To be published as HC 1065-iv

House of commons



Energy and Climate Change Committee

The UK’s energy supply: security or independence

TUESDAY 28 June 2011

Nick Wye, Chris Hunt and David Odling

David Loughman, John MACArthur, Peter Mather and Steve Jenkins

Evidence heard in Public Questions 250-358



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Oral Evidence

Taken before the Energy and Climate Change Committee

on Tuesday 28 June 2011

Members present:

Mr Tim Yeo (Chair)

Barry Gardiner

Dr Phillip Lee

Christopher Pincher

John Robertson

Laura Sandys

Sir Robert Smith

Dr AlanWhitehead


Examination of Witnesses

Witnesses: Nick Wye, Spokesperson, Gas Forum, Chris Hunt, Director General, UK Petroleum Industry Association, and David Odling, Energy Policy Manager, Oil & Gas UK, gave evidence.

Q250 Chair: Good morning and welcome to the Committee and our inquiry, which has been going on for a little while now. You may have seen some of the previous evidence that has been given both orally and in writing. Could I start off by talking about oil stocks, which in this country are held by the industry rather than some sort of national account? Do you think that is a good idea from the point of view of energy security?

Chris Hunt: I could start by answering this, Mr Yeo. No, certainly, for the 14 years I have been in UKPIA, we have been campaigning for an agency to manage that on behalf of the UK, which is a very similar system to that deployed across most of the EU. The agency will bring a benefit of slightly lower costs, but that is not the whole reason. It is centrally managed in a transparent way, rather than in individual member companies, where it tends to be washed up in day-to-day business, hard to identify. Transparency is a big issue.

Secondly, at some point, we will lose the derogation we enjoy through our North Sea enterprise, which actually reduces our obligation under EU rules to 67.5 days from 90. That will go and it will incur somewhere between £4 billion to £5 billion of increased storage costs, which we feel an agency is better placed to manage and an agency can make decisions on a strategic basis on behalf of the nation.

Q251 Chair: The £4 billion to £5 billion is the extra amount of capital tied up in the extra stocks, is it?

Chris Hunt: It would be tied up in terms of not just the additional capital in the stocks, but the actual building of storage itself as well. We think that is far better managed by a central agency. The agency can decide whether it wants to build new storage, what that storage will be built for, and moreover, where it is built. For the whole sector, it will be a clear and transparent way of managing a national resource. It is not a commercial company resource.

Q252 Chair: It is not a great time to be suggesting public expenditure on a project like this, is it?

Chris Hunt: This will be completely self-funding, so it will not be drawing on the public purse at all. It will be a transfer really from the individual amounts that individual companies are catering for into a central agency. There will still be a form of charge from the agency to the obligated companies to manage that situation.

Chair: Hang on. You said it was going to cost an extra 5 billion.

Chris Hunt: The extra 5 billion is the increase in storage, which will come anyway because of the loss of the derogation.

Chair: The companies will have made the Government an interest-free loan for that purpose.

Chris Hunt: The agency will be able to source its own funding, we think; it will be an AAA-rated organisation as it is in the rest of Europe.

Q253 Chair: Won’t the Treasury rules say that comes under public borrowing?

Chris Hunt: We believe not. We have put a proposal in jointly with DECC that should be released to Ministers shortly, which shows how that particular hurdle can be overcome so it does not offend Treasury rules.

Q254 Chair: Do you envisage all the stocks in the future being held by this agency?

Chris Hunt: Eventually, yes.

Q255 Chair: How long do you think we are going to keep our exemption as a producer from the 90-day requirement?

Chris Hunt: Figures vary. Probably David, who represents North Sea, will bear that out. Projections as to when the North Sea decline in production will actually trigger a nullification of our reduction, our derogation of EU rules, are unclear, but any time from 2018 onwards, which relatively is round the corner.

Q256 Chair: Is that your view?

David Odling: Chairman, I am not sufficiently familiar with how the detailed rules work on the stocking, but it seems a reasonable assumption-some time later this decade.

Q257 Chair: For the moment, is our exemption still justified by the circumstances?

Chris Hunt: Yes.

Q258 Chair: If we did have an agency managing the stocks, how do you think it would actually work?

Chris Hunt: The agency would, in fact, take due cognisance of the overall UK obligation to the EU and then to the IEA, which supersedes it. The agency would set in place plans for how it wants to manage that stock through things called tickets or physical stock. It could then go on to the open market to buy tickets or to manage physical stock, and its running and operational costs would form the basis of a re-charge to those supplying into the market. The agency, in effect, cannot lose, but needs to be managed efficiently and effectively to be any good.

Q259 Chair: Would most of this extra stock be physically held or is it in some sort of futures contract?

Chris Hunt: It would be entirely a matter for discussion between the agency and Government. At the moment, there is a fair proportion held in what has formed as tickets, but increasingly as we go forward that market is going to become increasingly tight, particularly in terms of what we term "Cat 2" products, which are diesel and aviation fuel. There might well be a call, when it is agency managed, to have more in physical stock. In fact, that is one of the benefits of an agency looking at this whole issue on behalf of the nation rather than an individual company.

Q260 Chair: What are the circumstances under which any of that stock is released?

Chris Hunt: As now, it will be released either by instruction of the IEA, as has happened only this week, or by UK Government putting up a case for release to manage out the short-term UK disadvantage.

Q261 Chair: In the second instance, what will be the circumstances under which the UK Government might put up such a case?

Chris Hunt: If, for example, we had a significant and long-term refinery outage or some sort of breakdown in the infrastructure, there might well be a requirement to do that.

Q262 John Robertson: To move on to the refineries, that last comment you made about a long-term refinery outage is interesting, yet we are selling off our refineries, aren’t we?

Chris Hunt: Certainly, four of the eight operational refineries have been placed on the market for sale. Two of those are in the end stages of completion for successful sale. That is the Shell refinery in the north-west of England, Stanlow, which is going to an Indian company called Essar, and the Pembrokeshire refinery operated by Chevron, which will be sold to Bolero. The two other refineries up for sale are Milford Haven, operated currently by Murco, and the Total-operated Lindsey refinery up on the Humberside.

Q263 John Robertson: This comes from a position back in the 1970s when we had 18 refineries. You talked about storage earlier as well. Are refineries not used for storage of fuel?

Chris Hunt: Yes. Obviously, refineries have a fairly significant storage of both crude oil and finished products. Over the years-bearing in mind we have been operating our current compulsory stock-holding obligation for many years-part of the storage they have will be taken up by national strategic stock.

John Robertson: We are selling off storage so we can build new stuff. This is what you are telling me.

Chris Hunt: We have not actually sold off any storage as yet.

John Robertson: Well, we had 18 refineries at one time and now we are down to eight, soon to be four.

Chris Hunt: The 18 refineries have been closed for a number of reasons. If you look at the overall refinery output, in fact it has gone up since the 1970s, so the eight operational refineries have increased capacity.

John Robertson: Storage could be there if we want it, but it is just that we do not want it.

Chris Hunt: Storage of the 18 would have gone.

Q264 John Robertson: Let us move on a wee bit. The actual refinery and product that we are producing does not meet the UK’s needs. Why?

Chris Hunt: The refining capacity in the UK, in terms of capacity, meets UK demand, but unfortunately not in the exact product mix we need. We, in common with Europe, all the European-

Q265 John Robertson: That is not what the Deloitte report said, is it?

Chris Hunt: Because of the lay-out configuration of refineries put down some 30-plus years ago, we in common with Europe produce effectively too much petrol for our UK demand and too little diesel and aviation fuel. Again in common with Europe, we would export surplus petrol to the United States and we will be importing diesel. Some diesel and aviation fuel may come back.

Q266 John Robertson: As we said, as we get closer to a stage where our stock starts to deplete, we will be importing all this expensive fuel, particularly aviation fuel, and we will not be putting anything else back in the market. Why are we so short-sighted in this? Why has the business in this country not thought ahead?

Chris Hunt: The business has thought ahead, but we must recognise why there are four out of eight of our refineries up for sale.

Q267 John Robertson: Is it just short-term profit? Is that what we are really talking about?

Chris Hunt: No, it is a long-term view taken by integrated oil companies that the particular issues you have in Europe and the UK, in terms of profitability, return on investment, and your future view of where this market is going, mean that if you are a global company, there are probably more exciting areas in which to invest your funds.

What it also means is an opportunity for other companies like the Essars and the Boleros with a different business model to come in and buy those assets and operate them under a different business plan.

Q268 John Robertson: The Deloitte report recommended that the Government should determine the minimum level of refining capacity that should be maintained as an insurance against market breakdown. Do you have a view on that?

Chris Hunt: My view, which we have expressed to Government repeatedly, is that Government needs to have some sort of policy framework for refineries. We are kind of seen in the downstream part of the oil business as invisible, and we are invisible, I think, simply because we do such a good job; we very rarely let the consumer down at all. North Sea and my colleagues from North Sea-it is far sexier than the refining and marketing part of the business. Consequently, we tend to be airbrushed out a bit from the future energy scenarios.

Q269 John Robertson: We have let the country down in diesel and gas oil and aviation fuel, haven’t we? I have the figures here, and the amount coming from abroad would suggest-why are we not in that? Netherlands is 26% of diesel and gas oil. Why are we not doing that?

Chris Hunt: I dispute that we are letting the country down, because we have not seen massive queues at petrol filling stations for diesel, nor are we letting down the aviation industry.

Q270 John Robertson: That leads me to my last question. In 2000, there were fuel protests and some refineries were blockaded by truck drivers. That has serious knock-on effects for fuel availability and there was a stampede to try to get stuff. Is there a risk that that could happen again, and what has the industry done to try to stop it happening again?

Chris Hunt: The possibility of some attempted mass blockade of refineries and terminals is in the hands of those who might want to do that. As I say, I cannot categorically say they would not make that attempt again. What has happened since the 2000 blockades is that the industry and Government have worked very closely together.

We now have in place-we have had for some time-something called the national emergency plan for fuels, which is jointly between the industry, Government, police and every other affected agency to manage a whole range of scenarios where this might happen. Principally, it has been looking at things like access roads to refineries and terminals, and has had close collaboration with the police to keep them open. In fact, in the last year, there have been a couple of attempts to blockade, particularly down at the Coryton refinery in Essex. The police have immediately been on the case. In fact, the police were very proactive and went to visit some of those claiming to launch these campaigns and had a quiet word in their shell-like and said it was probably not in their best interests to carry that forward. We are in a far better position than 2000. As Baldrick would say, "We have a cunning plan" and we will-

John Robertson: Well, we will not ask what it is. Keep it secret.

Q271 Sir Robert Smith: I remind the Committee of my entry in the Register of Members’ Interests as relevant to this inquiry as a shareholder in Shell, also Vice Chair of the All Party Group, the Offshore Oil and Gas Industry, where the secretariat is provided by Oil & Gas UK.

On the refinery thing, it has always struck me with briefings on refinery that all the money is made before it gets to the refinery. Would anyone build a new refinery in the UK?

