Examination of Witnesses (Questions 620-639)
MR NIGEL
WOOLEY, MR
RICHARD GUERRANT
AND MR
PAUL TRIMMER
17 JUNE 2008
Q620 Chairman: What is the oil price
this morning?
Mr Guerrant: I am not sure. Yesterday
afternoon I believe that the WTI (West Texas Intermediate) benchmark
was in the range of $137. As to the question of what causes it
to be where it is today, clearly there are temporary factors that
influence some of these things. There are experts round the world
who say that speculation is not the issue. It may be due to the
weak dollar and many of the familiar things that we read in the
newspapers every day. It is a difficult question. Our costs in
finding new supplies are also going up. One of the issues about
which we are concerned is that our job of bringing on new supplies
to try to moderate this, to get access to new resources and develop
them and bring them online is becoming more difficult. We are
going into more difficult and higher cost areas.
Mr Wooley: The fundamentals that
Shell has described are exactly those that we observe in the market,
too.
Q621 Chairman: I understand that
in the United States limits are placed on the size of positions
taken by traders. I know you have underplayed the importance of
speculation, but there is no such rule in the London markets and
the FSA certainly has no such provision. Do you think there is
a case for capping the size of positions taken by London traders
in the same way as happens in the America?
Mr Wooley: In relation to the
traded gas markets in the UK one of the benefits we have seen
and talked about is the liquidity in those markets. Obviously,
the positions which various companies and trading houses take
in bringing forward that liquidity are a benefit to the market.
I am not sure what benefit there will be in capping the size of
a position that is taken.
Q622 Mr Clapham: When we look at
the gas market in Europe, there has been enormous change. For
example, in 2003-04 we imported about 2% and by 2008-09 it is
likely that the figure will increase to about 40%. When one compares
the UK gas market with Europe—you were in the room during
the previous session and heard what Ofgem said—it seems
as though it is the European relationship that will impact and
have an influence upon prices in the UK. Is that your view? Do
you see it changing in the near future, or are we in for a long
haul whereby prices in the UK will be determined by what happens
in the gas market in Europe?
Mr Wooley: What we have seen over
a period of time is a transition in the UK market. If you go back
to the period prior to 1998 when the interconnector between the
UK and continental market was opened the UK was essentially an
island economy which benefited from plentiful natural resources
around its coast and was predominantly supplied from UK sources.
It was able to maintain a reasonable balance in the market. We
entered a period of liberalisation which encouraged the bringing
forward of lots of new gas supplies to the UK. In the mid-1990s
leading up to the opening of the interconnector we saw very low
prices and the development of a very competitive market in the
UK and we experienced levels of gas on gas competition within
the UK market. As the UK has moved away from being a net exporter
of gas to an importer of gas the pricing signals which the UK
market experiences are much more determined by those that come
from continental Europe and the oil indexation and long-term contract
nature of that market. Therefore, I think the market has seen
a period of transition and as we go forward we expect more and
more to be involved in the European market and to take price signals
from there. Further, with the development of the LNG terminals
which will serve the UK market increasingly LNG trades at least
on a regional basis and is connected in a global sense. We see
some global price indicators from LNG markets coming to the UK
too.
Mr Trimmer: I emphasise the last
point. The interesting transition is how quickly the UK is absorbed
into pan-European pricing, but how quickly will pan-European pricing
be absorbed by global pricing? All of Europe's incremental supplies
now come from very long distances. Even the Russians, for example
have an opportunity to put gas into LNG or a pipeline; similarly
the Algerians and the rest of the North Africans. Therefore, there
is another overlay. When does the global market have a very substantial
impact on UK prices?
Mr Guerrant: Over the past five
years there has been an evolution of liquid markets on the continent.
In the Netherlands there is a very active liquid trading hub called
TTF. It is very similar to the way in which NBP is being traded
and it has a gas index very similar to what you see here in the
wholesale market. In the past two years we have seen the German
system change with a new grid access model that allows the markets
there to create these trading hubs. We have seen trading hubs
around: there is the E.ON system as well as another hotline system
called BEB. In northern France we have seen the evolution of a
trading hub. My company is trading on all of those hubs today.
