Conclusions and Recommendations
1. Gas supplies this coming winter are likely
to be tighter than was anticipated in February, principally because
of the continued faster-than-expected decline in production from
the UKCS. New import and storage facilities are coming into operation
roughly at the rate predicted. The difficulty in predicting actual
import rates has grown because of the effects of the hurricanes
in the Gulf of Mexico this year: the uncertainty about the extent
and duration of the damage to the USA's gas production facilities,
with the resulting unpredictability of demands for LNG imports
to the United States. We note National Grid's assessment of the
security of supply this winter, and the Meteorological Office's
suggestion that there is about a 66% chance of this winter being
a '1 in 10'. Although it is extremely unlikely that domestic
customers and the majority of businesses will suffer any interruptions
to their gas or electricity supply because of the tight gas supply,
it is very likely that the largest I&C customers will, if
they have the relevant contracts, suffer interruptions, or, if
they purchase gas on the spot market, have to pay very high prices
for that gas, or both. It is, unfortunately, impossible to do
anything to change this situation now, although some mitigating
actions can be taken. However, we believe that the Government
needs to pay closer attention to the consequences of this situation
and to demonstrate greater urgency in pursuing a single market
within the EU.
The Department entirely concurs with the Committee's
assessment of the level of gas supplies this winter. The experience
of the winter to date bears out this assessment. However it is
worth noting that so far this winter, the risk of industrial customers'
gas supplies being interrupted has been low and indeed, there
have been no 'Gas Balancing Alerts'. The demand-side response
predicted in National Grid's Winter Outlook report from the non-power
heavy users was always dependent on big users switching themselves
off in relation to high prices rather than through interruptible
contracts. As we have seen, some are already doing so. Most
of the predicted demand-side response comes from power generators
switching from gas to coal or distillates, again in response to
price.
The Department would like to take this opportunity
to reassure the Committee that we are paying close attention to
the consequences of this situation and ensuring that any lessons
to be learnt from this winter will be fully taken into account
in planning for next winter. Officials have had a number of meetings
with industry and other stakeholders, in the context of the follow-up
to the Number 10 meeting with the CBI and others on 9 November,
to discuss these lessons and substantial work has continued to
be progressed to refine and communicate existing emergency arrangements.
We will continue to liaise closely with industry, Ofgem, National
Grid and others in preparation for next winter.
We should also like to reassure the Committee that
the establishment of a properly functioning EU energy market remains
a top priority for the Government. We pressed hard for this during
our Presidency. At the Energy Council on 1 December it was agreed
that secure supplies of electricity and gas, delivered in open,
transparent and liberalised markets were crucial for Europe's
competitiveness. Gordon Brown and Alan Johnson wrote to Neelie
Kroes, the EU Competition Commissioner, on 5 December in support
of Ofgem expressing their concern about the lack of competition
and transparency in the European gas market and asking her to
investigate, as part of the Commission's sector inquiry, whether
abusive behaviour or distortions in the European market may be
causing the price volatility in the UK gas market. The Commissioner
has agreed to investigate and report on the findings soon.
2. Although the effect of peaks in prices on the
wholesale gas market is moderated for domestic consumers by the
averaging effect of their billing mechanisms and by the fact that
wholesale prices form only about 50 percent of the retail cost
of their gas, rising fuel prices will mean that more people fall
into fuel poverty. Although greater energy efficiency is the most
effective means of reducing the number of those in fuel poverty
absolutely and permanently, it is not—as the Minister acknowledged—an
immediate response for those suffering now from higher energy
prices. If fuel prices continue to rise it will be essential to
provide further assistance to the elderly. However, we are particularly
disappointed that little progress has been made in dealing with
the plight of some non-elderly vulnerable groups, particularly
disabled people, whose difficulties in relation to fuel poverty
have been known for a long time.
The Government takes the issue of rising energy prices,
and its potential impact on the number of households in fuel poverty,
very seriously. Government, with other interested parties, has,
therefore, taken a range of measures to mitigate the impact of
price rises. As Committee members will be aware, the Government
has already announced further assistance to elderly households
through the significant additional funding of £300m to tackle
fuel poverty across the UK announced in the Pre-Budget Report
on 5 December 2005. The Chancellor of the Exchequer also announced
in the Pre-Budget Report that Winter Fuel Payments to all pensioners
would continue to be made throughout the life of this Parliament.
The additional £250m in England will increase
Warm Front Scheme funding to more than £800m between 2005-8
and will enable the Scheme to focus a greater level of activity
towards pensioner households in receipt of Pension Credit through
the provision of central heating. The increased funding will also
provide those pensioner households who are not eligible for benefits
with a contribution of £300 towards the cost of the installation
of a central heating system.
