Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Quesitons 340-359)

MR ALAN ROBINSON AND MR DAVID MANNERING

3 JULY 2006

  Q340  Mr Hoyle: Should we really be concerned about the security of supply for gas and coal then?

  Mr Robinson: I think we should be concerned to maintain sources of both so that both contribute to the generation of electricity in the UK. I think that is the key point. As I say, I think there is a strong future for coal in the UK. For those owners of power stations that have opted into the Large Combustion Plant Directive, they have, perhaps for the first time for many years, a knowledge that that station has at least a 10-year life and they may need to consider their contracting strategy in the light of that. If you go back a number of years when it always seemed that coal stations were just about to close and the pits with them, then it became difficult on both sides to let term contracts. Now I think everyone believes that the opted-in plant have at least 10 more years and that does create the ability to back investment with contracts. I cannot tie anyone else to that but that is my judgment.

  Q341  Mr Hoyle: There is a great worry at the moment, and we have seen it already. You have talked about Australian coal. You say it is far away and distant, but the reality is that Australian coal is being sucked up by China. We also see India's growth at the same time as that of China. These two great expanding markets have great energy needs and they are turning to gas and coal. That is what is driving the issues about security of supply in this country because previously we dealt with Australia. All right, we are going to look at Russia, South African coal and a little bit from Indonesian but the truth of the matter is Australia did not even blink; China just soaked all that up and it is now looking for more.

  Mr Robinson: China exported about 80 million tonnes of coal last year and was I think the third largest coal exporter, so it is still a net exporter. To come back to your question, am I satisfied that long-term I can source coal internationally? Yes, I am fully satisfied. You are talking about a world market of something like 4 billion tonnes a year production, of which over 500 million is internationally traded. Can I source five or six million tonnes reliably for my uses? Yes, I can. There are many plans in many countries around the world to expand that. The shipping is easily expanded if necessary, so, yes, I believe that there is a long-term secure international market for coal from stable places, not from difficult places.

  Q342  Mr Hoyle: That is excellent. Is that the same for gas as well?

  Mr Robinson: For gas again it is a question of diverse sources. We have seen recently the growth in LNG projects. We are now seeing that gas is becoming the global market where it was previously a regional market, if you like, or the European gas market. It is now very much a global market with LNG ships that can move from the Henry Hub point in east coast America through to Europe and the Far East as well. Certainly, all the studies we have looked at suggest that there is again a lot of gas out there, but much of it will have to be in liquefied form into the future. I think that is fair. That is one of the reasons why I mentioned earlier that we are looking at securing LNG-based contracts.

  Q343  Mr Hoyle: I have mentioned about demand being driven by China and India. How do you see coal and gas prices in the future? Will the price continue to rise or do you think the price will be level at where we are now? What are your projections?

  Mr Robinson: The big advantage of diversity is that you can switch generation according to relative fuel prices. It is very difficult to see gas in the medium or even the long-term moving very far away from the oil-indexed route, for some perfectly good reasons and some perhaps less good reasons, but I think it will stay heavily indexed to oil, whereas coal price tends to be fairly independent of oil. Obviously there is a certain amount of oil in the freight costs. What we see is the relative costs of coal and gas moving around quite a lot. That is why a diverse mix is commercially attractive. If you can move generation in a high gas-priced year more to your coal stations, and then if the coal price starts to rise, you can move back, you can re-balance your portfolio. That is why commercial integrated generators value diversity. Many economists say that they do not and it will become a monoculture. I am saying that we do value diversity because it is commercially sensible to be able to switch fuels as prices move and to try to keep the total cost down to the minimum.

  Q344  Mr Bone: I want to ask one or two questions about improving security of supply. We are getting different views on how important that is. You seem to be quite relaxed and you suggested a list of possible ways of doing it: diversity of sources, supply chain for gas, improved storage, demand reduction for energy, energy efficiency and demand management. One of the things that has come up frequently as we have taken evidence is the fact that the European market, as you referred to it earlier, is not a European market; it is a protectionist market in continental Europe and an open market in the UK. Are you satisfied with the action recently taken by the European Commission to open up the continental gas market?

