UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 293-v

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

BUSINESS AND ENTERPRISE COMMITTEE

 

 

ENERGY PRICES

 

 

Tuesday 17 JUNE 2008

 

MR ALISTAIR BUCHANAN and MR ANDREW WRIGHT

MR NIGEL WOOLEY, MR RICHARD GUERRANT and MR PAUL TRIMMER

Evidence heard in Public Questions 534 - 668

 

USE OF THE TRANSCRIPT

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Oral Evidence

Taken before the Business and Enterprise Committee

on Tuesday 17 June 2008

Members present

Peter Luff, in the Chair

Mr Adrian Bailey

Roger Berry

Mr Brian Binley

Mr Michael Clapham

Mr Lindsay Hoyle

Miss Julie Kirkbride

Anne Moffat

Mr Mike Weir

Mr Anthony Wright

________________

Memorandum submitted by Ofgem

Examination of Witnesses

Witnesses: Mr Alistair Buchanan, Chief Executive, and Mr Andrew Wright, Managing Director, Markets, Ofgem, gave evidence.

Q534 Chairman: Gentlemen, thank you for coming to this important session of evidence of the Committee's inquiry into energy prices. We know who you are. In particular, I have met Alistair Buchanan both formally and informally on a number of occasions, but nonetheless perhaps for the record you would introduce yourselves.

Mr Buchanan: I am Alistair Buchanan, chief executive of the industry regulator Ofgem.

Mr Wright: I am Andrew Wright, managing director of markets at Ofgem.

Q535 Chairman: Thank you for all you have done to assist this inquiry and the informal session we have had with you. We also thank you for your written evidence and further written submissions which have been genuinely helpful. Why did you change your mind? On 16 January you told the Chancellor of the Exchequer that there was absolutely no problem and a few weeks later you launched an inquiry.

Mr Buchanan: On 16 January we went to see the Chancellor following a letter we received in early January inquiring about two things, first as to what was going on with regard to increased prices because Npower had put up its prices in early January; second, we had an invitation to give the Chancellor a range of ideas, which we did, with regard to fuel poverty. At that meeting we basically outlined two issues. First, we believed that the markets were working well with regard to investment coming into the marketplace, innovation both upstream and downstream, choice and quality. We also felt that with regard to the patterns of pricing strategy we had seen in the sector at the end of 2006 and through 2007 when prices were falling the confidence that Ofgem had had in markets remained. We also wanted to respond specifically to the claim made in the Sunday Times which we were concerned about on behalf of consumers that there was overt collusion and meetings on motorways by the big six so prices were being fixed in that respect. We confirmed that we had no evidence of that, and such evidence still has not been presented to us. In terms of our decision on 23 February at the board's monthly meeting - these meetings are arranged well ahead - as an executive team the board confirmed its concern that the pricing pattern as announced effectively by the industry in late January/early February suggested two things and one additional factor: first, that the pricing strategies we had seen from the companies before with regard to the timing of pricing announcements had changed. If you look at when they dropped prices, effectively there was a period of nearly eight months between the first company announcing its drop and the last company effectively, largely under name and shame from Ofgem, following suit. Equally, the amounts by which they dropped their prices had a range suggesting a product offering to the consumer. This time round the companies went roughly at the same time. There were immediate price increases and on a national average you will see that the charts suggest very little differentiation between them. That is combined with the third factor which is very important and comes back to our statutory duty to represent consumers. There was tremendous consumer concern, including obviously this Committee's, that this needed to be reviewed. Clarity over the word "this" did not matter because there was a lot of concern. We had similar concerns in 2004 when we announced our previous probe in the upstream market. We felt that the combination of those three factors led us with confidence to go to the court and take time out to look at the marketplace particularly with regard to retail pricing, which is what we are doing at the moment.

Q536 Chairman: There are two concerns about the integrity of your inquiry. Let us deal with the first one. The fact that our decision to launch an inquiry was followed two weeks later by yours is also quite interesting. We are pleased that you followed our precedent. What about the fact that you have said effectively there is no problem but you will investigate it anyhow? How can you say there is no problem? You have given part of the answer in response to the previous question in that you have said that prices are moving more closely together, but there is a view out there that really your heart and soul are not in it because you do not believe you will find a problem. By the way, we agree that there is no collusion; we have had no evidence of it, but imperfect markets deliver imperfect outcomes.

Mr Buchanan: Ofgem frequently hears this accusation. If one goes back to 2004 when we conducted a probe, that was an inquiry which arguably stretched outside our normal activity. I know that today you are taking evidence from witnesses from BP, Shell and ExxonMobil. They were not thrilled about a downstream regulator coming into their business. Generally, when we started that probe there was a similar degree of cynicism, which was that it would be a whitewash; it was not because we came out with some very substantial findings with regard to both the Sean field and why it was not running but also the missing £1.4 billion that appeared to be being lost to the British consumer in the very uncomfortable gas/oil indexing contracts on the continent. I have to say: judge us on what we have done before. I feel confident that when we produce our results you can judge us on the quality of the work we have done.

Q537 Chairman: You will have followed the evidence we have had so far. The other way you seem to prejudge your outcomes is by not looking at the wholesale markets this time. A lot of the evidence we have had so far indicates that the wholesale markets are the real problem and that is one of the reasons we want to talk to the oil and gas companies after you. Why not look at the wholesale markets?

Mr Buchanan: You will see within our terms of reference that we have clearly indicated that will not be excluded. Indeed, within the terms of reference we are looking at the vertically integrated companies and that will be taken into the review.

Q538 Mr Clapham: Mr Buchanan, I want to ask questions regarding the way in which the European gas market impacts on gas prices in the UK. For example, we see that in the summer gas is pushed down the interconnector into Europe. That gas then bears the European price which is increased, but at the same time we see gas going into storage also taking the European price. In winter time we then have higher gas prices because gas has gone into storage at the same price as European gas. What can be done about that?

Mr Buchanan: I think we have come quite a long way. Your Committee and the British Government have helped in terms of the pressure exerted both by DGCOMP and DGTREN in the past two to three years in Europe but also the pressure we have brought to bear individually on companies. Therefore, we have seen substantial advances. You are absolutely right that markets work with quality and transparency of information. In France and Belgium we have had substantial advances in information flow. That has been a big success in the past couple of years. DGCOMP has cracked the whip over some of the companies about which we have been most concerned, the E.ONs and RWEs. In reaction to that they are looking at unbundling voluntarily, but does that get us to the information we need from Germany in particular at the moment? It does not. We need to keep the pressure on DGTREN and, if need be, to do it by DGCOMP cracking the whip over them and threatening them with articles 81 and 82 and serious fines - 10% of global turnover - if they do not provide us with this information. You are right that at the moment Germany has the benefit, due largely to historical reason, of 18 BCMs of storage compared with Britain's 4 BCMs. That is due largely to the fact that Germany has two large umbilical cords, one to Russia and one to Norway. You can see why they needed that storage, but we do not know what is in it, when it is there and what the flow of gas is. You are absolutely right that it leads to great uncertainty in the marketplace and is something on which we need to keep pressure.

