Examination of Witnesses (Questions 640-659)
MR NIGEL
WOOLEY, MR
RICHARD GUERRANT
AND MR
PAUL TRIMMER
17 JUNE 2008
Q640 Chairman: What is inhibiting
your ability to move that gas around?
Mr Trimmer: There are some physical
constraints in the system and also different regulatory interpretations
can sometimes make it difficult to move gas round, but that is
improving and I believe that things like unbundling will help
that also.
Mr Guerrant: There are also different
specifications of gas across Europe that make it very complicated.
All of those technical issues need to be worked out. Therefore,
there is a hardware problem which is all about bottlenecks, specifications
and so forth to make it fungible, but there is also a software
problem which is more to do with contracts, regulations and so
forth.
Q641 Mr Weir: We were told in an
earlier session by one of the major users of gas, INEOS, that
it had time on the interconnector and had sought to buy gas in
Europe on the type of contract that exists in Europe but no one
would supply on that basis. Presumably, you all deal in gas both
on the European mainland and in the UK. Why is it that you or
one of your competitors would not supply gas to them from Europe
on a European-type contract but only a UK-type contract?
Mr Guerrant: I am puzzled when
I hear something like that because it does not make sense. If
they were going to be taking delivery of gas in Europe they should
be able to get the price.
Q642 Mr Weir: They were going to
take it back to the UK through the interconnector.
Mr Guerrant: If my understanding
of the question is that he had taken capacity to where he was
going to take delivery of the gas in Europe he would be taking
title to the product there. It puzzles me because there is gas
available to be sold there. I am puzzled that he was not able
to do that.
Q643 Mr Weir: So, if he approached
you you would sell him gas on that basis if he wanted it?
Mr Guerrant: Yes; I am always
looking for new customers.
Q644 Mr Weir: Given the strong link
between the UK and the mainland European market, is there any
point in the UK having a fully liberalised market if Europe is
not following along and doing the same thing?
Mr Wooley: I think that what you
are observing at the moment is that the UK has taken a particular
path and Europe, if it has followed at all, has followed very
slowly. Therefore, some of the issues we are describing are ones
where the UK has not benefited from liberalisation in Europe because
it simply has not taken place. An example I talked about earlier
was security of supply. When security of supply is in discussion,
particularly for the winter, there are very large storage reservoirs
available in some of the continental European countries. One of
the questions often asked is: when you get into a peak period
in the winter and there are high prices in the UK why is it that
only a limited amount of gas flows from Europe to the UK? That
is certainly an area where liberalisation would help and you would
expect to see more gas moving around. More liquidity in the European
markets would promote greater flows of gas to the UK in those
periods.
Q645 Mr Weir: But if Europe does
not liberalise to the extent the UK has should the UK for its
own security of supply look to de-liberalise some of the market
here?
Mr Guerrant: First, based on what
I said about the development of trading hubs in Europe it is starting
down that path. I would disagree that there is no liberalisation
because that is occurring now and we are selling into those markets
every day. The fact that the UK has liberalised has allowed us
to make the $13 billion investment to bring in new LNG into the
UK. The fact that you had a liberalised market was a key attribute
for us to select the UK for that project. It has allowed the UK
to get new supplies from the Netherlands also with the BBL. I
would say that you have enjoyed more advantages than disadvantages
over time. We may be seeing some short-term aberration. On the
continent many of the long-term oil-based contracts have lag effects
and now we start to see higher oil prices we may see prices on
the continent flip the other way and the UK may be cheaper. Usually,
these things stay pretty close together over a long period of
time and you end up with aberrations over a short period of time.
Q646 Mr Bailey: With oil prices likely
to continue to rise obviously irrespective of other factors the
price of gas will go up. That is very convenient for the producers.
Is that not the real reason why this link is being sustained?
Mr Trimmer: If we talk about the
UK there is no link. There are some old contracts
Q647 Mr Bailey: But it impacts upon
the price of gas in this country?
Mr Trimmer: Yes, that is also
why I say we have a transitional period where there is some influence
from the continent. One of the biggest influences which will arise
fairly quickly is that of the global market. I personally do not
see the link and the motive which says that we would hold on to
a particular way of working on the continent if it did not give
us the signals we need to make the new investments and to do the
sorts of things we want to do around the UK. The nature of the
UK market is that it provides us with the confidence to invest
a considerable amount of money in the Langeled pipeline and the
very large Ormen Lange gas field that we have just started to
bring on the strength of the UK price base. I do not accept the
starting point which says that Shell is particularly aligned to
one form of pricing or the other. It is the market pricing in
the UK that drives the pretty successful investment programme
at the moment.