  Mr Mannering: I think what we have seen from the European Commission is a period of quite extraordinary energy on this particular topic. There have been a number of initiatives that are underway at the moment. First of all, we have the DG Competition inquiry into the operation of the energy markets across Europe, which is currently underway. Secondly, we have the benchmarking report by DG TREN, which will be reporting towards the end of this year, and will be looking at the development of competition in individual countries across the EU, and will be making recommendations as to whether there are any further legislative changes that need to be made. Thirdly, we have the gas regulation, which came into effect just two days ago, and which makes great steps towards the kind of liberalisation that is so important to the UK's access to European gas supplies. For example, it promotes the transparency in tariffs for the transport of gas. It promotes transparency in the utilisation of capacity and the amount of free capacity, so that will make it much easier for companies like our own, RWE Trading, who specialise in trading gas from continental Europe and importing it into the UK when we need it, to undertake that function. At the same time, recently, on 25 April, the European Regulators' Group for Electricity and Gas, which is a group of the 25 national regulators set up by the EU, has recently launched the Gas Regional Initiative specifically aimed at making the European markets more integrated and breaking down the barriers. The UK is in the north and north-west region, which puts us together with most of the markets where we would be seeking to source our gas. Lastly, there is the European Union's priority interconnection initiative, where they are funding feasibility studies with a view to looking at where interconnections should be built as a priority. I am very optimistic that the European Union will be moving on apace with integration measures that will really open up the markets and improve our access to Europe.

  Q345  Mr Bone: With all due respect, that sounds like the normal EU claptrap and waffle. What on earth have you got evidentially to suggest that they are actually doing anything? Our consumers—our domestic gas payers, our domestic business customers—have been screwed by the European Union, to be honest, over the last few years. We have done what the European Union said should be done. Our continental cousins have not. Do you really think that in six months' time that is going to change?

  Mr Mannering: I think one needs to take a step back and reflect that it perhaps took us 15 years to move to the position of the liberalised, fully competitive market that we have in the UK now. The electricity industry was privatised in 1989. I do not think the full GB arrangements came in until 2005. It has taken the UK quite a long time to get to the fully competitive, fully liberalised market that we now have. To some extent, we anticipated some of the regulations of Europe where we were ahead of the game. As I have mentioned, the gas regulation that builds on the Gas Directive only became effective two days ago on 1 July. I think we have to give time for these measures to take effect. It is probably a bit premature to pass judgment as to whether they are effective or not. As I have said, if they are not effective, DG-TREN will be producing its report at the end of the year on how progress has been made. If it finds that insufficient progress has been made against Directives that are in place, then they will be recommending further measures. I would say to you that at the moment there is a very large number of very energetic European initiatives in train. We need to give them time to see if they work.

  Q346  Mr Bone: I am going to press you on this point because this is not just some academic argument about the UK and the European Union. It really does affect households. I am thinking about the evidence that it is calculated that the average family paid £189 a year extra last year because of the failure to liberalise the EU market. We have seen that the wholesale gas price was more than double here from what it was in the continental European Union. We really are at a significant disadvantage. Do you think that is going to be cleared up, shall we say, within the next year?

  Mr Robinson: Do we think it is going to be cleared up absolutely in the next year? The simple answer is no. As David has said, there is a new energy in Europe, an energy which has never existed before, to try to get the UK style market really operating. What are we doing about it? It is hugely in our interests as well. We are a trading group. We have created a trading group to try to trade across Europe to try to arbitrage out these price differences and make sure that there is, if you like, close to a single price across Europe. We are absolutely wedded to that. We can but lobby; we fully support all the Ofgem work that they have been doing in their investigations. We have experienced the same problems. We have tried to move gas from Germany across into Belgium and found it difficult to get capacity. We are not blaming individual companies because we understand that there are regulatory constraints on the use of storage and all sorts of things, which need to be sorted out. For once, I am optimistic on this because I have seen really strong action now from Brussels to try to get it sorted and push individual Member States to do it. It certainly has our support from RWE.

