APPENDIX 19
Memorandum by OFGEM
1. INTRODUCTION
1.1 Ofgem welcomes the opportunity to respond
to the Trade and Industry Committee's inquiry into security of
supply in the GB gas market for the coming winter. This is an
important issue and Ofgem welcomes the Committee's interest in
this. The gas supply and demand balance for this winter is expected
to be tight and there is no room for complacency.
1.2 Market participants, including National
Grid (NG) have a role to ensure that customers' demand is met
and hence to deliver security of supply. The primary responsibility
for balancing supply and demand lies with the market and commercial
arrangements provide incentives to achieve it. All market participants,
including NG, also share responsibility to work to enhance these
market arrangements to deliver security of supply.
1.3 This document outlines Ofgem's view
of the gas supply and demand position facing GB this winter and
how it has changed since February 2005. A summary of Ofgem's views,
other relevant market developments and the actions Ofgem has taken
are set out below:
Gas supply:
— NG's forecast of available beach
gas supplies has reduced by 7% based its hindsight view of availability
for 2004-05 and its base case projections for 2005-06;
— The two key projects to deliver additional
gas supplies for this winter—the Isle of Grain Liquefied
Natural Gas (LNG) import terminal and the increased import capacity
through the Belgian interconnector have been, or are on course
to be, successfully completed; and
— US gas prices have moved above GB
and NW European gas prices for this winter because of the impact
of hurricanes Rita and Katrina on US gas production. This may
reduce gas supplies to the GB and NW European market as LNG cargoes
may divert to the US.
Gas demand:
— NG's forecast of gas demand in severe
weather conditions (1 in 50 severe winter) has reduced by approximately
6% based on its hindsight view of supply availability for 2004-05
plus assumed demand side response and its equivalent base case
projections for 2005-06;
Market developments
— Wholesale and retail prices have
increased since February 2005 reflecting the movements in supply
and demand; and
— NG's overall assessment in its Final
Winter Outlook Report (WOR) was that under average weather conditions
there are sufficient gas supplies to meet all demand and that
even in the event of a severe winter (such as one that would only
be experienced once every 50 years), there are sufficient gas
supplies available to supply all domestic and small commercial
customers;
Ofgem actions
— Ofgem made sure that NG's Final WOR,
which was published in October 2005,[34]
signalled the need for gas producers, electricity generators,
energy suppliers and large customers to make sure they had in
place the necessary commercial and operational arrangements to
manage the challenges posed this winter;
— Ofgem has worked with suppliers and
large customers to improve the information that NG makes available
to them about the daily supply/demand balance in gas to enable
them to improve their ability to provide demand side response;
and
— Ofgem approved, in the face of industry
opposition, a change to the market rules proposed by NG that improves
the incentives for price-sensitive imported gas to continue to
be delivered in the event of a gas supply emergency.
2. NATIONAL GRID
WINTER OUTLOOK
REPORT
Background to the report
2.1 Each year, Ofgem asks NG, as System
Operator of the gas and electricity networks, to produce an assessment
known as the Winter Outlook Report (WOR). The purpose of the WOR
is to inform the market of any potential operational issues facing
the gas and electricity systems in GB for the coming winter, particularly
in the event of severe weather conditions (1 in 50 severe winter).
NG's report also provides information and analysis intended to
assist market participants in assessing the potential risks to,
and the interactions between, the gas and electricity markets
this winter.
Preliminary WOR
2.2 In May 2005, NG published its Preliminary
WOR.[35]
Rather than offering a "central" forecast of the level
of supply for the winter as in previous years, NG opted to conduct
a consultation exercise with the industry, using the report to
present a number of supply scenarios. These scenarios assessed
security of supply under a range of different demand and supply
conditions in both the gas and electricity systems. It was intended
that these scenarios would enable interested parties to identify
and understand the potential supply and demand situations which
might develop over winter 2005-06.
Final WOR
2.3 On 5 October 2005, NG published its
Final WOR,[36]
taking account of industry responses to both its Transporting
Britain's Energy (TBE) consultation and the Preliminary WOR consultation.
