Oil-gas price link
36. One of the key characteristics of the European
gas market is the indexing of long-term gas contracts to the price
of oil, usually with a lag of 3 to 9 months.[64]
This exists largely for historical reasons, but persists because
the gas market in Europe is not sufficiently liquid to allow producers
to use it to index long-term contracts.[65]
One of the main concerns with indexation to the oil price, highlighted
by the European Commission in its sector inquiry, is that wholesale
gas prices cannot respond to changes in supply and demand, which
is potentially damaging to security of supply.[66]
The Commission did not find any trend towards a more market-based
pricing mechanism for long-term gas import contracts. It concluded
that creating greater liquidity in Europe's gas trading hubs would
increase confidence in price formation, and help break the oil-gas
price link. Because the UK's gas market is relatively well-established,
there has been a move here towards contracts linked to prices
on the wholesale gas market. But as European gas prices set a
floor for those in the UK the oil-gas price link will continue
to be a major influence on price movements in the UK market.
37. While there seems little Ofgem or the Government
can do to influence the development of gas trading on European
hubs, it is worth considering the role UK markets play in determining
the price of oil. Crude oil is currently trading at about
$140 per barrelup more than 40% over 2008. The Chief Executive
of Gazprom recently stated that prices could reach $250 per barrel
in 2009.[67] This compares
with a low of $10 a decade ago. There has been much debate over
whether market fundamentals are driving the current increases
or speculation by traders.[68]
Although the oil and gas producers told us that market fundamentals
will determine the price of oil in the long term, Shell also stated:
"we find it difficult to rationalise all of the price movements
on the basis of fundamentals alone".[69]
ExxonMobil also said: "We are surprised about the prices
we see today".[70]
Since June 2008 US politicians have voiced concern that speculators
are exploiting differences between the regulatory frameworks for
energy commodity trading in the UK and USan issue referred
to as the 'London loophole'.[71]
This has led to a confrontation between the two countries' financial
regulators over US regulation being imposed on UK markets. On
the other hand, many commentators are sceptical about claims that
speculation is even in part to blame, saying that investment in
oil futures is not large in relation to global trade in oil, and
pointing to the absence of increasing inventories of oil which
would exist if prices were too high.[72]
38. The contractual link between oil and gas prices
on the Continent distorts the wholesale gas market and therefore
the environment in which investment and consumption decisions
are made throughout the EU. In the absence of liberalisation in
the short to medium term, it seems unlikely that market liquidity
will increase sufficiently on European trading hubs to provide
an alternative means of indexing long-term gas contracts. The
oil price will therefore continue to have a significant influence
on UK gas prices. It is likely that European gas prices will continue
to rise in lagged response to the current increases in oil prices,
and thus will feed through to the UK market.
39. Trading on London markets plays an important
role in setting the global price of oil. We fully acknowledge
the important role futures markets play in helping purchasers
of commodities to hedge against future price movements and so
assist in planning their businesses. We also note the Treasury
Committee's current interest in this subject. We consider, however,
that the Financial Services Authority would be well advised to
investigate the extent to which speculators within its jurisdiction
are currently driving up global oil prices, and to take action
if appropriate.
Gas contracting
40. The Chief Executive of INEOS ChlorVinyls told
us gas suppliers on the Continent had refused to sell gas to the
company on the basis of European-style long-term contracts if
the company intended to ship it back to the UK via the Interconnector.
Instead the company was only offered prices using the UK pricing
structure, which is based on the National Balancing Point.[73]
This is despite the fact that the company's operations on the
Continent are able to buy gas under European-style contracts.
Shell said it was "astonished" that the company had
received this response, while ExxonMobil said it was "puzzled".[74]
Ofgem told us it had been made aware of the issue by the company,
and congratulated it for going public with its concerns.[75]
41. Clearly something is wrong with the GB wholesale
gas market if INEOS ChlorVinyls, one of the UK's biggest industrial
energy consumers, would rather ship gas from abroad under a European
contract, than engage directly with the domestic market. Not only
should Ofgem investigate why companies are behaving in this way,
in conjunction with the European Commission it should also investigate
the legality of gas suppliers offering widely different contract
terms in different jurisdictions within the European Union. We
cannot believe such behaviour is compatible with the Single Market.
42. One of our major concerns is that Ofgem's
investigation is not giving more explicit attention to the wholesale
gas market. In 2004/05 Ofgem conducted an inquiry into the upstream
sector in response to gas price spikes that winter, but the recent
price spikes have been sharper still. The focus of Ofgem's investigation
this time is on the supply to households and small businesses.
As part of this it will examine the relationship between retail
and wholesale energy prices. However, it also needs to look again
at whether the wholesale markets themselves are functioning satisfactorily.
