Memorandum submitted by INEOS ChlorVinyls
1. EXECUTIVE
SUMMARY
1.1 INEOS ChlorVinyls is a major chemical
company operating throughout Europe. We are able to provide evidence
based on extensive and comprehensive knowledge of the gas and
electricity markets in which the Company operates.
1.2 Our evidence is based on first hand
experience of the operation of UK and Continental European markets.
1.3 The UK and industrial consumers in particular
need secure supplies of competitively priced energy—absolute
price level is less of a concern if all consumers are similarly
affected. Since the Department of Trade and Industry Committee's
"Security of the Gas Supply" Report (Report HC 632),
UK market prices have gone through a period of very high price
volatility. For a brief period the UK did enjoy comparatively
low and therefore competitive prices. However, this was short-lived
and once again both UK gas and electricity prices are significantly
higher than other major European markets. (See Addendum 1).
1.4 For example, we can broadly assess UK
gas market forward prices as being at close to European levels
in summer but having a significant premium above this in the winter.
As a result UK annual prices are uncompetitive. This situation
is apparently driven by the price required to attract LNG supplies
to the UK in winter. With the expected need for growing LNG imports
in future years this situation seems set to deteriorate further.
1.5 Such uncompetitive price levels are
a huge concern to us and other industrial consumers. The need
for increasing imports could lead to further severe price distortions
as witnessed in Winter 2005-06. During this period we had to severely
curtail production with significant financial impact on our business.
Meanwhile a number of manufacturing sectors, including paper and
glass reported site closures as a result of high energy prices.
1.6 The electricity market is a cause for
further concern. The anticipated short-fall in generation capacity
in the medium term creates further uncertainty. While there is
now clear intent to allow new nuclear capacity to be built we
consider ideally this needed to be clarified a number of years
earlier.
1.7 It is rather surprising that this situation
has arisen again when the UK has apparently the most competitive
gas market in Europe and remains a major producer of natural gas.
1.8 In this evidence we have made various
comments in response to the specific questions asked in the original
call for evidence.
1.9 We have covered a range of themes, some
of which we have highlighted in previous submissions to Select
Committee Inquiries. These themes include:
— Barriers to entry to energy markets.
— Interaction of UK and Continental
European markets.
1.10 Previous Committees have acknowledged
the price distortions created by the interaction of the UK market
with the less liberalised European markets. We recognise the support
the UK Government has given to the liberalisation agenda. However,
we remain extremely concerned at the rate of progress due to the
clear resistance that remains in some of the major European energy
markets.
2. EFFECTIVE
COMPETITION IN
THE RETAIL
MARKETS
2.1 We consider that for there to be effective
competition in the retail markets we would expect to see a diverse
mix of market players.
2.2 The UK Government and Regulator (OFGEM)
frequently herald the UK as the most liberal and competitive energy
market in Europe. However, we believe that such statements do
not properly recognise a number of structural faults within the
operation of the gas and electricity markets in the UK.
2.3 In the case of electricity, the UK market
is now characterised by large vertically integrated players with
broadly identical product offerings. The early days of market
liberalisation in the UK found many small independents offering
differentiated products, independent generators operating single
(or a small number of) power stations and competing successfully
with the incumbents. This is no longer the case.
2.4 INEOS has extensive experience of electricity
markets throughout Europe. In our opinion the UK offers a significantly
poorer market structure for small and independent players than,
for example, Germany and the Nordic countries. This is borne out
by the number of industrial consumers accessing wholesale markets
directly in these countries providing a strong base for increasing
liquidity, in stark contrast to the UK position.
2.5 It is not only our view that the UK
market is failing to provide the desired liquidity. We note that
there has also been very significant concern highlighted by a
number of the major market players. As a result of this the Power
Trading Forum of the Futures and Options Association is leading
a "Market Design Project" to "encourage a more
liquid traded market" (see http://www.foa.co.uk/forums/power.jsp).
2.6 We would suggest that the problem is
largely a result of the increasing consolidation and vertical
integration found within the UK electricity industry. This is
compounded by the increasing difficulty for independents and small
companies to operate alongside the major vertically integrated
companies. Increasingly modifications to the major UK Codes strive
to deliver better economic models with increasing complexity and
risk without regard to the impact upon the UK market in the broadest
context. As a result we are delivering an electricity market where
small independents have disappeared and new entrants are wholly
absent.
2.7 As an independent operator in the power
market (and to our knowledge the only UK industrial operating
in this way) we suggest that the above situation is driven to
a large extent by market rules that are significantly over complicated
and appear to us to go well beyond what is required for effective
and efficient market operation. These rules create a major hurdle
for small players and new entrants to overcome and create significant
risk and hence competitive disadvantage for such small operators.
2.8 As an absolute minimum a test for all
modifications to the governing Code Structures should be an over-arching
objective that they make the market simpler and more accessible
thus increasing participation and liquididity.
3. EFFECTIVE
COMPETITION IN
WHOLESALE MARKETS
3.1 In this section we have highlighted
our particular views on the operation of the wholesale UK gas
market—an area we have made much comment on in the past
few years including written submissions to inquiries undertaken
by the Trade and Industry Select Committee.