Chris Hunt: I could give an opinion: probably unlikely. If you look at where all the investment in all the new refining projects is going worldwide, it is India, China and the Middle East, because those are the growing and expanding markets. Our market is fairly flat and will probably decline with new measures to reduce the carbon footprint of transport. Therefore, if you invest your money, would you be doing it in the EU or particularly the UK? The answer is probably not, but what we need to do, for the eight operational refineries we have, is attract future inward investment. It is significant. We reckon at least three projects in the UK at £500 million apiece are needed to improve that situation with diesel and aviation fuel.

We still need to attract that and that is why we are saying to Government, "You do need to have a policy framework that covers refining and, quite frankly, stops this burden of pressure where we have UK-only CO2 policies like the carbon reduction commitment and the renewable heat incentive". If that had gone through in its original form, it would have completely wiped out the entire refining margin for the UK, which affected UK refineries only against the EU. Then you look at the raft of EU regulations like the reduction for refineries and other heavy industry; that again is disadvantaging EU refining versus global, and we are in a global business. We have to be very conscious that first, if we are creating UK-only policy, that is going to affect refining and other energy-intensive industry and, secondly, on the EU scenario, if we are developing further carbon reduction policy versus the world, that we are in a global business, and you disadvantage those very valuable and important assets from a strategic point of view quite greatly.

Q272 Sir Robert Smith: How is the dialogue with Government on those concerns?

Chris Hunt: We have a very good relationship with our Energy Minister and that part of DECC. Personally, I think that there is a tension where you have the environmental and climate change part of Government in with energy, because there is always a tension between one and the other. Our relationship with that part of Government is fine. We do have some fair and frank exchanges of views with other parts of Government on where this policy is going on climate change. Again, we must emphasise that we are never looking for favours or advantage, but really for a level playing field for UK refining.

Q273 Sir Robert Smith: On the upstream side, the UK became a net importer of gas in 2004 and oil in 2005. Has that caused any security problems?

David Odling: In terms of energy security, do you mean?

Sir Robert Smith: Yes.

David Odling: So far, no, particularly on the gas side. The world gas market has changed dramatically over the last four to five years. We have seen a huge increase in the availability of gas reserves and a huge increase in particular in international trading of gas. Mainly, gas is a regional fuel, but there is a growing trade in inter-regional trade.

On the oil side, clearly the oil market has been tighter than the gas market of late, but there have not been physical shortages. The market has responded. Of course, one of our biggest overseas providers of oil is Norway, which is the nearest major producer. We and Norway are the two big oil producers in Europe. Nobody else comes near us. Clearly, their production is more than ours, but they are a very significant supplier to this country.

Q274 Sir Robert Smith: From a security point of view, not having our own domestic production is not necessarily a risk, but it is the loss of economic benefit, balance of trade and jobs?

David Odling: Yes, our view very much is that it is the economic losses and the consequences of that, which there is a degree of inevitability about, but in terms of energy security we do not think it has moved the picture hugely.

Nick Wye: Certainly, on the gas side-perhaps in the Gas Forum, which is where the main interest of the association is-quite clearly the UK has responded, and responded in fairly good time to decline in UKCS in so far as we have spent roughly, I think, about £5 billion on infrastructure in the last five years. In terms of the actual capacity, I believe, of import capacity, we have invested money to allow us to import a maximum of 140 bcm a year, which compared to the annual demand is around about 90 to 100, so our import capability far exceeds our annual demand, so clearly the market has recognised-

Sir Robert Smith: The physical, structural input capability, but you obviously have to have gas-

Nick Wye: Yes, the commodity to follow. In the last year, if you look at the breakdown of where the gas has come from, the numbers are from Norway, 24 bcm, and this is against a total demand of about 90 to 100 bcm; LNG, 17 bcm. The year before we had 6 bcm from LNG, so it showed a marked increase in LNG importation-thanks probably quite a lot to the fact of US discovery of shale, which has been very helpful to the UK-and also 9 bcm from the interconnector from Russia, from Holland and elsewhere.

We have responded in terms of infrastructure and the market has responded in terms of commodity, so we seem to be doing okay.

David Odling: Just to add to that, I would say that we now have the most diversified gas supply in Western Europe in this country.

Q275 Sir Robert Smith: We still have an estimated 24 billion barrels of oil equivalent of our own to potentially produce. What sort of investment would be needed to benefit from all that reserve?

David Odling: Currently we spend roughly £10 capital for each barrel we recover, so a very simple sum tells you that is £240 billion in today’s money. Having said that, it is inevitable that future resources are going to be more difficult to recover than current resources. That trend, of course, has happened over the last 30 years. Quite where that will take us, who knows? But today’s figure is capital roughly £10 per barrel.

Q276 Sir Robert Smith: When it comes to investment, obviously we have already taken evidence from you on the budget impact as you see it on investment. One of the key things you emphasised was that it was not just so much the tax but the shock and unpredictability of the tax that means that for future investment there will be more risk built in to decision-making. Is there anything in the way the Government approaches tax changes that could reduce that risk profile for the UK?

David Odling: Given that we have a unique tax system, and clearly it is a very sensitive matter as far as investment is concerned, we would certainly favour the kind of model they have in the Netherlands, which is that the special tax regime that applies to us is not changed without warning, but is changed as a result of discussions with the industry to see what is going to work best for both parties in terms of the national exchequer and the industry. I think it is the "without warning" side that is extremely damaging.

Q277 Sir Robert Smith: Is there any downside with warnings that people could be tempted to make-is there any risk? Treasury are always very frightened of sharing their thoughts in case investors can suddenly-

David Odling: Which is the worst, to share your thoughts and negotiate a deal on the one hand, or just to spring a surprise on the other when all the signals before the surprise was sprung indicated that no such thing was going to happen? We think that the second of those is far worse than the first.

Q278 Sir Robert Smith: If you can get rid of the surprise element, you can then have a constructive negotiation?

David Odling: Which is what we are trying to enter into now, of course, in the aftermath of what happened; to see what could be done to alleviate some of the consequences of that. Unfortunately, what that move did-going back to the physical side of it, the amount-is that it more than negated towards the end all the previous administration’s arrangements over difficult fields, high pressure, high temperature fields and so on that had been put in place. They were just wiped out completely by the move.

Q279 Sir Robert Smith: So movement on the field alliances will, at the margins, make a-

David Odling: Potentially we think that is a very useful area, plus of course, as I think is well known, resolving the difficulties over the taxation of decommissioning. It is difficult now to separate those. Frankly, the whole package needs sorting out. Unfortunately the Treasury has agreed, and therefore we are into detailed discussions with them to try to resolve this whole tangle, because it needs to be resolved.

Q280 Dr Lee: Mr Odling, you said that so far security had not been impaired by becoming a net importer of gas and oil. Putting aside our close relationship with Norway-I note you were once employed by a Norwegian organisation; I think we are very fortunate to have that relationship-let’s go to a doom and gloom situation, a globalised world in July 1914. Judging by economic indicators at that point, no one anticipated the conflagrations to come. At that point, the British people’s perception of oil and gas security, energy security is, "What do we own ourselves?" That is the man in the street, "Do we have enough oil and gas? Do we have enough power?" As I said, we did not predict it last time around, so why should we predict it next time around? If we go down the path of protectionism with a nationalistic, looking after ourselves type of approach, which one could foresee developing at the moment, in Europe for sure, do we have energy security in the way that the layman in the street would understand it?

David Odling: It is a fairly complicated answer. Two things: in my lifetime at least, the biggest threat to the economy and energy supplies in this country came from a mining strike, and that was entirely internal. That was back in the 1970s. Interestingly, if you go back to the First World War, after what happened in the general strike, that was internal. The great thing, surely, is that international trade has been transformed in the last 50 years and we have seen markets opened for almost everything you care to name. Not just energy-energy came later-but even in other essentials like, say, food and clothing, with the result that we can move goods around the world in a way that was never before possible.

I think the crucial thing there is that both the suppliers and the consumers get into a position of interdependency. In other words, suppliers are looking for the revenue as much as the consumers are looking for the goods, and we see that in the energy markets, so our view is that politically we should do everything we can to maintain the best relationships possible with supplier companies, and that is true as a nation and it is true as the European Union. The European Union after all is an even bigger importer of fuels energy than we are; oil, gas, coal and so on.

Secondly, in pursuing those relationships, we should remove as many barriers to free trade as are physically possible, and then you create optionality, diversity and security of energy supplies or anything. Food or clothing again-same thing-will come from diversity and that diversity supports our own production.

Q281 Dr Lee: But that is predicated on the suppliers continuing to not need the oil and gas themselves, so if you have a developing Middle East growing significantly in economic terms-China of course always plays a part-there is a possibility you will get to a point where they will say, "No, we don’t have anything to sell", or they may choose to engage in some sort of economic warfare; a sense of, "Right, we are going to retain our resources, what we have, because we know in time that that will do you harm". I know that it all sounds a bit scary to be talking in these terms but I am not convinced at the moment that the type of security that the people want is necessarily the type of energy security that we are talking about. Do you understand what I am trying to say? I do not think people fully understand. They think, "Oh yes, we have oil; we have gas", but in fact they will not have any concept of the fact of what proportion of it relies upon retaining good relationships with foreign partners.

Nick Wye: Relations are important, no doubt. Our relationship with Norway and our relationship with Qatar were important in terms of ensuring we had the facilities built in the UK with the pipeline or energy-receiving terminals. At the same time, you understand that there is essentially a glut of gas. There are the traditional countries still supplying gas, but there are a lot of new countries coming to the market, such as Australia, Brazil and the Caspian Sea. There is an excess of supply, and there isn’t the market locally and there will never be the market locally to satisfy that supply, so as long as we have the ability to signal our need, which is essentially the market, and the ability to move the gas from A to B, which is either through a pipeline or through LNG, I would suggest that security is pretty safe, mainly because of diversity of supply in where we can obtain gas in the future.

Chris Hunt: Can I just interject? These are very interesting questions, and I recall that the last IEA World Energy Outlook said there are 1,354 billion barrels of oil available, which is the equivalent of 45 years’ worth at 2009 consumption rates. As we often say in UKPIA, oil is not running out, so you needn’t rush on our behalf. From my perspective, the security of supply issue is that at the moment we can process through our refineries crude oil from 120 different sources. We use a lot of North Sea but we can process from 120 different sources. That gives you an enormous amount of supply robustness. If, unfortunately, through policy or lack of commitment from Government to the refining sector you lose a lot of that capacity, you are then in exactly the situation you are talking about. You are reliant upon the former Soviet Union and the Middle East more and more for finished products to come into the UK and I think that, if you repeat some scenarios of a major conflagration, it will put you in a more difficult position than if you were refining your own product from 120 different sources.

Nick Wye: There is a similar issue with gas in so far as, as you probably know, there is a variety of gas quality throughout the world. In the UK we have different quality parameters compared to mainland Europe; for example, the LNG that comes in is fairly rich gas, so it has to be treated, and that is treated at the terminal level. They balance it with nitrogen to bring it down to the quality level we require. Going forward, it may be more of an issue if we are importing more gas, particularly pipeline gas, let’s say, from Russia. There may be issues in relation to making sure the quality of that gas is appropriate for usage in the UK. Historically, the UK approach has been very much a polluter pays approach, so at the LNG terminals, the LNG companies are the ones investing in those process facilities.

