APPENDIX 11
Memorandum by energywatch
1. CONTEXT
1.1 energywatch strongly welcomes the Trade
and Industry Select Committee (TISC)'s decision to stage another
investigation into a critical sector of the UK economy and its
announcement of 27 September, and is grateful for the opportunity
to submit this evidence. Although the submission is from energywatch,
it draws upon a series of business breakfast events, seminars
and discussions hosted by energywatch for a range of consumer
groups and commercial energy users who are concerned about the
consequences of colder than average weather, tight supply and
energy shortages.
1.2 The last two years have seen turbulent
energy markets, which have caused considerable distress to gas
and electricity consumers of all types. In particular a number
of fundamental issues have emerged at the root of these difficulties,
and all the indicators are that these factors could be even more
influential this winter. Forecasters are flagging up the potential
for severe weather conditions, the UK's own gas resources and
supply infrastructure faces real challenges in meeting increased
demand in those circumstances, and international energy markets
are continuing to see very high prices as global demand and supply
conditions remain tight at a time when market sentiment is adverse.
At the same time, the ability of the demand side (daily metered
gas customers) to respond to price and reduce demand on a location-specific
basis remains largely untested.
1.3 In one way or another, all these factors
have a linkage to security of supply on the gas system and will
be in play this winter.
2. ENERGYWATCH
POSITION
2.1 energywatch believes there are four
key areas of focus for TISC to address in its investigation. They
go right to the heart of the operation of the current UK energy
market regimes and are:
— issues flowing from supply/demand
scenario plans that are being made, especially by National Grid
(NG), that warrant discussion and analysis;
— building confidence that assumptions
about whether short-term energy needs can be met this winter are
correct, and if not why not;
— considering how to increase the robustness
of the energy system over the longer term and stimulating greater
demand side responsiveness in the gas sector; and
— addressing overhanging issues from
this year's earlier gas enquiry by TISC that interrelate with
the current investigation.
3. PROBLEMS WITH
SCENARIOS AND
ASSUMPTIONS
3.1 At first glance, NG's Winter Outlook
2005-06 gives the impression that in normal conditions the energy
demands of British energy consumers can be met. However, digging
deeper into the assumptions behind the Outlook reveals a number
of issues that require further investigation. They include:
— the potential for assumed demand
response under current rules and incentives, and whether this
capability is being overstated;
— assumptions about energy supply flows,
some of which may be overly optimistic; and
— whether there is, with a little more
effort, much greater potential for demand side involvement than
is currently possible under market arrangements, and whether accessing
it requires additional measures especially by NG and shippers.
3.2 We expand on each of these points below.
4. DEMAND RESPONSE
FROM INDUSTRY
4.1 This is a critical area. NG's figures
imply that voluntary reduction in consumption will be required
through interruptability clauses in the contracts of daily metered
gas customers outside the power sector even under average weather
conditions. In a one in 10 cold winter, 30% demand response from
non daily metered industrial customers would be needed and, in
NG's opinion, could be expected for periods of up to 40 days.
In the "Siberian" one in 50 scenario, the requirement
on commerce and industry would be immense and would extend beyond
voluntary agreements, perhaps exceeding 50% of the non-power Daily
Metered sector over as much as 50 days if supplies to domestic
consumers are to be preserved. This level of curtailment is simply
assumed by NG to be there and available when needed. It would
be additional to any disconnection of gas-fired power stations,
and the allied disruption this would cause in the electricity
markets, a contingency, which does not as far as we can see, appear
to have been fully worked through in an integrated analytical
process.
4.2 We accept that no energy system is designed
to guarantee continuity of supply in the most extreme of weather
conditions. Much of the media and industry attention, however,
has focused on average weather assumptions and scenarios. Met
Office reports of a 67% probability that this winter will be colder
than average would mean that domestic supplies could only be guaranteed
through disruption to certain non domestic gas consumers and in
severe weather conditions the disruption might spread to the power
sector.
4.3 We would make a further point on the
presentation of the outlook. Whilst NG's analysis is useful in
that it shows average trends over an entire winter, conditions
within the season are likely to vary. This situation means that
there may be times in a winter which is classified overall as
mild where significant demand response is required from the industrial
sector on exceptionally cold days. The position could be severe
were any cold snap to occur early into the winter, leading to
an early recourse to modest storage quantities available in the
UK (see further comment below).