  Q347  Chairman: What do you mean by "we" in this context? RWE is riding a couple of different horses, is it not? In the UK, you are in a liberalised market. In Germany you are the heart of the cartel arrangements that Peter Bone is attacking. It may be that your evidence on energy is that it pays to know the fact that you know your own front door was opened on a dawn raid by the Commission, how many days ago was it now?

  Mr Robinson: We are talking gas here and our Chief Executive Harry Roels has made it very clear that we fully support liberalisation of gas markets across Europe.

  Q348  Chairman: You did have a dawn raid six weeks ago, did you not, from the Commission?

  Mr Robinson: Not on the issues of gas; those were other local issues not anything to do with European gas markets.

  Mr Mannering: I would say that RWE very much supports liberalisation and supports competition. There is a lot of evidence to justify that claim. It is just not an empty statement. For example, the company has built new interconnectors between Germany and Holland and Germany and France recently. It is currently exploring the possibility of building a further interconnector between Germany and Holland. As you may know, the European Commission has really emphasised the importance of interconnection to create market integration and moving towards the European market. RWE is one of four companies that has recently started publishing production data on the European Energy Exchange. RWE Energy was one of the companies that unbundled its businesses before German law required them to do so under the Directive.

  Mr Robinson: To summarise, we are very much a free market company. We have a Chief Executive, an ex-Shell guy, who believes absolutely in free markets. That is the way we are trying to drive our business and set up our business.

  Q349  Mr Bone: To follow on from what you have said, I want to talk about the LNG import capacity. Last winter when we thought that that was going to be used a lot more, there was a lack of capacity. Why do you think that happened?

  Mr Mannering: There are a number of possible explanations. Ofgem is currently very actively pursuing an initiative across Europe to try to understand in more detail the reasons for that. The discussions that I have had with colleagues internally suggest that most of the explanations may have a contribution to make to the answer that Ofgem would come up with ultimately. The first point to note is that just because there are pipelines on a map does not mean that gas can flow through those pipelines. In particular, there is a point on the Holland-Belgian border, I think it is called Zelzate, where gas literally cannot flow into Belgium.

  Mr Robinson: The pressure differentials and the way it flows are not in that direction. There are physical constraints there stopping Dutch gas getting into Belgium, for example, which is where it needs to get to if it is going to flow through into the UK. With the Balgzand to Bacton link directly from Holland, maybe that will bypass that.

  Q350  Mr Bone: This is new evidence, is it not? I do not think we have heard this before. The gas that was going to come through our interconnector from, say, Holland, could not come through because it got stuck.

  Mr Robinson: That happens at certain times of year with certain flows and things like that. For gas to flow, clearly you have to have a greater pressure for it flow down. There are certain times of year in the winter when it is very difficult to flow gas in that direction down that pipe. I think that is something that Ofgem have already worked out, that the flows between Holland and Belgium have physical constraints, as they do between Germany and Belgium as well. Getting gas into Belgium has proved to be a constraint. As I think Ofgem observed, how is it a constraint one day and then suddenly later on in the winter when Rough went down, it ceased to become a constraint? I think that is because it is a physical factor; it depends what gas is coming out of what store when, what LNG has being delivered at what terminal. It is to do with managing flows in networks. It is not perfect by any stretch. I think people are now investing to get round these issues. We are certainly encouraging that investment. I think there are genuine physical reasons. It is not someone somewhere is sitting there saying, "Let's try to be awkward here". People would love to sell gas into the higher priced UK market.

  Q351  Mr Bone: There are one or two bizarre things about the whole of last winter, are there not? You would have thought that that was the case.

  Mr Robinson: In the same way as today the interconnector is exporting heavily because UK gas is much cheaper than continental gas at the moment, so it is going the other way.

  Q352  Mr Bone: Can I make my last point? You may have answered this. Did other suppliers have the gas which they could have sent here if we had had the right sort of infrastructure, or better infrastructure?

