingdom Continental Shelf. In particular, our oil and gas
production peaked in 2000 and it is the case that since then the
market has been tighter and as a result of that there has been
some increase in prices, there have also been increases in prices
for the reasons that I heard Ofgem give you earlier today. It
is the case that our aims are to try to ensure that the market
operates for the benefit of the consumer and that includes the
industrial consumer. It is noticeable that we had a particular
problem spike last October. That was one of the reasons why you
initiated this inquiry. The forward markets for gas, particularly
industrial gas, are an issue which we have looked at and we are
continuing to work with Ofgem and both the producers and the purchasers
of gas, in particular, to identify ways in which we can seek to
reduce this problem of a spike round about October. If you look
back, in previous years there was often this spike round about
October, and I heard, I think, Mr Clapham say that there were
problems going back with the gas industry, and it is the case
with forward prices that we have seen that spike. There does seem
to be a coming together of buyers round about October, and we
have done a couple of things to look at that. We have set up a
working party with Ofgem and the various industrial buyers to
look at how we can ensure that there is proper information in
the market. Also, we are going to hold a seminar, if you like,
in about a month's time, which will enable some of the buyers,
industrial companies who buy gas, to come together to look at
the purchasing strategies, the way in which the market operates
and just share some ideas on how they can spread out this problem
perhaps which seems to arise in October. It may well be that they
will take a view, I think probably it will be the right view,
that if they spread this purchase of gas a bit more through the
year we will have less of a problem with a spike round about that
time. Also, we need to get some more information into the market,
and we started a process, after the problems which arose in 2003,
of bringing together the industry to see if we could get more
information into the forward market so that it could better make
judgments about the sorts of prices they wanted to pay. What happened
last October is very difficult to analyse. We have had a few people
looking at it and indeed we still have got an economist looking
at it. It does seem to be that there was a conjunction of various
factors: the tightness of the market, the anticipation we could
have a cold winter and that prices could go up. It is interesting
that there is also an apparent spike round about October in the
forward market for the coming year. What seems to have happened
is that a number of the purchasers started to rush into the market,
the price went up and, at a later stage, the best guess as to
what happened is that some of the suppliers decided the market
was behaving in a way they were not entirely happy with and so
they started to withdraw, which again reduced the amount of supply
in the market and the price went up.
Q511 Chairman: Do you not think that
the suppliers did that in order to let the price go up? You do
not have to be an entrepreneurial genius to know that if you withhold
supply the price will continue to rise, in fact it will accelerate?
Mr O'Brien: If that was their
intention, the effect of doing that was that some of the buyers
came out of the market too, because the price went up quite high
and the market self-adjusted. Within a matter of a week or two,
the market came straight back down, steadied itself and has continued
since. We have seen that spike over a number of years, and what
I think we need to do is look at ways of seeing if the market
can operate in a much more effective way which does not have that
conjunction of purchasing and problems round about that period.
I think we can do that by providing more information and by getting
the market to engage with each other on how that process can be
avoided.
Q512 Chairman: I can see that, but it
still does not answer the other question, to which you have alluded,
in fairness. The fact that in the first quarter of 2006 the forward
price looks like being at 45, which is quite high, and we know
that there is going to be, by and large, a sufficiency of supply,
we know that statistically the argument for a cold winter is best
left to the climatologists of the Daily Mail, who have been fairly
well discredited, so where do we actually come into the game?
What more has to be done to try to avoid spikes?
Mr O'Brien: One of the things
which will happen beyond next winter is that the extra gas provision
will expand.
Q513 Chairman: I understand what is going
to happen. Since pretty well November, people have seen that the
rather vague expression used by Ofgem, market sentiment, was misplaced,
to put it mildly, but it still seems to have prevailed?
Mr O'Brien: I am not sure it was
just entirely market sentiment but there was a view that the price
would go up, nobody knew by quite how much, and it did start to
go up and there was a brief period when the market went too high
and then self-adjusted. Markets do that, sometimes they do shoot
up and come back down, and this one did it and it self-adjusted:
it worked, in a sense, when a problem arose it self-adjusted itself.
What we are seeing in the forward market at the moment is that
there is still a view that the gas market is going to be tight
in the UK for the coming year and that is reflected in the forward
prices. Interestingly, much of that spike you refer to was not
particularly evident in the spot market prices and therefore they
stayed fairly steady throughout. The obvious thing that you would
have said to buyers was, "Well, why aren't you buying more
on the spot market and why are you focusing so much on the forward
market?" Of course, they will say "We want to guarantee
our long-term supplies," and you can understand that to some
extent. The spot market has been fairly steady throughout, we
anticipate that it will remain fairly steady in the future, we
cannot guarantee anything but that looks to be the case. In due
course, going past next winter, the price of gas will start to
come down because we will have the LNG terminals at Milford Haven
and the Isle of Grain and we will have the doubling, or even trebling,
of the Bacton-Zeebrugge pipeline, the new Dutch pipeline and the
Langled pipeline from Norway. Incidentally, I am just about to
go to Norway, tomorrow morning, to talk to the Norwegians about
finalising a treaty on that.
Q514 Mr Hoyle: Minister, do you see conflict
in the DTI role as both sponsor and regulator of the offshore
gas industry?