Q539 Mr Clapham: But there is greater uncertainty for consumers. It is a real worry when one looks at the oil and gas linkage. We see gas prices linked via the oil contracting indexation system. Talk of oil probably reaching $200 a barrel by the end of the year means that again consumers will be on the receiving end of hefty price increases. Why can we not break that link? For example, we have heard from Energywatch that the link is irrational.

Mr Buchanan: All of us - the British Government, the Committee, the MEUC and Jeremy Nicholson who came to see you on behalf of industrial consumers - are trying to bring pressure on Europe. I know that Philip Lowe of DGTREN is trying to break this down so we get quality information and we can identify what is going on. We can then start to work out how we treat that going forward. I do not downplay what Neelie Kroes is doing at DGCOMP. It is rather like looking at what happened in the UK energy scene in the 1990s when on the one hand the vision side was pushing market and transparency of information and, on the other hand, Steven Littlechild was regularly thumping the companies, forcing divestment and getting action that way. One needs both the soft glove and the hard fist and I believe we have both in Europe at the moment. The key is that with the third directive going to the Council of Ministers this week what we must not do is say, "Phew! Now we can worry about something else"; we have to keep pressure on energy.

Q540 Mr Clapham: I hear what you say about the hard fist, but what we have here are uncompetitive European prices that determine prices in the UK to the great detriment of consumers. You say there is a move in Europe and further proposals will be put to the Commission, but what can we do to make those proposals more robust because there is a clear need to move towards liberalised markets? How long is it likely to be before we see liberalised markets in Europe in your estimation?

Mr Buchanan: I think we will see how the Council of Ministers resolves the third directive this week. Clearly, the European Parliament is quite radical in terms of market liberalisation and forced unbundling. It will be interesting to see how the decisions of the European Parliament align with the Council of Ministers' and it is worth coming back to talk about this in the autumn. I am sure that you will invite me back anyway after we have announced the findings of our probe because we will then know where Europe will go and we will have a much better feel. We shall need to think very carefully about the issues that you rightly raise. It is uncomfortable.

Q541 Mr Wright: One of the issues briefly touched on was the question of gas storage in the UK and the difference between us and Germany. You talked of BCMs. What we could have in two three years is perhaps 19 days' storage capacity whereas in Germany it works out as 99 to 100 days. Do you think that the market will increase the capacity of gas storage in the UK?

Mr Buchanan: I was looking at my notes when we had a chat about the 2004 probe. It is worth putting it in context. We can take Germany and the UK as quite good examples. Basically, the UK has 4 BCMs of storage for 100 BCMs of gas demand; Germany has about 18 BCMs with a demand of 87 BCMs. Historically, we came from quite different places. You could argue that the UK had 155 ports of call with the various fields on which it could draw, whereas Germany had its umbilical links to Norway and Russia in particular. When we spoke in 2004 we had a genuine hope which was also shared by this Committee that 4 BCMs would rise to 10 BCMs by 2010. Here we are half a year away and we are nowhere near that. When you look at the history, one of the major reasons is planning. A good example has occurred just in the past few weeks. Canatxx is looking to develop a huge salt storage facility in Lancashire and has been denied permission for the second time. I am afraid that an element of history is developing here. One hopes that the new planning Bill proceeding through Parliament will unblock this because it is clear that the market wants to do it. Scottish and Southern and Statoil are developing Oldbury. Some sites are being developed, but as we look at it today planning is something of a curse on storage development. On a more positive note looking forward, it is worth bearing in mind that in the UK, certainly from what I have read of the debate so far, it is not something that has been given very much coverage. When one looks at the 180 BCMs of potential supply that Britain will have next year against 100 BCMs of demand it is worth bearing in mind that 50 to 60 of that come from three new pipelines and 50 to 60 come from five or six LNG facilities, so we have a range of options in terms of security of gas supply which Germany simply does not have. Germany has been planning for as long as I can remember to build an LNG facility at Wilhemshaven and it still has not done it. It remains very locked into those essential relationships with Russia and Norway. From the point of view of our potential security of supply, looking out to Nigeria, Oman and Qatar, that is an advantage we enjoy as a country.

Q542 Mr Wright: We might have the advantage you describe as a country, but surely we knew 15 or 20 years ago that eventually North Sea gas would run out and our capacity for storage would have an effect. Quite clearly, the industry is now making an awful lot of money by virtue of the fact that we do not have this storage facility within the UK and it is in their best interests for planning to be delayed even further. Is this something that the government should do perhaps in terms of having strategically placed storage capacity within the UK and taking it away from the market?

Mr Buchanan: I am sure that is something that you will be asking the government, but it would appear to me that to a certain extent the government is trying to approach that by means of unblocking the planning process. Stepping back, one of the concerns is whether it is an art or a science. The oil majors are to talk to you today. I suspect they will argue that how fast one has a run-down of a field is an art rather than a science. One of the complications for potential investors in the market is that, as you remember, until 2002/03, maybe 2003/04, proper information about the market was not provided. Therefore, only with that did one start to get information coming through about the marketplace. One then had MOD006 that Ofgem pushed through about 18 months ago which gave us real time information. If one looks backwards to decide whether we should have been cleverer, maybe we should but I certainly think that for potential investors coming into the marketplace it is a bit like us looking at German storage today. It was quite difficult to see what was going on in the North Sea. If one takes the argument that field depletion is an art, again one does not want to be too hard on decisions taken by people 10 years ago.

Q543 Mr Wright: Looking at the other side of the coin, with regard to LNG it was seen as another avenue that could be used to fill a particular gap, but we hear evidence that the Isle of Grain storage facility has been little used during 2008. Why is that the case?

Mr Buchanan: Jeremy Nicholson raised that point and I asked my team to get the data for me. The LNG facility at Grain has been offered 64 times and because there are pre-emption rights BP Sonatrach has taken that 63 times. Effectively, that is their facility. Perhaps the flavour of the discussion suggested that those rights had not been taken up but that did not appear to be the case from the data I obtained.

Q544 Mr Wright: Do you think that the new Milford Haven and other storage facilities for LNG will stabilise price volatility in the gas market? Do you think it will have any effect?

Mr Buchanan: It will potentially provide a substantial input for us, but it comes back to the market price. Where does LNG fit within the global market? Currently, Japan is paying about 75p to 80p per therm which suggests that arguably on the global market, which is about $15.5 per NMBTU, it might compete at that kind of price. Therefore, arguably the facility would be used in that environment, but the oil and gas majors who are to come will give you a better flavour of it.

Q545 Chairman: You say that the Isle of Grain has been used during this year or might be used?

Mr Buchanan: From the data that I received this morning - with the caveat that I will double-check it because I noted that that question was raised - there have been 64 opportunities for delivery and 63 have been taken up by BP Sonatrach.

Q546 Mr Hoyle: Possibly we see NLG as the future, but we know that ships have been on the way to the UK and the product has been resold. What guarantee do we have in the market when that happens? Is there further evidence that what we believe to be a secure supply coming to the UK is suddenly sold just before it arrives?

