Examination of Witness (Questions 240-259)
MR ALLAN
ASHER
20 MAY 2008
Q240 Mr Bailey: On wholesale electricity
now, I would really seek some sort of clarification on your submission,
in that you said traded electricity volumes appear to be heavily
skewed to shorter durations, particularly in the front quarter
or season. Then you go on to say "The volume traded is only
three times physical consumption—considerably below the
ten times level said to be evidence of a healthy market."
To a lay person such as myself, volume traded something three
times physical consumption might seem a reflection of a fairly
liquid market. Just how is the level of liquidity related to physical
consumption and volume traded? Could you just clarify that?
Mr Asher: If we go back to 2002,
the markets, say, just for electricity in GB were very, very active
ones. You had lots of traders who were buying and selling, generators
who were buying and selling, and the way in which forward markets
and liquidity is measured is the amount of times that that power
is wheeled before it is actually consumed. Ours were at the rate
of seven. It is a small chart and I will happily submit it to
you, but since then our market is the only key market in Europe
where liquidity has been plummeting, and we find Germany and the
Netherlands are now much more actively traded markets than ours,
and Belgium, Spain and France are all increasing in liquidity
while ours is falling. What that means is that the ability for
buyers to be able to negotiate with sellers and get efficiency
and predictability is harder and harder, which explains why our
prices are going up at a rate faster than our European competitors
for business and for domestic consumers. If you wanted to buy
power more than six months out on the forward market, you simply
cannot get it, and that means that our businesses are at a huge
disadvantage—I am sure subsequent witnesses will spell that
out in more detail—and it has been, practically speaking,
the source of a loss of 100,000 jobs in the GB market in 2005-06.
Q241 Mr Bailey: Why do Germany and
Netherlands have this increased liquidity despite deregulating
after this country?
Mr Asher: Because over the last
five years there have been a number of European Directives to
liberalise markets. GB was of course ahead of the world. At the
beginning, during the last decade, GB had some of the best markets,
liquid markets, good competition, innovation, lower prices, all
of those things. We have allowed that to dissipate. We have allowed
vertical reintegration, we have allowed concentration, and we
have taken our eyes off that competition ball. All of the European
partners are doing the opposite. In the Netherlands and even in
Germany there are structural changes to make the market more competitive.
Some of the big conglomerates are talking about selling off parts
of their networks and these trading hubs are growing up. The Nord
Pool is a very powerful example. In the Netherlands they might
take over as being the gas trading hub of Europe because ours
are failing and European markets are succeeding. Their prices
are starting to come down as they liberalise. They have a long,
long way to go. Please do not understand me to be saying that
we are generally worse than Europe but the big problem is our
trajectory is down and theirs is up.
Q242 Mr Bailey: That is very interesting,
because certainly my perception was that in fact Europe had lagged,
and indeed, there is resistance to further "unbundling"
requirements by the EU, and that lower prices in Europe were a
reflection of the cosy relationship between the generators and
suppliers not experienced by consumers in this country. What you
have said would seem to be in contradiction to that.
Mr Asher: There are many in Europe
who resist change, and the big conglomerates still do not want
to be broken up. They are happy to have interests in production,
to own the pipelines and wires, and the distribution businesses
and retail. Of course they are, but the pressure from the European
Commission is to break that up. In fact, the European Commission
Competition Directorate last year published the most extensive
report ever on European markets. One of their findings, by the
way, was that GB was the only market where liquidity seemed to
be systematically falling.
Q243 Mr Bailey: That really is interesting,
because it would appear from what you have said that, although
there is a long way to go in Europe, the perception has been that
prices were lower in Europe because of, effectively, a cosy arrangement
and cartels and so on.
Mr Asher: I have never heard of
a cartel that charges artificially low prices.
Q244 Mr Bailey: Sorry, I will rephrase
that. Cosy relationships between the generators and suppliers.
However, from what you have said, that really is not the case.
It is actually that, although they have a long way to go, they
are more liquid than this country and the problem is in the liquidity|
Mr Asher: I do not want to over-simplify.
There are serious market problems in much of Europe and there
are a number of Member States who still have price controls. What
that often does is transfer welfare between businesses and consumers
in some cases, or consumers to businesses in others, but nonetheless
leads to terrible investment distortions, and they are undesirable.