All of our gas that is not dedicated to long-term contracts moves
to all of these trading hubs. That is not to say that the liberalisation
of the continent is moving fast enough, but it has started. We
have started to see significant liquidity developing there. We
are starting to see that and it is very encouraging.
Q623 Mr Clapham: It appears that
there are two factors which will impact on gas prices in the UK
in the long term: one is LNG and the other is the situation in
Europe. Mr Guerrant, given what you say about the interconnectedness
of the hubs in Europe, why is it that gas prices in this country
last winter rose so much higher than European gas prices? What
was the reason for that?
Mr Guerrant: You see a very close
correlation within a few pennies of the prices at these liquid
trading hubs on the continent with the NBP because the gas moves
from Norway and other places back and forth across those hubs.
You have a convergence. You still have demand centres around certain
areas that may cause prices to be a little bit higher at a particular
point in time, but those usually close back up and you get prices
at the liquid hubs to come back into some parity within a few
pennies which reflect transportation costs across the hubs between
the continent and the UK.
Q624 Mr Clapham: Is that the view
of all the witnesses? I am looking at the graph provided to us
by BP.
Mr Wooley: Referring to the points
that have been made about the connectedness of the European hubs,
primarily the issue is that the amount of liquidity available
at some of these hubs—we have talked about the French and
central European hub, the EGT in Germany—is at very low
levels given the current state of the market. We have seen some
evolution of traded gas at Zeebrugge and now at the TTF hub which
operates in the Netherlands liquidity is growing. It is still
a long way behind the traded rates in the UK, but there is some
liquidity. The amount of gas traded on the French and German hubs
still remains very small and therefore has only a very small effect
on the market.
Mr Trimmer: If you look at the
German market and what is happening in the spot market, it is
picking up very significantly, but the majority of the gas is
still sold on the basis of an oil-price indexation which picks
up the spikes but smoothes them out. The price still rises but
it is not as volatile.
Q625 Mr Clapham: We hear so much
about European liberalisation and that is constantly blamed for
the gas price increase but given the high price we saw in winter
why did not your companies provide more gas to that market to
bring down that price?
Mr Wooley: That is a common misconception
which has been referred to at one or two earlier evidence sessions
and in some of the remarks by other companies. There is no great
residue of excess supply being held back by the companies in the
North Sea that they can bring forward to the market. Throughout
the year and certainly in the winter time the companies in the
UK arena are very focused on producing all the gas that they can
from their reserves for delivery to the UK market. We tend to
take maintenance periods and production outages during the summer
to make sure we do that at periods of lower gas prices, but in
the winter time when there is the greatest need for gas we try
as best we can within the context of safe operations to run our
facilities as hard as we can to bring gas to the market. There
is no residue of gas out there which can simply be drawn upon
in those circumstances.
Mr Trimmer: Shell did move some
gas which was originally destined for continental Europe across
to the UK, but there is a limit to what we can do for the reasons
that have been identified, plus the fact that we have contractual
obligations. We need to be able to comply with our contractual
obligations, for example, in Germany or Denmark at the same time.
Mr Guerrant: The LNG facility
that ExxonMobil and its partners are building in Milford Haven
was based on the ability to be able to move the gas all the time
in the marketplace; in other words, having a very liquid market
like NBP that we enjoy; otherwise, we would probably have looked
at another location somewhere else in the world. The fact that
you have a very liquid market here and a producer has the ability
to sell all of his gas all the time at a fair market price is
very attractive.
Q626 Mr Clapham: One of the big worries
we have looking at the gas market is that not only is the domestic
consumer paying more than his European counterpart but it is undermining
British competitiveness. There is a real fear that given the great
increases in gas prices we could see British competitiveness lose
out. You were present during the previous session when we discussed
the fact that British gas went into Europe when prices were high.
That sets a high price for British gas that goes into storage
for winter time. Consequently, we have high prices in winter.
At no time do we seem to have the same kind of gas prices that
our European counterparts have and that is a real blow to British
competitiveness. What can be done to deal with the situation which
will help British industry?
Mr Trimmer: One of the things
that we are doing in joint ventures with other parties or by ourselves
is to increase the connectivity of the UK to other sources of
gas supply. Now that we have made the switch from self-sufficiency
to dependency on imports we feel that this is one of the most
critical things we can do. It enhances the choice that the UK
has by having access to Norwegian gas and continental gas and
LNG but it also enhances the security of supply in case we have
a problem with one of those sources of supply. We are very active
in trying to increase the number of links that the UK has to all
of the possible sources.
