Examination of Witnesses (Questions 743-759)
MR SAM
LAIDLAW, MR
IAN MARCHANT
AND MR
RUPERT STEELE
24 JUNE 2008
Q743 Chairman: Gentlemen, thank you very
much indeed for coming in today. It is a slightly awkward arrangement
with the `Big 6'. We decided six at a time was too many so we
have split you into three and three, using such logic as we could
muster for the process. Thank you also for your written memorandum
which I appreciate. What I would particularly like to ask you
to do, as I always do, is to introduce yourselves for the record
and the companies you represent.
Mr Marchant: I am Ian Marchant,
I am Chief Executive of Scottish & Southern Energy.
Mr Steele: Rupert Steele, Director
of Regulation, Scottish Power.
Mr Laidlaw: Sam Laidlaw, Chief
Executive of Centrica plc.
Q744 Chairman: Mr Steele, we
appreciate why your Chief Executive was not able to turn up and
we are very grateful to you for standing in, thank you very much.
You must be about as popular as politicians I suppose really,
you three and your three colleagues later! Give us the bad news
first: the BBC tells us that power prices/gas prices will be up
40% later this year. What do you reckon the increase is going
to be?
Mr Laidlaw: Firstly, if I may
just make a couple of introductory observations about the context
because I think it is very important here. The UK after 200 years
of self-sufficiency, first in coal, then oil, and then gas, is
now over a ten-year period moving very rapidly into import dependency
so we are buying our gas on international markets. Unfortunately,
this is coinciding at a time clearly when oil prices, coal prices
and gas prices internationally are moving up very sharply. It
is also coinciding unfortunately at a time when there is a far
greater realisation of the impact of climate change and the need
to meet a low-carbon economy. It is also occurring unfortunately
at a time of a global credit crunch and possible recession, and
that makes it very tough for families with fixed income in particular
when we have got food prices moving up and we have got interest
rates of course of moving up, so we have a difficult period. The
reality is when you look forward, the wholesale prices for gas
move directly as a result of oil because that is the way gas is
sold on the international market. We have not made a decision
yet, but it is clear that the current prices, where we are buying
our gas at over £1 a therm, that at some point in the future
gas prices are going to have to move up.
Q745 Chairman: And by?
Mr Laidlaw: This is a competitive
market and it is very important, I think you would all recognise,
to keep it a competitive market and therefore until we actually
announce to all our customers what our price moves are, whether
they be up or down, you would not expect us to comment.
Q746 Chairman: And to be fair, in
your supplementary evidence to this Committee you have pointed
out that you are not always the first mover so it is unfair to
ask you to make the first comment anyhow. Do any of you want to
hazard a guess that the BBC's 40% figure is right, a bit high,
a bit low, or are you all with Mr Laidlaw on commercial confidentiality?
Mr Marchant: It is not commercial
confidentiality. Pricing in our market is effectively driven by
two forces: input costs and competition. We can see tremendous
pressure on input costs and if you run simple models of input
costs plus margin you can get the sorts of numbers the BBC will
have come up with. It is not difficult to see how you can do the
maths but that is not how you will make a final decision on pricing;
you look at what the competitive landscape is. That is why I suspect
you will find that none of the six of us will be prepared to comment
specifically. We do not have plans yet. Unless something drastic
happens, I can see that prices in the whole industry will have
to go up significantly because of the rise in input costs.
Q747 Chairman: I think that is a
reasonable answer and all we can expect in the circumstances.
What this Committee is most concerned about is that Britain should
be on a level playing field with the rest of the world, and certainly
with Europe, so looking at Mr Steele particularly because theoretically
you are at least as well if not better informed than your colleagues,
what about the rest of Europe? Will increases in Britain be ahead
of, behind or keep pace with the rest of Europe?
Mr Steele: Much of Europe has
a rather different and much less competitive structure to the
energy markets, and that tends to cause movements to operate in
different ways. In some parts of Europe there are price controls
which may slow down movements both upwards and downwards. It really
is very difficult to compare precisely what will happen there.
It is certainly a problem that the markets on the main part of
Continental Europe are not as competitive as we would like to
see them.
Q748 Chairman: We will look at that
a little bit later. To be fair to you, Mr Laidlaw, I should give
you the opportunity to say what you said to us in writing as well
about the absolute price levels in the UK.
Mr Laidlaw: Thank you for raising
it, Chairman. The absolute price levels in the UK, compared to
certainly the EU15 gas prices, are currently—and there was
a BERR report on this that was published in March—the lowest
in Europe, some 45% below the median and electricity prices are
30% lower than the median at the time that the report was published.