On the whole, the moves in Europe are to far more open markets,
more liquid markets, more competition, hence more investment and
growth, whereas ours are atrophying and it is no wonder that we
are speaking of a crisis in investment for generation for 2013.
Q245 Mr Bailey: Why is it so poor
here?
Mr Asher: It is so poor here because
I think, having reached that excellent stage of a really good
competitive market and lots of competition, we started to believe
our own rhetoric and went to sleep at the wheel, and we just have
not noticed that the rest of the world is whizzing on. We have
stuck, and we do not see that to win is not to stand still, no
matter how good you are. You need a solid competition focus on
this all of the time, and that is why we have been calling for
the Competition Commission to put the cleaners through what is
a sclerotic sector which is so vital for the welfare of individual
consumers and industry.
Q246 Mr Bailey: You have partly anticipated
my next question, which is, how could it be improved? Is there
anything that you want to say over and above that?
Mr Asher: I think there are short-term
and longer-term issues, and I have made the point that really,
in our system of markets we have the sectoral regulators, who
are given specific jobs, and they are there to spot price-fixing
and, in the case of Ofgem, their main job, after all, is about
network regulation. They do that passably well. I think they make
some mistakes but on the whole they do that reasonably well. They
do not have particular expertise in these issues of competition.
We established the Competition Commission. It is a hugely well-funded,
globally recognised authoritative body but they have never had
a reference from the sectoral regulator, and they say that they
are puzzled as to why this is, and that they are ready, willing
and able to do it and there is a need there, but, for some reason,
it is not happening.
Q247 Mr Bailey: Just two quick questions.
New entrants would obviously help matters. What are the problems
for new entrants? Secondly, how would you assess the impact of
selling British Energy to an existing electricity generator?
Mr Asher: New entrants are of
course what we want to see. We want open markets and, by the way,
GB desperately needs vast new investment; whether it is for nuclear
or renewables or clean coal, all of that, we need tens of millions
of pounds. They are not going to come here if they think that
they are facing a vertically integrated industry with the suppliers
who exist owning the generators. You ask what the barrier is.
It is this: if you were somebody, even like Tesco, a big, ugly,
company like Tesco, powerful, it cannot enter this market because
it knows it has to buy its gas and power from the people who own
it and who compete against them. So they just will not be in that
market. If you were perhaps a global generator, you might see
this market and you might see some of the hugely fat margins.
After all, Ofgem said the generators are going to make £6
billion in unearned profits over the next few years that are not
going to be competed away, a very tasty target, but no generator
will enter this market because they know they have no way to market.
The vertically integrated companies own all the customers so they
are locked out. That brings us to British Energy, which actually
is able to produce power at a very low cost per unit but again,
they are stuck. They do not have a retail outlet in a vertically
integrated market and so they are trying to sell out. If that
was sold to an incumbent, it is a perfect formula for them charging
more and giving less, in other words, anti-competitive conduct,
and you will see statements by Centrica and any sentient economist
will say that is a bad thing to do if you want an efficient market
with good investment signals.
Q248 Mr Oaten: There was a rumour
that Asda were seriously looking at it. Have you heard that?
Mr Asher: I have heard a number
of rumours, and indeed, at the inquiry conducted by Lord O'Neill
just a few years ago, the last time this group looked at this
issue, I think it was Alistair Buchanan who reeled off the names
of dozens of people who had licences and were going to enter.
All I say is that at the gym I go to there are thousands of people
who have a membership but never turn up.
Q249 Miss Kirkbride: It seems to
me a logical conclusion of what you are saying is that there should
be a law prohibiting vertical integration and that companies should
be forced to divest themselves of one or the other, either generation
or their retail customers. Do you think that? Do you think that
might be the conclusion of a Competition Commission investigation
into them, and what powers do Europe have in all of this versus
the British Government and how are they flexing their muscles
to make that happen?
Mr Asher: Exactly a century ago
this was the debate that was raging in the United States that
led to the establishment of the Federal Trade Commission and the
trustbusters. It was the oil industry then doing exactly these
same sorts of things. In the end they did break them up and for
a century had some of the most competitive markets with the highest
levels of consumer welfare in the world. I work in many countries,
advising governments about deregulation, and the first thing you
do with this industry is both vertically and horizontally disaggregating
power so that you get those fierce winds of competition and innovation.