Mr Guerrant: The biggest thing
we can do is to bring on more suppliers. I point to Milford Haven
as a good example. We and our partners are spending $13 billion
to bring that supply into the marketplace. What ExxonMobil and
the industry can do is bring on those new supplies and create
greater interconnectivity. If over the past few years you look
at Vesterled, Langeled, Tampenlink and the BBL, all of those pipeline
projects bring more gas from the Netherlands or from the Norwegian
sector, which is very important, and, at the same time ensure
that we get the most out of UK gas: we are all working very hard
to do that, but we have to understand that it is a mature province
that is in decline.
Mr Trimmer: We are making investments
to upgrade and refresh the existing infrastructure and facilities
so they can last longer. We are investing in prolonging the life
of the fields. The UK has been astonishingly successful in perpetually
pushing out the date at which we drop off the cliff. New fields
are still coming on stream. Some of the incentives that have emerged
most recently to encourage new investment in existing acreage
are good.
Mr Wooley: It is key to emphasise
that the role of the upstream industry is to invest and bring
forward new supplies to the market. Earlier there was a commentary
about the Isle of Grain and the terminal where BP shares contract
rights with Sonatrach. We have been able to bring a large number
of cargoes to market over recent years through that terminal since
its inception in 2005. Obviously, that has made an important contribution
to the UK's supply in a period when prices were very tight.
Q627 Mr Clapham: Obviously, connectivity
is enormously important, but you guys are involved in the European
market as well as the global market. What is your view about the
timeline for liberalisation in Europe?
Mr Wooley: I think that those
of us who have been observing and participating in the market
for some period have noted that the pace of liberalisation in
Europe has always been a little slower than anticipated. Europe
has been running through gas directives and attempts to liberalise.
Q628 Chairman: I do not want to go
too far down this route. We shall ask you about liberalisation.
I want to make sure that my colleagues can ask about that in some
depth. Sometimes I feel a degree of tension among our three witnesses.
We shall not probe you for commercial secrets; sadly, we do not
have those powers, much as we would love to have them. But we
need to get a feel for the overall environment in which you are
operating. Mr Wooley, you have talked about the Isle of Grain
but you have not told us a great deal about it. How many gas shipments
were landed at the Isle of Grain so far this year? Is it 63 or
a handful?
Mr Wooley: I admit that I was
somewhat puzzled by the comments of Mr Buchanan when he sat in
this chair. In 2008 only one of 13 available slots in the Isle
of Grain has been used so far by BP. Our record over the period
since the terminal opened is that we have used 32 out of the 80
slots made available to us. Predominantly, those would have been
used in the first quarter of the year—the winter quarter.
The number we have used in different years has varied. As you
would expect, it is used in response to the relative position
of the UK market in comparison with global markets for LNG. Overall,
we have used just under 50% of the slots that have been available
since 2005.
Q629 Chairman: Mr Guerrant, at this
point I look to you. A massive investment is being made at Milford
Haven. To what extent are we insulated therefore from decisions
by those who seek to sell us gas so that supplies presently at
sea will not respond to price and go to Japan where the price
is higher but will still come to Milford Haven? What security
does that give us?
Mr Guerrant: Let me talk a bit
about how it is structured which I believe will give you a sense
of how it should work. Obviously, we have built this facility
with the liquefaction, or supply trains in Qatar and all the ships
and the actual import facilities in the UK. All of that is designed
to fit together for quality. The specification for gas here is
different from other places in the world. All of that is designed
to fit the UK market. Having said that, the question is: how do
you put together a commercial arrangement to ensure that it works?
At the end of the day a supplier like the Qatar Government wants
to ensure that it gets the market value for its gas compared with
all the other markets in the world. We could have gone down the
route that basically said we should find a buyer in the UK that
would guarantee to take all the gas at the highest price anywhere
in the world. That would not be a very fair thing for the UK consumer;
it would not be a good thing for the country. What we did was
to put together an arrangement that ensured Qatar got the market
price and it would have the option to move those cargoes when
other markets were higher. That allows the gas to be here when
the market price signals say that it should be sent here relative
to other markets in the world. That flexibility is critical. That
was the reason I said earlier that it was so critical to maintain
the integrity of that wholesale market. You have a base supplier
that has the ability to divert to other markets depending on the
price in the UK versus other markets.