Mr Buchanan: If one looks at the pressures within the marketplace, although current pricing in Japan suggests a figure of about 80p per therm the winter price is about 110p to 120p which is high. Why is that? It appears that Japan is sucking in LNG because it has problems with its nuclear plant. As we have seen on the evening news, Spain which is an LNG user appears to have problems with its hydro reserves; they are down by about 7% or 8% on this time last year. There will be tightness within the LNG market. We know it is tight because the Americans are taking none; they are staying with American natural gas. The American natural gas price has doubled in the past year but it is still below the LNG price. You are absolutely right. Although we have the facilities we are operating in a global marketplace.

Q547 Mr Hoyle: We seem to come back to the question of storage facilities to which my colleague Anthony Wright quite rightly pointed. It is not good enough. We cannot keep hiding behind the issues. The bottom line is that the people who should be providing the storage facilities are failing to do so. My view is that the reason for it is that they make more money by not having storage facilities. I think we will have to drag them screaming all the way to building these facilities. We cannot have another session here where it is not taken seriously. It is not good enough. At the end of the day, whichever way one looks at it the poor old punter - the housewife out there - who wants to turn on the gas cannot afford to do so because these companies will not build storage facilities. We have talked about Germany, but we have not even mentioned France's 122 days' storage. We are giving a poor deal. What are we going to do about it, and when will real action be taken? Are you the toothless tiger that we imagine?

Mr Buchanan: Some substantial storage facilities have been denied on planning grounds, so clearly there is active interest in building them. Let us hope that the planning Bill unlocks that. We operate in a market-based environment and therefore when prices are high we will attract LNG, as we did in the winter of 2006/07. You will remember that Excelerate literally threw up its LNG facility on Teesside and took its first boatload because the price in the UK was a preferential one. That is what you get from a global market.

Q548 Mr Hoyle: If oil and gas are brought out of the Falklands and are supplied straight to the UK where will we store it?

Mr Buchanan: It depends on whether it becomes LNG. There is plenty of LNG storage.

Mr Hoyle: We will need a lot.

Q549 Mr Binley: I want to ask about wholesale gas contracting and storage. Mr Buchanan, why do you think that oil and gas companies favour off-market contracts for gas over the open forward market?

Mr Buchanan: I believe this question is about lack of liquidity of the market which drives contracts off market. It may be small comfort but in the gas market liquidity in European countries is very low. From the figures I have seen recently, trading in our marketplace has gone up from about 16% to 20% in short-term trading. Based on information from Poira[?] Associates, in the gas market you can now trade out to 60 months, so there is liquidity. From that and other information I have received within the industry it appears that there is liquidity in the gas market. The electricity market remains however profoundly illiquid and in that regard you heard comments from a number of independent generators and suppliers.

Q550 Mr Binley: The long-term market is now about gas contracts of five to 25 years, are they not? Energywatch has made it clear that this is not a transparent market, does not help us with planning our supplies and is generally one of the factors that force up prices. What should we be doing about that?

Mr Buchanan: I am not entirely sure what Energywatch is talking about in that respect. As far as concerns the UK market, it is highly transparent thanks in part to Energywatch which supported MOD006 that provides real-time information to all players so industry knows what is going on in the marketplace. I do not quite understand that issue with regard to transparency of information.

Q551 Mr Binley: Let me quote what Allan Asher, chief executive of Energywatch, told us: ". . .we think there ought to be much more disclosure of some of these secret contracts, these long-term contracts, by which gas and power are dealt with. A lot more of that should be brought into the forward market", so he is saying they are not transparent.

Mr Wright: I do not believe it is unusual for a market to have commercially confidential long-term contractual arrangements.

Q552 Mr Binley: Mr Buchanan is saying it is transparent and you are saying it is not.

Mr Wright: We have transparency in terms of the flow of gas. We know where it is coming from and from which fields but we do not necessarily have full transparency of the long-term contractual arrangements between suppliers and companies which are properly commercially confidential. I am not certain I understand what harm that does to consumers. I would say it is normal for a market to have a combination of public exchange trade arrangements along with long-term contracts.

Mr Binley: Mr Wright, I am hearing different answers. Mr Buchanan said earlier in this session that markets worked best with transparent information and yet these long-term markets according to Allan Asher are not transparent; they are secret contracts. I am not quite sure what you are telling us.

Q553 Chairman: About 80% of all gas traded is subject to these long-term contracts. How can you say it is a liquid market when so little is being traded?

Mr Buchanan: With the greatest respect, I am not entirely sure about that. I was looking at the industrial and commercial trading figures. From the figures I have, 40% is spot trading and 44% is based on spot out to a month, so I do not know from where that information has come. Certainly, the information that I have been given by industry appears to indicate that one of the reasons why the large industrial consumers, to whom you spoke last week, are so concerned is because of their spot trade activity and the fact that they go short term for their product. That is the best part of two-thirds of all usage in the UK.

Q554 Mr Binley: We were told by Energywatch that about 80% of long dated physical volume is sold on long-term contracts. What concerns me is that you are there to protect the interests of the consumer as you rightly say. Do you not need that information? Do you not need to be more aware of what 80% of the market is doing? If you are not aware how can you possibly do your job on behalf of consumers?

Mr Buchanan: We have to ensure that the market has transparent and open information upon which commercial contracts can be made. I cannot support or otherwise those figures provided by Energywatch because they are not ones that I recognise at first glance.

Q555 Mr Binley: There are a lot of people out there who are very concerned about rising prices of energy as you well know. Will you undertake to find out from where Energywatch got those figures because, quite frankly, you ought to have them?

Mr Buchanan: I certainly will.

Q556 Mr Binley: Given the low level of liquidity in the forward gas market and the effect of that on price transparency, does it concern Ofgem that industrial consumers tell us that the majority of contracts are linked to forward gas prices? If you find out the truth of this matter what will you do about it?

Mr Wright: The majority of contracts are linked to forward prices. That is not a concern in itself. If a company has been able to secure long-term lower cost sources of gas there is a question as to whether that ought automatically to be passed through to consumers. Whether or not that is the case is a question in an open market. Companies and suppliers procure gas under a variety of arrangements, some long term and some short term, and some of those arrangements are commercially confidential and some are publicly traded.

Q557 Mr Binley: Should not Ofgem have found that out before it told the government there was no concern about the market?

Mr Buchanan: Perhaps I may pick up something about which we have raised a lot of concerns.

Q558 Mr Binley: Can you first answer my question? You can then go on to tell me what else you want to say.

Mr Buchanan: Do we think that the market has adequate information? We have sought to ensure that it does. We are carrying out a probe, as you know.

Q559 Mr Binley: My question was not that but whether you should have got hold of this information before you complacently told the government in January, I believe, that there was no problem with this market?

Mr Buchanan: I do not believe that our understanding of the market and how commercial contracts are struck within it would affect the advice we gave the government at the time.

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 DGTREN and DGCOMP. 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 EUTS 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?

Mr 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?

Mr 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 six 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 Petrolia of Spain which owns Scottish Power. For example, would you be concerned if there was a contraction from the big six to the big five 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 six, 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 six, but conventional non-incentivised generation is taking place almost exclusively within the big six. 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 six in supply you have a big six in generation. Clearly, the issue involving British Energy that we have just been talking about highlights that that is not the case. The big six 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 six. 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 six 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.