4.4 In this context, there has been remarkably
little testing of potential gas consumer behaviour, especially
outside of the energy intensive users. Soundings from this sector
suggest that little attempt has been made to capture demand responsiveness
outside of traditional contractual arrangements and outside of
the most energy intensive players. Such a focus is of course understandable
against a historical backdrop of abundant, cheap gas supplies,
but in our discussions with small and medium-sized consumers we
have been surprised to learn that there has been little appetite
by upstream players to identify further flexibility as depletion
has occurred faster than expected and as prices have escalated.
A factor here is simply that of context. Following a sustained
period of low energy prices, there are indications that many large
consumers have run down their physical and intellectual capability
to provide back-up supplies and increase operational flexibility
to deal with high prices. An example here is the water sector
where significant back-up generation has been taken out over the
1990s, but it is unclear whether this diminished capability is
reflected in the energy industry's contingency planning.
4.5 There are also a number of practical
or logistical aspects of demand response that require consideration
as there are indications that these points have not been taken
into account by NG. They include:
— quantification of back up/switching
capability in the light of environmental consents and restrictions
on operation;
— ensuring that Environment Agency
restrictions do not inadvertently increase energy supply insecurity
by placing consenting limitations on operating back-up plant.
There is a clear tension here between the Government's objectives
in reducing greenhouse gas emission limits and the possibility
that coal and oil-fired plant may need to run beyond their Environmental
Agency restrictions, possibly through derogation, to meet demand
in the case that insufficient gas is available to run gas-fired
plant;
— ensuring that electricity DNOs have
up-to-date operational voltage reduction capability;
— alerting consumers to the logistical
limitations on operating their back-up plant, including:
— fuel supply procurement and delivery
during severe weather;
— condition of equipment;
— adequacy of timescales to switch
fuels; and
— potential operational duration
available from switched fuels.
4.6 We also note NG's statement from the
Winter Outlook that "It is unlikely that NG will use its
interruption rights to contribute materially to this required
[demand] response." We believe that this situation effectively
means that shippers' individual commercial incentives—especially
those regarding balancing of their own positions and gaining from
others being out of balance—will naturally encourage them
to act first in their own commercial interests, and not in the
interests of the wider system. We therefore believe that incentives
on shippers are not necessarily aligned with those of NG, or indeed
consumers. If so, it follows that their behaviour at times of
system stress could have a detrimental effect on overall system
stability.
5. ASSUMPTIONS
ABOUT ENERGY
FLOWS
5.1 energywatch questions some of the assumptions
about import availability behind supply demand forecasts for the
winter in the Winter Outlook. NG's report itself says that "Security
of supply will . . . significantly depend upon the commercial
arrangements [in global markets and Europe] relating to the importation
of energy and demand side response. This market backdrop inevitably
creates uncertainty." Experience of the cold snap in February
and March 2005 suggests that even very high prices in Great Britain
would not necessarily curtail exports from the UK continental
shelf into Europe. NG data assumes 100% utilisation of existing
import links and 75% of new links, but we believe this could discount
the very realistic possibility of gas flowing out of GB. The European
Commission is also examining access limitations that may restrict
surplus gas on the continent finding its way into GB.
5.2 We also believe that the international
nature of the gas market means that we should not assume import
capacity will directly translate to access to gas when we need
it, especially when so many unresolved issues exist about the
ability to achieve unfettered access from neighbouring markets
with dominant players. LNG is another example of the complexities
of increasing globalisation of energy markets. LNG cargoes cannot
necessarily be relied upon for delivery to the UK when they are
needed even if new facilities are commissioned to timetable—if
prices are higher elsewhere, as was demonstrated earlier this
year, then the gas will not flow into the UK.
5.3 Equally, it is often observed that the
UK has less storage relative to our European partners, with an
average of 11 days storage compared to 55 days in Europe—a
position that has been highlighted by other parliamentary committees.
We have yet to see schemes under development come on line when
they are needed, a fact that was recently acknowledged by the
energy minister. He told MPs recently: "I would have hoped
that some developments had come on line a year or two earlier."
"That is partly the result of the fact that the decline in
oil and gas from the North Sea happened at a faster rate than
many in the market and in government had anticipated." [19]With
gas dependency due to increase over the both the short and longer-terms,
we would like to see the Government address how vital strategic
projects can be incentivised and brought through the planning
process expeditiously, especially where they increase the flexibility
of the system to respond to shortage.
6. ENCOURAGING
LONGER-TERM
DEMAND SIDE
RESPONSE
6.1 Security of gas supply is not just a
winter 2005-06 issue. Wholesale gas prices for winter 2006-07
prices stand well in excess of the 50p/therm level, and oil price
forecasts continue to be revised upwards by industry analysts.
As TISC has already noted in its previous gas inquiry, it is not
the case "that the decrease in production [from the UKCS]
will take place in a managed and predictable way." Therefore,
in these circumstances, there are considerable merits in demand
response contributing to a more resilient energy system.