Q630 Chairman: Therefore, you and
the Qataris themselves have put a lot of money in a terminal that
may not be used?
Mr Guerrant: When it is not used
it is available for third parties to use.
Q631 Chairman: But they also respond
to price signals round the globe?
Mr Guerrant: That is true. From
the perspective of LNG supply/demand over the past year or so
we have been in a fairly tight situation. Earlier reference was
made to Japan's nuclear problems. In addition, there has been
cold weather in Korea. Then new buyers in China and India have
come into the marketplace and paid high prices for LNG. That has
tightened up the supply/demand balance. We shall see some new
suppliers come on. We have not had new LNG supplies come on in
the past couple of years. The Qatargas venture will bring on new
supplies and there are other ventures in Qatar as well as other
supplies. In 2008 and 2009 we will see new supplies of LNG come
on around the world. Obviously, depending on weather and how the
world economy responds, we believe that that may moderate the
situation we see today.
Q632 Mr Bailey: Earlier it was said
by Mr Wooley that the price of European gas obviously had an effect
on domestic prices. Looking at the continental model where prices
are linked to oil prices, what puzzles me is how in a market you
can have the price of one commodity, ie gas, determined by the
supply and demand model for another commodity, ie oil. What is
the rationale for that?
Mr Wooley: Perhaps I may start
with the traditional European model, as it were. The history of
gas prices in long-term contracts that supply the European market
has developed largely on the basis of competing fuels. When the
resource owners in perhaps Russia, Norway or Algeria look to develop
their gas reserves and sell them into the European markets they
will place those volumes with the large-scale, national monopolies
within those markets. The companies that would be buying the gas
would look to make sure that they would be able to place that
gas in their own markets. To go back perhaps 30 years, largely
they would be doing that by developing the gas market by successively
displacing gasoil and fuel oil from heating services within those
markets. Therefore, it was very important for those companies
in the national markets to ensure they could acquire the gas at
a price that would enable them to compete at the burner tip with
fuel oil and gasoil. That was why as a general rule the contracts
struck with fuel oil and gasoil indices linked to the base price
for gas.
Q633 Mr Bailey: That is an interesting
historical explanation, but what is the rationale now?
Mr Wooley: I think the rationale
that has underpinned it over 30 or 40 years is one that underpins
long-term contracts. The nature of the business which enables
those supplies to be brought forward is that very large long-term
contracts are put in place to support the development of the resources
in remote regions which will then supply the market. The continuation
and competitiveness of that pricing structure has been the foundation
of the industry. If your question is that there is now a different
model available within the UK and a pricing structure which relates
more to gas on gas we can imagine that that competition will start
to develop and move more into Europe, but given the sheer quantity
of gas in Europe compared with that in the UK increasingly we
see the price signals from Europe come to the UK rather than the
other way round.
Mr Guerrant: I completely agree
with the history, but in considering the traded markets like the
UK and other traded markets round the world it goes back to: what
is the energy mix or demand in the UK and the percentage of the
various fuels that provide that energy mix? For gas to be competitive
in that marketplace it will have to compete with those other fuels
just as my colleague said, but when you do not have long-term
contracts all of that mix of fuels determines how the price in
the traded market and the demand for that gas will compete against
those other fuels. For instance, at times in a traded market in
the UK the ceiling could be around oil and you could have the
floor price, because it goes up and down based on supply and demand,
down at the coal price. My point is that the fuel mix of a particular
country and the extent to which it is connected to global markets
really determines how gas will compete and ultimately be priced
in that market.
Q634 Mr Bailey: I would have expected
the price to determine the mix to a certain extent. Obviously,
there are issues to do with capacity and production, but in terms
of demand I would have expected the price mechanism to determine
the mix, whereas here it seems to be the other way round.