There were a range of different views from market participants
as to the likely level of gas supply for this winter, which NG
used to create a base case. The base case supply forecast for
the wholesale gas market was as follows:
| Supply source |
Maximum
supplies (mcm/d) | Base case (mcm/d)
92.5% max beach,
75% new imports and storage
|
| Beach | 327 | 303
|
| LNG imports | 17 | 13
|
| Interconnector imports | 48
| 42 |
| Existing storage | 114 |
114 |
| New storage | 6 | 5
|
| Total | 512 | 476
|
| | |
2.4 These supply projections should be compared to NG's
projections for peak day demand of 494 mcm under average weather
conditions and 563 mcm under 1 in 50 severe winter conditions.
2.5 As was the case with the Preliminary WOR, in its
Final WOR NG identified that the main security of supply issues
for this winter continued to relate to the wholesale gas market
in the event of a severe winter. NG also considered the potential
interactions with the electricity market in these circumstances
as gas-fired electricity generators make up a significant proportion
of gas demand.
Overall position
2.6 The figure below shows the supplies that NG forecasts
would be available to meet demand on the 100 days of highest demand
over the winter under average and severe weather conditions. Where
the demand for a day exceeds NG's forecast of the available supplies,
NG assumes that the shortfall would be overcome by demand side
response. This would consist of large customers, including power
stations, either switching to back-up fuels, reducing their gas
demand and selling gas back into the market or being interrupted
under the terms of their supply contracts.
2.7 On the basis of NG's Final WOR, the key messages
for winter 2005-06 are that:
— under average weather conditions there are sufficient
gas supplies to meet all demand with only a modest amount of demand
side response required; and
— even in 1 in 50 severe winter conditions there
will be sufficient gas to maintain supplies to domestic and other
non-daily metered customers although this will require much greater
demand side response.
2.8 NG's conclusions are based on assumptions regarding
the level of demand-side response that will be available. Under
average weather conditions only 0.1 bcm of demand side response
is necessary whereas in 1 in 50 severe winter conditions 3.7 bcm
may be required.[37]
2.9 While the main issues for this winter continue to
relate to the wholesale gas market, in terms of the electricity
market NG's analysis suggests that:
— under average weather conditions there is sufficient
generation to meet all demand; and
— in 1 in 50 severe winter conditions there is sufficient
generation to meet all demand, provided that plants are reliable
and adequate gas fired (CCGT) generation remains available when
demand side response is required in the gas market.[38]
3. SUPPLY SIDE
SENSITIVITIES
3.1 This section comments on the main supply side issues
that were raised in the WOR, however it is important to note that
there could be other supply side shocks which are not reflected
here. Extraordinary events can occur, for example hurricanes Katrina
and Rita, which cannot be predicted in advance. Therefore, in
this section, we are setting out our views on issues which were
highlighted by market participants' during the WOR consultation
process as being the main foreseeable events that may affect gas
supplies during this winter. It is important to stress that the
tightening of the supply-demand position is acknowledged by market
participants and has been reflected in price movements.
Beach
3.2 As shown above, in the Final WOR, NG's maximum predicted
beach supply for this winter (2005-06) is 327 mcm/d, which is
slightly lower than the figure of 336 mcm/d which was quoted in
the Preliminary WOR. Several respondents to NG's WOR consultation
considered that a figure of 336 mcm/d was optimistic and so the
downward revision to 327 mcm/d represents a more realistic view
of maximum predicted beach supplies in accordance with the views
of market participants. NG's Final WOR figure of 327 mcm/d compares
to its prediction at the same time last year that maximum supplies
for winter 2004-05 would be 364 mcm/d. On the face of it, this
is a significant decline but, based on its experience last winter,
NG subsequently outlined in the Preliminary WOR for winter 2005-06
that its hindsight view was that maximum beach availability in
2004-05 was 351 mcm/d. For this winter, NG has continued to take
a more conservative approach to projecting beach supplies with
the result that its projection is likely to represent a more realistic
estimate than those produced in previous years. It is important
to note that although the supply and demand position this winter
is tight, the year on year comparison must be considered taking
into account the over-forecasting of the maximum level of beach
supplies in previous winters.
3.3 NG has predicted that the average level of beach
supplies will be 303 mcm/d based on a 92.5% availability figure.