Q580 Mr Bailey: I am just puzzled why you did not do that before given that this was public information.

Mr Wright: It may simply be a matter of some liquidity being a good thing and more liquidity may be a better thing.

Mr Buchanan: Let us square the circle and give you a written answer to that.

Q581 Mr Bailey: I turn to relative pricing. I suppose that there are two issues: first, why is there such a difference in the annual cost to somebody who has a prepayment meter and somebody who pays by standing order, particularly prepayment?

Mr Wright: The analysis we have made suggests that on average the difference between somebody paying by prepayment and somebody who pays by direct debit is about £125. Our work also suggests that the difference in cost is about £85. We are doing further work on those cost differences and trying to establish that. On average it appears that the price differential is greater than the cost differential. Within that there is quite significant variation between suppliers, so for some that gap is significantly greater and for others it is close to or even below £85. Therefore, there is a different picture with different suppliers. The differences in the differentials between suppliers may reflect differences in costs. That is not necessarily an excuse. One would expect in a competitive market for cost differences of that size to be competed away. We would be concerned if such cost differences were sustained and those increased costs were passed through to customers in a competitive environment. I believe that is an issue regardless of whether that is cost reflective. You would expect us to say that this is right at the heart of what we are looking at in our probe. Obviously, if there is evidence of discriminatory pricing particularly for groups of vulnerable customers that is something we are concerned about.

Q582 Mr Bailey: The data we have shows that the average is £145, not £125.

Mr Wright: One can cut the data in various ways. It depends on how you average it, whether you extend it beyond the big six and how many kilowatt hours or therms of usage one is looking at. Some suppliers argue that to use the standard consumption of 3,500 kilowatt hours is wrong because these consumers tend to use less electricity, for example. There are methodological differences and I am not surprised that it is possible to come up with different numbers of that order.

Q583 Mr Bailey: Is it fair to summarise what you say on that issue that there is a price differential that cannot be accounted for by the increase in cost and therefore there is a prime facie case for investigating what appears to be an imperfectly working market?

Mr Wright: We are yet to get to the very bottom of that. We are doing a lot of work on the cost structure of companies and how they allocate costs between different tariff groups and checking whether that cost allocation is appropriate. We shall get to the bottom of the issue. I think there are some bits and pieces of evidence that give us concern. One is that a number of companies charge a significantly higher premium in some areas than others and it is hard to see why the cost in Newcastle should be different in Birmingham, for example. That does make us concerned.

Q584 Mr Bailey: When will you be publishing the results?

Mr Wright: That will be part of the initial findings we publish in late September.

Q585 Mr Bailey: If you look at the prepayment market as being separate from the other, there is a very wide price differential in what people pay in different parts of the country with different deals.

Mr Wright: Yes.

Q586 Mr Bailey: On the surface that seems to indicate there is not much competition even within this particular market let alone the direct debit market. Would you comment on that?

Mr Wright: That goes back to my previous point. Even if these are cost-reflective differentials we would expect that difference to be competed away. Prepayment customers do participate in the competitive market in quite large numbers, in some areas more frequently than the average customer, but we have some concern that switching decisions are not always good. There is evidence that some prepayment customers move onto higher tariffs. We have written an open letter to try to seek out ways in which we may be able to improve the quality of information provided to prepayment customers at the point of sale to reduce the incidence of prepayment customers moving to more expensive tariffs. We are concerned about the quality, not quantity, of competition and switching in that prepayment market.

Q587 Mr Bailey: I think that your approach should be a little stronger than "some concern". Given the way prices are rising, the big differential and the fact that a lot of people on prepayment meters are lower income consumers there ought to be huge concern. Do you accept that it was a mistake to remove price controls for prepayment meters?

Mr Buchanan: If I may, perhaps I may hold judgment on that until we have carried out the probe. The question is fair and the areas in which you have sought to interrogate us are all valid and are ones we are picking up. This Committee will be our first port of call once we have carried out the probe.

Q588 Chairman: You have talked about prepayment meters a lot but standard credit customers are also incredibly important and are often overlooked in this debate. A good number of them are also in fuel poverty; a lot are on fixed incomes.

Mr Buchanan: More are on standard credit. Only 20% of the fuel poverty lie within PPM, and one of the areas we are investigating is why the standard credit gap has risen from about £40 to £60. Therefore, that is within our review.

Q589 Anne Moffat: I should like to move to switching which we are very concerned about. There is a major con going on. How can a market where half of the consumers have never switched be described as competitive?

Mr Buchanan: Perhaps I may start with the macro approach. I think it depends on one's starting point. In relative terms the switching that we have seen in the energy market is quite successful. We see nearly 50% switching in energy. Fixed telecom is about 37%. If you start to get down to mortgages at 20%, pensions at 10% and bank accounts at 2% the switching rate is high relative to other sectors, and it is very high in relation to other markets that have sought to open. In the half of the United States market that has been opened only 1.5% of consumers have switched; in Germany it has been about 4%. In the Nordic countries it has been 10% to 15%. When you look at the contrast, the UK consumer sees price going up and so does not really care about that. What benefit is there? I will ask my colleague to speak about that. The question is whether the switching proposition is working or whether one is being encouraged to switch to the wrong tariff. When one looks at how well the concept of choice and switching has worked by contrast to other UK sectors and internationally where markets have been introduced, this has worked quite well. Also bear in mind that, based on the various surveys that have been done - again, it may be small comfort - of the 50% who have not switched 15% have self-selected that basically they never will because they just do not want to, or they are lucky enough to have too much money or whatever it is.

Q590 Anne Moffat: When you say "lucky enough to have too much money" it makes me think about the fact that a third of switchers end up paying a higher tariff without realising that is the result.

Mr Wright: If I may make one clarification of what my colleague said, the proportion of people or households who have never switched is more like 20% than 50% because a lot of people have switched gas but not electricity, so in terms of the households that have switched one or other of their suppliers it is closer to 20%. There is a very high level of participation. As I suggested on prepayment tariffs in our probe we are very concerned to look particularly at quality as well as the quantity of switching. A high level of switching is good; it shows that the market is working, there is participation and that consumers are engaged in the market, but it could be because of consumer dissatisfaction and not all those switching decisions necessarily lead to consumers having a better deal. One thing we have noted is that a high proportion of switching is in response to outbound selling as opposed to consumers actively choosing in a proactive way. One thing we are looking at is the quality of switching as a result of outbound selling - doorstep and telephone selling - which may be a concern. It may simply be that consumers are making a choice between two alternatives rather than looking at the whole market, but that is something that is within the scope of the review we are conducting.

Q591 Anne Moffat: Do you think there is fairness among consumers about whether or not it would be a good idea to switch and whether or not they can receive the full information, that is, those who are computer literate and those who have a better standard of living and some who may not? I acted as a daft lassie once when someone came to the door. The con was unbelievable. I was asked who my electricity supplier was. I said I did not know. Immediately they knew they had someone of interest to them. They came into the house and looked at the meter; I let them go through the whole process because I wanted to see it for myself. I am worried about the more vulnerable people who will be conned by switching. Should there be stronger regulations by you particularly about doorstep and phone marketing?

