Examination of Witnesses (Questions 560-579)
MR ALISTAIR
BUCHANAN AND
DR ANDREW
WRIGHT
17 JUNE 2008
Q560 Chairman: This line of questioning
goes to the heart of our inquiry. What you have told us is factually
at odds with what we have been told by previous witnesses as far
as I have understood it. There may be a way of reconciling this
because different definitions are being used. We were told by
the large users that their contracts were determined by a tiny
volume of traded gas which then determined their long-term contract
prices, so there is not the liquidity in the market that you claim
and that goes to the heart of the problem. You deny that, so it
is very puzzling to the Committee.
Mr Buchanan: I am saying there
appears to be liquidity in the gas market. Certainly, in the meetings
that we have with the large industrial users they make it very
clear that they seek to trade short term and do not seek to lock
in long-term contracts. I am interested that they have given you
an indication otherwise. We certainly need to marry up the information
flows.
Q561 Chairman: It is absolutely crucial
that we marry it up.
Mr Buchanan: It is absolutely
crucial.
Q562 Mr Binley: We were told that
forward curve prices were therefore based on limited trading activity
and might not be a robust indicator of future costs. That does
not equate with what you told the government in January which
had a massive impact on how people now feel about energy prices.
It is this lack of information of which you are in command that
concerns me because you cannot do your job without it.
Mr Buchanan: We feel that we can
be confident about the market with the information flows we have.
Should we feel that we need more information in the light of the
review we are doing that is something that will have to consider.
Q563 Mr Wright: While we are considering
wholesale gas contracting, one of the issues that has been raised
is the difference between wholesale prices on mainland Europe
and here. Evidence was given to us that a company trying to buy
gas from mainland Europe to put through the interconnector was
not offered the same price in mainland Europe; the supplier would
sell it only on the basis of the UK wholesale price, which is
absurd bearing in mind that the company has interests in mainland
Europe and can buy it cheaper there, but the same gas would have
to be traded in the UK. Does that concern you?
Mr Buchanan: This is very interesting.
I give full marks to INEOS Chlor who went public with that information
when it visited the Committee. I was privy to that information
a little before that. They provided that example to DG TREN and
DG COMP. INEOS Chlor has done a very good job in drawing attention
to instances of what appears to be bizarre behaviour on the part
of some of the large pan-European players in terms of their inability
to move gas across Europe and get a suitable price.
Q564 Mr Weir: To develop that, INEOS
seems to want continental-style contracts with large suppliers,
but in answer to Mr Clapham earlier you talked about the link
between oil and gas prices on the continent. You gave the impression
that this was a bad thing because it kept prices high, and that
is certainly the evidence we have had from others. However, that
seems to contradict INEOS's position; they wish to have these
contracts as they seem to be of the view that that will give them
longer-term security on price. Can you explain the apparent contradiction
between the link which keeps prices high and large users wanting
to have contracts on that basis?
Mr Buchanan: With a caveat, what
INEOS has done has been breakthrough work in trying to assist
us to obtain market instruments and to get the marketplace to
work in Europe. Where I struggle with some of their discussions
is the inference that they could pack up Runcorn and move over
to Germany or other countries in Europe. The starting point is
the forward price curve. Italy which is an oil and gas market
and Holland and Britain have substantially higher prices; for
Italy and the UK it is €20 and for Holland it is €10
higher than for Germany. Why is that? Primarily, it arises because
Germany is driven by a coal-based market whereas we are driven
by an oil and gas-based market. Let us say one up sticks and goes
to the Ruhr. One gets that €20 pick-up, which incidentally
is no different from where it was when we discussed this three
or four years ago in the probe. There are a number of things about
which one needs to be quite worried. First, the transportation
and network cost within one's overall bill is substantially higher
in Germany; it represents over 20% of the bill, whereas in Britain
it is below 5%. That wholesale price is therefore not one's final
price. If one moves to the Ruhr one has to consider two things
that might have an impact. First, there is the oil/gas lag index
within Germany. One might still have that impact in the UK, but
from figures that I have seen coming from the City there is a
belief that the EU trading certificate is trading €10 low.