  Mr Robinson: I think certainly for the early part of the winter, the simple answer is that they had gas in storage but, for understandable reasons based on their own need or projections of what their requirements were across the winter, they were reluctant perhaps to release it. The physical limits came in as well but I think there is a lot of storage in Europe, more storage than in the UK, but that is because most of the gas flows into Europe are base-load constant supplies coming in from Russia and Norway and the only way of managing summer to winter demand levels is through storage. Therefore, at the very beginning of winter, when you pump the stores up, you are still expecting to need that gas in February and March to meet your own customers' needs. I believe they have similar regulations to ours. We have storage monitors in the UK which allow the National Grid Transco to block gas coming out of storage if they feel that too early in the winter the storage is being drawn down too fast. It is difficult to criticise our colleagues in Europe for having similar regulations because we have them as well, even in our free market.

  Mr Mannering: The point is that although Ofgem say that there was a price differential and you would expect gas to flow, as Alan has said, what that does not take into account is that continental companies buy for their customers' needs, and they will then have to buy back the gas at some future point. It is very likely that they may have to pay more than they sold it for. It is not economically viable for them to do it either, quite apart from the fact that clearly understandably the prime concern of any company is first for its customers' needs.

  Q353  Chairman: I am a little confused as to how I sum up your evidence on this point in one or two sentences, which I am always anxious to be able to do. At one stage we have a dysfunctional gas market that is universally criticised and condemned by all and sundry and the European Commission praised for its robust action to free it up and liberalise it. Now we hear it is a bunch of very happy little traders really anxious to sell their gas to us but given it by only entirely rational economic situations of the marketplaces and infrastructure issues. I am just a bit puzzled.

  Mr Robinson: Perhaps to draw the two together, the missing ingredient in that recipe is the fact that the market structures are in themselves a barrier. Some of the market structures make it difficult to move this gas quickly and easily to get access to the pipelines on a spot basis rather than a contractual basis. We are mentioning some physical things that we did not talk about because I had assumed you had had quite a lot of evidence about it already. Yes, there are contractual and market structure blockages to people who have already bought the capacity in the pipe; they do not have use-it-or-lose-it rights; and it is very difficult for them, even if they wanted to, to sell it on in some of the market structures that exist. It is not just physical. There are contractual and market structure blockages as well.

  Chairman: Thank you, you have brought the two halves together.

  Q354  Mr Wright: I suppose one of the ways over this particular problem about supply is to have a dual-fuel plant, such as the one you have at Didcot. Could you let us know how that was used last winter?

  Mr Robinson: Didcot A coal-fired station is 400-500 megawatt coal units; three of the four are also capable of burning gas. They can switch online from coal to gas, any mix of the two, and switch back and forth. It is a very flexible set-up at the station. To be honest, the winter use of that is not something that occurs because clearly that is an economic switch. Is gas cheaper than coal, allowing for carbon, sulphur and other costs? Clearly in the winter the station is already fully on burning coal. If it was burning gas, it could release the gas in the market but it will not be economically; it will be burning coal anyway in the winter. So it tends to burn gas at certain periods in the summer, and a few weeks ago it burnt gas for a while at times when in particular the interconnector is down to Europe. The UK is still a net producer/exporter of gas in the summer. Didcot can take some of that spare gas and not burn coal in that period. The more useful thing for the winter, if I could develop the question, is really: how do we use the rest of our portfolio in this fuel flexibility, this diversity I talked about earlier? How is it practically used? I think the very good example is on the peak days in February and March for peak gas prices. Oil-fired power stations, at Littlebrook down the river on the Thames and at Fawley near Southampton, which would normally run one or two hours through the peak, we switched on to run for 16 hours from before breakfast through to late evening. We switched the CCGTs off and released the gas back into the gas market, so that we can literally better use stored oil, if you like, rather than stored gas. Obviously those gas-fired stations, we can then offer back to National Grid. If they do need them at peak, then they let us know, and we will then purchase a small amount of gas on the spot market just for peak running. Effectively that is how the fuel switch occurs in our portfolio. In the summer, yes, we can switch coal/gas but in the winter the coal is running anyway, so it is not helping to release any gas, but we can run oil and release gas. We saw the CCGTs in total do more than Rough. People talk about having a second Rough. We have a second Rough; it is the CCGT portfolio. Overall in the winter, they turn down by more than the peak export of Rough, and they reduce their total winter demand by more than the total store capacity of Rough. The CCGTs are a second Rough, all the time you have the diverse fuel mix of coal and oil and other plant to make the electricity instead of the gas.