Mr Wright: There is a question about individual fairness in that respect but there is also a question mark about the market working well. Does consumer choice and switching provide adequate price discipline on suppliers? We are looking at it in both directions. There are really two issues. One is to ensure that consumers have good information on which to make choices; the other is to ensure that the benefits of competition are available to all consumers, not just those who are engaging in the market. One feature one would also expect from a well-functioning competitive market is that the benefit is not available just to those who switch.

Mr Buchanan: We will not shy away from using our enforcement powers. Currently, we are inspecting the Npower case which has been compiled by a number of parties including Energywatch.

Q592 Anne Moffat: Even if there were some guidelines that people could access very easily that would be an improvement on what we have at the moment.

Mr Buchanan: As to prepayment meters, there are certain licence conditions whereby companies are meant to provide the advantages and disadvantages. Do they, and how do they do it? Is it so difficult to get to? Is it slanted? Those are the things that we are looking at and particularly in this area we would be happy to come back to the Committee to talk about it.

Q593 Chairman: I just want to make clear how your investigation of the doorstop selling scandal interacts with the fuel price inquiry. Is it entirely separate and carried out in different compartments?

Mr Buchanan: It will run along its own enforcement track.

Q594 Chairman: Doorstep selling is hugely important to switching given the proportion of switching that it has achieved. In terms of getting people to change supplier it is important but it must be done very well.

Mr Buchanan: Indeed.

Mr Wright: There is a large grey area between a perfectly functioning market and mis-selling which is in breach of licence. We are potentially also concerned about where the market is not working well but it falls short of something that we can enforce, so we are not just looking at things that are currently a breach of the licence; we are looking at how well the market is working for consumers and how well it is working as a price discipline for the companies.

Q595 Chairman: I think you agree with everyone else that the big gain from the switching is your first switch. When you move away form the incumbent monopoly of the CEGB days to the new competitive world for the first time that is when the big savings come; after that the savings are more marginal?

Mr Wright: Not necessarily. You are right that there is often a big saving to be made when moving away from incumbent suppliers, particularly if you move from standard credit to direct debit at the same time and get the benefit of a dual fuel discount, but there are still significant savings. If you compare dual fuel direct debit you can make significant savings at the moment by moving from a standard billing approach to online billing. There are still substantial savings to be made from participating even if you have switched once. We would encourage people to continue to look around for the best deal because what was the best deal yesterday may not be the best deal today.

Mr Buchanan: The majority of it is on price, but it may be you want to switch to a green supplier like Good Energy or a supplier like First Utility which now offers smart meters within its package. You may be very distressed by service you get from a company and go to JD Power; it may be published in the newspapers and right at the top of the service league you see "I'm getting lousy service."

Q596 Chairman: It may be rational to switch to a higher price?

Mr Buchanan: It may be that you choose to do that. Perhaps a green product is offered at a premium price.

Mr Wright: Some companies have a record of being at or about the bottom of the price range, if they are not absolutely the cheapest at every moment in time. You may choose someone who is on average in the cheaper half of the tariffs.

Q597 Chairman: So, switch is not a surrogate measure of competition because it may be logical to stay with the current supplier because you know that he will become cheaper in due course?

Mr Wright: I think that is right. Switching may be a one-dimensional measure of competition. It is important because it shows participation in the market; it shows that consumers can switch. If switching rates were very low it would be a concern to us, but there are other factors that influence the quality of competition.

Q598 Roger Berry: Energywatch say that there is "a huge amount of fraud going on". Are they right?

Mr Wright: "Fraud" would be a very strong word.

Q599 Roger Berry: "Fraud" was what they actually said.

Mr Wright: We are currently engaged in a process to establish some guidelines for green tariffs and central to that those guidelines will be that any green tariff must demonstrate an additional benefit to the environment.

Q600 Roger Berry: Why have you not done this before?

Mr Wright: We are doing it now and it is something of which we have become aware and are addressing. We would expect proposals to be in place before the end of this year. This is a matter that we have been looking at for nine months. We are doing it by way of co-operation with suppliers rather than relying necessarily upon the cumbersome licence approach and we think it will be successful.

Q601 Roger Berry: You acknowledge that at present there is no scheme to verify the claims made in relation to green tariffs. For years all of us as consumers have been offered deals by suppliers in relation to green tariffs. Only now are you getting round to checking to see the extent of the fraud in that market. Is that not a bit slow? A lot of us have signed up for green tariffs in good faith and assumed that what we were told was correct. You are now acknowledging that that may not be the case.

Mr Buchanan: You are absolutely right that in the past two to three years green tariffs have developed. Eighteen months ago the NCC which becomes the new Energywatch in a few months' time produced a very good report which flagged up concerns. The Energy Savings Trust was, I believe, the prime movers. Either they were invited to do so or they themselves started to develop green tariffs. You are absolutely right. We believed that this had begun to become such a serious issue that we wanted to bring our own work and brand to it and be involved in it. That was why we became involved in the past year. My colleague is very close to releasing what will be a substantial step up in comfort for consumers. You are absolutely right to point it out. We are onto it.

Mr Wright: Although it is a small part of the market it is important that people do not make the assumption that somehow they can mitigate their environmental impact by signing up to a green tariff and they still keep pressure on reduced energy use through energy efficiency measures at the same time. Unfortunately, sometimes that is the message that gets across at the moment.

Roger Berry: That is absolutely correct but it is a different message. We can all take individual actions to try to reduce our impact on the environment. Interestingly, for years and years many people have signed up to green tariffs in the believe that it is an additional contribution and only now is the regulator getting round to looking into it and the consumer watchdogs say that there is a huge amount of fraud taking place. I suppose the polite response is that it is better late than never.

Q602 Chairman: Mr Buchanan nods in agreement, I think.

Mr Buchanan: No. We are working with it and trying to take industry and Energywatch with us as well.

Q603 Mr Weir: National Energy Action told us that consumers who were off the gas grid had an average energy bill in the region of £1,700 per annum compared with about £1,000 for those on the gas grid even with rising price. Many propane/home oil prices are rising faster than domestic and gas electricity prices. Is Ofgem content with the level of regulatory oversight of the domestic heating oil and propane markets?

Mr Buchanan: This issue has been raised with us. Within our remit we have sought to try to approach the off-gas network from the angle of encouraging the networks to be developed. I think we took some substantial steps with the initiatives in our gas price review put through the industry at the end of last year and early part of this year which will run for the next five years. As to regulatory oversight, if they are local gas networks there is an element of oversight by us. If it is off the network I am not entirely sure where we would come into the regulatory oversight.

Q604 Mr Weir: You say that you are encouraging the development of networks, but many rural areas, including my constituency and others, will never have a gas network; it is too far away from the existing networks. It appears from evidence we have heard that there is no regulator whatsoever in either the home oil heating market or propane gas market. Given that there is regulation in a number of parts of the energy market and the importance of this particularly in rural and other areas, it is right that there is no regulation? Should a regulator like you or someone else take on this market?