Clearly, in a coal-based market that will have an impact. Therefore,
when one looks at the simple statement about moving from Runcorn
and going to the Ruhr that is an easy sound byte. One needs to
break that down.
Q565 Mr Weir: That was not my point.
We are told that the oil/gas link creates higher prices in effect
because of the escalating price of oil, but INEOS appears to be
saying to us that contracts based on that link are better value
than contracts based on the forward gas price as appear to exist
in the UK. I cannot quite get my head round the contradiction
between these two concepts.
Mr Buchanan: Perhaps we need to
go back to them to get additional clarity, but I believe they
are saying that the German price is more preferable to them and
maybe that is because it is coal-based and they have not felt
the full impact of the EUETS which are yet to come. There are
other issues within Germany such as local tax breaks from the
various Länder that may have a benefit. I went to
Runcorn and chatted to them about it and they acknowledged that
that could be quite a substantial issue within the overall package
in Germany.
Q566 Mr Weir: We have heard concerns
voiced by some of the small suppliers about lack of liquidity
in the electricity market. Is that a concern you share?
Dr Wright: Yes. It is a message
that we hear consistently from small suppliers. We have not seen
the same increases in liquidity in the electricity market as we
have seen in the gas market over the past few years. On some measures
we have seen a decline and the increasing vertical integration
of the industry may well have contributed to that in addition
to the exit from the market of various trading companies such
as Exxon and TXU earlier. That is a concern and it is something
we are looking at as part of the probe. We are concerned by anything
that makes it more difficult for small suppliers to establish
themselves in the market.
Q567 Mr Weir: Are you able to tell
us what effect this lack of liquidity has on wholesale electricity
prices?
Dr Wright: Because the majority
of electricity suppliers are vertically integrated to some extent
it may make it more difficult for new entrants to come into the
market and so it may mean that the competitive environment in
electricity supply is less intense than it might be if we had
a range of new entrants able to enter the market easily. The management
of wholesale market risk is a major challenge for a small supplier.
Q568 Mr Weir: Given that a major
player, British Energy, who produces electricity is not in the
retail market would you be concerned if that company was bought
up by one of the existing `Big 6'suppliers and so led to even
less liquidity within the market?
Mr Buchanan: Perhaps I may just
outline our broad strategy and then answer the question. We do
not comment on any potential deals because we do not want to be
seen to be affecting capital markets. There is a 10-day window
on the back of a major deal that John Fingleton at the OFT as
competition authority would offer. We would put out a consultation
during that phase. It will not surprise you that we have had substantial
representations. I have been out on the road to see a number of
companies which have raised issues in this regard to which I will
come back. The third element is that whether it is the European
Commission or our own Competition Commission we will make a detailed
comment. We have had similar comments from you and from both independent
generators and suppliers which we take seriously. My colleague
mentions that it is being reviewed as part of the problem. As
they have said to you, the question is whether there is any way
that a certain amount of the trade should be made transparent.
Should contracts be made transparent in the marketplace? What
will we do about historic information? From companies like British
Energy or Drax currently one gets a vast amount of information.
Would all of that go or would you get just one line in an EDF
group account, if you are lucky? Therefore, how can independents
understand what is happening in the marketplace? It is a matter
of both liquidity and information. We hear what they are saying
and, as my colleague infers, that is something we are looking
at within the probe.
Q569 Mr Weir: Another point about
lack of liquidity is what is happening on the continent. Despite
what you say about unbundling there is evidence that some of the
big companies are trying to buy up others to create bigger entities
and that could have a knock-on effect in the UK if, for example,
EDF was successful in buying Iberdrola of Spain which owns Scottish
Power. For example, would you be concerned if there was a contraction
from the `Big 6' to the `Big 5' in the UK?
Mr Buchanan: In those instances
the likelihood is that the OFT would blow the whistle and say
it would like to hear from the parties and the usual range of
criteria would be looked at: market shares, HH index and regional
and national factors. I cannot go further than that, in part because
I am not the competition authority but also because I am sure
that these issues would be raised with it.
Q570 Mr Weir: It has been suggested
to us by some other witnesses that the integrated firms, in effect
the `Big 6', should be forced to trade some of their electricity
on the open market. Is that something that you believe has merit?
