Memorandum submitted by BP
INTRODUCTION
1. Many of the issues covered by this Inquiry—such
as those appertaining to the retail gas and power markets—are
beyond the scope of BP's activities. Accordingly, we limit the
majority of our comments to the wholesale market, and in particular
the area of gas supply.
2. In addition, many of the comments made
by BP in its memorandum of 9 December 2004 to the Trade and Industry
Committee are still relevant and applicable in our view; and the
Committee may wish to refer to this document in their deliberations.
This memorandum updates and qualifies the points made previously
where necessary.
UK GAS PRICES
3. The fact that gas and electricity prices
have risen significantly in recent years has led to understandable
concern, with many consumers claiming that they are both unjustifiably
high as well as a reflection of a failure in the operation of
the market. However, we would maintain that the UK wholesale gas
market continues to operate efficiently, and that the price increases
we have witnessed are consistent with the known internal and external
influences.
4. Such influences can be grouped under
two key themes, namely:
— the decline in UKCS production
and concerns over security of supply which are both key drivers
for UK gas price movements; and
— the pace of European liberalization,
and the continuation of oil price linkage in European gas prices
with its impact on the UK market.
5. In the last five years, the share of
UK gas which is imported has risen from 2% in 2003-04 to what
is predicted to be around 39% in 2008-09 ie increasing by a factor
of twenty. The proportion of imports will continue to rise at
around 5% per annum as UKCS supplies decline (see Appendix). This
increased reliance on imports creates both concern over security
of supply and means that the UK must compete for supplies with
European and other world markets where gas prices are linked to
oil prices.
6. Other points discussed in our previous
submission are still relevant. For example, and in brief,
— suppliers of gas to the residential
market, driven by the need to obtain certainty of prices over
time (in contrast to constant spot price fluctuations) have had
an impact on the forward market;
— when there is increased concern
over security of supply in forward winter periods, the consequent
change in forward purchasing behaviour will have a disproportionate
effect upon future price movements;
— in terms of "prompt"
prices (ie where gas is delivered on or immediately after the
specific day of an agreement), a strong correlation exists between
supply and demand fundamentals and the prices agreed for the day
or day ahead. This is supported by a deep and liquid market, and
does not reflect either market manipulation or market failures;
and
— the lack of gas-to-gas competition
in Continental Europe, linked to the indexation of gas contracts
to the price of oil, has led to further volatility and has contributed
to a general lack of confidence in the gas market's ability to
both register and react to reliable supply/demand signals.
7. We continue to maintain, therefore, that
taken as a whole the UK market has been working effectively. And
as we highlighted in 2004, additional comfort is provided by the
very significant number of material investment projects planned
or under construction. These include:
— Interconnector expansion, thus
increasing the UK's import capacity;
— Isle of Grain LNG import terminal;
— Milford Haven (Qatar Petroleum/ExxonMobil)
LNG import terminal;
— Milford Haven (Petrol's) LNG
import terminal;
— BBL pipeline—Netherlands
to the UK.
8. The number and complexity of these projects
is very difficult to reconcile with allegedly inaccurate market
signals. What is even clearer than four years ago, however, is
the need to differentiate between capacity and commodity. Whilst
new facilities bring additional capacity, it is a separate issue
as to whether additional commodity (gas) will flow into the GB
market.
THE EUROPEAN
GAS MARKET
9. It has been apparent since 2000 that
Continental Europe is a major driver for the movement of UK gas
prices. Most long-term contracts in Europe remain indexed to oil,
and high oil prices provide incentives to capitalise on the arbitrage
opportunities associated with selling UK gas into Europe, and
from European buyers seeking cheaper UK gas to meet their demand
needs (see Appendix).
10. Whilst liberalisation of continental
arrangements began some while ago, these developments remain ongoing.
The emerging spot markets at Zeebrugge encourage a gradually deepening
liquidity, but the reality of an inter-connected network of continental
trading hubs remains a distant goal, and significant barriers
to liquidity remain, including difficulties in securing economic
access to continental storage facilities; gas quality specification
issues; and issues associated with access to transportation.
11. But while lack of progress in this area
remains a source of regret, it is still doubtful whether it is
having the effect on UK competitiveness which is sometimes alleged.
There are perceptions that UK consumers are at a disadvantage
to their continental European competitors regarding their gas
price. There is some difficulty in obtaining like for like comparisons
but both Gas Strategies data (see Appendix) and BERR's Energy
Trends and Quarterly Energy Prices show that the UK is reasonably
well placed in comparison to continental Europe.
12. One of the benefits of a liberalised
market is that there is greater transparency in pricing. That
is one of the reasons why consumers will benefit from full implementation
of the Second Gas Directive in all EU Member States and from the
development of the EU Third Package.
13. We reiterate the improvements which
BP advocated in our previous memorandum:
— full legal unbundling of transportation
and supply businesses, with customers enjoying the freedom to
select service provision for supply independent of the provider
of transmission and distribution services;
— the equivalence of transmission
and distribution services, when provided by a regulated entity
to a third party; and
— the freedom of Parties to source
supplies from any other party and sell services to any other party.
14. But it has become necessary now to add
that the pace of European liberalisation remains slow. The second
Gas Directive is still not fully implemented in all Member States
almost five years after its introduction. Furthermore the EU's
Third Package of energy measures is still under development and
even once implemented it is unlikely that it would be before 2010
that any of the resulting Directives would actually take effect
in Member States.
15. Thus, the benefits of liberalisation
remain in terms of greater transparency. But other realities remain,
which is why liberalisation does not, per se, lead to lower
prices. Rather it gives consumers the freedom to choose suppliers,
encourage the development of new products and services while allowing
the market react more quickly to changes in supply/demand fundamentals.
CONCLUSIONS
16. It has been clear for many years that
the UK supply demand balance has been changing fundamentally.
The transition from supply surplus to a greater reliance on imports
of gas is bound to necessitate higher consumer prices, despite
the various infrastructure enhancements coming on stream. Moreover,
it must be remembered constantly that an enhanced infrastructure
does not of itself guarantee that additional gas will arrive in
the UK market.
17. BP continues to believe there is no
fundamental flaw in the UK market, nor any manipulation. Prices
have been responding as might be expected. The effect of greater
gas import dependence will be to increase supply diversity which
in turn can enhance security of supply.
18. There remains some nervousness, reflected
in forward prices. However, attention should be given to the growing
linkages in world gas prices which have become more pronounced
in recent years. In particular, LNG—which now forms an important
part of the UK gas supply mix—is influenced by world LNG
market signals as evidenced over recent months by Asia attracting
LNG cargoes which might otherwise have arrived in the UK. Within
the EU, the Spanish market has also been prepared to pay a premium
to attract LNG cargoes. In a world in which LNG is currently in
relatively tight supply, the willingness of other competing markets
to pay a premium for LNG naturally puts upward pressure on GB
gas market prices. Looking into the future, growth in world LNG
production is predicted to be steady and no step change is predicted.
19. Additionally one observes in the worldwide
arena growing concerns about securing sufficient supply from producer
countries, with anecdotal reports of some producer countries applying
a longer term strategic view to how they intend to permit production
of gas resources. Such sentiments are likely to put upward pressure
on market gas prices.
20. The UK is seen as an attractive market
for investment as evidenced by the significant capital projects
either mooted or in progress. However, the UK can no longer exist
in "splendid isolation"; and a fully liberalised Europe
is necessary to ensure ongoing security of supply. We remain supportive
of OFGEM's determination to discuss these issues with the European
Commission.
APPENDIX
Source: Gas Strategies
14 April 2008
| 
