Energy Bill

Memorandum submitted by Stag Energy (EN 04)

1. Stag Energy is a private company based in Edinburgh. We are developing the Gateway Gas Storage project on behalf of the Gateway owners.

2. The Gateway owners include Petrofac, a major FTSE100 oil and gas engineering company , and other private equity investors experie nced in offshore oil and gas .

3. Gateway is by far the largest gas storage facility being developed by "independent" owners (i.e. no other related gas market ing interests) in the UK. It is 1.5BCM in size and located offshore in the East Irish Sea.

4. We have obtained all necessary permits and permissions from the relevant Authorities and completed "FEED" (front end engineering and design). The facility is now ready to move to "FID" (Final Investment Decision) and begin construction.

5. We are now actively marketing Gateway to potential equity investors who are major participants in the GB gas market. Consequently we consider ourselves to hold current expert knowledge regarding the market views of potential owners of new GB gas storage.

6. We would therefore like to submit evidence to the Energy Bill committee concerning Clause 79 of the Energy Bill. This clause gives OFGEM the power to enact more speedy changes to the balancing rules in the liberalised GB gas market.

7. OFGEM is now conducting a "SCR" (significant code review) to examine such possible rule changes in detail. OFGEM have said they intend to make an initial report in July 2011.

8. The stated objective of Ministers is to ensure greater security of gas supply against unlikely but potentially catastrophic events (sometimes called "Black Swans"). This will be achieved by incentivising further gas storage build in Great Britain as a result of the sharpening of balancing penalties envisaged in Clause 79.

9. The Parliamentary Under-Secretary of State, Department of Energy and Climate Change (Lord Marland, in a written answer to Lord Jenkin of Roding, 3rd November 2010, stated; "The forthcoming energy security and green economy Bill will include a provision to strengthen the market incentive mechanism for ensuring sufficient gas is available. This will help underpin commercial demand for gas supply infrastructure, including gas storage facilities. The Government keep the gas market regulatory framework under constant review, but have no plans for further measures."

10. We do not oppose Clause 79 in itself. But we do argue that a sole focus on balancing rule changes is unlikely, in itself, to incentivise significant new gas storage in GB.

11. This view is based on our current active discussions with potential storage investors. The feedback we have received from major potential storage investors is that;

Ø New gas storage construction in GB under our fully liberalised gas market arrangements requires a price signal in the forward gas markets.

Ø The GB gas market only delivers price signals up to 3 years ahead, which is far too short a period to give complete confidence for major infrastructure investment decisions involving construction periods of 4-6 years and payback times of over 10 years.

Ø Gas forward price markets are also highly price volatile because they are driven by short term events. A summer winter seasonal price differential (spread) of a minimum of 15 pence/ Therm is necessary to justify investment. This has occurred on a number of occasions in the last 10 years, but not for sustained periods.

12. Consequently we consider reform to price setting in the gas balancing mechanism, currently being prioritised by DECC through the OFGEM significant code review (SCR) process, is very unlikely to have a fundamental structural impact ex ante on the gas forward price curve and so provide the necessary storage price signal.

13. Markets find it very difficult to price remote but significant risk in areas where they have had no previous experience, as the recent banking events have also shown. Indeed, since the intention to change the balancing mechanism was first announced by DECC in September 2010 gas forward seasonal spreads have weakened further.

14. Gateway has therefore been consistent advocates of enhancing the scope of the already existing gas "PSO" (public service obligation, otherwise known as supplier stocking). This is the normal European solution to the difficulty of ensuring market led storage investment. PSOs are already being place in all three of our directly connected gas neighbours, namely Ireland, France and Belgium

15. We argue for;

Ø An indicative target to be set for a minimum increase in the level of gas storage capacity within UK jurisdiction (akin to the December 2010 DECC electricity capacity margin proposals.)

Ø A PSO to be placed on all gas suppliers (and shippers to large NTS final consumers), based on previous year individual sales to all consumers, the size of which is specifically designed to deliver the target increase in storage capacity. (We have suggested this target should be at least 30 days winter peak coverage in the context of a European norm closer to 90 days and an existing GB coverage of less than 10days)

Ø The incremental storage capacity target and the consequent PSO to both be initially set between zero and a low level and then only increased over time to accommodate the transition of the GB market to a major gas importer and the lead time for the construction of new gas storage capacity, as market conditions require.

16. In July 2010 DECC published a report they had commissioned from the consultants Poyry which recommended the establishment of a framework PSO to be implemented, if and when necessary, along the lines we set out above.

17. We think this PSO framework needs to be in place sooner rather than later to ensure security given the long lead times involved to build new storage. Design and consultation about a PSO will inevitably be a protracted process. A storage target and an associated PSO incentive mechanism does not of course preclude the implementation of other security measures. Any increase in PSO obligation may be tailored to accommodate the effectiveness of other measures.

18. Therefore we think it essential that a PSO design framework is included in the OFGEM SCR and that Parliament does not signal that it is content that the measures included in Clause 79 are sufficient to guarantee future gas security.

19. A PSO design framework is a low cost pragmatic solution which will give additional confidence to potential storage investors. If our pessimistic view of the effect of Clause 79 in the event proves incorrect, then there will be no need to proceed further.

20. Ministers have also spoken about other flexible sources of supply contributing to security as well as storage. However storage is self evidently the most flexible source of security. It also provides above all the most certain security because it can come under immediate direct control of the government under extreme Black Swan type circumstances. In our view therefore other security routes should not be prioritised at the expense of storage.

21. We have submitted written evidence in support of the above points to the Energy and Climate Change Select Committee Energy Security Inquiry, and have been invited to give oral evidence to them on June 7th 2011.

June 2011

Prepared 8th June 2011