Sometimes it does not work very well, sometimes it does. What
we have had though for the last six years is everything to be
fast reversed. So first, stop it getting any worse, then secondly,
try to lever it open. I doubt that our political climate would
readily cope with unbundling the suppliers because of their huge
power; we have become so dependent on them. Economically, it would
be a sensible thing to happen but you can just see in Europe the
sort of opposition that comes out when you start to threaten the
economic interests of incumbents. One of the values of the Competition
Commission is that they are an objective body and they have industry
experts, they have all of these specialist panels, and they can
spell out the actual costs and benefits. The market I am talking
about is not one for tomorrow but if we want a market that is
effective for the next 20, 30 years, now is the time to get these
signals right so that we can get new entry from vigorous competitors
at either the supply or generational level. Do not let the incumbents
own wind, do not let them own nuclear, and we have a chance of
the diversity that we had briefly years ago, when prices here
were genuinely the most competitive in Europe.
Q250 Miss Kirkbride: What is to stop
that? There is nothing to stop that. You are saying (inaudible)
will not break up the market, so why should all this stuff not
be provided by the existing big six? Why should anybody come into
the market? You have already set out good reasons why no-one would
want to come and build on this, because they would not get access
to the consumer market.
Mr Asher: There are some other
ways of perhaps levering the market open more gradually. I hope
the Competition Commission would come out with a finding that
we would be much better off in welfare terms and investment terms
and sustainability terms with vertical disintegration.
Q251 Miss Kirkbride: If it did that,
what would happen?
Mr Asher: What would happen is
that lots of new entrants from different parts of the world, different
business models, different technologies would come in, and we
would have a whole raft of innovation which would transform our
economy into a different sort.
Q252 Miss Kirkbride: I do not understand
why the Competition Commission saying that would make any difference.
Surely it would have to have some legislative force.
Mr Asher: Two things would happen.
Them saying it would have a little more authority than me saying
it. Of itself, you are quite right, but in addition, there are
a number of other measures where we think that there ought to
be much more disclosure of some of these secret contracts, these
long-term contracts by which gas and power are dealt with. A lot
more of that should be brought into the forward market. I think
the vertically integrated bodies should be forced to trade a proportion,
perhaps 20%, of their power and gas on the forward markets. They
could buy and sell too perhaps but at least then we would start
to get these signals that would allow people who see a profit
to move in or, if it were the case that there was a loss, to move
out, and you would get the dynamism that makes a market economy.
We lack that and it is not getting better; it is getting worse.
Q253 Miss Kirkbride: In short, it
would be legislative changes which fall short of requiring them
to disaggregate their vertical and horizontal investments.
Mr Asher: Yes, partly legislative,
but the Competition Commission has the power to recommend those
sorts of split-ups if it wanted to, as does the European Commission
in some circumstances.
Roger Berry: We will come back to the
Competition Commission in a moment but I want to move on to wholesale
gas.
Q254 Mr Binley: Mr Asher, I just
want to pursue this a little further. In terms of the supply market,
what you are advocating could lead to not having a British champion,
quite frankly. Does that worry you?
Mr Asher: If you look at the track
record, there are now just two suppliers still remaining in British
ownership, and part of the reason for that is that we allowed
our market not to be as efficient and competitive. If it were
competitive and making higher earnings, they would not have been
acquired. I do not think there is anything, short of absolute
protectionism, that is going to stop those companies being acquired
unless there is a more competitive market. I believe actually
that Centrica is keen on having a vigorously competitive market.
I have had many discussions with their Chief Executive, and I
hope when they are giving evidence, if they do, you will ask them
some of these questions about what they are doing to break this
toxic gas-oil indexation and lots of those things.
Q255 Mr Clapham: That is one of the
points I want to come to but, first of all, just looking at the
way, for example, in the early Nineties we disaggregated the energy
industry, it seems that one of the things that we failed to do
was to ring-fence each particular disaggregation to avoid the
re-aggregation. Had we done that, but allowing competition in
each of the sectors, we would have had a much healthier market
today.
