Examination of Witnesses (Questions 240-259)
PROFESSOR JOHN
GITTUS
27 JUNE 2006
Q240 Mr Hoyle: So you have calculated
just enough resources.
Professor Gittus: I very much
doubt whether the lives of the existing stations will be extended.
One or perhaps two might.
Chairman: We have heard conflicting evidence
on that point. We will move on to the mainstream subject that
we intended to discuss today, first of all the question of risk
which you have already touched on in your initial answer. Peter
Bone.
Q241 Mr Bone: These are a series
of questions about your calculations of business risk, but just
before I go to that, you are coming from a nuclear background.
Professor Gittus: Yes.
Q242 Mr Bone: And an insurance background.
You discussed insurance premiums for overseas contracts, but of
course you could always use a letter of credit and then you would
not need any insurance premium, could you not?
Professor Gittus: The risk does
not disappear if you use a letter of credit, it is being shouldered.
Q243 Mr Bone: We will disagree.
Professor Gittus: You cannot possibly
disagree with that.
Q244 Mr Bone: I can. I will go from
my basis of chartered accountancy, you go from your basis of insurance.
Professor Gittus: I have done
both.
Q245 Mr Bone: Then you have a great
advantage over me; I have only run a plc and only been a chartered
accountant. Could you explain to me how your journey from the
nuclear and the insurance industries enable you to calculate energy
risks? How did that journey all come together?
Professor Gittus: Really almost
by accident. The underwriter for nuclear risks was asked to set
up another syndicate to insure political risks and, more or less
at the same time, the DTI announced a one day conference on energy—this
was in 2001—and asked me if I would give the first paper
of the day summarising energy forecasts globally. So I did this
and I encountered statements that had come to be made—verbal
statements—that this country was going to rely on Russian
gas—I am quoting now from five years ago—and that
any fool could see that that was a mistake because you would not
rely on it. I am paraphrasing, but that is what people were saying.
I said to my colleague, you are now insuring political risk, how
does it differ between Russia, for example, and the Middle East
from which we get our oil and this country, and Canada from which
we get uranium and whatnot? He was able to answer it immediately
because of course he had had to read it up in order to found a
profitable syndicate, so that is how I got into it. I then discovered
that there are big databases, and I referred to them in talking
to Judy Mallaber, and that there are also comparable databases
on business risk, nothing to do with insurance, but the kind of
things which you must have used actually, running a plc, to decide
just how risky it was to trade with different overseas countries.
Out of interest I compared these databases which you can do very
easily now, and I found that they correlated; the difference was
that the business risk database used arbitrary numbers and I put
some of them in that Platts article, and they were numbers between
nought and a hundred for risk, whereas of course the insurance
premiums were an actual measure of financial risk, increased by
a factor to make sure that the insurers would make a profit. That
is how I got into it; that is how I got steeped in it.
Q246 Mr Bone: Talking about the business
risk and the insurance parameters and their calculation, you say
there are these databases but how are they calculated in the first
place?
Professor Gittus: The insurance
risk is easy: all that has happened there is that people look
at their accounts at the end of the year and they say things like
for insuring your financial risk when trading between, I do not
know, France and Portugal we chose 0.73% premium and we have made
a loss, had we charged one and a half% we would have made the
18% profit that we like to make, so next year that is what we
are going to charge. That is how the insurance database works,
it is just pragmatic. The business risk databases again are based
on inputs from businesses around the world which are served by
firms like RBC, for example, which is a risk-based capital advisory
consultancy. They apply this, many, many companies around the
world on business risk and, in part exchange for giving them advice—they
inevitably charge them of course—part of what they get for
it is the actual business experience of their clients, fed back
to the centre—it is like a mutual society—and that
is how that works.
Q247 Mr Bone: If I am following correctly,
these business risk and insurance parameters are based really
on all trade, it is not specific to the energy sector.
Professor Gittus: No.
Q248 Mr Bone: That is correct, is
it?
Professor Gittus: Absolutely correct.
Mr Bone: Thank you.
Q249 Mr Binley: I have been a senior
manager in publishing and database building, but do be gentle
with me. I want to move on to the comparison you make in terms
of risk between Russia and other suppliers of gas because that
is an important area of knowledge. Can I ask if you have done
a similar analysis for the other countries from which the UK may
source gas in the future—just to name a few, Norway, Netherlands,
Algeria, Qatar, Egypt, Malaysia, perhaps even west Africa. If
so, what does your analysis show in relation to those?