Mr Buchanan: I wonder whether you have brought this up within the framework of the Energy Bill as well. That may be a framework suitable for that debate.

Q605 Mr Weir: It has been brought up in several fora and nobody seems to be taking it on at the moment. There does not appear to be any consumer interest or any regulation of it at all.

Mr Buchanan: I should like to go back and find out more and then have a bilateral discussion either with you or the Chairman.

Q606 Chairman: This is a matter of considerable concern. I receive letters from my constituents who say that prices are rising significantly faster than for mainstream gas and electricity customers. It is not your fault.

Mr Buchanan: But there is concern about it and we should follow it up.

Chairman: The OFT says that it can do a major inquiry but it is busy with all kinds of other things and it does not have time for it.

Mr Wright: Another reason why regulation is required is that prices have increased to such a level that some people cannot afford the minimum delivery requirements of the companies. It is now so expensive that people do not get deliveries; the suppliers will not supply below a certain amount. That is another problem.

Q607 Chairman: If this Committee were to recommend that your remit should be expanded to include this section of the energy market would you resist it?

Mr Buchanan: I should like to go away and look at it in more detail before I give an answer.

Q608 Mr Clapham: Do you have any idea how many customers use LPG?

Mr Wright: We know approximately how many are off the gas grid; it is somewhat less than 20% of all households. This is also an issue for the supply market probe. We are looking specifically at whether the competition is as effective for customers who are off the gas grid. A lot of the focus of the competition is on dual fuel and often it is harder for door-to-door salesmen to get to these customers because they are in rural areas. These customers may well get some benefit through the SERT and EET programmes for energy efficiency. This just shows how complicated the issue of fuel poverty is because that is another dimension that feeds into it.

Mr Weir: The point is that these consumers have just fallen off the radar of the regulator. There is no one looking at decent tariffs for them as they do in gas and electricity. In many ways they have been forgotten. To say that you will develop the gas network is impractical in many areas of Scotland and other areas.

Q609 Chairman: The problem is the density of the population. The irony in Worcestershire is that the big gas mains that take gas all round the place roar through the county and people who live almost next door to them cannot get access to piped gas for their own houses, and never will; it is not feasible.

Mr Buchanan: Clearly, the range of concern is substantial, so we shall definitely follow it up.

Q610 Roger Berry: You recently published your fuel poverty action programme. I welcome the attention that you have devoted to this issue. What proportion of those who are currently living in fuel poverty will be taken out of poverty as a result of your action programme, and over what period of time?

Mr Buchanan: There is our programme and what the DWP plans to do which in many ways is much more substantial. As one would expect, they focus on trying to use data management both to access those who are fuel poor and to get benefits to them. The scale of the benefit will be the key. The ability to do this by the winter and the scale of it are questions I would be asking them, as I am sure you would. That will be the main driver. For every 10% increase in price 400,000 people go into the fuel poor league. This is a very big problem now, and we are receiving price warnings from the companies. My answer is that there are three questions aimed at government and DWP. What we are trying to do is to enhance the quality. We have a programme running with the Citizens Advice Bureau called the best advice programme. I think it is working well. We are working with the University of Bristol to ensure we get good research to identify ward by ward across England where the worst areas of fuel poverty might be. We are trying to do what we call our find and fix programme by working with relevant bodies, but I think the real difference will be felt by the scale of the DWP programme and what the government will do.

Q611 Roger Berry: I am sure you are right. The much proclaimed £225 million of extra social assistance over the next three years - the deal with the big six companies - is an increase from £50 million to £150 million annually. I do not say it is not worth a row of beans; it is money, but the increase is from £50 million to £150. Clearly, someone somewhere is treble-counting. As I understand what the DWP has said, this is being targeted as extra money to help pensioners in fuel poverty. The obvious question here is: what about the three-quarters of a million children in fuel poverty? What about disabled people who are not pensioners but are in fuel poverty? Where do they fit into this?

Mr Buchanan: That is a very good question. I should like to come back on the slicing and dicing and the way it is going up. Thank you for the information.

Q612 Roger Berry: What does Ofgem think of the government's position on social tariffs?

Mr Buchanan: That is an interesting question that is probably best directed to the government. I believe that the government is trying to approach fuel poverty through a three-pronged package. The first is the DWP-based package which is linked to what they are trying to do on the Warm Front programme. You will know that that was pulled back a little in terms of financing. It is also focusing on the companies to step forward. We have seen companies develop their plans possibly under additional pressure. Scottish and Southern has now rolled out its energy-plus plan from 20,000 to 100,000 potential customers. It must identify them and get the benefits to them. Ofgem is concerned with information facilitation and driving through the opportunities within the marketplace for the fuel poor. I think that is the government's three-pronged approach to it. If it wishes to take a step forward and say that it wants to reregulate a form of tariff then that is really a question you must ask Malcolm Wicks or John Hutton.

Q613 Roger Berry: You have come up with some specific proposals. Perhaps the most celebrated one is that some of the £9 billion windfall that UK energy companies are set to receive from the allocation of carbon permits under phase two of the EU emissions trading scheme should go towards helping those in fuel poverty. How much of the £9 billion should it be, and how do the various partners in this exercise feel about your proposal?

Mr Buchanan: This was considerably highlighted when we were invited to see the Chancellor at No.11 and give our views and provide ideas on fuel poverty as an issue and what the government could do. Our ideas included, amongst other things, that we should get on with smart metering and have a look at the various DWP data issues now being developed. We also referred to one of the ideas that we flagged in April 2006 in an earlier representation to the government, namely that this pot of money was sitting there. The companies will argue that the pot of money is there for them to be able to reinvest in renewables. I think an interesting question to ask them is: have they invested that money in new technology? It is worth looking at a number of companies. One company that comes to mind is Drax. At the moment the City forecasts that about 70% of its EBITDAR over the next four years - £1.6 billion - will effectively come through the EUX scheme. How much is it investing in the next few years? On city forecasts it appears that they are investing about £350 million, so there are some interesting issues there. I pick just one company; I am not picking on it, but some interesting questions can be raised. This is a matter for government because Ofgem is not a lobby group. As with smart meters, we raised these issues with government and urged them to look at it. It is up to them.

Q614 Chairman: I want to reinforce what Mr Berry said about people other than the elderly who are in fuel poverty. This Committee has been banging on about it for years and nothing seems to happen. As fuel prices rise to eye-watering heights it is becoming a greater problem. I know I am lecturing the wrong people here, but the Committee attaches importance to the inclusion of other groups in fuel poverty measures. You have a difficult task on your hands. I began with some questions which expressed scepticism about your good intentions given that you thought the market already worked perfectly. We know that fuel prices will continue to increase. Look at the oil price. We know that this is a continuing problem that will get worse and worse. Companies are talking of further increases all the time and people are hurting. Every one of us finds his fuel bill an intolerable burden. Therefore, if you do not make a reference to the Competition Commission at the end of this you will look rather weak, will you not? It is the only thing that people think you can do.