Again, this is a more conservative assumption than NG has adopted
in the past, when it predicted that, on average, 95% and even
100% of maximum supplies would be available. With the benefit
of hindsight, this has been shown to be overly optimistic and
respondents to the WOR consultation considered that a more conservative
assumption should be adopted. It is important to note, however,
that reliability on any given day is dependent on a number of
factors including the flows from price sensitive gas fields, as
discussed further below.
3.4 One reason that NG estimates that average winter
beach supplies are lower than its maximum supply projection is
that the average projection excludes the output of so-called "price
sensitive" fields (whereas the maximum projection includes
them). Price sensitive fields are fields where gas production
only occurs if the gas price is high. In an average winter, the
number of days output from such fields may be relatively low but
if the winter is cold and rising demand drives up gas prices then
some of these fields are capable of continuous production for
several months at a time. Including the output of these fields
would increase the average level of beach supplies back towards
the peak level.
3.5 However, one of the risks regarding beach supplies is
that the information that NG received via the TBE process may
be overly optimistic. This has been a problem in previous winters.
If this is the case then the level of beach supplies could actually
be lower than predicted in the WOR.
LNG
3.6 In addition to beach supplies, large scale LNG imports
via the Isle of Grain terminal will be available for the first
time this winter. Several shipments of LNG have already been delivered
and processed so the operation of the terminal has been proven
ahead of the winter. NG has predicted that, on average, 13 mcm/d
of LNG imports will be available although the maximum processing
capacity of the terminal is 17 mcm/d. Therefore, on very cold
days, an extra 4 mcm/d may be available.
3.7 On the other hand, the LNG market in GB is part of
wider North Atlantic regional market for LNG and therefore we
would expect deliveries to be targeted at those markets within
this region that have the highest gas prices. At present, this
would suggest that cargoes might be diverted from NW European
markets or GB to the US, where gas prices are very high (around
73 p/th for November gas compared to 45 p/th in GB). However,
there are a number of factors other than price which will influence
the decisions that LNG suppliers reach on where to send their
supplies. First, LNG may not be able to access the highest priced
market due to limited importation capacity in the US or gas quality
problems and in this case would go to the next highest price market.
Second, the price premium may not be high enough for any LNG cargo
to be diverted because of the additional transportation costs
involved in sending it to that market. Finally, the extent to
which the LNG is contracted on a long-term firm basis to end users
makes it difficult and costly to make diversions on a spot basis.
3.8 Should it become apparent that the UK is heading
into a severe winter, it is likely that GB gas prices would start
rising and commercial incentives to divert cargoes away from the
Isle of Grain would disappear. As the figure below shows, based
on the current forward curve, prices for January 2006 would only
have to rise by a small amount for diversions to the US to become
unprofitable in that month. (The European cost advantage is taken
from a CERA report that suggests a premium of 0.75-1.00 $/MBTu
is "usually sufficient" to attract uncommitted cargoes
to the US Gulf Coast). Further discussion of the US situation
is contained in the annex.
3.9 It is also the case that cargo diversions do not
necessarily have to disadvantage GB—they can result in additional
LNG arriving in GB. This has already occurred as, in early October,
a cargo was diverted from Zeebrugge to Grain, presumably because
there was an opportunity to sell the cargo on more favourable
terms.
Interconnector
3.10 Some respondents to the WOR consultation expressed
concerns regarding the reliability of gas flowing from the interconnector,
due to the lack of liberalisation in the European market. Ofgem
has worked hard to progress this issue for a number of years and
is particularly supportive of the DG Comp initiative which is
looking at the degree of liberalisation in the various European
markets. It is unlikely that any progress will be made before
this winter, but we will remain proactive in terms of our support
of the DG Comp investigation and our input into the Council of
European Energy Regulators (CEER) to ensure that market liberalisation
in Europe does occur as quickly and effectively as possible.
3.11 For the coming winter another potential risk area
concerns the level of interconnector imports. NG has assumed that
100% of existing interconnector imports and 75% of new imports
will be delivered. This raises two issues: first, will the new
interconnector capacity be available for the winter and second,
will the forecast level of imports materialise. As regards the
first issue, Interconnector UK (IUK), the operator of the interconnector
connecting Bacton and Zeebrugge, has not only confirmed that the
new capacity will be available for this winter but also that it
is on track to be commissioned in November 2005—one month
ahead of schedule.
