Examination of Witnesses (Questions 279-299)
MR HUGH
CONWAY, MR
JEREMY NICHOLSON
AND MR
CHRIS TANE
3 JUNE 2008
Q279 Chairman: Gentlemen, welcome to
this evidence session of this Committee's inquiry into energy
prices. We will begin with the easy questions. Thank you very
much for your memorandum, by the way, which the Committee has
greatly appreciated and it informed the questions you are going
to get now. The easy one is if you can each introduce yourselves
for the record and say what your organisation does, and also I
am curious to know whether there is any overlap to your memberships,
how discrete your organisations are?
Mr Nicholson: I am Jeremy Nicholson
and I am Director of the Energy Intensive Users' Group. It is
an umbrella group that represents a dozen or so trade sectors—steel,
glass, ceramics, cement, aluminium manufacturers and so on, and
including the Chemical Industries Association and the MEUC within
our membership. We are solely there to represent the interests
of the intensive sectors that depend on secure and internationally
competitive energy supplies.
Mr Conway: I am Hugh Conway and
I am the electrical Chairman of the Major Energy Users' Council.
We are an organisation which was founded about 20 years ago upon
the privatisation of gas and electricity and we have members who
are basically buyers for large energy users, and they range from
individual manufacturing companies right through to multi-site
retailers and also more recently government purchasing agencies,
which I think is possibly quite interesting.
Mr Tane: I am Chris Tane. I am
here with two hats on today: I am representing the Chemical Industries
Association, which is the trade association for the chemical industry
in the UK, which is, as I am sure you know, one of the major contributors
to the UK economy; and also in my real job I am the Chief Executive
of INEOS Chlor Ltd, which is one of the major chemical producers
in the UK and we are the largest single point user of electricity
in the UK at our site at Runcorn.
Q280 Chairman: Mr Tane, you are the
only member of our witnesses today with a current commercial interest.
You used to be with Rugby Cement, Mr Conway, but you are now representing
an organisation.
Mr Conway: And I do not have any
connection with them now at all.
Chairman: Thank you very much. Mark,
do you want to come in with your point?
Q281 Mr Oaten: We are going to get
into the issues but just generally I am interested to understand
as the three bodies which represent so many users of energy what
actual power do you feel that you have yourselves to try and influence
energy costs and energy prices? Are you under enormous pressure
at the moment from your members who are saying to you, "Look,
come on guys, you are meant to be our voice; use the muscle. We
come together because we want jointly to put pressure on the Government
and the suppliers; what are you doing about it?" I just wondered
what power you have got and what action you have been taking to
try and affect the current difficulties?
Mr Nicholson: The perception of
energy users is that we are very much price takers. That is the
first point. We are at the mercy largely of what events produce
in the wholesale market of gas and electricity and, as you will
see from our evidence, it is the wholesale market price that really
underpins all of our energy costs as large consumers and it accounts
for the overwhelming bulk of the bill to our sectors. We do not
feel that we have the influence that is warranted in terms of
dealing with government departments and the regulator and that
the issue of international competitiveness, in our view, although
acknowledged is perhaps not given the emphasis that it deserves
on occasions, and indeed there has been some denial I think, at
least for the intensive sectors, about the extent to which we
are facing genuine competitive disadvantage at the moment. Maybe
that is not true equally for all classes of consumer but for the
large industrial users there is an abundance of evidence now that
we face significant and enduring price disadvantage in power,
and to a lesser extent in gas.
Mr Conway: Can I make a very simple
comment which might explain some of the problems we have. Just
to give you an example, if I were to buy gas for my company from
October for 12 months, the current price is, shall we say, 87
pence wholesale. On top of that we might have to pay three pence
for transport and the last number is 0.5% suppliers' margin, so
we have no—
Q282 Chairman: We are getting into
some of the detailed stuff.
Mr Conway: What I am trying to
say is we have no control over what is going on; that is our biggest
problem.
Q283 Mr Oaten: But the point I am
trying to get is that collectively with so many of you coming
together can actually have no influence at all?
Mr Nicholson: In terms of on the
market I think that is unfortunately the case. Chris may want
to add something from the perspective of an international operator.
Mr Tane: My company of course
is a major buyer of gas as it happens and we have no ability whatsoever
to have any impact on the market. We are a big buyer of petro-chemical
feedstocks for example and we are sufficiently big that we influence
the market as a buyer. That does not happen in the gas market
at all and we have no ability to either directly ourselves or
through the trade association get recognition of the problem.
As Jeremy was saying, it has been pretty difficult over the last
two or three years. We have been saying repeatedly that we see
a major problem of competitiveness emerging and, generally speaking,
the response that we have seen from regulators and government
has been to say there is no problem. Now it is very clear to everybody
that there is a big problem but it is rather late to do anything
about it, so we have not really had the influence that is needed
for an industry that is as important as the chemical industry
is to the UK economy.