Mr O'Brien: I pause because I
am not entirely convinced that I would use the word regulator
in the traditional sense, in terms of our role in the upstream
oil and gas industry. What we are in the upstream oil and gas
industry on the UK Continental Shelf is the licenser of the operations,
we issue the licences. We do not operate as a traditional regulator
in terms of regulating the market, it is a free market. The oil
industry, as we all know, is a global industry, and therefore
what we will see is that the global industry will go to where
they can make money, and if we start to impose a large amount
of regulation they will go elsewhere, and we know that. We have
always taken the view, and it has been very successful since 2003
in particular, that we would attract people in not by having a
traditional regulator in the upstream industry but by having quite
a light touch, pretty much a free market, issuing licences, intervening
where we need to in the licensing process by the fallow field
process, the brownfield process, a number of other licensing initiatives
on promote licences, and so on, which in the last two or three
years have brought 40 new companies into the North Sea. Enormous
success for us, particularly at a time when everyone is talking
about the decline of the UK Continental Shelf and North Sea oil
and gas. We have got 40 new companies coming in and they are investing
in the North Sea and one of the reasons they are doing that is
because we have got a very light touch, in terms of the way we
are regulating it. We do have some powers in here. We can intervene,
and this is by agreement, where there is a dispute about infrastructure,
for example, but by and large we operate the North Sea as a free
market. Whilst we are the sponsor, as you say, I do not think
I would quite use the word regulator, not in the traditional sense
at least.
Ms MacNaughton: I think the sponsorship
role is directed towards getting the maximum out of the United
Kingdom Continental Shelf, not sponsorship in the traditional
role of sponsoring industry, per se, but actually sponsoring
to get the best out of that national resource in the national
interest.
Mr O'Brien: What we have seen
in particular is the build-up of PILOT. PILOT I think is a really
good initiative taken by the industry and by the Government, whereby
we have got the upstream groups coming together with the Government
on a regular basis and working out how we can maximise that output
from the UK Continental Shelf. Given that we have gone past the
peak in 2000, the remarkable success we have had in attracting
new companies and the way in which we have managed to operate
the licensing system to attract more of them, it means I think
that we are getting that balance just about right. I would not
be in favour of changing our role to extend the powers of Ofgem.
I think Ofgem have got the right powers, they can investigate
if there is something suspicious going on, or if they have got
queries about what is going on, if they need to, but I would not
want to extend their powers to be an overall regulator.
Q515 Mr Hoyle: It is interesting, because
you have touched on how I was thinking we ought to put the questions
next. If we look at the way that the North Sea development has
taken place, where producers jointly exploit the fields, the fact
that they share the infrastructure, production-related information,
it is all there, it is all passed between producers, and the fact
that as one pulls out it is passed on to another because, quite
rightly, you are bringing in more companies as it seems to be
reducing, do you really think it is a competitive market under
those circumstances?
Mr O'Brien: In a situation where
you have got 60 companies competing and none of those companies
has more than 14% of the market—I think Exxon Mobil are
the largest with 14%, I think the next one is down at about 13,
12%, in fact one of my graphs will show that—the level of
competition going on in the upstream market is serious and significant.
Q516 Mr Hoyle: Is it real competition?
Mr O'Brien: I think it is real
competition. We are attracting in companies who are looking for
new markets, new resources to exploit. There has been the biggest
level of interest we have had in a decade in the round of licences
I issued last year, in new companies coming in to prospect in
the North Sea. It is a fascinating change in the way in which
the UK Continental Shelf is operating, and indeed what we have
seen is that some of the majors who previously held quite a lot
of the fields are relinquishing some of those to smaller companies
and they are going in in two ways. They are going in to identify
new, smaller fields often, and they are going in also to exploit
the remains of some brownfield sites that have already been exploited
in the past, and that is quite significant. Have we got competition?
That suggests not only have we got competition but it is increasing,
it is going in the right direction.
Q517 Mr Hoyle: They are going to use
the technology on the existing brownfields, presumably?
Mr O'Brien: Yes, indeed.
Q518 Mr Hoyle: How many producers actually
sell their gas directly to the wholesale market rather than simply
to other producers for onward transfer?
Mr O'Brien: I would guess that
most of them would. I look to Joan. I would have thought, most
of them would, probably, in the UK.
Ms MacNaughton: As I understand
it, I think all of the majors—of which I think there are
seven—actually hold shipper licences, but, as the Minister
has said, the largest producer, Shell, is 14%, so there is not
a lot of concentration. On the point about competition, I think
the witnesses from Ofgem explained that they have powers under
the Competition Act to investigate if they believe there is any
anti-competitive behaviour, and I am sure they would not hesitate
to do that if they had any reasonable suspicion of that sort of
behaviour going on. That does not rule out, of course, sharing
of infrastructure and those sorts of things which are necessary
to get the maximum take out of the UKCS.
Mr O'Brien: When there were problems
with the spike to which the Chairman referred earlier, of course,
Ofgem were prepared to look into these matters and ask the relevant
questions.
Q519 Mr Hoyle: Look into the matters
and ask the questions. I think people may say they could have
been a little stronger, but that is another thing, but it does
take me on to what Ofgem actually did, the assessment. The gas
producers disagreed with Ofgem's assessment about the average
levels of production outages in the North Sea in 2003. What is
your view? Was Ofgem right or were the producers right?
Mr O'Brien: The Ofgem report was
the result of quite serious investigation. They spent a lot of
money and a lot of time investigating the way in which the operations
in the North Sea were conducted and their supply was conducted,
and I think the report that they published was a thoroughly professional
report. I am afraid I am not going to put myself in a position
where I disagree with that. On outages, it is the case, however,
that we needed to get more information out there. The way in which
some of the companies, the purchasers of gas, have looked at it,
they are a bit concerned, a bit worried, about exactly what is
happening in the market out there, and I think if we can get the
level of information to them much more effectively then I think
that will reduce some of their concerns. For example, we now have
a voluntary agreement which is getting a process going whereby
the various companies will supply information to Transco about
not only outages but also levels of production. They will then
be able to put the aggregated figures out there from the various
companies so that people are better informed about what is going
on, and I think that will lower some of the concerns expressed
by some of the companies who are buying.
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