6.2 Looking forward, energywatch believes
that there are a number of measures that can be taken to enhance
demand side participation in energy markets. Better integration
of the demand-side into energy markets that are dominated by supply
interests would have a number of real advantages. It could:
— bridge short-term supply shortfalls;
— in so doing, alleviate excessive
supply-side pricing pressures;
— help offset any predatory pricing
in the market place on a localised basis;
— contribute to efficient resource
usage; and
— generally mitigate pressures to burn
environmentally detrimental substitute fuels.
6.3 Demand side response is often the "bridesmaid"
in energy markets, and needs more thoughtful analysis and examination
both conceptually given differences between the electricity and
gas sectors and in terms of practical delivery. There are several
indications that NG has not placed sufficient emphasis upon this
option in its planning. In the short term, energywatch considers
that immediate actions can still be taken. Work taken forward
by Ofgem and the Demand Side Working Group (DSWG) this year has
identified some enhancements, but the work needs to be taken significantly
further forward, if not for this year, at least as an imperative
for 2006. The need to take action in this respect is no less real
in the longer term, and short-term measures should form part of
a more coherent strategy to establishing an enduring role for
the demand side.
6.4 Examples of areas that energywatch considers
warrant early examination are:
— NG should be asked to evaluate gas
balancing services as it has already done in the electricity sector.
We believe there are options and opportunities that need not necessarily
lead to a redefinition of NG's role in this area, which we understand
is a concern to the company;
— to do this, DTI and Ofgem should
urgently clarify the ability of NG to contract direct with customers;
— customers need additional routes
to market for surplus gas or gas they elect not to use. We do
not understand, for instance, why they cannot be permitted to
trade in the on-the day commodity market should they have the
appetite to do so, thereby enabling them to capture the benefits
of their own flexibility;
— more information must be made available
to customers on the forward view of supply/demand conditions,
backed up by requirements on physical participants where necessary
to give volume indications. Having information on the day or for
the day ahead only in gas is in stark contrast to the position
in electricity where operating margins are publicised up to a
year ahead. For many consumers with rolling weekly production
processes, taking a view over at least the operational week ahead
is an imperative. energywatch continues to believe strongly that
transparency is a key requirement for appropriate economic signals
to be provided to users and the market in general; and
— additional routes need to be identified
for customers to sell their flexibility back to the market, and
the necessary rule changes made. For instance, permitting the
involvement of agents/consolidators in the sale and resale of
gas. We see no justification for current limitations that tie
customers to their existing shipper/supplier.
7. OVERHANGING
ISSUES
7.1 The inquiry highlights a number of important
interactions with wider market developments. The Committee addressed
a number of these in its 2004-05 price investigation into the
gas market, but most of these still overhang the market. In particular,
we would note:
— wholesale liquidity continues to
decline. There has been no influx of traders as predicted, and
there remains a number of real structural impediments to realisation
of active wholesale trading in both the gas and electricity markets;
— the understanding of interactions
with continental gas markets is limited and evidence suggests
the problems of gaining access to the UK gas market may be greater
than initially thought or at least more deeply entrenched;
— initiatives to improve market transparency
have not progressed. Recommendation 15 of the 2004-05 TISC report:
"It is currently impossible to provide real time information
on gas flows . . . Information delayed [only] by an hour represents
a huge increase in the transparency of this market". Producers
and shippers continue to share information of a strategic and
commercial nature to which customers have an equal right, but
still no access, both in absolute terms and in terms of timing;
— the assumption that vertical integration
creates efficiency for consumers and contributes to greater security
of supply is contestable. Moreover, we believe that there are
risks to UK consumers from moves to increase consolidation within
national energy markets across Europe;
— we believe that analysis (conducted
on behalf of DTI by Global Insight) of energy market conditions
in 2004-05 as a "perfect storm"—an isolated incident
triggered by a unique coincidence of remote events—underestimates
circumstances that are demonstrably repeatable, have since been
repeated, and which may, we believe, create significant risks
and costs for consumers in an even more extreme form this winter.
8. CONCLUSION
8.1 The TISC inquiry comes at an important
time. energywatch strongly supports the committee's desire to
establish a deeper understanding of the drivers behind security
of supply on the gas system at a time when the UK is becoming
increasingly dependent on imports. This heightened dependency
is making British consumers more susceptible to competitive distortions
in international energy markets, and it is they who will be exposed
in the event that the domestic markets do not operate as expected.
19 Westminster Hall debate on oil and gas security
of supply, 12 October 2005. Back
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