If you are looking at the interconnector, there are many parties who bring gas through the interconnector, many capacity holders, all with different economic drivers. It might make sense to consider a more centralised approach to ensuring that the quality from the interconnector is sufficient for UK consumption. I know that there have been very occasional issues with quality coming through the interconnector and fluxing through the operation of the pipeline on the Belgian side. On a couple of occasions they have had to run the stock and their level right down to ensure that they could supply the UK with the gas that is required. That may become a bit more of an issue, particularly in terms of pipeline gas, in the future, but LNG is kind of sorted because the regasification terminals already have the process and compliance in place.

Q282 Barry Gardiner: Mr Odling, in your submission for Modern Gas UK you said that you would prefer to be building gas-fired power stations rather than renewable plant. That may be no surprise, but given that we have about 24 GW of gas at the moment and another 24 either under construction or with consent, what further emissions reductions are possible by replacing coal-fired power with new gas, and why do you believe that it is preferable, given the UK’s renewables targets, to be building that gas plant instead of renewables?

David Odling: To answer your first question, we ran some calculations based upon evidence that is available publicly, and in round numbers, if you replaced all the power generated currently by coal and oil with gas-there is very little oil, of course-the reduction in CO2 emissions per year would amount to 50 million tonnes. There would also be concomitant reductions in sulphur dioxide emissions, nitrous oxide, particle matter and so on, and various other pollutants, so you get not just the CO2 gain but also air quality gains of a very significant order.

Why would you want to build when we have the renewables target? One of the things we also said in the submission was that we thought it might have been better if that target had been a low carbon target, rather than necessarily specifically a renewables target. But accepting the policy as it is, it seems to us there are several things. First, the renewables are going to have some sort of backup anyway. If you take wind, the best that wind has done so far in this country, on an annual availability, is about 30%. On some years it has been down in the 20s. That should rise with offshore wind, unless there are severe reliability problems, but let us set those aside, so we might get up to, say, 35% availability. None the less that still means that it is going to have to be backed up for 65% of the time, which actually of course is a lot more than the 35%.

We are going to have to build both, aren’t we? Or at least it seems to me, on a very simple arithmetic, that we are going to have to build both. It also seems to us much less risky in the first instance to build the gas, because it has financial advantages and it has delivery advantages. It will not strain the supply chain to anything like the same extent. We are going to need the plant anyway. It has these benefits in terms of emissions, on top of which it will buy time to allow some of these new technologies to have the necessary research and development funding put into them, so we can find out what actually is likely to work and, therefore, how we might look at things in the longer term, whereas, at the moment, we seem to be making a commitment that is extremely testing financially and from the point of view of physical delivery. One of the things that worries us most is that there will be competition for supply chain resources and, in particular, human beings, qualified engineers and so on. Where are all the marine surveyors going to come from?

Q283 Barry Gardiner: Mr Odling, you are, in a sense, repeating the Committee’s own fears, from a previous inquiry, as I am sure you will know. Let me ask you this, in pursuit of what you just said: do you believe that there will come a point where perforce, like it or not, the Government will have to renege on those targets?

David Odling: We think it is going to be extremely difficult to meet the 2020 renewable energy target.

Barry Gardiner: That is what you said in your last answer. I am asking you a further question.

David Odling: Forgive me. I am not sure it is for us to pronounce on that. I think that is something, if I may say, for the Government to decide.

Barry Gardiner: It will be for Government to decide. I am asking you for your opinion. As a person in your position, it would be strange if you did not have an opinion on such matters.

David Odling: We certainly think we are going to miss that target, and miss it by an appreciable margin.

Q284 Barry Gardiner: Thank you very much. You have obviously seen the Energy and Climate Change Committee’s reports. You will know that they said, and I quote, "There is no role for investment in coal plant without full carbon capture and storage to come on the system beyond 2020, and only a limited role for unabated gas plant. That is, for example, running at low load factors in balancing intermittent generation. If there were to be investment in either form of unabated fossil fuel capacity for baseload generation, the required sector decarbonisation would not be achieved". Do you disagree with that?

David Odling: It comes back to this question of developing new technology. It seems to us that there is a bit of an assumption there that carbon capture and storage at power station scale is going to be made to work. We are still only-

Barry Gardiner: Sorry, no, the quot e actually talked about how if it was unabated then it would be incompatible with reaching the low carbon targets.

David Odling: That may well be true, but surely that is not the only consideration, because the Government has three interlocking overall objectives, which are to reduce emissions, to secure supplies, and to do it all in an affordable way that keeps the economy competitive. That particular quote was, if I may say so, only looking at one of those three overall objectives. The question in my mind is, how do you tie all those three objectives together? To come back to my point, it is almost assuming that carbon capture and storage could be made to work. Well, maybe it can, but we don’t know yet and we don’t know how long it is going to take, and we don’t know how much funding it is going to take.

Q285 Barry Gardiner: Let’s stick to the question that I put. I understand there are other factors here, but I want your opinion on this. If the sector were to go on and build unabated CCGT plant, do you accept that beyond 2020 that is incompatible with meeting the CO2 target, the reduction in emissions?

David Odling: If those are the calculations that the Committee have done, then so be it. That is obviously the correct answer.

Q286 Barry Gardiner: In that case, if that is the correct answer, and given the scepticism that you have just expressed about the possibility of carbon capture and storage being fitted to CCGT and working, how could you justify as a sector continuing with the 24 GW that is in the pipeline to be built, which is currently going to be built in unabated form?

David Odling: The crucial question, the point there, is the date 2020. That surely is the nub of it.

Barry Gardiner: You said you agreed with me.

David Odling: Yes, but will carbon capture and storage be ready by 2020? That is the big question in my mind. It may well be ready, but I think by 2020, in a commercial sense, it is most unlikely.

Q287 Barry Gardiner: When do you expect it to be available?

David Odling: Well into the 2020s; it could even be 2030. A timing issue is crucial there.

Nick Wye: I think I would agree with that. In terms of your question about CO2 emissions, and in view of what David said, the Government’s own research, carried out by Redpoint as part of the EMR, said that if you replaced all the currently existing coal plants with CCGT, the levels of carbon emissions would be 30% lower compared to 1990 levels. It is unabated, so it is a fairly significant contribution to reduction in CO2 reduction. Beyond that, of course we have the potential for CCS. At the moment it is untested, the science is untested and the economics are untested, so we have to wait and see, but there is hope that that will be possible.

Q288 Barry Gardiner: Of course, key to that, and key to the role that the Energy and Climate Change Committee sees gas playing as a balancing fuel within the electricity sector, will be the capacity to deliver CCS that is in itself flexible in being able to be ramped up and closed down at short notice. What evidence do you have, or do you have evidence that would show it is not possible to have such flexibility in CCS plant?

Nick Wye: I have no evidence either way, to be honest, as regards CCS.

David Odling: I think a lot depends on the exact technology that comes out of the research and development. I don’t pretend to be an expert, but currently they use a thing called an amine absorber. The one thing that characterises all big plant, frankly-it does not matter whether it is a power station, a chemical plant or whatever-is that it much prefers to run a constant load, just like a motorcar. You are better off steadily driving up the motorway than you are stuck in the traffic of London or Manchester.

Q289 Barry Gardiner: Finally, going back in some respects to the first question that I asked, you argued in your submission that it would be cheaper to invest in new gas plant rather than renewables. Given the constraints that we have just talked about and therefore the need to have those plants at least compatible with the retrospective fitting of CCS technology, and ultimately with the fitting of that CCS technology, and given the cost that will be involved, can you still make the same claim that it would ultimately be cheaper, in the long run, than renewable technology?

David Odling: The figures that we have run on this, Chairman, are that round three offshore wind developments are costed at roundly £100 billion in capital for 25 GW of capacity. The same capacity in gas-fired power would cost between £12 billion and £15 billion, that sort of order, so there is an awful lot of money out there in the difference between the two. I think the question we were fundamentally raising in our reply, though, was that the programme that has been set involves so many different new developments on a very big scale, all happening at the same time, which has huge financial implications. It has huge technical implications and it has huge implementation-actual physical delivery-implications. That really is the point we are coming from. We listed eight major factors in our response to you where we are trying to make really substantial changes to the energy systems of this country. It is a question of risk and optionality, and what we were trying to say was that we think this is the lower risk route, which also keeps options open, depending on how technology develops, because the crucial unknown is the development of new technology. We just do not know how some of these things are going to develop, and we need time, it needs money and it needs space in order for these things to happen.

Q290 Christopher Pincher: My question has been partially answered by Barry’s last question, but you mentioned, Mr Odling, that there is a technological challenge with CCS, but isn’t there also an economic one, in that, as I understand it, if CCS is applied to gas-fired stations, it effectively makes it much more difficult for them to be dialled up and dialled down to meet peaking demand? I think that is an economic and a technical problem. As a result, we are turning them into nuclear baseload-style stations, and doesn’t that then place an even greater risk on reliance on intermittent technologies to provide peak capacity?

David Odling: As I think I was trying to explain in answer to the previous question, we just don’t know yet exactly how these things will operate in practice. I don’t pretend to be an expert on absorption of CO2 from power station chimneys. All we do know is that complex plant tends not to enjoy variable load. It prefers constant load, and I was trying to make the point that generally that is true of all the machinery and plant and so on. So it remains to be seen, but I have no great expertise in that technology and much will depend on how things evolve during the course of the experimental period that we are going into.

Q291 Sir Robert Smith: Two quick things. One is that in the optimistic scenario, pre-combustion CCS producing hydrogen and burning hydrogen in a gas plant should potentially provide that flexible response that actually works, because you can buffer the fuel, but it was just more on this challenge of meeting the three targets for Government. It seems that going to gas early instead of coal is a quick win, but the worry is that in the long run, without a massive CCS retrofit, you will not achieve the emissions targets. But if the renewables and other technologies take off, will those gas plants have paid back? The worry people have is that once you have the gas, the incentive to get the other low emissions may disappear, but if you run those gas plants for a short period of years, will they repay their investment, even though they still have more life in them?

David Odling: We are now getting into power station economics and power station financing, which again is a big area, and clearly the power generators are really the people to answer those questions. But again, what struck us was that if we were going to build the gas now, let’s get on with it, for that very point, because then you have a chance of getting the capital back, and we are probably going to need those gas-fired power stations anyway, given the sheer amount of conventional capacity that will have to be retired in the next 12 or so years; coal, oil, even early gas, and of course a lot of nuclear, and we have to keep the lights on-security of supply. If the renewables programme takes longer than planned, and that is what we believe to be the case, then in order to do all those other things we are going to need those gas-fired stations anyway. I accept entirely that there is a risk, but there are very considerable risks in what we are doing now. It is a question of which is the lower risk, balancing all those different competing interests.

Nick Wye: We have a pretty competitive market in the UK and investment is done on the back of that. As long as the framework is clear and the policy is clear, private companies will make investments on that basis, and one would assume that being fairly astute individuals, they would ensure the returns they get cover the costs and give them a profit margin. As long as it is clear where we are going, you can leave it to private industry to determine whether or not they should build a power station. In the very short term it is clear we do need additional generation pretty quickly. We have something like 19 GW coming off in the next 10 years or less-actually, it may be less than 10 years-and that is essentially replaced by the new build CCGT. I think 12 GW is being constructed now and there is a potential for another 12 GW, I think, in various stages of development. There is a very short-term need, but longer term, as long as the framework is clear, as long as the policy is clear, I think the market will decide whether or not it is economic to build more.