We need to tackle fuel poverty across the entire
range of vulnerable households, though. In England, we have a
target of eradicating fuel poverty amongst vulnerable households
by 2010, which, as well as the elderly, includes families with
children, and households containing someone who is sick or disabled.
Some one million households have now been assisted by Warm Front.
Grants under the Scheme are available to elderly households and
those on specified disability or income related benefits, enabling
them to get a range of central heating and insulation measures.
Benefit Entitlement Checks are also available to households if
they do not qualify for the Scheme at the time of application
or if their dwelling cannot be brought up to a set energy efficiency
level. Energy supply companies also provide a range of assistance
to customers as part of their work to deliver their targets under
the Energy Efficiency Commitment. In addition, last October they
launched the Home Heat Helpline, an industry initiative designed
to enable customers to be directed to assistance available to
them from their supplier. Customers can also be referred to DWP
for a Benefit Entitlement Check where appropriate.
On the specific issue of fuel poor households containing
someone who is sick or disabled, we acknowledge that the reduction
between 2001 and 2003 (the latest available data) was not as large
as for households containing children or someone who is elderly.
We are considering options in the context of the energy review
on how best to tackle fuel poverty among all household types,
and accept the Committee recommendation that tackling fuel poverty
in households containing someone who is disabled is a very important
element.
3. The Government cannot directly affect the price
of gas. However, it can ensure that there are no regulatory or
economic barriers to maximising gas supplies and storage facilities,
and improving the functioning of the gas market. It can also encourage
energy liberalisation in the European Union, and help I&C
customers to share best practice on how to cope with high prices
and a volatile market. We are pleased to note that the Government
has been pursuing all these. However, in the area where the Government
can take direct action—ensuring no-one is penalised because,
with gas interruptions looming, they have temporarily breached
emissions limits as the only alternative to suspending operations—the
Minister seemed reluctant to do anything at all. We accept the
enormous importance of tackling climate change, but we cannot
see that giving temporary derogations in extremis
(and both Ofgem and the DTI believe that the tight supply situation
is likely to last for only another couple of years, and that this
winter is likely to be the most problematic) would seriously undermine
the Government's long term climate change programme. We look forward
to receiving the Minister's assurance that the Government would
be willing to give temporary derogations this winter and in the
next two winters if prolonged cold spells make large scale gas
interruptions inevitable, at the same time as his making it abundantly
clear that such derogations in the years thereafter would not
be forthcoming except in a case of grave national emergency.
The Government welcomes the Committee's acknowledgement
of the effort we are putting into removing regulatory and economic
barriers to maximising gas supply and storage facilities and improving
the functioning of the gas market as well as our work on promoting
EU energy liberalisation and competition and helping I&C customers
share best practice. Regarding the latter, Energywatch and DTI
held a successful seminar for small and medium-sized businesses
and public sector organisations on 30 November, and Ofgem have
been running a series of seminars for energy purchasers across
the country.
The Government is sorry to learn that the Committee
came away with the impression that we were reluctant to look at
temporary derogations in emissions limits in extremis. The Government
has decided not to increase emission allowances under the EU Emissions
Trading Scheme or under the industry-specific Climate Change Agreements.
Both of these already have flexibility built into them through
the ability to trade allowances to cover increased emissions,
and by applying to the year as a whole, such that higher emissions
at one time can be offset by reductions at other times.
However, where site-specific environmental regulations
restrict emissions, there is scope for flexibility and we have
been looking at ways of taking work on this forward for some months.
The Minister wrote to the Environment Agency to encourage them
to take as flexible an approach as possible to requests for temporary
derogations to allow oil-fired power stations to run for longer
periods, thus reducing pressure on demand for electricity from
gas-fired generators. At the same time officials have been working
closely with the Agency to ensure that any companies writing to
them requesting temporary derogations to conditions set out in
their specific environmental permits, are treated as flexibly
as possible to allow fuel switching. We have also been in touch
with the Scottish Environmental Protection Agency through the
Scottish Executive.
We are pleased to assure the Committee that in both
these instances the Agency has confirmed that they are taking
a flexible approach for the winter, subject of course to any over-riding
unacceptable environmental impacts (correspondence attached at
annex A for the Committee's information). The Agency has approved
26 applications from energy intensive industry to allow fuel switching
at the time of writing.