Mr Trimmer: I think there is a
transition. We all understand the history of the European gas
model and pricing and why it developed that way. If you go forward
and ask what it will be like when there is extensive and good
liquidity across the energy markets as a whole I suspect you will
find that, just as in the States, when one of the main energy
forms moves up the others move with it. If you look at coal at
the moment, for example, that is also increasing very significantly
in price not necessarily on the back of something specific that
is happening to the coal market but because it is now much more
integrated into the overall global energy mix. The problem we
need to face is that energy as a whole is coming under pressure
and it is not just one market that is moving; all of them are
moving. We tend to talk here about oil and gas but we see the
same thing happening with coal. It may not be a message that we
like to hear but that is happening.
Q635 Mr Bailey: I could understand
that if they were separate markets they would often tend to follow
each other, but this is a formalised link between the two markets
which I believe is a clear demonstration in effect that there
is an illiberal market where normal market mechanisms are not
operating.
Mr Guerrant: There is a very liquid
and competitive market here in the UK. Just to demonstrate that,
it trades at about nine times the physical volume in the UK. If
you add together all of the various instruments it can be as high
as 14-plus. If you put it on the same terms and compare that to
the US, which is a larger market, the volume traded versus the
physical volume is about 12½, so it is very close. It is
notably the most liquid market in the world. We look at this market
as being one of the most liquid in the world.
Q636 Mr Bailey: If my memory serves
me right, one of the reasons it is very liquid and price-responsive
to demand is because a relatively small proportion of the gas
is actually traded on this market, so a small increase in demand
has a considerable impact on the price mechanism. I do not deny
that the British market is liquid, but to a certain extent the
increase in price is due to the illiquidity of the European market.
To move on, where is the demand for the link between oil and gas?
Is it imposed by producers or demanded by consumers?
Mr Guerrant: If we return to what
I said about the fuel mix, the relative consumers of fuel and
how they build their facilities and the percentage that ultimately
end up determining how gas will compete with those fuels and will
penetrate that market and be priced. To answer your question directly,
it is driven by consumers and the facilities that consume fuel
in the marketplace and that percentage mix.
Q637 Mr Bailey: How can the link
be broken?
Mr Guerrant: When you look at
supply and energy demand overall until 2030, ours and many other
forecasts say that 75% of demand will be met by oil and gas. That
said, we will need all of the fuels; we will need nuclear, oil,
gas and coal—all of them—to meet our energy challenge
in the future. Clearly, one of the things you can look at is your
mix of fuels. Do you go more nuclear, coal or one of the other
fuels? That mix is the driver for how gas and oil will compete
in your marketplace.
Chairman: The view forming in my mind
is that the reason you are being quite evasive on the oil and
gas question is that it quite suits you in the European markets
in which you operate. I am a bit sceptical about the evidence
we are hearing so far on this issue. I ask Mike Weir to ask about
European market liberalisation, and Mr Bailey can come back if
he has further supplementaries.
Q638 Mr Weir: We have touched on
the liberalisation of the market already to some extent. How far
away do you think a liberalised European market is?
Mr Trimmer: One of the things
I consider when I try to answer that question is the motive of
different governments. I believe that one of the issues we also
have to face is that different people in different constituencies
have different objectives. We believe that because of our history
and what we have experienced so far the best thing for us is a
particular sort of liberalised market. We have mentioned the French
and the extraordinary length of storage they have. That is driven
by the fact that to all intents and purpose they have no oil or
gas and so they have a perspective on security of supply that
we have never had. I do not believe liberalisation will take place
unless someone has a real go at it and grabs the whole thing by
the scruff of the neck; otherwise, it will not lead to a converged
single interpretation of that. In terms of the pace of change,
that will be determined by how individual governments react, but
from our perspective one of the key things we need, maybe not
so much as a fully liberalised market in each location, we would
like to be able to move gas around with more freedom than we've
been able to do so far. They have every right to have a particular
structure, but we would at least like the ability to move the
gas around so we can then achieve what we want in the UK.
Q639 Mr Weir: Given energy security
about which there is some concern at the moment, is there not
evidence that some countries have retreated to looking after national
energy security rather than a liberalised European market? In
that instance is it likely that there will ever be a fully liberalised
European market?
Mr Trimmer: I guess that is why
I said I thought people would end up in different situations in
different locations, but there is another perspective, namely
if that is the way people wish to go—it is not for us but
elected people to determine that—at least give us the freedom
to move gas around, so we would perhaps focus a bit more on saying
that we would like freedom to move gas around rather than be particularly
concerned about a particular price.
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