3.2 Those inquiries were triggered by rising
UK wholesale gas prices that reached record levels during the
winter of 2005-06. In early 2007 UK wholesale prices fell to comparatively
low and competitive levels as the gas supply and demand balance
in the UK and across Europe improved—albeit this was significantly
influenced by an extremely mild winter across Europe.
3.3 Later in 2007 prices again started to
rise. Significantly these rises have been much greater than comparative
price rises in other markets. The result of these increases is
that UK wholesale prices in both gas and electricity (which is
largely driven by gas price) are once again uncompetitive (Addendum
1). As an industrial consumer we would stress that our concern
is much less about absolute price level than the absence of a
level playing field (Addendum 2).
3.4 Forward summer prices now trade at levels
which are broadly around European price levels (for either gas
or coal[277]).
In winter, UK prices have a premium of at least 20% to wholesale
markets around the Atlantic Basin.
3.5 Over recent months through discussions
in various market forums (individually or through industry associations
including the Energy Intensive Users Group and Chemical Industries
Association) we have highlighted our view of key issues in the
UK gas market:
3.5.1 Liquified Natural Gas (LNG)
— Deliveries of LNG so far this winter,
through the only operating terminal at Isle of Grain, have been
very significantly below the maximum available capacity. We note
OFGEM have asked for information from parties with regard to use
of spare capacity at this facility and we have yet to see the
outcome of this review. However, it is does appear that there
is significant concern regarding the effectiveness of the Use
It Or Lose It (UIOLI) regime in place as to our knowledge, released
capacity has never been used by another party.
— It is apparent that LNG prices can
now determine UK gas prices at least in winter as UK prices have
to rise to the highest in the world to attract any cargoes. In
the winter of 2005/2006 it was suggested that the price levels
at the time were a short-term issue as new infrastructure had
arrived too late to match UK Continental Shelf production decline.
However, with the need for LNG imports expected to increase dramatically
in coming years (source National Grid), then we are hugely concerned
that uncompetitive prices are set to become an enduring issue
in the most (or only) liberalised market in Europe.
3.5.2 Norwegian Flow Information
— Norway has become a crucial supplier
of gas to the UK market—and this is set to grow significantly
over the coming years.
— We note the contrast in the amount
of information now available to the UK Gas Market (largely through
the efforts of consumers) compared with the information from offshore
and in particular Norwegian imports to both the UK and other European
gas terminals. Most disturbingly this lack of information is in
sharp contrast to the situation deemed suitable by the Norwegians
for trading in the Norwegian electricity market (Nordpool).
— We believe that UK Govermnent must
push at EU level for much greater transparency of information
on Norwegian (and other importing countries) flows into European
gas terminals.
3.5.3 Impact of the Large Combustion Plant
Directive
— It is becoming apparent that the
Large Combustion Plant Directive is having a more significant
impact on the gas and power markets than perhaps even some of
the more pessimistic forecasts.
— It is very noticeable that gas demand
for power generation has increased above that which would have
been expected from market prices. Most particularly, from the
introduction of the LCPD, we have seen a requirement for gas fired
generation to replace coal generation as baseload supply.
— Of most concern is that a significant
amount of "opted-in" coal plant is off-line for extended
periods whilst they await completion of Flue Gas Desulpherisation
(FGD) projects. These facilities appear to have been given far
more stringent constraints than the "opted-out" plant
and have been largely removed from the generation mix.
— This situation appears perverse,
particularly while we have a period where nuclear generation capacity
and gas availability are both low. Our greatest concern is the
apparent failure of government to properly consider the impact
of policy (be it European or UK) on the market. The introduction
of this policy in January, the period of maximum demand in the
UK energy market suggests, at the very least, a failure of adequate
impact assessment.
4. GROWING CONSOLIDATION
IN THE
ENERGY MARKETS
4.1 As we noted in section 2, we do now
see greater consolidation in the UK energy markets. In the previous
"dash for gas" during the nineties, there were a number
of new entrants who entered the market.
4.2 Many of these new players have since
withdrawn from the market for a number of reasons. These issues
largely prevail and include:
There are now a very small number of new/small
entrants (in the UK) and we believe that we are also seeing a
move towards increasing market concentration throughout Europe
by large and vertically integrated companies.
4.3 Our view is that these current market
developments rather suggest that the balance of risks within the
market is wrong such that new entrants are effectively excluded
and size and vertical integration overly rewarded. This cannot
be conducive to the development of a healthy and competitive market.
5. RELATIONSHIP
BETWEEN WHOLESALE
AND RETAIL
MARKETS
5.1 We consider the situation in the gas
and electricity markets is rather different so we have considered
these separately.
5.2 Gas
5.2.1 In the UK market end user prices are
determined based on the Wholesale (NBP) market prices plus "add-on"
costs.
5.2.2 We consider that the cost of the add-ons
is quite transparent and in particular the "retail margin"
is relatively low compared with the total cost of the bill.