  Q355  Mr Wright: To get this right, you said that during February and March when the peak varies you can release the gas back into the market again?

  Mr Robinson: Yes, by running other plant.

  Q356  Mr Wright: Would that mean that you could actually make a profit on that? You have bought the gas on the spot market and you could put it back into the market again at a profit?

  Mr Robinson: Yes, if we bought the gas on a term contract or whatever. That is how markets work. We would look at the overall net cost of producing electricity, but if the value of gas in the gas market, allowing for the efficiency of conversion to CCGTs and carbon costs, is higher than the cost of burning oil and the carbon cost and all the other factors, then we will switch our merit order round, if you like, and we will run oil plant ahead of gas plant and sell the gas back into the market. Yes, it is all about cost minimisation and if that means we can sell the gas on at a profit, we will sell at a profit. Of course, at the same time our retail business is having to source additional gas, so some of that extra gas we may use internally because as the weather gets colder, clearly people consume more gas within our retail business and we have to go into the market and source additional gas. On any one cold day we are both releasing gas from our generation facility but we are also having to source additional short-term gas to make sure our retail customers get all the gas that they require.

  Q357  Mr Wright: Would you consider any plants to be of the flexible nature that you have got at Didcot, dual-fuel?

  Mr Robinson: There is a limited use of that sort of fuel switch, the coal/gas fuel switch. Certainly we have seen a lot of CCGTs in the system that have the capability of switching to distillate oil, doing that, and, again, it is a similar economic switch in that distillate is more expensive than heavy fuel oil we burn at Littlebrook, but efficiency of the CCGT burn is higher than the efficiency of oil. It is a very similar economic switch. Clearly, in the sorts of markets we have seen and the volatilities we have seen, anyone looking at new CCGTs will certainly be seriously looking at whether they want to make them dual-fired from day one. I think that is more likely where fuel switching will be seen. We saw a lot of fuel switching this winter and I think it will be a feature of next winter as well with more oil being burnt, more coal, in order to release gas at the appropriate time.

  Q358  Mr Wright: Do you see a role for the government in trying to encourage the maintenance of this type of flexibility?

  Mr Robinson: Frankly, I think there is no need. All the economic incentives are there for people to do it. It costs money to retain that capability and you make these decisions every day, that is what running a commercial business in markets is about, often you have to spend the money upfront in the hope that an opportunity arises to take benefit from it. We brought back Little Barford power station in Cambridgeshire. We had dual-firing with oil capability, distillate capability originally, we had effectively mothballed it but we brought it back last winter because the economics were right, so we made the investment to bring it back and use it in the marketplace. That is the beauty of flexible plant portfolio, you can make these decisions six months out, one year out. For this winter we are bringing back another oil unit at Fawley near Southampton, a second oil unit at that station, because we judge the market will pay for it, but it is going to cost us millions of pounds to bring it back. It is our commercial risk; maybe the market needs it and maybe it does not, but our judgment is it will so we are bringing it back for this winter.

  Q359  Mr Clapham: Is there not another aspect of this and that is the coal-fired stations are even more flexible than the gas-fired stations, they can be brought on and off quicker and, therefore, there is a predisposition to use the coal burners in the winter time? For example, in this last winter we were producing 50% of our electricity at peak periods from coal.

  Mr Robinson: There are two parts to that. Coal was significantly cheaper than gas, so coal plant would have been running first in cost order. Traditionally you would have been right. If you had asked me three or four years ago I would have said coal plant is definitely a lot more flexible than CCGTs. The coal plant has got no less flexible but people are beginning to learn how to be a lot more flexible in the running of CCGTs. In the same way as when the coal plant was built in the 1960s and 1970s everyone said it could not do shift, it cannot switch off, it cannot be done, when markets require it people learn how to do it, and certainly we have seen most CCGTs, if not all, capable of now switching off and turning up and down during the day very much in a similar way to the coal plant. The advantage is we have no less flexibility there and we have added flexibility in the gas portfolio now.


 
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