Mr Buchanan: We did not make a reference on the back of the 2004/05 probe when prices were very high compared with what they had been previously. We had been looking at prices of about 10p to 20p per therm and they went to about 50p to 60p. There was great concern at the time. We came out with a package of measures which the CC at that time did not feel was necessary, but for you and any other consumer there was a weighty tome of evidence to show why we had come to that conclusion. I know that the board will approach September with an open mind to see what the right course of action will be, but everything will then be published and you will see whether or not we have taken the right course of action. I imagine that we shall be hung from the lamp posts if you say that in producing the information our judgment is missing because our own information tells us to go to the CC and we have not done it.

Q615 Chairman: As a well-educated man you will be familiar with the rock and whirlpool of Scylla and Charybdis. If the rock of Scylla is the expectation that you can do something with that kind of reference failure to push the nuclear button will in some sense ruin your reputation, but the whirlpool of Charybdis means that if you do make such a reference you will disrupt the investment plans of major city companies at the crucial time to keep on the lights. You are damned if you do and damned and you do not, are you not?

Mr Buchanan: It is a difficult job.

Chairman: On that note we shall bring this session to a conclusion. Thank you very much for your evidence. You have promised us at least one matter in writing. If there are other things that you want to give us as you characteristically do we shall welcome them.

Memoranda submitted by BP, ExxonMobil and Shell

Examination of Witnesses

Witnesses: Mr Nigel Wooley, Supply Director, BP Gas Marketing, Mr Richard Guerrant, Director, Europe, ExxonMobil Gas and Power Marketing, and Mr Paul Trimmer, Vice President, NW European Business Operations, Shell, gave evidence.

Q616 Chairman: Gentlemen, thank you very much for coming to this very important session of evidence. You have heard some the reasons we want to ask you questions. I know that they have been explained to you beforehand. We are grateful to you for the information which you have already provided to the Committee. I begin by asking you to introduce yourselves for the record for the benefit of those who are listening to our proceedings.

Mr Wooley: I am Nigel Wooley, the supply director of BP Gas Marketing.

Mr Trimmer: My name is Paul Trimmer and I am with Royal Dutch Shell. We produce and buy and sell gas in various countries across Europe.

Mr Guerrant: My name is Richard Guerrant, one of the directors of the ExxonMobil UK group company. I am responsible for natural gas marketing across Europe.

Q617 Chairman: This session marks a change of gear for the inquiry in a way. Next week we have a very significant number of the chief executive officers of the big six coming in to talk about their work which will be fascinating. Today we are looking at rather more specific issues that affect your companies. The first blindingly obvious question from the chair is: why are oil prices so high? Are they here to stay, and to what extent does speculation contribute to those high prices? That is the million-dollar question.

Mr Trimmer: If one looks at the medium and long term whilst Shell does not speculate on prices - I shall not give a price forecast; if I did it would almost certainly be wrong - there are certain fundamentals coming together on the demand side which are impossible to deny, that is, growth in demand in India, Indonesia and particularly China with the build-up to the Olympics. That puts immense pressure on the demand side. The populations and industrialisation of these areas are set to grow, so there seems to be a very strong fundamental pressure on the demand side. As to the supply side, the era of easy to find but cheap to produce oil and gas is disappearing. We are not finding the large oil and gas fields that have been around. There are, therefore, two fundamentals coming together which appear to push in the same direction and provide a medium to long-term perspective. Reading the newspapers at the weekend, if you talk about other things that may have an impact on prices, the amount of money that is available to go into the markets has gone up from less than 7 billion in 2004 to over 130 billion this year. Presumably, a lot of that is going into the energy markets. The flows of that gas in and out of those markets can have an effect. Certainly, from Shell's perspective we find it difficult to rationalise all of the price movements on the basis of the fundamentals alone, but whether or not that is a long-term effect is difficult to determine.

Q618 Chairman: You do not know or you are not telling us; it is one or the other.

Mr Trimmer: I am saying what I believe to be the fundamentals which are pushing in one direction. If you look at it over time it is pretty clear that prices are heading in one direction.

Q619 Chairman: Gentlemen, I suspect that you agree with the general thrust of that; it is not a very controversial view. To what extent do you believe that speculation plays a part in driving current market prices?

Mr Guerrant: To add just one more comment, ExxonMobil believes that over the long term the fundamentals of supply and demand drive the price. We are surprised about the prices that you see today.

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 news 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 in 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 1996 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 European 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 can pan-European pricing be absorbed by global pricing? All of Europe's incremental supplies now come from very long distances. Even the Russians have an opportunity to put gas into an LNG 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 DEON system as well as another hotline system called BB. 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 MBT 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 particular point in time, but those usually close 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 amounts 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 all-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 to 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 operation 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 we 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 Exxon Mobil 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 MPB 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 Vestalaird[?], Linalaird[?], Tampenwing[?] and the BBL, all of those pipeline projects bring more gas through the Netherlands 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 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 and 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 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 Qatar gas ventures 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 will 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 were 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 the 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 121/2, 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, is the ability to move gas around with more freedom than we have had 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 if there is a particular concern about a particular price.

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.

Q647 Mr Bailey: But it impacts upon the price of gas in this country?

Mr Trimmer: Certainly, there is 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 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 in 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; they are 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 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 INC 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 hear, 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. 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 marketplace. 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. 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 on the situation. You have to understand a lot more detail about the marketplace.

Q660 Mr Wright: I quote from the evidence. They went to 19 suppliers many of which had supply points on the continent and only six replies came back. Every one of them offered a price based on the UK rather than the continental price.

Mr Guerrant: If he has taken delivery of the gas on the continent I am puzzled; I do not understand it. I think the example he gave was that he took capacity on the interconnector into the continent so he could buy the gas on the continent and then haul it into the UK. I am puzzled about that, if that is the situation.

Mr Wright: Obviously, we can take this up with suppliers anyway, so it narrows it down a bit.

Chairman: It is something that we shall have to take up with the company again because in a sense it goes to the heart of what this inquiry is about.

Q661 Mr Binley: I want to ask about gas storage because we have a serious problem here which from my perspective has not been dealt with very efficiently or effectively. I recognise that the change from supplier to purchaser in this respect relating to the North Sea is a major factor, but what I do not understand is that that can be seen. We are then told that the planning problems in this country have added to those difficulties. I am sorry but they have been around for a long time, too. I do not understand why the present massive need for gas storage to help us equalise winter and summer prices was not seen a considerable time ago. I should like to know whether the market will deliver increases in gas storage in the UK and in what timeframe. It is a big factor. The information we have received is that we will not get it for perhaps three or four years. What is your view?