Mr Buchanan: I want to be very
careful here. We have a probe running. You will be our first port
of call when we arrive at our views in September.
Q571 Chairman: We are discussing
today primarily prices but they are related to everything else,
particularly investment. Along with prices availability of electricity
and gas is also crucial. We face a particular problem in relation
to generating capacity for reasons we all know. What puzzles me
is that incentivised generation where there are subsidies, for
example renewables, is being undertaken by some smaller companies
alongside the `Big 6', but conventional non-incentivised generation
is taking place almost exclusively within the `Big 6'. Why is
that? Is there some market failure there?
Mr Buchanan: I think it is worth
standing back. There is a tendency to say that because you have
a `Big 6' in supply you have a `Big 6' in generation. Clearly,
the issue involving British Energy that we have just been talking
about highlights that that is not the case. The `Big 6' in generation
have 50% to 60%, so what is the remainder? Drax, British Energy
and International Power have grown their market share from about
4% to 9% in the past few years. One also has Teesside Power and
Conoco. There is a list of about 13 players in all within the
generation market. One starts from that position. If one looks
at the new plants in what one might call the traditional end of
the marketplace, where are they coming from or what is changing
hands? Teesside Power with the largest gas-fired power station
in Europe has just been bought by Gaz de France. That is a new
entrant into the electricity market in the UK. A very large power
station in Aberthaw in South Wales is being built by Welsh Power,
an independent. Last week a plant in Redditch was bought by Severn
Power, an independent. Hatfield's 900 MW power station is an independent.
The two stations that are being built in the traditional sector
are Langage by Centrica and Marchwood by Scottish and Southern.
Those are the `Big 6'. Even within the traditional area the knee
jerk reaction that it can involve only the large players is not
working out like that at the moment. E.ON, RWE et al would
like to build big power stations at Kingsnorth, Tilbury, Pembroke
and Staythorpe. Yes, they would, but clearly there are independents
coming into the traditional end of the market. As we discussed
last time we were here, if you are looking at the kind of subsidy
with which the renewables certificate provides an entrepreneur
will seek to go to the renewable end of the market because the
returns are quite substantial.
Q572 Chairman: So, they are responding
to market signals?
Mr Buchanan: I think they are.
Q573 Chairman: Until recently there
was a risk—perhaps it still is—that British Energy
would be bought by one of the `Big 6' with the loss of liquidity
that would flow from it as Mr Weir just discussed with you.
Mr Buchanan: Indeed.
Q574 Chairman: A huge slice, give
or take 20%, of independent generation would be lost?
Mr Buchanan: Yes.
Q575 Chairman: Are you really confident
that vertical integration of the electricity market is not dulling
market signals for new entrants?
Mr Buchanan: You have put your
finger on something that we are looking at within the probe.
Q576 Chairman: Did you refer to a
plant in Redditch?
Mr Buchanan: Yes. RDI has a small
oil-fired open gas plant.
Q577 Chairman: You will know that
BizzEnergy is in my constituency and the Committee will be taking
evidence from them next week. Why are the smaller electricity
companies which say they have a problem buying electricity not
investing in generating capacity themselves, albeit incentivised
generation?
Mr Buchanan: Some are and some
are not. Good Energy whom I saw recently are looking to develop
further their windfarm site. Some smaller players are doing so,
and BizzEnergy will answer for itself.
Q578 Chairman: You are saying that
some make a commercial choice?
Mr Buchanan: Yes.
Q579 Mr Bailey: In a moment I want
to ask about the retail markets particularly prepayment meters,
standing orders and so on. Before I do so, one matter has been
puzzling me. I go back to the issue of continental liquidity in
the gas market. Given the fact that both energywatch and the intensive
users said in public session that there was illiquidity and you
appeared to think there was liquidity, why did you not pick it
up and explore the reasons for the difference in perspective?
Mr Buchanan: It does depend on
perspective. If they are talking about Europe I do not believe
there is liquidity. Within the UK market there is much better
liquidity than in European markets and perhaps that was what they
were talking about. The best answer I can give is for me to go
back to the large users. I will speak to Jeremy and Chris Taylor
in INEOS Chlor and come back to you with a written answer.
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