Letter from E.ON UK plc
LOWER WHOLESALE
PRICES AND
RETAIL PRICES
Because wholesale gas prices are volatile we
buy most of our gas in advance—up to several years ahead—to
reduce our residential customers exposure to short term variations
in price.
In the industrial and commercial market we buy
the gas at the start of each contract, and the rises in the forward
market have therefore been fully reflected in retail prices, and
I am pleased to say that the fall in the forward market is already
reflected in recent contract prices.
In the domestic market be buy gas further ahead
to provide more stable and predictable pricing for domestic consumers.
This has advantages from consumers when wholesale prices are rising
as the impact on them of higher wholesale prices is deferred.
However it also means that, in a falling wholesale market, they
do not see the benefits of lower wholesale prices as early.
You asked for comments on price movements since
December 2005. Last winter our retail prices were not covering
our future gas purchase costs by some very considerable margin.
Since then, we raised our retail gas prices by 24.4% in March
2006 and 18.4% in August 2006, to reflect the increases in our
forward wholesale gas costs.
We very much welcome the fall in forward gas
prices over the past few months. This appears to have been driven
partly by increasing market confidence that sufficient supplies
this winter will be available to meet demand. Nevertheless the
position this winter remains uncertain as is the future direction
of forward gas prices.
We do of course keep our prices under review
but our current view is that wholesale prices would need to have
fallen on a much more sustained basis before we could consider
reducing prices for domestic consumers. The level at which we
set prices will also have to reflect other costs. For example,
we will see significant increases in gas distribution costs in
2007 and the costs of energy efficiency commitment in 2008.
For consumers the best guarantee they can have
is that there is a highly competitive retail market with large
numbers of customers switching between suppliers. This is actively
monitored by the regulator Ofgem. Competition will maintain downward
pressure on prices and ensure that any sustained reduction in
supplier costs is passed on to customers.
It is worth commenting on the longer-term outlook.
As you know, the UK has benefited historically from indigenous
gas sources. This gas has historically been available at much
cheaper levels than world prices and the UKCS has also provided
sufficient cheap "swing" flexibility to meet demand
fluctuations, thereby minimising market price volatility.
New import infrastructure built by E.ON and
other companies will provide sufficient additional import capacity
to supply gas to the UK from 2006-07, alleviating recent capacity
shortages, but the UK will be subject to changes in the availability
of gas from external sources (as well as from the UKCS), whether
supplied through pipeline from Russia or Norway, or LNG.
From 2008 the NBP forward curve is signalling
that the UK is now part of the European/global gas market with
UK prices converging with global prices. Global gas prices are
closely linked to oil prices which are themselves volatile. This
means that UK gas prices will be increasingly linked to the price
of oil and that we can expect volatility in UK wholesale gas prices
to persist.
I hope that is helpful. Please let me know if
you need more information.
12 October 2006
| 