Q648 Mr Bailey: But one of the intensive-energy
users said that it had tried to buy gas and asked for a continental-type
contract but could not get it.
Mr Trimmer: I can honestly say
that I am astonished at the statement.
Mr Wooley: I can say for BP that
at the moment that is not an area of the market that we would
serve. We withdrew from that sector of the market some years ago.
Q649 Mr Wright: We know that during
the summer months there is always a downturn in gas production
in the UK for obvious reasons. Is there any evidence that the
interconnector is used more to export gas from the UK rather than
import it?
Mr Wooley: The balance of flow
through the interconnector over the various periods of the year
is obviously a matter of public record, as it were. Historically,
when the UK had a large production surplus it was able to export
quite significant volumes in the summer months. As the UK has
become less self-sufficient the amount of gas it can export in
the summer has reduced and is quite small. Correspondingly, the
volumes of gas that are imported both through the interconnector
and the BBL line have increased to the extent where basically
we import about 40% of our gas on an annual basis.
Q650 Mr Wright: Is that directly
through the interconnector or BBL?
Mr Wooley: Through a combination
of the interconnector, BBL, some LNG imports and connections to
the Norwegian systems.
Chairman: There is a lot of jargon in
this industry and Anne Moffat will ask you about one example which
is relatively new to me.
Q651 Anne Moffat: It began this morning
when the Chairman did not understand what the national balancing
point was. I do not think any of us knew it. One of the notes
we have says that it is the virtual trading location for the sale
and purchase of natural gas. It sounds like something out of Star
Trek. Maybe you can enlighten us.
Mr Guerrant: I will take a stab
at it. There are various segments of the market here in the UK.
Clearly, there is the domestic sector or retail sector, but the
sector in which my company is involved is the wholesale sector
which is what is called the NBP, the national balancing point.
Essentially, this is all the gas that goes into the national grid
system. That gas is traded on various terms but primarily on a
short-term basis and I talked about the pricing of that a minute
ago. If we look at the absolute volume of gas going into the grid
from which UK consumers pull their gas, the buys and sells are
multiples of nine to 14 times the physical volume that consumers
like ourselves pull off the system. That system of buying and
selling is what creates the liquidity and creates the highly competitive
market and the transparent market pricing one has.
Mr Trimmer: You may imagine a
market. Why is it a virtual and not actual location? You do not
have to bring the gas to a particular point in order to make the
sale; it is virtual because many different points count as your
having put gas into the market. You do not have to bring it physically
to Easington or London in order to make the sale; you can do that
by putting gas in in the north and someone can take gas out in
the south. That does not matter because it is within the national
grid system.
Mr Guerrant: What is very important
is liquidity. If I had to haul the gas to your meter to serve
you there would not be liquidity; there would not be multiple
buyers. By creating this virtual point it allows all the buyers
and sellers to be on the same basis. There is full liquidity and
no one has an advantage.
Q652 Anne Moffat: What proportion
of UK gas is traded by this balancing formula?
Mr Guerrant: The NBP is a market,
not a formula. Looking at UK demand, nine to 14 times is actually
traded, so a lot is traded in multiple times. That creates the
extra liquidity, so it is the other way round. Does that make
sense? You have the physical volume of molecules that go to the
customers. Let us call that 10 units. The number of buys and sells
of all the wholesale players' buying and selling is 90 units;
in other words, it is nine times the physical volume. You have
a lot of buying and selling among all the various traders.
Chairman: But that characterises a lot
of markets, such as futures markets and so on; it is not a particularly
unusual feature. It does not tell you how much gas is being traded
off that market or how prices are being set by the small percentage
that is being traded on that market. I will ask Mr Wright to put
his questions.
Q653 Mr Wright: This is quite relevant.
There was some confusion as a result of the previous session when
Alistair Buchanan talked about the amount of gas put on the off-market
as opposed to the forward market. energywatch has stated that
about 80% of the product is in the off-market contracts, leaving
only 20% in the forward market. Is that a true reflection of the
amount or is it somewhat different from that?
Mr Wooley: In this regard I can
speak only in respect of BP. The history of contracting in the
North Sea is that very often in the early days fields would be
contracted to customers, primarily British Gas in the old days.
You would sell the production of the field for the field life
under a so-called depletion contract. You would commit all the
gas from that field over its life. Obviously, in today's market
we still continue to sell that gas to the original customer. In
the mid-1990s there were lots of what we call supply contracts
whereby we would commit to supply reserves from fields for, say,
a period of 15 years. Those would still be dedicated to a particular
customer. The more recent history is as we have developed more
fields or old supply contracts have come to an end is that we
put those volumes through the traded market.