3.12 With regard to import levels, it is, of course,
impossible to be categorical on this issue. However, there seems
to be no reason to believe that there is likely to be a repeat
of the behaviour seen in late September/early October 2003 when,
at least for a short time, the direction of interconnector flows
was inconsistent with gas price differentials and gas was exported
from GB despite prices being higher here than on the continent.
We concluded that one reason for this apparently irrational behaviour
was the difficulty of obtaining transportation capacity to deliver
gas to the interconnector. This is unlikely to be an issue over
the true winter months since the normal pattern is for the interconnector
to import gas to GB over the winter.
3.13 Additionally, as the shareholders funding the interconnector
upgrade, the primary capacity holders must anticipate that the
extra capacity being delivered by the upgrade will be of value
and will be utilised. As outlined further below, current prices
for the winter period in GB and NW Europe suggest that gas will
be imported into GB at maximum rates. Given these factors, one
would anticipate that the IUK capacity holders would be seeking
to ensure that they are able to flow gas into GB for the coming
winter.
Storage
3.14 In addition to the commissioning of new storage
facilities during the course of the year, which were included
in the May 2005 Preliminary WOR, Ofgem is aware that the release
of additional deliverability of gas from storage is being considered
for this winter. Clearly, additional deliverability would help
in the short-term by making more gas available on any given day
but it would not alter significantly the overall outlook for the
winter since, in the absence of opportunities to refill the storage
facility, it would simply mean that the gas in storage was exhausted
more quickly.
3.15 Additionally, since the publication of NG's Final
WOR the intended release of additional capacity at Rough, the
largest gas storage facility in GB, has been announced. It is
envisaged that up to 30 million therms (circa 84 mcm) will be
offered for sale. This would be available for the forthcoming
winter starting in November 2005.
4. PRICES
GB wholesale prices
4.1 Forward wholesale prices for this winter are now
between 15% and 30% higher than they were in early February. They
have also, until very recently, been consistently over 50% higher
than forward prices were for the equivalent period last winter.
Additionally, outturn prices for the period February to October
2005 have also been around 50% higher than they were last year.
All these facts suggest that outturn prices for this winter will
be high although forward prices and outturn prices can diverge
significantly.
European wholesale prices
4.2 Reported forward prices remain higher in GB than
in Europe, although it should be noted that published prices for
continental gas markets apply to only a small fraction of the
gas being sold. Over the past 10 days, the premium of GB prices
over Dutch prices has increased significantly (data on current
prices is provided in the appendix). These prices suggest that
currently, as in past winters, the interconnector should be used
for imports to GB, as assumed in NG's base case.
4.3 While wholesale prices in GB are high it is important
to note that lower taxes and network charges mean that overall
GB retail prices remain competitive with those in the rest of
Europe.
US wholesale prices
4.4 As referred to earlier, at the Henry Hub in the US
gas is currently trading at around 73 p/th for November compared
to 45 p/th in GB. The US price is around 40% higher than the GB
price.
Retail prices
4.5 Between February and October 2005, average annual
domestic gas bills have risen by 2%, although more price increases
have recently been announced. These follow on from substantial
increases during the previous year and are primarily linked to
the rise in wholesale gas prices.
4.6 Ofgem is very conscious of the impact that rising
retail prices can have on the fuel poor and has recently (13 October)
held a seminar to promote debate on this issue. We highlighted
the continuing need for innovative approaches to target help at
the hardest to reach fuel poor customers. Over the past year,
there has been considerable progress towards adopting a more "joined
up" approach to fuel poverty, for which we called last year,
and following the guidance we produced at the end of last year,
most suppliers have now introduced some form of social tariff,
designed to alleviate the position of the poorest customers. With
every 1% increase in prices increasing the numbers in fuel poverty
by 40,000 more needs to be done and Ofgem continues to take forward
a number of initiatives including encouraging best practice on
benefits health checks and communicating to consumers how they
can save money on their bills by switching supplier, switching
payment method or through energy efficiency.
5. OFGEM'S
ROLE IN
SECURITY OF
SUPPLY
5.1 Ofgem has been working to facilitate the efficient
operation of the wholesale gas market in order to protect the
interests of customers and will continue to do so going forward.