The Agency will be monitoring the environmental impact
of fuel switching very carefully. This response is an appropriate,
not an environmentally reckless, policy for this winter. We would
also like to emphasise that we would expect companies who expect
to face similar issues next winter to discuss with the Agency
well in advance what scope there is for building the necessary
flexibility into their permits or indeed to take action to ensure
that temporary fuel switching does not lead to adverse environmental
impacts in the future. While it is important to build flexibility
against possible contingencies into environmental constraints,
it is equally important to take environmental concerns into account
in developing contingency plans.
4. Financial institutions that might have been
expected to take part in or finance trading in the forward market
for gas are not interested in doing so: the UK market is not big
enough, and they are unlikely to become involved unless there
is a Europe-wide forward wholesale gas market. This is depressing,
but not surprising. It supports our predecessors' conclusion that
the forward market was too illiquid to be considered functioning,
and it underlines the fact that the operation of the liberalised
UK market is heavily dependent—and becoming ever more so—on
the unliberalised Continental European one.
We welcome the Committee's highlighting of the difficulties
caused to the UK market by an unliberalised Continental Europe.
It is also extremely helpful that the Committee recognises that
the best way to address this issue is through encouraging liberalisation
on the continent rather than moving to adopt protectionist measures
in the UK in response. One of the recommendations of the study
of the Forward Gas Market that DTI commissioned from Global Insight
in early 2005 was that whilst the market is functionally liquid,
more could be done to boost confidence in it and encourage participation
by banks, commodity traders, hedge funds etc.
Officials have been discussing the lack of liquidity
with the Futures and Options Association's (FOA) Power Trading
Forum, an industry body in the City which campaigns to improve
the liquidity of traded markets. On 6 November, the FOA held
a Roundtable with DTI, Ofgem and representatives of banks, traders,
exchanges and industry to investigate why more players are not
trading on the forward market and whether there are any barriers
to entry that Government could help remove. The conclusion was
that the framework of the market was good, but that there were
too few people holding gas and so it had become a sellers market.
There were signs that a number of financial institutions were
on the point of coming in and they would bring cash and take risks,
as companies such as Enron and Dynergy used to. There was not
much Government could do to help them get involved but a number
of actions resulted:
— harmonising
gas and electricity trading calendars;
— training and education for commodity
traders; and
— improving industry documentation/contracts.
We are following up these actions with the FOA and
others.
5. The reports published by DG Transport and Energy
and DG Competition on 15 November seem to us to provide a comprehensive,
rigorous analysis of the failure to achieve real liberalisation
in the European market to date and of the obstacles remaining
to electricity and gas companies seeking to trade in, buy from,
or use transit or storage capacity in, Continental Europe. These
obstacles will not be overcome quickly or easily—the Commission
has noted that many of the legacy contracts that make purchasing
or transporting gas through Europe so difficult have a decade
or more to run—with the result that we risk having a malfunctioning
forward gas market for a decade. Although LNG imports will alleviate
some of the problems of liquidity, the UK will be competing for
those with not only some European countries (such as Spain) but
also the Far East and the USA.
We agree with the Committee that the reports published
by the Commission on 15 November 2005 provided a comprehensive
and vigorous analysis of the state of EU energy markets and we
look to the Commission to propose remedies to tackle the serious
malfunctions it identified. An interim report on the preliminary
findings of the sector inquiry is to be published in February
2006. While it is true that some of the obstacles may take time
to remove, there are a number of areas where action could be taken
under existing legislation to bring about a significant improvement
in the functioning of EU energy markets, for example to increase
transparency, make unbundling more effective, optimise use of
pipeline capacities. Better functioning energy markets will provide
the market signals needed to attract gas supplies to markets that
value them most.
We endorse the Committee's view that LNG imports
will alleviate some of the problems of liquidity in the forward
gas market. The UK is an attractive and competitive destination
for LNG and the new Isle of Grain import facility is making a
valuable contribution to the UK's gas supplies this winter. Further
projects are being planned at Milford Haven (two projects), Canvey
Island and Teesside. As the Committee recognises, the portability
of LNG means that the UK will be competing with other countries,
both in Europe and further afield. However we should not just
look at the downsides of this. LNG supplies are very flexible,
which means that we can import supplies from a much wider range
of countries, including for example Algeria and Qatar. This added
flexibility is a very useful addition to our own North Sea reserves
and the pipeline supplies we get from Continental Europe.
6. We expect the UK Government to give its full
backing to the Commission in its attempts to enforce existing
legislation, and to introduce any amendments designed to close
any loopholes.