Obviously this is a moving feast. Some European countries have
since put up their prices; some UK prices have gone up, but I
think if you look over a period of the last four or five years,
there is no doubt that UK prices have been below the rest of Continental
Europe. The difficulty we have now is as we import more gas from
Continental Europe we are having to pay the imported price, which
is an oil price for piped gas, and for LNG we are having to pay
a price that actually is competitive with not just the Atlantic
Basin consumers—the US and Europe—but also the Asian
consumers, and their prices have been very high.
Q749 Chairman: So you are not saying
that the reason our prices in the UK are lower is entirely due
to the nature of our markets, there are also fundamentals underlying
this issue, for example perhaps the investment that our colleagues
have made in gas storage, generating capacity, addressing green
issues, greater investment in renewable technologies, those kinds
of things can also influence the price differential?
Mr Laidlaw: The investments have
certainly helped and in the UK there has been over £10 billion
of investment going into gas importing infrastructure, whether
it has been pipelines or whether it has been regasification tunnels,
in a competitive market. The other thing that has helped historically
is there has been gas-on-gas competition because there have been
a number of independent North Sea producers who have been competing
to sell their gas into the UK. As we move forward, there are fewer
large exporters and the gas-on-gas competition is being replaced
with the sort of contracts that the rest of Europe buys their
gas on which are oil-linked contracts.
Chairman: I think that brings in Mr Hoyle.
Q750 Mr Hoyle: I think the British
public's view of it all is that you are the fat cats of the energy
market or the fat cats of British industry; is that fair?
Mr Laidlaw: No, I certainly do
not think it is fair. If we look at the numbers, they are very
clear. We are probably the only company that actually separates
the supply margin, the retail margin if you like, and over the
last four years the average margin that we have had before tax
in this business is 3.6%. I think by any standards that is not
a high margin. We need to make a return in this business because
we need to invest in new sources of gas for the UK and we need
to invest in replacing our power generation fleet in the UK. Over
25% of our power generation fleet in the UK is going to have to
be replaced over the next ten years. That is clearly going to
have a very significant cost. We will also of course have additional
cost if we are going to replace it with renewables and low-carbon
technologies, so there needs to be a return in this business.
I think by any standards the returns in the supply business have
been, as they say, modest.
Q751 Mr Hoyle: I think most people
would describe them as obscene profits, but there we are. Can
I just take you on to how you actually buy the gas. How do you
do it? Is it the spot market or are you using the forward market
or long-term contracts?
Mr Marchant: Perhaps I could give
Sam a break and pick up that one if that is okay.
Q752 Mr Hoyle: Whatever; share it
round.
Mr Marchant: We have no access
to upstream gas. We do differ from most of our competitors.
Q753 Mr Hoyle: Is that all of you?
Mr Marchant: That is us.
Q754 Mr Hoyle: Who wants to own up
then to being up-stream as well?
Mr Laidlaw: We have some up-stream
gas production. About 20% of the gas that we have to buy for our
customers comes from our own up-stream gas production. Our up-stream
gas production is taxed. It has a windfall profits tax on it and
it is taxed at 75%, so the reality is that in a higher gas price
environment, the amount of additional revenue that we are making
on the up-stream by no means compensates for the amount of additional
cost. We will be spending this year over £1 billion more
to buy our gas for the UK consumers.
Q755 Mr Hoyle: So it is heads you
win, tails the customers lose? It is one of those?
Mr Laidlaw: I think you misunderstood
me. In a rising market we are actually in a situation where margins
get squeezed. The reality is we are at the moment for the next
winter buying gas at £1 a therm and after transportation
and distribution costs we are selling it at 60p a therm. That
is not a sustainable business model.
Q756 Mr Hoyle: So what you lose in
the upstream market you will gain in the downstream market?
Mr Laidlaw: No.
Q757 Mr Hoyle: So you are losing
at both ends?
Mr Laidlaw: At the moment we are
losing in the downstream business.
Q758 Mr Hoyle: But you are making
upstream?
Mr Laidlaw: We are making a bit
more upstream but the upstream piece is taxed at 75% and is a
very small part of our business.
Mr Marchant: We buy all of our
gas on the open market. We buy a mixture of short, medium and
we have some long-term contracts. The market is liquid in the
short to medium-term end. However, it is very illiquid at ten-year
plus and all of our long-term contracts will expire by 2011-12.
They are generally indexed to oil as well. Basically for our residential
customer demand we have to buy all of that gas on the market.
We are a pure gas retailer.
Mr Steele: We are in the same
position. We are a gas retailer so we are facing this input cost
of buying gas at £1 a therm for new acquisitions of gas at
the moment. We do not have any of our own production.
Q759 Mr Hoyle: So are you more exposed
than Mr Laidlaw?
Mr Marchant: We do not have the
hedge that you were describing.
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