Professor Gittus: Yes, I have
done all those and the databases contain numbers for all the countries;
if you set up this kind of thing it is as easy to do it for everybody
as for one or two. It shows that Algeria is risky, Norway is not,
Qatar is not as risky as Russia, but there is a risk there and
it is riskier than Norway. Those are the kinds of comparison.
Q250 Mr Binley: So they are the sorts
of business judgments that you would make when you were talking
to any supplier, that is the point I am trying to make.
Professor Gittus: Yes.
Q251 Mr Binley: It seems to me that
your judgment is that one of the most risky of deals of this kind
is with the Russian Federation, is that so?
Professor Gittus: Yes, but partly
because at the time when I did the analysis it did seem that most
of the Russian gas supplies would come to us by pipelines that
pass either through the Ukraine or through the Ukraine and Belarus.
Q252 Mr Binley: Now you are looking
at the Baltic.
Professor Gittus: Now of course
there is an alternative route. You can see the problem, the Ukraine—
Chairman: We are going to hear about
the Russia/Ukraine in detail in subsequent questions so we will
deal with that with other colleagues. On a general broad overall—
Mr Binley: I would just like to ask about
the Baltic because that does—
Chairman: We will do that later, we will
come back to that in other questions.
Mr Binley: You have been gentle with
me, thank you for that.
Q253 Chairman: What is the risk of
all these countries going wrong together?
Professor Gittus: That is an issue
that I address. You might say zero but then you have got to think
of OPEC and you have got to look back to 1974. In 1974 Japan was
almost ruined by the fact that supplies of oil from OPEC countries
had dried up on political grounds; their GDP had been increasing
by an average of 8% per year until then and in that year, instead
of increasing by 8% it fell by 1%. That was the start of the Japanese
nuclear programme, that is when they decided to have a very significant
nuclear contribution to generation, and they were receiving oil
from many different countries, but their supplies dried up. The
question is, is the same kind of thing likely to happen with gas?
It is no good answering that question with sweeping gestures and
saying no because the future of this country actually depends
very largely on the answer to a question like that, so we have
to address it very seriously. Of course, we do not know the answer
to it, but we do know that gas suppliers do liaise and in papers
that I have not published but which are on my website, again work
done for BNFL, I have indicated the kinds of liaison that do exist.
It is not a kind of gas OPEC but it could be the seeds of it and
one can see it could be of interest to gas producers to talk to
each other. It is not going to be zero, therefore, you cannot
say "well if Russia stops it, Qatar will keep on selling
us tanks full of it" because there is always the possibility
that they may find it in their interest, for a broad range of
reasons, some of them national security, to follow suit. I have
made some estimates of the likelihood because I am in the business
of producing numbers and not adjectives and those guesses underpin
part of my Platts paper.
Chairman: Thank you, that was a helpful
answer. Lindsay Hoyle has a supplementary before I bring in Mike
Weir.
Q254 Mr Hoyle: Obviously, you do
a lot of the risk analysis about all these countries and security
of supply. What have you given to the gas and oil reserves in
the Falklands and that being used by the UK, maybe as an alternative
to nuclear?
Professor Gittus: The gas reserves
where, I could not hear?
Q255 Mr Hoyle: The Falkland Islands.
Professor Gittus: Yes, that is
a possibility.
Q256 Mr Hoyle: Have you done any
risk analysis because it is outside OPEC, there are huge reserves
and obviously in a favourable position as an overseas territory
of the UK.
Professor Gittus: How much do
they supply?
Q257 Mr Hoyle: The claims are that
there are huge reserves there.
Professor Gittus: How much are
they supplying?
Q258 Mr Hoyle: None at the moment,
that is what I am saying, so the UK is the oyster.
Professor Gittus: I could ask
you the same question about the Alberta oil sands.
Mr Hoyle: I do not think it is an overseas
territory though.
Mr Wright: It should be.
Chairman: That is definitely outside
the terms of this inquiry. We are now going to look at Russia
in a little more detail. Mike Weir.
Q259 Mr Weir: I was interested, Professor,
in what you were saying earlier about political risk and I noticed
that much of the argument you include when dealing with the Russian
Federation is not directly related to the gas supply itself.
Professor Gittus: No.
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