13 Ev 183, para 2.4 (Centrica) Back
14
Ev 559 (Dominic Whittome) Back
15
Ev 459, para 91 (Ofgem) Back
16
Ev 464, para 7 (Ofgem) Back
17
Over-the-counter assets are not traded in a formal exchange. Rather,
brokers negotiate directly with each other. Back
18
Ev 274, para 38 (Energywatch) and Ev 464, para 7 (Ofgem) Back
19
Q 656 (Shell) Back
20
Ev 274, para 38 and Ev 337 (Energywatch), Ev 451, para 62 (Ofgem)
and Ev 184, para 2.9 (Centrica) Back
21
Ev 337 (Energywatch) Back
22
Ev 197, para 7 (Chemical Industries Association) Back
23
Ev 465, para 14 (Ofgem) Back
24
Ev 337 (Energywatch) and Ev 559 (Dominic Whittome) Back
25
House of Commons Trade and Industry Committee, First Report
of Session 2005-06, Security of gas supply, HC 632, December
2005 Back
26
Ev 408 (Major Energy Users' Council) Back
27
Ev 429 (NHS Purchasing and Supply Agency) Back
28
Ev 167, para 5 (BP) Back
29
Ev 147, para 28 (BERR) Back
30
Q 541 (Ofgem) Back
31
Ev 197, para 5 (Chemical Industries Association) and Ev 505 (Shell) Back
32
Ev 169, para 16 (BP) Back
33
The HHI is calculated by squaring the market share of each firm
competing in the market, and summing the resulting numbers. Back
34
Ev 447, para 44-46 (Ofgem) Back
35
Because of the way the HHI is calculated (see footnote 33) measures
for certain parts of the market can be particularly concentrated,
while the overall market figure remains relatively low. Back
36
Ev 449, para 52 (Ofgem) Back
37
Q 286 (Energy Intensive Users' Group) Back
38
National Grid Back
39
Q 291 (Major Energy Users' Council) Back
40
Ev 468, para 26 (Ofgem) Back
41
Ev 399, para 3.5.1 (INEOS ChlorVinyls) and Ev 250, para 13 (Energy
Intensive Users' Group) Back
42
Q 628 (BP) Back
43
Q 546 (Ofgem), Ev 371, para 5.3 (E.ON UK) and Ev 169, para 18
(BP) Back
44
Q 292 (Energy Intensive Users' Group) Back
45
Ev 469, para 29-30 (Ofgem) Back
46
Ev 250, para 14 (Energy Intensive Users' Group) Back
47
Q 543 (Ofgem) Back
48
Ev 468, para 26 (Ofgem) Back
49
Ev 393, para 3c (Growhow UK Ltd) Back
50
Q 291 (Chemical Industries Association) Back
51
Ev 452, para 68 and Ev 468, para 20 (Ofgem) Back
52
Q 663 (BP) Back
53
Qq 298 (Chemical Industries Association) and 541 (Ofgem) Back
54
House of Commons Trade and Industry Committee, Second Report
of 2001-02 Session, Security of Energy Supply, HC 364,
February 2002, and Twelfth Report of Session 2004-05, Fuel
Prices, HC 279, June 2005 Back
55
Q 622 (BP) Back
56
Qq 318 (Energy Intensive Users' Group) and 644 (BP); Ev 198, para
12 (Chemical Industries Association) and Ev 408 (Major Energy
Users' Council) Back
57
Q 19 (Minister for Energy) Back
58
Q 905 (European Commission) Back
59
Ev 188, para 5.9 (Centrica) Back
60
European Commission, Inquiry pursuant to Article 17 of Regulation
(EC) No 1/2003 into the European gas and electricity sectors (Final
Report), January 2007 Back
61
Ev 459, para 93 (Ofgem) Back
62
Q 627 (BP); Ev 501, para 41 (Scottish Power), Ev 408 (Major Energy
Users' Council) and Ev 250, para 14 (Energy Intensive Users' Group) Back
63
House of Commons Trade and Industry Committee, Twelfth Report
of Session 2004-05, Fuel Prices, HC 279, June 2005 Back
64
Ev 584 (Ofgem) Back
65
For an explanation of gas price indexation, see for example,
House of Commons Trade and Industry Committee, Twelfth Report
of Session 2004-05, Fuel Prices, HC 279, June 2005, page 33 Back
66
European Commission, Inquiry pursuant to Article 17 of Regulation
(EC) No 1/2003 into the European gas and electricity sectors (Final
Report), January 2007 Back
67
Financial Times, Gazprom predicts oil will reach $250,
10 June 2008 Back
68
For example, Ev 154 (Alan Barton) Back
69
Q 617 (Shell) Back
70
Q 619 (ExxonMobil) Back
71
See for example, The Times, US watchdog wants London to tighten
oil market rules, 18 June 2008 Back
72
Again, for example, see The Economist, Don't blame the speculators,
July 5th 2008 Back
73
Q 291 (Chemical Industries Association/INEOS ChlorVinyls) Back
74
Qq 642 (ExxonMobil) and 648 (Shell) Back
75
Q 563 (Ofgem) Back