Q292 Laura Sandys: We are talking very much in terms of free trade, of an open market, when one starts to look at potential politicisation, potential protectionism that in many ways could create shocks within the system. I think there is nothing more illustrative of that than, in many ways, pipeline policy, and the investment and the political investment in the development of pipelines. Mr Odling, you said in your submission that the Nord Stream pipeline between Russia and Germany would greatly improve the security of European gas supplies. That would not be necessarily what I would think if I was sitting in Poland. Why do you believe that is crucial, or that it contributes an important part of our energy security?

David Odling: Clearly, it is a substantial increase in pipeline capacity between Russia, as a very large supplier of gas, and Western Europe, and considering that the interaction that did occur a few years ago was the result of a spat between Ukraine and Russia, and we all know the consequences of that, fortunately it has been patched up and relations seem to be on a much better footing than for some time, maybe not as good as we would like. Clearly, the addition of a capacity of 55 billion cubic metres per year, which is what the total capacity of Nord Stream will be when it is fully commissioned, is a very significant piece of infrastructure enhancing security of supply in Western Europe. If you are in Poland, I accept entirely that it is a different matter, but on the other hand, Poland has a separate Russian pipeline passing through it, which incidentally throughout the Ukrainian dispute continued to flow at maximum capacity. Sometimes that gets overlooked.

Q293 Laura Sandys: But do you feel that there is the possibility-these are captured markets in many ways, when you have pipelines going from point A to point B. There is certainly quite a lot of friction; you mention the Ukraine in particular. Do you not see that certain elements of the infrastructure can be politicised and, certainly, if there was a very cold winter in Russia, we would actually end up being very much subject to their internal politics and that, when you continually talk about this expanding diversified market, there are certain shocks, or potential shocks, within that diversified market that might increase pricing? Again, affordability is part of our energy security as well as access.

David Odling: But surely an increase in diversity is exactly what we need to get security, and Nord Stream increased diversity.

Nick Wye: There are two things I would add to that. Nord Stream is a commercial pipeline. It is underpinned by commercial contracts. It is not a political pipeline, so that in itself should be heartening. Secondly, and I agree with David, the more capacity you have in relation to gas coming from mainly Russia of course, which sits in the west, the more likely you are to get more gas-to-gas pricing. As you know, a lot of contracts in Europe are oil indexed. If you have more spare capacity, suppliers will want to use that capacity and obviously profit from the utilisation of the pipeline. It is more likely to lead to gas-to-gas pricing, which of course we have in the UK, and therefore, hopefully, we should attract the thermal gas we need to start up our boilers.

Q294 Laura Sandys: If you are talking about the diversification of pipelines and access to gas, would you not start to look at the Nabucco gas pipeline? Do you believe that it will actually come to fruition, and do you think that there should be political investment in speeding up the pipeline?

David Odling: I was in the audience, Chairman, when you took evidence from Professor Jonathan Stern and two others a few weeks ago. Professor Stern probably knows more about gas from the former Soviet Union and so on than any of the rest of us. If I remember rightly, his answer was that he did not think there would be a pipeline, whether Nabucco or something else, from that part of the world to Central Europe before the 2020s, and I defer to his far superior knowledge in these matters.

Nick Wye: It is a very long pipeline and a very expensive pipeline, and to date I believe it has not done anything by commercial contracts. So in the short term, no; in the longer term, I really cannot answer the question.

Q295 Dr Lee: With the German Government’s recent decision about nuclear, in terms of capacity, and on the presumption that they are not going to be getting that power from wind farms, and it is between 20% and 25% of their usage, is there a problem? I envisage this Nord Stream pipe coming down and the Germans saying, "Right, we need a bit more of that. We need a bit more of that because we no longer have nuclear power". Eventually, it is not going to provide the diversity you refer to, if that was the case.

Nick Wye: I understand. I have read elsewhere that the likelihood is that Germany will require an extra 16 bcm of gas to support the field, the CCGT, to account for the loss of nuclear, but Nord Stream itself carries 55 bcm, so there is a fair amount of space in that pipe to supply on.

David Odling: Interestingly, the most recent figures I saw on what has happened since the seven power stations were shut show that gas demand has not changed at all in Germany, but what has gone up is coal demand.

Q296 Christopher Pincher: There seems to be general consensus that gas storage capacity is inadequate. You mentioned Professor Stern. When he came before the Committee a few weeks ago he said that through a constellation of unusual events-he was referring to the very cold winter at the end of last year and the start of this year-the UK came close to major gas supply problems, adding, "I would say, we have been lucky". Can you say just how bad you think our gas storage situation is, if it is bad?

Nick Wye: In terms of figures-I will not bore you with the figures-we have built quite a bit recently; we have built 1 bcm in the last five years and there is a lot more storage slated. Who knows how much is going to come, but there are a lot more projects out there. I think numbers in excess of 5 bcm should double our current capacity, so there is potential for additional storage. I believe other individuals have given evidence, particularly those with storage interest, and have talked about the problems in relation to building storage, in particular the seasonal spreads and issues relating to planning, and so on. There are a number of issues out there but there are a number of projects that could be built. Whether they will be built depends on the economics. I think it is fair to say there is a general view that we do need more storage, and on that basis one would assume that the market would respond as it has responded in the last five years, and some of these projects will be built.

The other thing to be aware of is that there is a major project being built in Holland called Bergermeer, the size of which I believe is greater than our total storage capacity in the UK. That facility is only 20 km away from the BBL pipeline, which is the interconnector pipeline between Holland and the UK, so even though physically it may be argued that currently we don’t have enough storage, we may have in the future. We will also have access to storage from, for example, Bergermeer, which will be a third party access facility, so we don’t necessarily need to look purely in the UK. We can look a bit more broadly at facilities that can support UK flexibility.

David Odling: I have heard that statement-that we came within a whisker and so on and so forth-yet if you look at the records of what happened in the market during that period, there is no evidence that the market was reacting as if we were about to hit a crisis. There was none at all, so I am a bit puzzled by some of those statements. Clearly, demand was very high, and 2010 as a year recorded nine of the 10 highest days of gas demand ever in this country; three were in January and six were in December, yet the market seemed to take it pretty much in its stride. There were a few ripples here and there but they were soon sorted out, so I am a bit puzzled by some of those statements along the lines that we came within a day or whatever of disaster.

Q297 Christopher Pincher: Do you agree with the Energy Minister when he said-I think, he was speaking to clause 79 of the Energy Bill-that we do need more gas storage, or do you think that the market will always provide and that there isn’t a problem?

David Odling: We are on record, including in our reply to you, that we foresee a need for more gas storage, but we also think that the market should do it, and the market slowly is doing it. But don’t discount what has happened in the LNG world; LNG has started arriving in this country in very considerable quantities, and what is more, it has shown enormous resilience and flexibility. We have suddenly had-pipelines tend to flow more steadily-this very significant transformation, and to a degree LNG is a kind of buffer because you always have stocks in the tanks at the reception towers, so in part it can act a bit like storage.

Q298 Christopher Pincher: You said the market is reacting. I have a list of about a dozen consented facilities for gas storage. Some are onshore and some are offshore. Of those, Centrica, who are going to provide 0.6 bcm in an offshore facility, are not planning any activity in 2011. The plan is on hold. Eni, I understand, have gone cold on their reservoir, which has 4.6 bcm, and there are technical challenges that InfraStrata is facing in its salt reservoir, which would offer 1 bcm, so it seems that perhaps the market is not moving as quickly as you think it might to provide gas storage capacity.

David Odling: It has been moving slowly, I acknowledge that, but there has been no evidence that to date we have needed more than we have. It would be nice and comfortable to feel that we have more but there are projects happening. Our view, which I think we also put in our evidence to you-we certainly did to DECC in the electricity market forum-is that the type of storage that is more likely to be needed in future is the quick-in, quick-out type of storage, the salt cavity, rather than the big quasi-strategic offshore field of 3 billion, 4 billion, 5 billion cubic metres. We think that the economics of something like that are probably extremely difficult.

Q299 Christopher Pincher: You pre-empted my next question, which was, do you think we have the balance right between those porous reservoirs, which act like a sponge-you pump gas in and you only get a proportion of it out-and reservoirs that have more capacity to push the gas out themselves; salt caverns, for example? Do you think we have the balance right between them?

David Odling: Certainly on the list we have of those that are either under development or which have planning consent, the predominance is salt cavity.

Christopher Pincher: So you think the balance is right?

David Odling: Yes, we think this is right. Yes, because we think it is going to be the quick-in, quick-out type of storage that is more likely to be needed in future.

Q300 Christopher Pincher: One final question. Do you think that the Government should establish-you talked about it earlier on with respect to petroleum-a stock-handling agency with respect to gas? Would that be a sensible move?

Nick Wye: I can’t really see the need for it. If you are talking about public service obligations, you kind of mean withholding gas and storage. We do a bit anyway. National Grid does contract for some storage to assist. It is called operating margins for emergency rundowns. We do a little bit of that, if you like, but if you are looking further afield more widely about imposing PSOs on the market, I think they would probably undermine the market. They are more likely to crush the spreads and less likely to underpin investment in these facilities. Ultimately, we have facilities built on the back of the market. We have a number of facilities looking as though at least some will come on stream on the back of our current arrangements. PSOs tend to be used in markets that are illiquid, where there is no ability to buy flexibility. Anyone can buy flexibility. We have a very active MBP, so I don’t think it is actually required in the UK, unlike perhaps somewhere in Spain, where it has been used for many years and where they don’t have a very liquid trading market.

David Odling: The costs will be absolutely astronomical. There was a calculation about three years ago at European level, and what the calculation did was take the 90-day IEA stocks across the EU27, turn that into money and then convert it back into stored gas. How much gas would you have for that amount of money in relation to demand? So 90 days’ oil came out at something like 2 or 2½ days’ worth of gas. The numbers would be enormous.

Q301 Dr Whitehead: The EU third energy package was designed to free up the market, make it more liberal and flexible, allegedly to add to collective EU energy security; how would that play in the UK?

Nick Wye: I think, in terms of the UK itself, we don’t need to do too much because we are pretty market-focused already. I think it will help in relation to the continent. We keep talking about the need to be able to move gas from A to B, across borders, and certainly the third package is focusing on opening up these markets. They are very slowly opening up and there seems to be a bit of a wind behind them now. The hope is that the third package will be the final step towards encouraging opening up of the continental markets, which in itself should aid security in the UK, allowing us to access gas from the east to the west through pipelines that are open to third-party access and across borders between countries as well.

Q302 Dr Whitehead: I think you mentioned in your written evidence that there is potential for gas flowing into the UK to be of different quality from what we are used to. I assume that relates to what we are adapted for in the UK and what imperfections are tenable as far as UK gas supply is concerned. The interconnectors in the UK were originally designed as outward interconnectors, I believe, so a flow of gas in, or equally in as well as out, could lead to those quality issues, could it not?

