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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