Mr Trimmer: Perhaps I should kick off with some of the things that we consider when looking at investing in underground storage. We feel that our skill lies more in underground storage that makes use of, say, depleted reservoirs than in other facilities. That is the business we are in. To stick to that, the sort of thing that will be important is the difference between summer and winter prices. A matter to bear in mind is that that has increased very significantly over the past two or three years. If you go back three or four years, there was no track record of a very large differential. Another element is the availability of reservoirs. We would naturally want to deplete a reservoir before converting it into storage, so it is the geology that determines when fields come up. When they do come up we consider them. The other matters are the fiscal and regulatory regime and the planning aspect that you have talked about. Another factor is prediction of the supply/demand balance. It is only in the past two or three years when planners have become aligned with a supply/demand balance which really focuses on the fact that the end is coming - because we had false dawns on many occasions - together with a market, not surprisingly, beginning to show an increase in summer/winter price differentials, that the commercial environment means one should go ahead. These things are significant investments and one needs more than a whim and a prayer to make them go. The economic signals come through. Things like planning just do not help; they slow down the whole thing. I believe that with the signals we now have and the fact that more reservoirs are becoming available we can expect to see more projects coming through as we do.

Mr Guerrant: First, I would reiterate that given the market signals the incentives were not there because the market was able to handle that flexibility in the past. Those are now there. Second, we all recognised that a couple of winters ago the country was relying on one large facility and that was another important signal that we needed to expand. As an investor when you put down your money you want to make sure that you can get it done. I do not underestimate the importance of the two Bills that are currently being considered to ensure that the planning process is streamlined and allows it to go forward so that when investors start to develop these things they have the assurance that they can get a reasonable return.

Q662 Mr Binley: In terms of your investment programmes you were caught out because volatility has become a much more important factor than you ever thought it would be?

Mr Guerrant: First, just now we are seeing the market say that you need it. Second, we need streamlining in the planning process to ensure that it can be economically viable and built.

Q663 Mr Binley: If the market cannot do it is there a case for the government to invest in strategic storage? With 13 days' storage we are vulnerable, are we not?

Mr Wooley: The question may be whether the market has yet received pricing signals of sufficient strength and duration to encourage investment in storage. Clearly, the way the market has evolved over the past two or three years has brought forward a number of companies that are beginning to look at the opportunities in the offshore and onshore environment. Companies such as BP are looking at some opportunities, but in order to bring forward these things in terms of a depleted offshore field one is looking at hundreds of millions of dollars of investment both in the facilities that need to be developed to extend the field life or put the terminals on the coast but also to provide the cushion gas that is needed to make these reservoirs effective. One may be talking of twice as much again in cushion gas costs. There need to be strong and sustained economic signals. As we saw with the development of the infrastructure and the new capacities in the pipeline networks given the UK's development of the regas terminals, if there are strong market signals over a period of time the track record of the industry is that it will respond.

Q664 Mr Binley: Here we are as consumers in Britain at the mercy of supply. We are in a much more vulnerable position than the continent for historical reasons, which you have gone into. You have not seen that coming and as of today you have not invested enough, and the government has lagged behind as well. Who will take responsibility for the vulnerability of our marketplace and the problems that consumers may face?

Mr Trimmer: Perhaps I may go back to something I said a little earlier. Interconnectivity is important and the increase in capacity of the interconnector, the creation of the BBL which links us with the Netherlands and the opening of the Langeled pipeline in the past 12 months are a very significant response from industry. For example, Langeled is the longest offshore pipeline in the world which links one of the most challenging, complex and large fields in the North Sea. That is industry's response. There can be issues to do with whether or not we have enough storage at the minute, but connectivity is becoming much greater and in terms of security of supply and the ability to balance in times of local shortage is worth a lot. For the future we must have more storage and the signals will bring it through.

Mr Guerrant: The LNG facilities which have been added over the past few years and will be added are significant new supplies to meet the need.

Q665 Mr Binley: Therefore, you are saying that the price volatility that Britain is experiencing because of shortage and storage problems will be equalised in the foreseeable future. When do you think that will happen bearing in mind that we simply have plans to go up to about 18 or 19 days from 13 whilst Germany is about 99 days and France 120.

Mr Guerrant: As new supplies come in volatility will be dampened.

Mr Binley: Perhaps I may turn to a personal concern of mine: carbon capture and storage. How do you view that bearing in mind that we have 240 years of energy requirements under our feet on this island. If we can solve that problem the North Sea seems to be important in that respect. Can you tell us a little about how that is developing and what the timeframes are? Can you also tell us a little about whether the projection of 15%, maybe 20%, of additional fuel from the North Sea can be forced out perhaps by using that technique?

Q666 Chairman: If it is off-piste I understand but it is interesting.

Mr Guerrant: I believe that globally industry, governments - all of us - have a lot of work to do to come up with technologies that are economically viable to ensure that when we utilise CCS it is cost-effective for the consumer. We are a long way from that. That said, many of us in the industry are today doing pilots and investing in new breakthrough technology to figure out a way to separate CO₂ from other material and to be able to liquefy it and pump it in a way that is cost-effective. In addition, we will need a regulatory framework that makes sense to be able to do the commercialisation of CCS. If you ask the very simple question how long it will be I cannot give a specific answer, but we have many years to go before we are able to get the results back from pilot projects, get new breakthrough technology and put together a commercial framework that makes sense in order to use CCS.

Mr Trimmer: In that context there needs to be a partnership among industry, regulators and government to make it go as quickly as possible. For example, I know that the Norwegian Government is very active in trying to develop and promote schemes in Norway.

Mr Wooley: BP's experience with the additional scheme at Miller that was touted for some period of time was a disappointment and a setback to us in that regard.

Q667 Chairman: We are getting to the end of our time. I want to put one question to you to summarise what we have heard over the past two sessions. We heard some very loud complaints from customers about the illiquidity of the market and volatility of prices and the position was quite broken. We have heard you say that it is all quite liquid and is going rather well; it is much better than anyone thinks and for some reason the European model works in Europe and the British model works in Britain, so we should not break it. The regulator has said he does not know what is going on, and he even gets his facts wrong about the level of imports at the Isle of Grain. This leaves us in something of a quandary to say the least. This Committee faces the three worst positions. There is no meeting of minds at all. What are we to do? What would be the consequences of a recommendation by this Committee that the only people who can sort out the wholesale gas market are the Competition Commission? Apart from the huge cost, what would be the consequences?

Mr Wooley: As an upstream company the most important role we can play is to focus our energy on the development of new resources and to apply our technologies to bring forward our investment and new supplies both to the UK and to other markets. That is where we should be focusing our energy.

Mr Trimmer: I totally agree. In the context of the UK we should also make sure that we maximise the benefit we get out of the existing production facilities and infrastructure we have, so other things can be done there.

Q668 Chairman: You should be politicians; you have completely avoided the question. Let us see whether Mr Guerrant can do it.

Mr Guerrant: You know that I will agree with the need to bring in new supplies because that is what we do best and that is what we can do to help the consumer. You need to protect your market and the integrity of your NBP wholesale market. We believe that it is working and it has underpinned huge investments in this marketplace. If you do something to send a chill into that good market or change it there may be consequences which will concern investors who investing in it.

Chairman: This is an issue with which the Committee must wrestle. Gentlemen, we are grateful to you for your time. It was not too painful; you did not have to give us any great commercial secrets. You have been helpful, if confusing in terms of the conflict with evidence received earlier. If on reflection you believe there is anything else you would have liked to tell us we would welcome it in writing. Thank you very much. I release you from your bonds.