Nick Wye: I mentioned earlier that we do import. We are importing gas from the continent now, and I mentioned before there have been a couple of occasions where Fluxys mentioned that they had issues in relation to their own systems supporting the export of gas through the interconnector into the UK. As we state in our evidence, we think the Government should look seriously at quality issues and consider whether or not something needs to be done more centrally in relation to sorting out quality issues before they get into the UK market. It is a problem for the pipes or comingled pipes where you have more than one shipper/supplier moving gas, because not every single party is a physical party. A few of those parties are traders. They have no interest in the physical commodity, so it may need a push to encourage the proper processing plant to be built to ensure that quality is maintained.

Q303 Dr Whitehead: This is a rather ingenuous question: at which end?

Nick Wye: I don’t think it really matters as long as it is done one end or the other. I guess it would be easier at our end, wouldn’t it, because it is on our land, but it does not really matter.

Q304 Dr Whitehead: How serious is that as an issue and who might do that? I presume it has to be done one end or the other and has to be reliable.

Nick Wye: Yes. The problem is our problem rather than the continent’s problem because we are importing their gas. Clearly it is our problem, something we need to resolve. At the moment it is not a big problem, but as we become more import dependent it probably will become a bigger problem. I can’t say when and I can’t say how much of a problem it will become, but I know there is work going on in the EU about gas quality and how to harmonise gas quality. It is just something you need to be aware of. I think historically we have looked at it in the UK. I know Ofgem did some work a few years ago looking at where the costs should be imposed to build such facilities and, as I said earlier, the conclusion was, the polluter must pay, which is fine-I say "it is fine", they may not agree-in so far as you are talking about a single provider of gas through a singly owned, let’s say, LNG terminal, where the gas can be properly identified. It belongs to this company and therefore they should pay for the processing. But when you are talking about a pipeline with many players involved, it is far more difficult to identify who should pick up the cost for building the necessary facilities.

Q305 Dr Whitehead: So we invite them to send gas to us; we scrub it at this end, we charge them?

Nick Wye: No I think they probably wouldn’t swallow that. I think we need to look at-I hate to use the word "socialisation" because that is a dreadful word-some way of sharing the cost, probably at our end, in relation to making sure the gas quality is appropriate for our own consumption.

Q306 Dr Whitehead: Just a minor thought on that. If they were required to contribute to the scrubbing of their own gas for importation into the UK, presumably you would be rather reluctant to import gas into the UK, might send it somewhere else?

Nick Wye: Certainly. I think that is probably a fair conclusion. Additional cost isn’t attractive, is it?

Dr Whitehead: So therefore we will have to pay for it ourselves?

Nick Wye: I think it is probably a more reasonable way to look at it, yes.

David Odling: Also if I could just add, you say "scrubbing". It is not really scrubbing in a sense; it is that the quality band in the continent is wider than ours. If you go outside our band, which some of their gas may do, it has to be treated to bring it back into our band, so that is a job for us, I am afraid.

Q307 Dr Whitehead: Yes, and what sort of cost is that?

David Odling: The only figure I have ever seen, which I think came from National Grid about three or four years ago, was something like £250 million; something of that order. It did sound-

Dr Whitehead: That is a one-off investment in-

David Odling: One-off investment, and then you have a bit of running cost, of course.

Dr Whitehead: Right.

David Odling: But amortised over 40 years. At the time, £250 million struck everybody else as an extremely large sum, but even if it were £250 million amortised over 30 to 40 years, with the volume of gas that you are talking about, you would hardly even notice.

Dr Whitehead: It is certainly a lot cheaper than changing every boiler in the country.

David Odling: It is hugely cheaper.

Nick Wye: I think I saw a figure at 0.1 pence per therm to an average household bill, something like that.

Q308 Dr Whitehead: Right. But presumably this is something that cannot really be put off, or should not be put off, i.e. we do it?

Nick Wye: Yes, you don’t want to wait until it is too late, certainly, so I think there is a push that something needs to be done in the near future.

David Odling: It would be very unfortunate-to go back to the question over here-if on one of those extremely cold days in December, Fluxys had suddenly said, "Terribly sorry, chaps, got to stop", and so suddenly 30 or 40 cubic metres a day did not turn up.

Chair: Thank you very much for your time this morning. We covered some useful ground.

Examination of Witnesses

Witnesses: David Loughman, VP Commercial, Europe, Shell, John MacArthur, Vice President CO2 Policy, Shell, Peter Mather, Regional Vice President, Europe and Head of Country, UK, BP, and Steve Jenkins, CEO of Nautical Petroleum and Chairman of the Oil and Gas Independents Association, gave evidence.

Q309 Chair: Good morning and welcome to the Committee. I think most of you heard most of the previous session, the first three witnesses.

The UK became a net importer of gas in 2004; oil in 2005. It does not seem to have caused any security problems so far. Is there anything inherently more secure about oil and gas produced here, compared with imports?

Peter Mather: Shall I take that first? I would agree with a lot of the points made in the previous session. I think the issue here is about diversity of supplies rather than energy independence. It is important that, clearly, the indigenous supplies of the UK are fed and watered, encouraged and prolonged as much as possible, but we clearly have to look at storage, we have to look at interconnectivity with Europe, and we have to look generally at the conditions that make an efficient market. There are lots of issues around energy security. You can’t defy gravity, as far as the North Sea is concerned, but clearly there are things that we are all trying to do to prolong its life.

Q310 Chair: We have been told that the recoverable reserves, oil and gas, on the UK continental shelf may be 24 billion barrels of oil equivalent. How much is it going to cost to get that out?

Peter Mather: That will depend on a number of different things; obviously, the technology breakthroughs, and I think all of us here are deeply involved in trying to push the frontiers on technology. It will depend on the fiscal rates, but obviously on the availability of the rocks as well. We are personally, as BP, committed to investing around £10 billion over the next five years in the North Sea. That is just one company. I am sure Shell and others will be looking at similar investment profiles. We are committed to doing our bit but, as I say, some things are out of our hands in terms of the geology, fiscal rates and clearly the availability of the technology required to get to the more difficult areas.

David Loughman: This technology point is very critical. I think in our industry we have constantly underestimated the technologies that can be developed over time. I would make another point, which is that in that 24 billion there will be some larger discoveries, but a lot of it will be made up of the typical portfolio of smaller fields that is the natural outcome of a typical geological basin, and the issue of infrastructure availability becomes just as important as the capital cost. Having the infrastructure available-we spent a great deal of money in maintaining that infrastructure, and will continue to do so-for those small fields to be pulled through into the supply chain is a very critical issue, not just for the UK but for many of the mature basin areas in the North Sea.

Q311 Chair: We were also told that changes in the supplementary charge on oil and gas, announced in the Budget this year, could cut investment in the UK continental shelf. Have any of your companies actually cancelled any projects as a result of that announcement?

David Loughman: We are evaluating the portfolio at the moment and looking at it in the context of the change. I think that the challenge will be particularly for the fields that I was just talking about; the smaller accumulations, the more difficult geological accumulations where I think, the point David Odling was making earlier, that with special incentives being negated, the challenges for some of those fields are now quite significant. The other issue, as of course has already been mentioned, is the relative impact on gas, which is for the moment not attracting the same price as oil, and the impact on gas development, particularly small gas developments, will remain to be seen.

Peter Mather: I am not going to sit here and tell you that we welcome a tax increase, obviously. It is actually the case that none of the immediate projects that we have coming off the blocks now will be stopped as result of the tax increase. Clearly we need to look very hard at the viability of some others. I completely agree with what my colleague from Shell said. I think there is another issue that we need to be very careful about: if the oil price comes back down again, we need to ensure that the Government sticks to its pledge to reconsider the additional taxation, because while prices are a little bit higher than they have been, clearly they could well come down, and I think this level of taxation at significantly low oil prices would be very bad for the North Sea.

Q312 Chair: Since the justification for the tax increase as far as I can remember was to protect petrol consumers, presumably if the oil price came down, it would not be difficult to persuade the Government to relax the regime.

Steve Jenkins: I hope it wouldn’t. But there have been projects that have been delayed, especially the smaller projects and the more difficult oil, HPHT, which benefited from the field alliances, and those have been put under closer scrutiny. It is very difficult to turn off a project that is in long-term planning. Cycles are, from expiration to development, something like eight years, so if decisions have been made to go ahead with a project, you cannot pull it easily. What is going to happen in the next couple of years is really critical, so there may not be any immediate effects, but in the next couple of years, one will see that projects that were scheduled to be developed will not go ahead.

Q313 Sir Robert Smith: Isn’t one of the concerns that by definition there have been less attractive returns on the investment, and the worry is that some of the more mature, larger hubs will start to become uneconomic sooner than they should have, or that there is not enough incentive to do infill investment to keep those hubs productive, and without those hubs, all these other small fields will be lost for ever?

Steve Jenkins: That is correct. I think post the tax change there are 20 fields, maybe, of which their decommissioning has been hastened by between one and five years. You are right, Sir Robert. Once the infrastructure is gone, it is gone. There will be no facilities that we can add the smaller fields on to, which are going to be the future of the North Sea and that would go towards the 24 billion barrels. That would be cutting back everything, because the infrastructure was just not there and these fields were not economic on their own.

David Loughman: I think the point was made earlier that given the complexity of this and the predictability, it is so important to have a dialogue about fiscal change, and I think one understands that when all the prices are moving upwards the Government will of course want to look at that. It really is a situation-the sort of complexities that my colleagues have described-to have a dialogue and discuss what can be done, because the immediacy is a challenge to all of these issues.

Q314 Sir Robert Smith: So it is very important that these discussions that are going on now about how the trigger will be changed on the way down and what other incentives in field allowances could mitigate the worst impacts of the tax increase are a constructive dialogue.

Peter Mather: They are very important indeed.

Q315 Sir Robert Smith: And that is about jobs and future tax revenue and future balance of payments, even if it may not be so much about security.

David Loughman: I think there is a component that links to security of supply. You mentioned the relationship with Norway earlier; we mentioned the relationship with the Netherlands, and of course the Netherlands has, in the Groningen field, Europe’s biggest gas field, what is essentially a large storage facility that is important to us. In that we are active in our own oil and gas industry, I think it does two things for us. One is that it shows that we are interested in oil and gas and that we are keen to work on developing the resources that we have. That sends certain signals to our key suppliers. And it also, in a general commercial relationship, gives us some bargaining power in terms of managing the various contacts with all of the suppliers that are going to contribute to our security of supply. I would agree that it does have an element of contribution to security of supply.

Q316 Dr Whitehead: As the oil production from the UKCS decreases, we know we will have to increase physical storage capacity, and we talked about that a bit earlier today-the question of derogation of energy and so on. One hundred per cent of oil stocks are held by industry for reserve stocks. Is that a similar profile to the situation elsewhere in Europe? How do other European countries deal with this in terms of who holds what stocks?

John MacArthur: In terms of specific corollaries with other European nations, I don’t have that information to hand. I would be happy to supply it, but going back to the earlier statements, I think the UKPIA position on the National Agency and much of the conversation we had earlier was something that, from a Shell perspective, we believe is certainly worth exploring.