Mr Asher: I think so, but remember
it happened in two ways. Initially 20 vigorously competing suppliers—and
I guess that was never going to be sustainable. You would never
have that number, but we just took the brakes off altogether and
that aggregation from 20 to six, remembering that in many regions
there are really effectively only two or perhaps three, so it
is not even six people competing for each consumer, but at the
same time we allowed that vertical acquisition, and that had the
double whammy of, firstly, that sort of concentration but also
the vertical concentration. In the gas markets, of course, it
was a slightly different area where we provided 110% of our own
gas to this current state where it is only 75.
Q256 Mr Clapham: British Gas still
has a 50% market share.
Mr Asher: Yes. 48, I think.
Q257 Mr Clapham: Given that we see,
and have seen over the last 18 months, the increase in oil prices—and
it must send shivers through some consumers when they see a year
again when oil prices have increased and there are now well above
$100 a barrel and there is talk about it reaching $200 a barrel.
Each time that happens, of course, as you have said, British Gas
will be rubbing their chin and thinking "Well, we have got
to increase our prices." What is the rationale for that indexation
of oil to gas and could it be broken?
Mr Asher: I think it is an absolutely
excellent rationale if you own the gas, and if you are a gas producer,
and if you are a European one who lives and works in a market
where there is the rule of law and vigorous competition laws that
would prohibit you from illegally agreeing on a price, if however
all of the gas producers independently say, "I know what,
we will relate our prices to this external variable, oil prices,
which are inexorably going up. That gives us a perfect way of
co-ordinating our conduct without breaking the law and making
a fortune." There is no rationale behind that in economic
terms and there is no rationale in resource terms and in fact,
the UK, when it had a deregulated market, had a fully functioning
market where the prices were determined by competition between
demand and supply. Sometimes that went up when there was an outage
or a crisis, and you would expect that, or if there was inadequate
supply prices would go up. You want that; it draws in new investors
and it would go down. Now it does not. It is just inexorably going
up, and that is a very negative thing. Once the inter-connector
between the UK and Europe was opened and we were starting to import
more and more gas from Europe as North Sea supplies have started
to run down, we have been affected by the contagion of this gas-oil
indexation. Half of our contracts are now tainted by this oil
indexation. We criticise the competition authorities in Europe
and in the UK for not being much more vigorously attacking that.
They have attacked all the other bits, the vertical integration,
long-term contracts and all of that, but for some reason they
have allowed this virtual gas OPEC to survive and it is a toxic
thing. It is not as though the gas that is traded here is in shortage.
As Jake Ulrich from Centrica, who knows much more about this than
I do, said, we are surrounded by gas. We just cannot get it here.
That is about this indexation issue and the monopolistic control
over networks and lack of liberalisation. They are the things
not just in Europe but in GB that need to be focused on.
Q258 Mr Clapham: Given what you have
just said and given the importance of gas prices, because of course,
40% of our electricity is generated by gas so it pushes up the
price of electricity, has there been any real, meaningful endeavour
to break that indexation? If so, why has it failed?
Mr Asher: In fact, it is going
the other way. Until four or five years ago we had liquid forward
markets where you could buy and sell gas. There were traders in
the market and this is the same story about how often the gas
or power is turned over before final consumption. Those have all
been falling and in part, because our wholesale markets have failed
in gas and electricity, even some large buyers are saying "We
are desperate. We don't know what makes a proper price."
So they are often forced, and indeed some even say, "What
we will have to do is accept a gas-oil indexation because at least
that is some objective measure that we can plan and hedge against."
The much better approach would be to re-introduce a fully competitive
forward market, get out all of the restrictive rules, the barriers
to entry, and just get more of the commodity traded in ways that
people will rebuild their confidence in the way prices are formed
and to allow the market that we all want to see work work. Effective
markets often require intervention. I think that is one of the
errors in the UK. Somehow we have assumed full competition in
effective markets means you do not have intervention. There is
no market in the world like that. Indeed, markets tend toward
market power and monopoly, and why not? That is exactly the intention
of every supplier. The state needs to intervene every now and
then when that market power reaches a certain level or where the
conduct of getting there breaches certain norms and putting them
back in their box. That is what we want. We want them to be fighting
each other, and they are not.
Q259 Mr Clapham: And of course, that
is what we have seen in the energy market. We have seen those
extremes; we have gone from disaggregation back to integration.
Mr Asher: Yes, that is right,
and that needs to be reversed.
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