Q284 Chairman: I think it is fair
to say that a lot of the debate at present about fuel prices does
concern residential customers/domestic households but we attach
great importance to this issue too because competitiveness is
one of your key concerns and we will come to that in a minute.
Can I just ask factually, presumably you buy predominantly from
wholesale markets? How do you buy?
Mr Nicholson: Most of our members
buy through supply contracts. One or two of them are auto generators,
they have their own power generation as well, but they are a minority,
and for the most part they are on annual or longer supply contracts.
Increasingly with gas there has been a trend towards indexed contracts
where the price of gas moves with the day ahead price in the wholesale
market, so in effect, even though they tend to be buying from
the suppliers, although some may source directly from the wholesale
market, the nature of their contracts means that effectively they
are getting a quote based on the forward market price at the time
the contract is struck or indeed a contract that is based on a
day ahead wholesale market price.
Q285 Chairman: This is another easy
question and you have already hinted at this in your earlier answers;
how important are energy prices to your members and to your company
in terms of their competitiveness internationally?
Mr Nicholson: As you would expect,
if you are an aluminium smelter where 40-45 % of your costs might
be energy-based, or if you are a steel maker and paper manufacturer
where 20-25% or more may be energy-based, if you are an industrial
gas producer where 70% of your production costs may come from
energy, this is a key input cost, and plainly if there are large
and enduring price differences in energy, accepting the fact that
there will be times when our energy prices are higher and lower,
that is natural in markets (although we have seen a lot of volatility
there) it affects investment decisions and the ability to remain
located in this part of the world if our energy prices either
become uncompetitive or are set to become uncompetitive in the
future.
Q286 Chairman: But you have given
us quite compelling written evidence suggesting that UK energy
prices for your member companies are consistently above European
prices.
Mr Nicholson: Recently that is
true and of course there are some firms that are not able to be
represented here because they are no longer trading. When gas
prices hit record levels two winters ago and the system came under
strain we saw demand destruction and paper manufacturers and glass
manufacturers in particular whose businesses did not survive that
period, and that is the risk, that it will not necessarily cause
major casualties in the short term but by a process of attrition
we will see continued reduction in the industrial base at a time
when the demand for our products worldwide is quite high. To put
some numbers on it, in the autumn after that difficult winter
the ONS was reporting 100,000 manufacturing jobs lost and relative
energy prices were cited as a major reason for that, and we think
there is a danger of that recurring in the future.
Q287 Chairman: Mr Conway, it was
your evidence that showed the graphs of electricity price comparisons
and it is quite worrying electricity prices in the UK over our
European competitors. The CIA has many members with foreign headquarters
so loyalty to the UK is not necessarily very high in these companies.
Mr Conway: I cannot remember when
I submitted that and what date it is but the interesting thing
is the curve has continued upwards and it is actually a greater
gap than it was when we sent in our evidence.
Mr Tane: Perhaps I could give
my own example. My business manufactures our core products in
the UK, Germany, Norway, Sweden and Italy, and 70% of the cost
of making our basic product is energy, so when the cost of energy
in the UK is as uncompetitive as it is versus those other countries,
we have a very simple choice as to where we put our investment,
and the longer this situation in the UK persists the more we will
be driven—unwillingly actually—to put our investments
into Continental plants to the detriment of our own position in
the UK but also to the detriment of the UK chemical industry because
we are a supplier of basic chemicals to the whole UK industry.
I think the chemical industry in general is in exactly that position;
it is a multi-national industry, it operates globally and generally
speaking in global markets. It cannot afford to pay uncompetitive
prices for one of its key inputs, in this case energy, because
that means it cannot compete on the world stage.
Q288 Chairman: A lot of your products
presumably are commodities so price is the key determinant of
who buys what?
Mr Tane: Yes, we are the UK's
only manufacturer of PVC which is a commodity plastic and business
changes hands if your price is 1% or 2% out they will go to the
French competition or the Belgian competition, and when 70% of
the cost is energy and energy is overpriced by 15% or 20 %, that
is much more than 1% or 2% differences.
Q289 Chairman: We will move on to
the way the markets work and some more detailed questions. Just
one question from me which does not require a particularly long
answer. If things remain unchanged, do you think the UK wholesale
gas and electricity prices are going to remain consistently above
the European prices in the medium term?
Mr Nicholson: In the medium term
I think it is highly likely that electricity prices will stay
above. We are approaching something of a supply crunch in electricity
in the medium term. In the long term we might have some solutions.