I think there is another part to this that has not been discussed yet, which is that we were looking through the lens of a traditional liquid fuel supply and oil from a transportation perspective and so on, and of course we do have the emergence of biofuels, which will have an increasingly important part to play in the energy fuel mix globally, particularly in the UK, which has, I think, about 20% of its biofuels domestically sourced. But it does give you that diversity of energy and liquid fuels. There are some 20 different countries that supply us biofuels from around the world, so I think the refining discussions and the structural discussions are not only that oil gives you liquid fuel security but there is also an important part for biofuels as well.

Q317 Dr Whitehead: One of the things that has been suggested by Deloitte is that because of the way in which UK stocks are held by industry, it may be more convenient and cheaper for, they say, a higher proportion of stocks to be held abroad if companies find it cheaper, instead of building new storage in the UK. How would that contribute to the UK’s energy independence and energy security?

John MacArthur: The UK’s security of supply, as we heard earlier on fuels, is dependent on imports in some regards. That is the nature of equilibrium in free markets globally, which brings a great deal of security of supply but also security of demand with our partners as well. There is a surplus of refining capacity in the world, and as I said before, you could bring biofuels into the mix as well, which gives you more diversity in that supply. But having a domestic refining infrastructure or storage does not necessarily make it cheaper for you. As long as we have those security of supply and demand relationships, as we heard earlier-for example, gas in the Groningen field in the north of the Netherlands, where I used to work getting the gas in out of many millions of cubes a day-those technologies are variable and the interconnectedness of storage, as you say, is certainly something that we shouldn’t only see within the UK as being the core of the discussion about interconnectedness with our partners in Europe.

Peter Mather: I would support that. To answer your original question, I think the model for stocks in Europe varies a little bit, but it is fair to say that on the whole there is a bit more state involvement than in the UK. I think the proposal, which was well-aired earlier on so I won’t go back over it, for the agency-type arrangement for oil stocks in the UK is eminently sensible. It seems administratively more efficient and simpler, but I think the point here, certainly on oil, is that it is an incredibly fungible, liquid market, and while we need to look at the economics of increased oil storage in the UK, were the derogation to go away, it is not something that one should fear too much because it is so easy to transport liquid fuels around north-west Europe. There is a very well-established system of not only refineries but import terminals in the Thames and tanker capacity, and obviously refining capacity at the mouth of the Rhine and other places.

Q318 Dr Whitehead: But if I am abroad, meaning in another European country, and I have a pile of oil sitting within my national borders, I may count that as my reserve supply. Meanwhile, we have counted that as our reserve supply in the UK because it is held abroad. Wouldn’t that lead to double-counting?

Peter Mather: That wouldn’t be very sensible; no, I agree.

Q319 Dr Whitehead: I appreciate that it wouldn’t be very sensible, but isn’t that rather a basic problem with this suggestion that UK supplies might be kept "abroad"?

Peter Mather: I think, if it is double-counted, that is wrong. I completely agree with you on that, but one has to look at the hierarchy at national and EU level and obviously IEA level stocks and make sure we are not double-counting.

Q320 Dr Whitehead: What would happen if they decided they wanted it at the same time?

Peter Mather: I think that would have to be clearly delineated under IEA rules in terms of pecking orders, priorities, discharge rates and beneficiaries.

Q321 Dr Whitehead: It is not at the moment, though, is it?

Peter Mather: I would have to get back to you on the exact system, but I don’t believe there is a lot of double-counting.

Q322 Dr Whitehead: As far as resilience of supply within the UK is concerned, in the event of, say, further protests and demonstrations at fuel depots, we heard earlier that police had had a word with some people who might be protesting. That does not strike me necessarily as leading to full resilience. What is your view in terms of future resilience of UK supplies in the event of protests such as we saw previously?

Peter Mather: Having lived through and personally been very involved in a couple of these situations over the last few years, when the Secretary of State at the time called us in to account for the potential supply disruption at the forecourts, we are only too aware of the possibility, obviously, of industrial action. I think there are a number of things that are important here, and keeping a good relationship between you and your haulier is vital. Maintaining both as a company and at a national basis a good infrastructure in terms of refining and terminalling is important, and obviously the UK has a large number of onshore pipelines for oil products too, which are very helpful, plus, of course, making sure that the UK is well-connected-going back to my earlier point-to the other markets of north-west Europe. It comes back to the point about diversity; ingress points, storage on land and refining capacity.

Q323 Dr Whitehead: I was going to ask you briefly about pipelines as you mentioned them. Certainly, in my constituency, you cannot move for signs in various nice parts of the country, saying, "Here’s a pipeline". How resilient might that make the system, and does industry or anyone else have any intention of extending that pipeline network?

Peter Mather: Personally, I’m not aware that we are involved in any expansion projects because, as I said, the combination of pipeline capacity plus storage capacity, haulage capacity in terms of road tax, and refining capacity is deemed sufficient and has proved itself robust during a number of crises over recent years.

John MacArthur: From a Shell perspective, I think the point is that the UK oil industry has proven itself to be very resilient over many years. Of course there was Buncefield in 2005, which is a good example of probably the most significant loss of capacity in recent times. We had to reorganise and respond, and I think we did that. One example, describing what we did with the pipelines, is that we had to increase jet fuel supplies from the southern pipeline down to the airports. It wasn’t without impacts. There were some flights rescheduled at airports, but considering the disruption-we redistributed the truck fleets; increased it through other terminals-there is flexibility, adaptability and diversity of different sources. Equally, diversity of infrastructure and different ways to move fuels around it is critical. We are talking about the resilience of the system; we are also a retailer and we have just bought 254 new service stations, and we would not do that if we did not believe that we would have security of supply to our customers as well.

Q324 Sir Robert Smith: Does that mean you now make money in service stations?

John MacArthur: Of course, but how much is really always the question, isn’t it?

Q325 Barry Gardiner: Perhaps you could very briefly describe how the oil price is determined and then say what the role of each of your companies is in determining those prices.

David Loughman: Maybe I could say the role we play in determining the oil price in the short term is minimal. I think our company owns on a proprietary, equity basis something like 1% of the crude oil moving around in the world at any one point, and since it is a very deep, liquid and open market, you can see that we have relatively little influence on it in the short term. In the longer term, although our companies, by international standards compared with national oil companies, are relatively small, we still have a leadership in technology, and our ability to lead the way into new areas, deeper hydrocarbons, more complex hydrocarbon accumulations, is of course in the longer term a way of mitigating long-term price evolution by bringing in new supplies and accessing new areas. That might not be very helpful in the short term, but I think it is the honest truth. Like everyone else, I am wondering where the oil price is going to go tomorrow or the day after, as a commercial manager in Europe.

Q326 Barry Gardiner: The first half of my question to you was to explain to the Committee how the oil price is determined. I appreciate that you have said that you as a company have virtually no impact, certainly in the short term, on how it is determined, but can you tell us, therefore, how it is?

Peter Mather: To be perfectly frank, the oil price is set by supply and demand. I don’t want to be facetious, but it really is. Supply and demand have many influences. Demand is influenced obviously by economic activity, and part of the reason for the recent increase to the oil price has been the economic recovery that we have seen in the United States and to a certain extent in Europe. Of course, China has generally fuelled a more buoyant oil market for several years as a large purchaser, and clearly the emerging economies suffered less in the recession than the OECD did. On the demand side, you are really looking at economic activity.

On the supply side, it is clearly world events. Oil is fundamentally geopolitical, and world events, whether they are uprisings in the Middle East or other supply disruptions, clearly have an enormous effect. OPEC is talked about a lot. Clearly, there is a group of countries that meet, and it is fair to say that the specific influence of OPEC is probably less than it used to be.

In summary, I think supply and demand on the whole wins through, certainly in the long term. There are short-term-

Q327 Barry Gardiner: On the index of pre-tax fuel prices-this is taken from Quarterly Energy Prices put out by DECC-how would you explain the spike that occurred in 2008-09 in light of what you have said about demand, and given that this was the beginning of the recession? I would have thought that you needed to tell me something about the basic costs of production and then overlay the other market factors that you have been talking about, but so far I have not heard that from you. How would you explain that in light of what you said about the demands coming into the market and affecting price, given that this was a period when the world went into recession? Are you going to say that because the world goes into recession, suddenly the risk became greater and that is what pushed the price up? I do not understand that.

Peter Mather: I cannot remember the specific circumstances, but if I remember correctly, I think obviously we still had virtually all Iraqi production off the market, which is now coming back on to the market. Unfortunately, that has been offset somewhat by Libyan production coming off the market-

Barry Gardiner: Sorry, I didn’t catch the first thing that you said.

Peter Mather: One of the features of that period on the supply side is that we were effectively getting virtually no production from Iraq, which is potentially one of the biggest exporters of oil, so I think that was a factor for the price increase. If I remember rightly, the Chinese were continuing to buy heavily during that period. The recession had not hit them as hard as it hit the OECD markets of the US and Europe. I think there were supply disruptions and I think there was still an awful lot of demand from Asia, if I remember rightly. I would have to look back at the exact circumstances.

Q328 Barry Gardiner: I would be grateful if you would, and actually supply the Committee of your analysis of just why it was that there was such a peak during that period, and then if you could justify that analysis against the statement that you made to the Committee about supply and demand.

Peter Mather: I am pleased to do that.

Q329 Barry Gardiner: The Government said in its response to this inquiry that exposure to volatile prices is the greatest risk to energy security. If that is the case, what more can be done to mitigate that risk? From what you have said, remarkably little.

Peter Mather: If we are talking about oil, with oil and gas there are similar issues.

Q330 Barry Gardiner: They say oil. You say oil and gas have similar issues?

Peter Mather: Let’s talk about oil.

David Loughman: Maybe I can talk about gas.

Q331 Barry Gardiner: Shell’s submission to the Committee made it very clear that they believed there was quite a distinction between oil and gas volatility, but you say they are similar.

Peter Mather: Yes. There are similar underlying factors, coming back to supply and demand, but I will leave my colleague to talk about gas, which has generally, as was said earlier, been very robust despite the coldest winter for a long time-200 years or something-last winter. On the oil side, last year actually saw a drop in volatility of oil prices. It has obviously come back up a little bit recently, but you have to look at the long term in terms of volatility, and if you look at oil price volatility in the long term, it has been relatively lower than many other commodities and has been something that people have been able to invest around. Of course, in terms of the consumer, one has to remember that the majority of the price at the pump is actually taken by the Government in the form of tax revenues.

Q332 Barry Gardiner: Let me just come back to the point of the question, which was what more can be done to mitigate the risk? I was suggesting in light of your earlier remarks that it might be remarkably little. Is it remarkably little, or are there real steps that Government can take to mitigate the risk of oil price volatility?

Peter Mather: In terms of Government, I think that what Government can do is be supportive of the industry, whether it is indigenous industry or companies investing overseas, to ensure that we all bring as many supplies on to the market as we possibly can, not only in the case of the companies here ensuring that we can continue to make the North Sea a fertile and productive area from an oil point of view, but also, as the Government does, support us in our endeavours in other countries around the world, because the key thing is bringing more supplies on to the market. That is what is-

Q333 Barry Gardiner: Mr Mather, forgive me if it was Mr Loughman who said this at the beginning, but one of you, I think, said that your proportion of the oil-

David Loughman: -that we own as an equity company.

Barry Gardiner: Did you say that the proportion was minuscule?

David Loughman: Yes, indeed, as a percentage of the total crude oil that is owned in the world.