5.2.3 However, we do find that the UK market,
in our experience, offers no alternative to this "NBP plus
delivery" model. We have explored different approaches at
great length but have been unable to achieve any alternative.
The UK is "NBP—take it or leave it". This approach
prevents UK consumers procuring gas at competitive prices or managing
competitive risk. Further, the NBP market essentially only offers
a relatively short-term market—two to three years—as
there is limited market trading beyond this period.
5.2.4 Large European utilities refuse to
offer contracts in the UK that are freely offered to INEOS sites
and other consumers throughout North West Europe. The inability
of consumers to procure natural gas on "common contractual
terms"—that is on the terms that retailers operating
in the UK market offer in other European markets—represents
a significant failure of European Market regulation.
5.2.5 We have already commented on the significant
price differentials between UK and other markets, particularly
in winter. This situation is considered in part to be due to the
lack of storage in the UK—a situation arising from the UK
having had highly flexible production for a number of years. It
is apparent that the need for storage will increase as import
dependency increases. This situation is being recognised throughout
the rest of Europe as gas demand is expected to grow.
5.2.6 We understand that Planning Reforms
seek to enable nationally important infrastructure projects to
be developed more quickly. We believe the need for this to be
implemented and to deliver the intended benefits will be crucial
in the very near future.
5.3 Electricity
5.3.1 In the UK market prices are related
to the wholesale market with pass-through costs. These costs are
less transparent and represent a significantly greater add-on
to the wholesale price than is the case with gas. Nonetheless
our experience is that retail margins are low.
5.3.2 Our greatest concern lies with the
"other" costs that are passed to consumers. The cost
of imbalance through Balancing Mechanism costs (Energy Imbalance)
or Balancing Services costs (BSUoS) is significant and adds hugely
to the retail price. Our experience in Germany and NordPool is
that large industrial consumers pay significantly less on top
of the wholesale price than in the UK.
6. THE INTERACTION
BETWEEN UK AND
EUROPEAN MARKETS
6.1 The impact of the interaction between
the UK and European markets was highlighted and accepted as a
significant issue in previous Select Committee Inquiries.
6.2 We recognise that there has been a major
political drive through the various European bodies and particularly
DG Competition. The so called "3rd Package" was a major
statement of intent and makes clear the desire to progress the
liberalisation agenda across Europe.
6.3 However, we note that very strong resistance
remains to some of the key elements of this package and in our
view it will still be a number of years before we see the markets
functioning effectively. The view of a previous Select Committee
(HC 279-1) that market liberalisation would not happen before
the end of this decade appears to have been correct.
6.4 During the interim period, the UK will
continue to be exposed to the market distortions that we have
seen in recent years.
6.5 It is essential that UK government maintains
its resolve and exerts its influence to ensure that properly functioning
markets are developed across Europe.
6.6 We would also stress that it is no longer
simply Europe that results in the UK "importing uncompetitive
prices". LNG is a rapidly increasing part of our primary
energy supply mix. Despite the expectation of secure supply arrangements
from countries such as Qatar, there is concern that such supplies
will only arrive if the UK can "out-bid" other markets
and so driving UK prices to un-competitive levels.
ADDENDUM 1
WHOLESALE ELECTRICITY PRICE COMPARISON
Source: Energyquote)
ADDENDUM 2
BACKGROUND TO INEOS
INEOS Chlor is based in Runcorn, Cheshire where
we produce 80% of the UK's chlorine and caustic soda. These products
are vital building blocks in the production of most chemicals
made in the UK. Chlorine is used to purify 98% of our national
water consumption, to produce 96% of crop protection products
and 85% of pharmaceuticals. It is also a major raw material for
the manufacture of plastics. Caustic is used in every major chemical
production process and is essential to a wide range of everyday
products including soap, cosmetics, clothes, antiseptics and cleaning
products. INEOS Chlor has around 1,400 direct employees based
in Cheshire.
The manufacture of chlorine is energy intensive.
INEOS Chlor purchases energy in the form of natural gas, which
is used to produce electricity for use in the chlorine production
process (electrolysis of brine).
INEOS Chlor purchases around 250 million therms
per year of natural gas for use in the Runcorn manufacturing activities.
As such we understand we are probably in the top three of industrial
consumers (by volume) in the UK, outside the power generation
sector. Natural gas represents some 60% of the total business
variable production costs. Every penny added to the wholesale
cost of gas increases our production costs by some £2.5 million.
INEOS Fluor, INEOS Vinyls and INEOS Enterprises
also have operations within the same site at Runcorn. While these
businesses are not as energy intensive as INEOS Chlor, energy
is a significant cost. More importantly, these businesses are
extremely dependent on the chemicals produced by INEOS Chlor.
Runcorn site is the home of a number of other companies including
APL and BOC that again are dependent on the chemicals produced
by INEOS Chlor.
INEOS Chlor and INEOS Vinyls also have manufacturing
assets located in Germany and Italy as well as several smaller
UK sites. The various sites consume significant amounts of energy
in the form of both natural gas and electricity.
March 2008
277 In this context the coal price referenced is the
equivalent price of coal and gas when converted to electricity
in a power station. Back
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