The Committee is right to expect the Government to
give its full backing to the Commission in its attempts to enforce
existing legislation and we shall continue to do so. We will
also support the Commission in identifying any areas where the
existing legislation may not be sufficient to address defects
identified in the functioning of EU energy markets. As mentioned
above in response to the first point, the Secretary of State and
the Chancellor of the Exchequer wrote to the Commission setting
out urgent concerns about the functioning of the EU gas market
and urging the Commission to immediately investigate whether recent
gas price volatility in the UK market might be due to an abuse
of market power or distortions in the wider European market, particularly
with respect to the supply of gas to the Zeebrugge interconnector
and the supply of LNG across the EU.
7. It is far from clear that all energy users
have derived continuing and sustainable benefits from the early
liberalisation of the energy market in the UK. The gas supply
problem this winter will affect—whether through high prices
of gas and electricity, or through actual supply interruptions—all
domestic and I&C customers. The problem is caused not only
by matters outside the control of government, but also by a legacy
of slow development of infrastructure, and the lack of a true
European market for gas. These are matters that do lie, at least
partially, under the control of the UK Government. It is therefore
right to expect Government to take steps to mitigate the impact
of problems this—and probably for the next two—winters.
Energy users in the UK have enjoyed significant benefits
in the form of lower prices since market liberalisation. However,
as the Committee recognises, the UK has moved to being a net importer
of gas and there have been worldwide rises in fossil fuel costs.
UK spot prices have been more volatile and higher recently because
of the tight supply/demand balance this winter. Gas has had to
be delivered from higher-cost sources, such as LNG, and the tight
supply situation has also put a premium on the value of gas in
storage. This has had a significant impact on energy-intensive
users such as the chemicals, steel, brick and glass industries
who are now buying gas on the spot market.
A large proportion of other industry, and essentially
all domestic customers, contract to buy their gas at fixed prices
which, at the time of the latest official statistics in October
2005, were still below average prices in Europe. However, we
are aware that a growing number of businesses have switched to
variable or floating contracts, that are linked to the spot price.
We also are aware that prices offered for fixed price contracts
have increased since October. However we would also like to emphasize
that we do not expect domestic supply interruptions.
We take very seriously the issue of companies facing
temporary financial difficulties as a result of high energy prices.
Companies affected by the current high energy prices that are
unable to meet their current tax obligations as a result should
contact Her Majesty's Revenue and Customs. HMRC's practice is
to work with individual taxpayers who are facing immediate financial
difficulties, to see what can be done to ease those difficulties
in the short term and ensure the survival of the business and
a return to timely payment. This has to be done on a case by case
basis, as HMRC needs to understand the precise circumstances of
each taxpayer.
The Government would therefore like to reassure the
Committee that we understand the tough conditions by which high
energy users are currently operating and are leaving no stone
unturned, working closely with industry to mitigate the situation
and reduce the impact. It is also worth making the observation
that rising energy prices are not solely a UK problem, but one
that is shared by all energy markets across the World whether
liberalised or not.
Next winter is likely to remain tight for gas supplies.
However there are additional infrastructure projects that are
expected to commission during the course of next winter which
should help to ease the situation. There are 3 projects expected
to commission in 2006:
— further
upgrade to the existing interconnector from Belgium;
— the new Langeled pipe-line importing
Norwegian gas to Easington;
— and the new "BBL" ("Balgzand-Bacton
Line") interconnector from the Netherlands.
Two further major import facilities are scheduled
to commission in 2007-08:
— Dragon
LNG import terminal at Milford Haven.
— South Hook LNG import terminal, also
at Milford Haven.
In addition, and subject to regulatory consents,
two new gas storage facilities may also commission in 2007-08
(Caythorpe and Albury).
DTI has played a proactive role working with developers
and regulators to smooth the regulatory path in relation to infrastructure
development. The Government has also decided on a number of actions
to facilitate future gas supply infrastructure projects:
— legislation
(when Parliamentary time permits) to establish an offshore regime
to enable innovative projects to go forward—gas storage
in salt caverns offshore, and LNG import projects with offshore
unloading;
— we are looking at the onshore consents
regimes, in co-ordination with the Energy Review, and with the
Barker Review into the planning and land use system; and
— measures to improve public understanding
of the need for additional gas supply infrastructure projects,
including onshore projects, and to promote best practice among
project sponsors when applying for regulatory consents.
The Government has consistently lobbied the Commission
to further drive forward the liberalisation agenda. We made the
liberalisation of European energy markets a priority for our recent
Presidency of the EU putting it top of the agenda for the Energy
Council on 1st December. The Council was unanimous that secure
supplies of electricity and gas, delivered on open, transparent
and liberalised markets are crucial for Europe's competitiveness.
As mentioned above, the Government is already looking
at lessons that can be learned from our experience this winter
with the intention of ensuring that difficulties in the coming
two winters are kept to a minimum.
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