Also we are rather more exposed to carbon prices in the UK than
for example markets like France. In gas I do not know whether
we will trade at a premium or not but we do know that our prices
are more volatile and there is greater risk so even if on average
our prices are the same as they are in Continental Europe the
risk of price spikes is higher.
Mr Binley: Do you ascribe this primarily
to the lack of storage facility?
Chairman: I think I am going to bring
in Mr Clapham straight away because that is really what Mick wanted
to ask.
Q290 Mr Clapham: What we have just
heard that energy prices are a threat to UK competitiveness is
really worrying. One of the things that we have noted is the linkage
between the oil price contracts and of course that indexation
that knocks on to gas. It has been described to us as being quite
an irrational linkage. Is it your view that that linkage needs
to be decoupled? Is there any possibility that you can see of
that being done?
Mr Nicholson: You asked two questions
there.
Chairman: It slightly anticipates what
Mr Bailey is going to ask about later as well so I have got to
keep control of my Committee here as well as my witnesses!
Q291 Mr Clapham: I will direct that
to LNG in particular. We see that the gas market is changing of
course: we have got LNG coming into the market; there is what
is left from the North Sea, and of course there is the Interconnector
from Europe and the linkage of course with Norway, so there are
a number of inputs of gas. There is a view that LNG is actually
determining the price and particularly we see that in winter.
Is that your view and is there anything that you feel might be
done?
Mr Conway: Our view of the market
in essence is that the oil price linkage in Continental Europe
and in other markets is effectively putting a floor on our gas
prices so they are unlikely for any length of time to drop below
that oil-indexed level from Continental Europe and elsewhere.
LNG is increasingly important as a marginal fuel, particularly
in winter periods, and you will have seen the projections for
where we might conceivably be in 20 years' time. That influence
is only going to grow. The LNG market is highly influenced by
the oil price and, for reasons we might explore later, we may
end up having to pay a premium over true contracted LNG in other
markets in order to make sure those cargoes arrive in the UK.
Therefore there is every expectation that our prices could be
at least as high if not higher than Continental prices on an average
basis, and on those occasions when gas prices are lower internationally
countries with greater storage capacity than we have can take
advantage of it; and we cannot. I do not know if Chris has anything
to add on that because he has an interest in storage as well.
Mr Tane: Just to give you some
statistics. I think after the new storage comes on-stream in three
or four years, the UK will have 19 days of storage. That compares
to 99 days in Germany, 122 days in France, and I believe similar
sorts of levels in the States, so one thing that is clear is that
this country has a very, very low level of storage and that must
be one of the factors in driving the way, both the level of prices
and the volatility of prices. Going back to the oil linkage point
just to reinforce what Jeremy said, fundamentally what we see
is that in the summer UK prices are at the same level as the Continent
and in the winter they operate at a premium to the Continent,
so from where I sit it will be extremely desirable if I could
buy gas on the Continent on a Continental-type of contract but,
for whatever reason, that appears not to be possible. My company
last year bought space on the Interconnector, we went into Europe,
we talked to 19 suppliers, many of whom supply our sites on the
Continent and we asked them to give us gas on the same basis that
we would transport it to the UK. Of the 19 we approached we got
six replies and all six supplies offered us prices based on the
UK pricing structure not the Continental pricing structure and
adamantly refused to give us prices based on the Continental contracts
that we were enjoying over there.
Chairman: We are straying into other
territory and we should try and stick to infrastructure. That
is very helpful but we are trying to stay on infrastructure at
present so back to Mr Clapham.
Q292 Mr Clapham: It certainly is
helpful in the sense that we can see that that pressure does contribute
towards increasing the price. Just coming back to LNG, and the
storage issue, why is it that the terminal at the Isle of Grain
is not actually being used in 2008? What is your view of that?
Mr Nicholson: We want to know
the reason for that but we have some suspicions, one of which
centres round the access arrangements at that terminal. We understand
that the arrangements there mean that there is only a relatively
short number of days' notice of when a spare berthing slot comes
up and that in practical terms it is almost impossible for a third
party to make use of that with such short notice. There may be
other explanations, and perhaps you might wish to ask terminal
operators or indeed the regulator their view about this, but in
our view it was a mistake for the UK to exempt the import facilities
from regulated third party access and more effective "use
it or lose it" provisions which will give notice to the market
sufficiently in advance of spare berthing capacity. I think I
am right in saying that we have seen no evidence that a third
party has ever been able to make use of that terminal in the entire
time it has been operational. We hope this is not going to be
replicated on a larger scale when the new and larger terminals
open at Milford Haven.
Q293 Mr Clapham: Has that view been
expressed at all to the Department for Business and Enterprise
and, if so, what is the response?