Q334 Barry Gardiner: How is helping you to bring as much of that minuscule amount on to the market as possible really going to affect the stability of oil prices and therefore mitigate, given that you said effectively, "This is supply and demand; we are takers of a price"? How is it actually going to help us to stabilise the situation and provide that security?

Peter Mather: Because I think the marginal price for any commodity often sets the price, so even though between the oil majors I don’t know what the percentage is-maybe it is 5% of world supply-that can be the marginal price setter, particularly given that in the case of the companies here, I think a lot of our investments are actually outside the OPEC area, so therefore they provide healthy competition, if that is the right word, to OPEC suppliers, but it is around marginal economics. I think there is one more thing that Governments can do-

Q335 Barry Gardiner: I am happy to come back to that, but at the beginning, the impression was that there was nothing you could do that determined the price, but now you are saying that your supply on to the market can actually be the determining factor.

David Loughman: Because it is the marginal barrel. It is the point I made about longer term, technological evolution.

Barry Gardiner: But you will admit there is a tension here between the answer to my original question, which was, "It is supply and demand; this is the market. We have a minuscule amount, and actually we don’t influence it", and the view that is now coming out that says, "Actually, we can be the price-setting determinant"?

Peter Mather: If you removed the activities that companies like us are involved with in places like the North Sea or the Gulf of Mexico or Angola or wherever, you would see a significant rise in the price of oil. The point is, structurally, we are price takers. Structurally, the longer term economics of oil and gas is supply and demand, but we are part of the supply equation. We are not-

Q336 Barry Gardiner: What you are saying, in effect, is that you have a determining effect in reducing what would otherwise be a much higher price of oil. Is that correct?

Peter Mather: I think it is quite hard, with respect, to put it that simply, because there are so many other factors involved, but yes, I think other supplies of which we are all part, and certainly non-OPEC supplies, are an important part of the oil equation, yes.

Q337 Barry Gardiner: I now feel much better informed but none the wiser, I have to say. I will move on. The UK price rises in 2005-06 came, we understand, from a lack of import and storage infrastructure. The UK now has a greater level of import capacity. Do you think that that has reduced the risk of a similar price spike happening in the future?

David Loughman: Are you talking about gas now?

Barry Gardiner: Did I say oil? Yes, gas.

David Loughman: You didn’t, sorry. I think if one reflects on the import capacity of the UK, which I believe is between 125% and 130% of the total demand in the UK at the moment, it is clearly a major step forward in determining security of supply. To go back to your earlier question about what we can do in terms of developing gas security of supply on that basis, which in turn tends to modulate price both in the short term and long term, I think it is very much about making efforts to diversify that supply base out there in the world. I think a key thing to understand about the global resource base of gas is that it is growing. We have this mental model that we are running out of hydrocarbons, but in fact the IEA statistics show that on a global basis we have added to reserves, when you look at production globally, every year since we recorded this in the early 1970s.

Q338 Barry Gardiner: Is that conventional gas?

David Loughman: Yes. It includes unconventional resources coming in as well. I am talking about total resources.

Q339 Barry Gardiner: Does that same claim apply if you limit it to conventional gas?

David Loughman: Yes, it does. What we are seeing is a resource base of gas that is also diversifying in terms of the countries that own the gas. We have seen, of course, the significant development of Qatar that was mentioned earlier. I think the UK is importing today from ten countries, and I think, for us, to develop the relationships that were described earlier with a wider range of gas suppliers and see what can be done to encourage them to bring gas to the market is in our interests long term. That is something we can do to increase the availability and diversity of gas supply. Of course, as you say, regarding the introduction of unconventional so-called gas-gas in tight reservoirs, coal-bed methane and so on-is probably, in terms of ultimate, recoverable reserves, the estimates are something of the same order as conventional gas, taking us up towards very large numbers; 800 trillion cubic metres. If all of that was to be recovered, it would mean some 250 years of supply at current global demand levels, which is, I think, impressive. From the suppliers’ point of view, the whole debate around security of demand becomes very important. At what point do we get an opportunity to bring our gas to the market? And there is competition from the suppliers’ side. I think it is in our interests to work and build a dialogue with those suppliers, exactly as I think we have done with Norway and some others. I think the dialogue with Russia would be very important as well, and other former Soviet Union countries.

John MacArthur: The diversity and source of gas is one element. The other one is the type of product you get from gas. This is where we do have a role to play in bringing technology into the market. David mentioned Qatar. This year we started our gas-to-liquid plant, which will be fully up and running in 2012, and that provides enough gas oil, which can power buses and taxis, and has been done in London, which would fill over some 160,000 cars. If you look at those different products and technology as well, it helps you in all these diversity of supply situations.

Q340 Barry Gardiner: You talked about the growth of hydrocarbons futures. In the peak oil debate, therefore, do you believe that we are before the peak? How do you think peak oil relates to the higher prices that we have experienced over the last few years.

David Loughman: That is a very complex question. Being a geologist, I get the peak oil question very often. To be honest, I don’t know, and what I often talk about are unknown unknowns, which I accept is an easy way out, but there are new basins, oil discoveries, being made in, for example, the deep subsalt play in Brazil. One of the two basins that have fully been explored in Brazil-there are several others that have yet to be-has the possibility of transforming our view of the crude oil output from that country. Being a geologist, I tend to be optimistic that we can do that again in other places and we can access, as we are doing already, unconventional resources that are very large, in the form of oil sands, for example. It is an evasive answer, I agree, but I am not sure about peak oil. I would not like to say when it is.

Q341 Barry Gardiner: Relating that part of my question to the other part of it, given the indeterminacy, you would say that considerations of peak oil should not be playing into price?

David Loughman: Of course, the price will also depend on people’s perceptions. They may not have the same perception as I do, so they may take their position in the market accordingly.

Peter Mather: In the history of the oil price, this is not a desperately high oil price in real terms, so it is not as if we are in a panic situation about future oil supply. David is right; it has always been a discussion between the economists and the geologists. In some ways at the moment there is a bit of agreement between the two of them, because there are unconventional supplies now being made available by the geologists that the economists feel can be developed at existing prices. When I joined this industry, the North Sea was going to have run out by now, so I am a firm believer that the hydrocarbons are there. It is just a question of technological breakthrough and choices about where we go in the world to explore.

David Loughman: Globally, I think we are very far, given the resource base I described, from peak gas. It will be very important for China to make decarbonisation efforts, as we all know, and a lot of that will be around the issues we were describing earlier in terms of gas back out of coal. That is an area where we are working with the Chinese, for example, and other companies to find ways of enabling that to happen, given that China’s gas resources are largely unconventional.

Q342 Barry Gardiner: Mr MacArthur, as the CO2 man in Shell, if, as Mr Mather and Mr Loughman believe, those hydrocarbons are there, should we be getting them out of the ground and burning them up?

John MacArthur: Thank you for the question. I think the two issues that were described earlier are economics and technology. In a world that needs more energy but less CO2, those become even more important considerations. You have to create the right carbon price signal to make sure that you can encourage something like CCS, and on the technology-carbon capture and storage or offshore wind-that needs that carbon price signal, at least to bring it to maturity. There shouldn’t be an ongoing thing, but we need to accelerate those things to try to hit the kinds of targets that we’re attempting to achieve and set the pace globally in the UK.

Q343 Sir Robert Smith: Moving on from that, setting the pace, should you be building more gas-fired power stations?

John MacArthur: If you have that carbon price signal, you will find that all power emitters who are involved in the EU Emissions Trading Scheme, which is an exemplar for the world-there are 11,000 emitters involved-as the cap comes down will have to invest in carbon capture and storage. I believe that wise companies who are building these gas-fired power stations are thinking of the outcomes of that carbon price signal. That is why it is really important that we make sure there is robust pricing that people know is going to be here in future so they will invest in third party tie-ins in their facilities when they are making the decisions now, so they can retrofit easily when they need to, or, when we build later on in the future, there is a clear case for doing so.

David Loughman: I think the CO2 emissions piece is about targets and setting milestones in the future, but it is also recognising that it is very short-term gain, and the shape of the overall CO2 emissions envelope-the value in terms of climate change effects in getting the CO2 that would otherwise be up there out early-is very important in terms of the total challenge, so therefore, "What can I do tomorrow?" is very much about getting CCGT capacity in place. As we discussed earlier, the advantages of that in terms of old coal are, I think, well known and understood.

Q344 Sir Robert Smith: Do you accept the Climate Change Committee’s view that unless the gas was abated by 2020, we would then not meet our rather strict targets on emissions?

John MacArthur: That is a bit of a simultaneous equation. I don’t have numbers in my head of specifically what would happen. I am quite positive. I believe that with gas we have that transition. The dash for gas has been mentioned before. I think we do have a dash for gas. It is important to dash for us to meet the objectives we have set out, but it is not only for the power sector to reduce those emissions. It is also in road transport and biofuels, which, I repeat, are an absolutely crucial part of reaching those 2020 targets, as well as energy efficiency as well. The behavioural side is a challenge for everyone. I have a hybrid car. Public transport; there is a long way to go there, but I think we are on the right track.

Q345 Sir Robert Smith: You said the emissions trading scheme was am exemplar. It may be in terms of its structure and scope, but in terms of its pricing, is it not failing to send strong enough signals?

John MacArthur: That is another question I welcome. In terms of the price signal, we have had quite unusual circumstances over the last few years, and all markets have been impacted to some extent by the change in the growth patterns in the OECD and so on. What we recommend is that in the next phase of ETS, there is a balanced reduction of available credits, so you have set aside some credits, which will give some more stability to that price. We also believe that post-2020, in the next phase, we should have an option reserve price as well, because although we have seen some of the reductions that have been achieved because of the financial situation in the last few years, there has been a reduction in emissions as well. Connie Hedegaard talked about, between 2008 and 2010, an 8% reduction, but it was still a learning period, and we did not expect, I would suspect, that degree of change in a relatively short period, but setting aside is something we should move quickly on. The EU should take positive action there to make sure we retain that really important carbon price signal.

David Loughman: If we go back to CCS, I think one can see it as an essential technology from a global perspective, particularly going back to China and the current build-up of coal-fired power generation, which will need to be retrofitted to have a material effect on global CO2 emissions. It is very important, given that the CCS will be retrofitted as some point beyond 2020, to have the pilot projects that are going on at the moment, so I think, from our perspective-the Longannet project in Scotland, the work that is going on in Norway at the technology centre in Mongstad-to indeed find out in detail and research some of the challenges that we face with CCS is very critical, but I have no doubt that in the long-term solution to 2050, CCS, as the Intergovernmental Panel on Climate Change have said, will be critical to the 2050 carbon future.

Q346 Sir Robert Smith: But it is important that we also have it for gas as well as coal.

David Loughman: Correct, yes. I think what you have to do is look at two things. Firstly, what is the cost per megawatt hour of electricity in terms of your CO2 capture? If you look at that for gas and coal, although you get less CO2 of course, the actual cost of capture per tonne of CO2 relative to coal is relatively similar, and that is what you are interested in. The key thing is that you have less CO2 per megawatt hour, and therefore you need less storage space, less compression, less of everything down the value chain for gas.

Q347 Sir Robert Smith: Do you see it being commercially viable by 2020?