There are a number of areas of progress which are relevant to
gas supply and demand over the winter 2005-06 period, in particular:
— Ofgem has approved a modification proposal to
revise the cash out arrangements that apply in an emergency. This
enhances the incentives for shippers not to be short of gas in
the run up to and during an emergency, thereby reducing the risk
of an emergency being called;
— the Ofgem led Demand Side Working Group (DSWG)
has been working to ensure greater demand side response will be
available to the market for this winter. Significant progress
has been made including the introduction of the Gas Balancing
Alert which will be issued when the system is tight as a signal
for large customers to offer demand side response to the System
Operator;
— the DSWG has worked to improve the information
available to market participants regarding the gas demand and
supply conditions. As part of this, NG has created a new website
which contains all the relevant information that customers need
to make a decision in relation to the provision of demand side
response. This is due to go live in November 2005;
— Ofgem is holding a seminar on 7 November 2005,
entitled "Options for energy buyers this winter". This
seminar is aimed at providing energy buyers with information which
will help them make informed decisions this winter regarding their
energy consumption; and
— encouraging the transparency and availability
of information to all market participants. This has included supporting
the DTI offshore information initiative. Phase 3 of this initiative
went live during summer 2005. The effect of this will be to ensure
that the market is aware of the forecast and actual level of beach
supplies and any maintenance problems, helping it to react accordingly
and source the gas from other means. Another proposal relating
to the publication of further information has been put forward
but Ofgem has decided to delay making a decision on this modification
until there has been time to assess the impact that the newly
released phase 3 data is having on the workings of the market.
5.2 In addition, Ofgem is working on an ongoing basis
in the following areas:
— Ofgem has an important role in conducting surveillance
of the operation of the GB gas and electricity markets. As part
of this market surveillance role, we will continue to monitor
the gas supply status throughout the winter. In relation to the
gas probe which Ofgem has recently undertaken in relation to gas
prices as part of its monitoring role, it is important to note
that Ofgem has concluded that there was no reason to take any
further action in respect of the North Sea contracts, in particular
the contracts for the Sean field.
— Ofgem has welcomed the decision of the European
Commission to investigate thoroughly the European gas (and electricity)
markets through a formal sectoral review. We are working closely
with the Commission on this enquiry. More generally, we are working
closely with other regulators to increase the information about
continental energy markets that is made available to market participants
and to remove obstacles to the establishment of effective wholesale
and retail competition.
6. CONCLUSIONS
6.1 Overall, the position in respect of the coming winter
has not altered significantly since February 2005. On the upside,
the Grain LNG terminal is now in operation, the interconnector
upgrade remains on track for early completion and there may be
more gas deliverability from storage than we had anticipated.
On the downside, there is a chance that high gas prices in the
US may lead to LNG diversions, reducing the extent to which NG
can rely upon LNG imports although there are a number of reasons
why such diversions may not materialise to any great extent and
are, in any case, likely to occur before the onset of the period
when the coldest weather could be anticipated.
34
"Winter Outlook Report 2005-06", NG, October 2005 available
at: http://www.ofgem.gov.uk/temp/ofgem/cache/cmsattach/12493_214_05.pdf?wtfrom=/ofgem/whats-new/archive.jsp Back
35
"A Consultation on Winter 2005-06", NG, May 2005 available
at: http://www.ofgem.gov.uk/temp/ofgem/cache/cmsattach/11584_14405b.pdf?wtfrom=/ofgem/whats-new/archive.jsp Back
36
"Winter Outlook Report 2005-06", NG, October 2005 available
at: http://www.ofgem.gov.uk/temp/ofgem/cache/cmsattach/12493_214_05.pdf?wtfrom=/ofgem/whats-new/archive.jsp Back
37
The comparative figure quoted by NG in its 2004-05 WOR for a
1 in 50 winter was an overall demand side response requirement
of 2.4bcm. Back
38
NG stated in its Final WOR that 1.8bcm of the overall level of
demand response which could be required in a 1 in 50 winter could
be provided by CCGTs without adversely impacting on security of
supply in the electricity market. The comparative figures quoted
by NG in its 2004-05 WOR were an overall demand side response
requirement in a 1 in 50 winter of 2.4bcm, of which 1.6bcm could
be provided by CCGTs without any adverse effects on the electricity
market. Back
| 