Mr Nicholson: Very clearly by
ourselves and indeed to Ofgem, the market regulator, who were
responsible for accepting these arrangements in the first place.
Q294 Mr Clapham: Just looking at
the import capacity, the opening of Milford Haven for example
gives greater gas storage. What kind of effect do you feel that
will have on price volatility? Is it something that is likely
to be advantageous or disadvantageous to industry?
Mr Nicholson: To the extent that
we need the capacity to import the gas, it is advantageous to
have it. It is necessary but not sufficient to fix the problem.
As we have mentioned, if you have import capacity, if you do not
have adequate access arrangements and you do not have the storage
to go with it, then we are not going to get the full advantage
of that potential flow. There is one other aspect to it, in many
other markets there is a greater degree of LNG being precontracted
whereas in the UK, at least at the moment, it seems that it is
very much driven by the availability of spot cargoes. That is
a very risky model on which to run the security of the gas system
which will ultimately depend on those cargoes being there. As
we discovered in recent months and years, we may have to pay an
extraordinary premium to get those cargos to arrive in the UK
perhaps at a higher price than industry is able to afford for
its gas.
Mr Tane: The experience with the
existing terminal running well below capacity suggests that terminal
capacity is not the issue so just adding more capacity is not
going to do very much; the real issue is what is it that is preventing
the gas actually coming through the terminal in sufficient quantity,
and that is the problem that needs solving.
Q295 Mr Clapham: What kind of responses
again have you received from Business and Enterprise because you
have raised these issues with them and they know full well what
your view is. Are they sympathetic? Have they made any suggestions
with regards to solutions?
Mr Nicholson: The response we
have had is that decisions have been made and it is difficult
to change them. The investment has gone ahead on the assumption
that there would be the current access arrangements and we have
heard nothing back, either from BERR particularly or Ofgem, to
suggest that they are minded to change the arrangements, which
in our view is regrettable.
Mr Clapham: I think that it is a very
important issue that we may raise with BERR.
Q296 Miss Kirkbride: I was very shocked
by the figure that you gave about the storage capacity that we
have in the UK. Why is that and whose fault is it?
Mr Tane: I think the reason why
is that until six or seven years ago the view was that we had
plenty of storage, it was called the North Sea, and of course
when we had plenty of gas coming out of the North Sea it was always
there underground and could be turned on or off as needed. It
seems to me that somehow the authorities, the market, whatever,
has failed to recognise what is now happening which is the decline
of availability in the North Sea.
Q297 Miss Kirkbride: How could that
be? There are plenty of statisticians to tell you how much is
left. How can that possibly be that someone has not worked that
out?
Mr Tane: I can only join you in
the question. I think it has been predictable for many years that
this decline in availability would come and I am staggered to
see that there was no forward thinking in terms of what difference
it would make once we were in deficit.
Chairman: In the interests of making
progress I think you have made your point.
Q298 Miss Kirkbride: Does the Government
or the market have a responsibility that that infrastructure was
not built? It is quite an important question, Chairman, because
if the Government or the market has a reasonability for that infrastructure
not being built—
Mr Nicholson: There is a bit of
both is the short answer. I am sure that the oil and gas industry
would say that planning is a big problem in doing anything at
the moment on energy infrastructure including storage facilities.
That does not explain the extent of the deficit but it does explain
why perhaps that has been a barrier to getting things on-stream
as quickly as we would like. I would come back to the point are
the incentives for suppliers, particularly suppliers to the domestic
sector where the big swing in demand for gas comes from, sufficiently
strong to get them to invest in the storage that is necessary
to secure supply? Because at the moment if the system breaks down,
as it very nearly did two winters ago and we came within 24 hours
of rationing gas to our members, and indeed some of our members
shut their plants down for as long as three months as a result,
the default position if we run short on gas is that our members
get their plants shut down in order to ensure security of supply
for the domestic sector. That cannot be a sustainable model for
managing our energy security.
Q299 Chairman: To answer Miss Kirkbride's
question then, you blame the regulator for not putting in place
the right market incentives?
Mr Nicholson: I think we would
question whether these incentives are strong enough. I think there
is a separate but related question as to whether the UK for strategic
reasons needs a strategic gas resource, but that is somewhat different
from the market question.
Chairman: We will have to move on but
thank you, that was very helpful.
Mr Clapham: Chairman, could I ask one
final question of Mr Tane: the situation that you describe where
you went into Europe to buy gas but you could not get the gas,
even though there would have been space on the Interconnector,
again have these issues been raised—
Chairman: I am actually going to say
that Adrian Bailey is going to ask these questions in some detail
now. Hear what Mr Clapham said and answer that when we deal with
Adrian's questions.
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