Q654 Mr Wright: The traded market
is the forward market?
Mr Wooley: Yes. BP puts about
60% of its volume through the traded market and about 40% through
the older contracts.
Mr Trimmer: To complement those
numbers, we are also active in the industrial and commercial sector
and so we market directly to companies. Between the traded market
and the industrial and commercial market as we call it we are
between 60% to 65%, so 35% to 40% is left under the old-style
contracts which are similar field depletion contracts. That was
all there was at the time because there was a monopoly buyer.
Mr Guerrant: To put ExxonMobil's
numbers in the UK in perspective, about 60% of our gas here is
on a traded basis and about 40% comes under the old contracts.
Q655 Mr Wright: So, the figure quoted
which shows that 80% of long-dated physical volume is being traded
on the off-market is not true. You have told me that the figure
is about 40%.
Mr Guerrant: There are two ways
in which gas is being traded. I am not sure about the question.
We call it the over-the-counter market.
Q656 Mr Wright: What is said is that
80% of the total production is already committed in off-market
contracts which are being negotiated behind the scenes in secret,
leaving only 20% to be traded, which obviously determines the
price. You are telling me that it is approximately 40% on the
off-market as opposed to 60% that can be traded on the open market.
Mr Trimmer: I do not know whether
this is another example of slightly different definitions or interpretations
of a word, but I can tell you that the traded market is definitely
at 20% to 25% and the industrial and commercial sector, which
is one or two-year contracts, is NBP-linked and that is another
40%. That leaves the last 35% to 40% under the old-style contracts
which are described in that way.
Mr Guerrant: ExxonMobil is not
involved in the industrial sector. We put either all of our gas
into the wholesale NBP market or it is subject to existing old-style
historic contracts. Our split is about 38% in old-style contracts
and the remainder goes to the wholesale market. If he says that
80% is in the long-term market it does not make sense for my company
and, from what I have just heard, for others.
Q657 Mr Wright: Is it true that the
forward prices are used as a basis for many of the off-market
contracts?
Mr Guerrant: We start to get into
commercially sensitive matters. Let me talk here in conceptual
terms; I will not talk about the specifics of my company. Generally
speaking, based on my knowledge of the UK a proportion of the
old-style contracts are linked to oil; a proportion are linked
to the PPI; and a proportion are linked to electricity and coal.
The splits can vary.
Q658 Chairman: We have heard a good
deal of evidence that a lot of the contracts of the major users
are on a forward price basis; they have to pay whatever the market
says at any time. They do not know the price which changes as
the wholesale market price changes. They say that a very small
proportion of gas is traded and that determines their contract
prices.
Mr Trimmer: I guess you are hearing
that there are three people who do not quite understand that statement.
I have to be careful about competition law here and so I shall
not go into detail, but we now have about 12—we are creating
up to 22—what we call value propositions, some of which
are fixed and some of which are floating. Therefore, the customer
can make quite a choice at the time the contract is signed, and
there are even arrangements that allow the customer to move from
one to the other in the middle of the contract. So this idea that
somebody is at the mercy of a particular market—if they
choose to have a price which is linked to, say, the day or month
ahead gas price that is their choice, but it is not the only thing
that is around in the marketplace. Maybe they lament the fact
that they did not lock in something earlier. I do not know.
Mr Guerrant: What is interesting
and very important information for you is that having a liquid
market allows more customised pricing than a market that is not
liquid.
Mr Trimmer: Absolutely. We would
not be able to offer some of the things we do if there was not
a liquid market. At the same time, in our marketing activity we
do not feel inhibited by a lack of liquidity in the market-place.
Several of the things that we put on offer are linked to transactions
that take place in the traded market and we could not do them
if there was not liquidity. This question of how much liquidity—certainly
if we are talking one or two years—if we are talking about
five to 10 years ahead then we get into a different area, but
if we are talking about the sort of thing which most industrial
and commercial customers talk about from my perspective there
is not an issue.
Mr Wooley: To clarify, the reason
why the older contracts which do not go through the market are
not indexed to gas prices is that when they were struck perhaps
20 years ago there was no gas market indicator to which they could
be related. That is why the coal, PPI and fuel oil-type indices
were used instead.
Q659 Mr Wright: My last question
is related to INEOS Chlor which trades in Europe and the UK. It
tried to get the same contract for gas supplies in the UK as it
has in mainland Europe. Why do you think there are two sets of
rules in terms of contracts for the supply of gas?
Mr Guerrant: I am still puzzled
about the comment and the situation. You have to understand a
lot more detail about what he was looking for in the marketplace.
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