Peter Mather: Perhaps I could just jump in. You have two companies here that have probably led the way on CCS. It is very difficult. We are all in various projects at the top of the learning curve, trying to get down it as fast as we can. If you want my personal view, I think 2020 is a bit premature. I think we are going to be looking at more like 2025 or 2030 before we have scale for CCS and real economic viability.

Can I also put a little bit of a plug in for the ETS? I think it is very easy to dismiss it. It is very early days for this market. Again, it is to a certain extent driven by fundamentals, and economic activity in Europe has been low. It would be interesting to see how it responds to a pick-up in economic activity, but one of the reasons why the price has been low is economic activity. Clearly, as we go through each of the phases and we tighten it a little bit each time, I think it is going to become a much more credible and robust price signal. For example, at BP, we don’t use the current ETS price in our projects. We use $40 per tonne for all our investments for carbon, so everything has to be robust, factoring that in. We are anticipating higher levels further down the road.

Q348 Barry Gardiner: I would just say that we were told, after the first stage of ETS, "We know we have got it wrong but we have quite deliberately had to start the market off," and now we are at the second phase where we are told, "But now we are going to get it right." Now you are telling us, "Well, maybe some time in the future it will be got right."

Peter Mather: Your point is well made, but I repeat that we are not factoring in the current price on our projects.

Barry Gardiner: No, I take that point.

Peter Mather: We are looking ahead to a tighter regime, which I think is important.

Q349 Barry Gardiner: Yes. I want to move briefly to the transport sector. Do you think it is fair to say that because of the lack of diversity of fuels in the transport sector, it is less resilient and more prone to supply disruption and price increases than other parts of the energy system?

Peter Mather: We talked earlier, didn’t we, about what I believe to be the robustness of the liquid transport fuels infrastructure in the UK. We talked about it in the context of industrial action. I would also echo what John said about biofuels. Again, you are looking at two companies here who are at the forefront of investment in biofuels. We have invested an awful lot over the last few years in-

Q350 Barry Gardiner: How quickly do you think that will happen, that there will be a wholesale transfer from petrol and diesel through to biofuels and electric vehicles?

Peter Mather: Our prediction or extrapolation, if you like, from today on biofuels-obviously there are various targets for the immediate future; 2020, which is basically the 10% coming out of the Fuels Quality Directive and the Renewable Energy Directive-is that we see, possibly in the UK, 30% being achievable by 2025-30, and on a global basis, biofuels are the fastest-growing of the transport fuels.

Q351 Barry Gardiner: I would be interested to know whether Mr MacArthur feels that that is justifiable in terms of the World Bank’s report on emissions levels for biofuels when you consider the opportunity costs of land use.

John MacArthur: The first point I would like to make to address that question is that this is an area where we are putting in a lot of effort together with Governments. The UK Government particularly has been strong in supporting transparency. You can go on the Department for Transport website and see the sources of all the different biofuels, and it is not one size; there are many different types. There is good and there is less good. Sugar cane ethanol, for example, is some 70% less emission-intensive, so I think it is really important that we get that.

Barry Gardiner: Not if you consider the alternative land use.

John MacArthur: That is where we are working together with Governments and other organisations. It is really important that we get these parts of the argument clear.

Q352 Barry Gardiner: What do you believe the role of Government should be in facilitating the transition here to alternative transportation fuels? Let me phrase that more provocatively: is the Government doing enough to switch people over to electric cars?

John MacArthur: In terms of being able to switch people over to full electric cars rather than hybrid, I think it is something that will take quite some time. If you have 900 million cars in the world, 50 million per year-

Barry Gardiner: No, I was talking about the UK.

John MacArthur: Within the UK stock it would also take considerable time to completely change over your car stock. That is why biofuels are so essential. Even then, I think there will be a mosaic, a variety, of different kinds of vehicles and different kinds of fuel, so whether it is biofuels and hybrids, whether it is liquefied natural gas and shipping, whether it is bio jet fuels, it is not as simple as just swapping over to electric cars. I think there is also the well-to-wire or well-to-wheels-the full value chain; you may switch over to an electric car, but then where does your electricity come from? Is it coming from a coal-fired plant? Is it coming from a gas-fired plant? These things all work together.

Q353 Barry Gardiner: Indeed they do, but you will have seen the figures that say that even if the electricity does come from non-renewable energy, it is still going to be less pollutant than a petrol engine. Would you not agree that moving to electric vehicles is actually one of the best ways to decarbonise the transport sector?

John MacArthur: We think electric vehicles have a very important role to play if we look at the broad picture. In that interim period, we think that biofuels are an absolutely vital transition.

Barry Gardiner: I would never have guessed.

Peter Mather: There is a sequencing here, and you do have to look at the impact that can be made from energy efficiency, hybrids and biofuels. I think that is bringing down the emissions curve quite substantially. If you then plug into a dirty or still relatively carbon-rich grid, you really lose all those benefits, so I think it is a sequencing thing. There is an awful lot that can be done with the internal combustion engine before you then look at a future for electric vehicles further down the road, so I think I would agree with the point.

Chair: Time presses a bit, and I have not taken part in that exchange because I have a declared interest in a second generation biofuels company.

Q354 Laura Sandys: My concern is that we would compromise food security for energy security, and that doesn’t really help us very much. I would like to move to the international perspective. Obviously Shell and BP operate on an international level. What do you consider the biggest threats and challenges to energy security in the international political spectrum, and what risk impact of the price on both oil and gas would you place in relation to what I would call political security? Very briefly.

Peter Mather: That is a massive question. I will help my colleagues out by going first. I think, as I said before, oil and gas are fundamentally geopolitical. I noted you raised the issue of Nabucco earlier. Maybe we can use that as a very short case study, because we are very involved in that whole discussion of a southern corridor. What you have there is the potential of gas imports into Europe through a southern corridor from Turkmenistan, Azerbaijan, Kurdistan and potentially, further down the road, from Jordan and Syria and other places like that, so you have a logic of demand in Europe and supply, not much of it yet available, but certainly not far off.

What is holding that up at the moment is politics and economics, frankly, so clearly a lot of the countries in that area need to sort out agreements between themselves so that they are prepared to trade and have flows of hydrocarbons between their countries, and we welcome the progress made between Turkey and Azerbaijan recently, for example. It is also economics. I am sure, as citizens, we would all love to have a massive, great big pipeline bringing all these supplies right to our front door; maybe not quite to our front door, but into Western Europe. Of course, the issue is who pays for that? It cannot be purely on the shoulders of producers like us to foot the bill for an oversized pipeline. Equally, there is option value in having an oversized pipeline. The industry and Government and the various infrastructure owners need to come to some sort of arrangement in these situations so that energy security is ultimately delivered, which is the goal.

David Loughman: Yes. If I talk about gas in general, again it goes back to the point about the distribution of reserves, which I think every region in the world, in the recent IEA report, shows to have similar levels of available gas resources. We expect the growth in the number of LNG-exporting nations to double over the next five to ten years, and that is something that we should be encouraging, because that is the fundamental mitigant to supply stoppage of challenging in any given area.

Q355 Laura Sandys: Yes, but you are giving me a narrative of how the international market works and needs to work. What do you see as the long-term risks, whether that is political instability, protectionism or the politicisation of energy? Having worked in the Caucasus, I have seen certain elements of that. This is not a clear, free market as we would like to look at it from turning on the heater back here in the UK. How do you cost that?

David Loughman: Something I am very conscious of because I work with it a lot in Europe, which I think could be an issue, is what we clumsily call above-ground non-technical risk, but it is basically the acceptability of having oil and gas facilities, particularly if they are designed for export, that are acceptable to growing local communities and other stakeholders who sit around that gas facility-it might equally apply to oil-who do not directly benefit from it. As you broaden the number of suppliers and go into different places, that challenge becomes ever greater. In our projects, that is just as important as managing the commercial impact on the economics of the project.

If I take the example of Norway, Norway has been going through a political discussion in the last few years as to what its role as a gas and oil exporter should be, given that a lot of its CO2 emissions come from that sector, and I am pleased to say that on Friday, the Oil Minister of Norway, having listened to many advocates from the UK, among others of their customer nations, took the view in their White Paper published on Friday that the oil and gas export industry in Norway should be an important contribution to global security of energy supply going forward.

Q356 Laura Sandys: Yes. I wouldn’t say that Norway would put a political risk premium on their role or their contribution, but when we start to look at the opportunities and the needs, when you start to look at development exploration in the Arctic-you also experience it in Nigeria; BP is in Venezuela-there are a lot of differences. You are working in difficult areas; terrorism, pipeline exposure to terrorism, all of these issues. What we are trying to get to is where you see the biggest risks, and what sort of impact is there on UK energy costs? What premium do you put on political insecurity?

Peter Mather: I think it is very hard to put a number on it. If you look at energy supplies over their history, they have been remarkably robust. Think how many political perturbations we have had in the Middle East and elsewhere. We had a Cold War and Russia remained a very reliable supplier. Ultimately, you need matched needs between suppliers and consumers, therefore contracts need to be good. Relationships have to be good. I think the role of Governments in facilitating commercial agreements between willing parties in the energy industry is massively important, whether it is-

Q357 Laura Sandys: The legal framework is absolutely critical, sure.

Peter Mather: Whether it is the legal framework, political support-

Laura Sandys: And the transparency of that legal framework.

Peter Mather: Yes. Contractually sound arrangements between willing buyers and sellers. All of these things are important. It comes back to a point, I think, that has been a theme here, which is diversity. It is terribly important that we are all talking to a number of different energy suppliers, and indeed consumers, so that the world can ride out the inevitable discontinuities that there will be. Libya is a case in point at the moment, but actually, in the overall scheme of things, the world, as far as oil supply is concerned, is riding out that particular crisis reasonably well.

David Loughman: If we look at the Arctic-I was in the Arctic two weeks ago on the Russian-Norwegian border-I think the message there is that we can manage the technological aspects, but what will be very important is co-operation between the Arctic nations and others, particularly in setting the standards and setting up international response mechanisms, the response to technical issues or spills, so that we have that in place and it is organised at an Arctic level. You saw that in the conversations between the Norwegians and Russians.

Q358 Laura Sandys: You would not invest in the Arctic unless there was a clarity of legal framework, and contractual and, in many ways, territorial clarity?

David Loughman: Yes. For example, the Russian-Norwegian border area has recently been resolved by Medvedev and the Norwegian Government, and that has opened up a vast new area for exploration. That is, on the Norwegian side, about the size of Central Europe. On Friday, the Norwegian Minister said we will move fast to open up this area for exploration but in very close co-operation with our Russian colleagues over the border. I think that is a good example of what you are describing.

Peter Mather: There is a lot to learn and a lot of care has to be taken before these areas can be opened up. In many ways, the world will need to make some of those choices with us, but our job is to make sure that where we do go, we do it in the safest and most responsible way.

David Loughman: In fact, the first steps in the process that I have just described are the environmental and other impact assessments, and in fact Norway already has a policy of no emissions in Arctic waters at all, so that has been in dialogue with the other Arctic nations.

Chair: Thank you very much. This has been a very helpful and interesting session. There may be one or two points we want to follow up in writing as well. We will be in touch about that. Thank you.

Prepared 1st August 2011