Select Committee on Trade and Industry Minutes of Evidence

Examination of Witnesses (Questions 660-679)


Mr Hoyle

  660. In your submission you state that nine gigawatts of nuclear generating plant is expected to close within 15 years. This is about 12.5 per cent of the installed generating capacity of this country. Do you have a view on how this might be replaced and whether you can take up that lack of supply in the market?
  (Mr Wybrew) We are going to need all possible sources of energy supply, gas, coal in so far as coal can be used within the constraints of environmental standards, renewable energy and greater efficiency, which in a sense is a form of contribution. Indeed we ourselves would be supportive of a serious look at nuclear itself because we are very conscious of the finite limitations of gas reserves. That is not to say that western Europe is not extremely well served with access to well over half the world's gas reserves in more distant locations around it, in Siberia, Caspian area, Middle East, North Africa, Nigeria. Nonetheless one looks for a diversity of sources. An important point when we talk about the supply/demand projections is the great degree of variability of gas demand as between summer and winter. One of the important contributions made by gas market liberalisation is the greater flexibility which is created on the demand side, empowering consumers to have more control over the choices available to them and helping to meet the balance from the demand side as well as the supply side. Every possible club in the bag will be needed to face the problems ahead of us.

  661. To take up that point, that you feel there ought to be a fresh look at nuclear in the future, would it be something the company would be interested in getting into in order that you also have a future if gas were to run out?
  (Mr Wybrew) We see the likelihood, as all the projections suggest, of a growing requirement for gas to underpin this period of great change. We have our hands full looking after gas both here in Britain and increasingly playing a part in trying to shape Europe in a way which will serve the interests of British consumers.

  662. You do not want to see more than one egg in the basket.
  (Mr Wybrew) Not as far as we are concerned. In looking at the board and its investment options, gas will be our dominant interest.

Linda Perham

  663. In paragraph 11 of your submission you recommend adopting a precautionary approach to network investment which recognises the need to build an adequate level of capacity and resilience into the infrastructure networks, both to allow network flexibility to cater for supply shocks and to allow more effective facilitation of competition. You also recommend a minimum storage inventory obligation on gas suppliers. How do you see that being achieved? Would there be any particular level of storage which you would advocate?
  (Mr Bolt) You have heard already how Britain compares with Europe in terms of the proportion of gas storage as a proportion of annual throughput. The question was raised earlier about the comparison with France. Even though gas use is lower in France, France has three times the amount of storage that we have in terms of volume. In a world where Britain's gas needs were essentially met by UK production and the Transco system was essentially just transporting that to customers, storage was effectively provided in the offshore production fields. The more we rely on imports, the more we need to move towards a European model and look potentially at the sorts of percentages of storage which they have. At this stage we do not have a particular number in mind. What we are starting to do through the consultation process with the industry is to set out options for the amount of storage to show what that could do in terms of protecting against supply interruptions; if, for example, there were a problem with the interconnector and we could not import, how much storage we would need to cover one month or two months of the interconnector being out of action. Those are the sorts of options which we are working up. At the end of the day, it is a matter of policy for Government as to how much of an insurance policy the country is prepared to pay to guard against those sorts of problems. We can illustrate the costs, but it is not really for us to say what the base standard should be.

  664. So the Government would set this minimum level.
  (Mr Wybrew) The other important aspect is to bear in mind that 80 to 90 per cent of Europe's gas, including ours, is going to be coming across Europe within 20 years and therefore there is a need to be working progressively towards common European standards. The sort of circumstance we have to worry about is an event affecting supplies to the whole of Europe when the UK is not going to be able to ride on the backs of those who have large amounts of strategic storage, as we might be able to do at the moment. There is going to have to be some commonality of supply security standards if we are looking to a genuine pan-European model for gas supply and gas transportation and storage.

  665. Minimum standards across Europe?
  (Mr Wybrew) Yes; one feels so. How else would we cater for a situation where there has been a supply shock of some sort affecting supplies to Europe, and the European countries then have the task of sharing the pain? Unless there has been some discussion as to the provision of infrastructure and the way in which that is done, it would be a pretty chaotic situation. One feels there has to be a drive towards some common standards or common understanding, common principles for dealing with these big pan-European problems.

Sir Robert Smith

  666. You have already mentioned that we are beginning to get imports in the winter peaks. Does that mean the market is perilously close already to not delivering the UK's needs?
  (Mr Bolt) No, the assessment we have to carry out is for a peak winter day, to assess the amount of gas which will be delivered at the beach from UK production and to see what is available from storage and from imports. For this winter, we are assuming on a peak winter day, which is the standard to which we have to operate, the one in 20 peak winter, that there will be imports through the interconnector as part of meeting that balance. There is also storage. We are not assuming on the peak day that storage will be delivering at the full rate. There is some flexibility there. The other issue we have to look at is the severity of the winter in terms of duration, not just the peak day, but if we have a series of cold days. We are certainly anticipating a need over the next few years for more storage to be required to make sure that we can continue to meet the gas demands in a severe one in 50 winter with that balance of storage and imports.

  667. What is the reason for the tight situation at the moment? Is it suppliers selling elsewhere or traders looking for short-term profits or the infrastructure not being adequate?
  (Mr Bolt) It is important to understand the way in which Britain has developed its gas network from a situation where we were essentially self-sufficient in gas. We have always worked to very tight standards—a one in 20 peak winter—and we aim in terms of the onshore capacity of the network just to meet that; not to provide in advance of need, but just to meet that peak one in 20. One of the questions going forward, as we increasingly rely on imports, is whether that standard is good enough or whether we need to provide more capacity in the onshore network to provide the opportunity to switch from supplying through St Fergus to supplying through Bacton. That would mean a degree of over-provision in the network compared with that one in 20 standard, but it may be necessary to provide greater resilience, given the uncertainties we are now seeing and the greater reliance on imports.

  668. Are you upgrading Bacton so it can flow into the country more efficiently at the moment?
  (Mr Bolt) At the moment we are investing to make sure we can cope with the current maximum import capability at Bacton and that is less than the maximum export flow at the moment. One of the issues is when, with additional compression at Zeebrugge, that import capability will be increased, which we are assuming will be 2005 and 2006 to make sure the Transco network is able to cope with those high levels of imports when that happens.
  (Mr Wybrew) One of the factors which has made a real difference in the last year or two—and this phenomenon of dependence in the winter has emerged quite rapidly—one of the factors which is driving it, and this is a feature of the liberalised market, is that in the summer, when there is a low requirement for gas in the British market itself, producers have been continuing to produce at high levels in order to export into continental Europe, where for the most part it appears that quite a lot of the gas has been put into strategic storage. One of our concerns expressed in our memorandum is some of the vulnerability of a liberalised market sitting right alongside an administered market based on contracts and strategic administration by governments and the extent to which that is perhaps making us more vulnerable to some of these shocks and uncertainties. We are advocating that more understanding of that is required before we can consider how to mitigate its effects.
  (Mr Bolt) One element of the investment programme we are now undertaking, reflecting that change in patterns with summer exports, is to provide more capacity in the summer. That will of itself give more flexibility at the winter peak and the question is whether that is giving enough flexibility, whether more resilience is needed.

  669. Is the timing of the Zeebrugge compressor because you do not think you will need it sooner or is it that it takes that long to get it achieved?
  (Mr Bolt) There is an issue about planning that investment, getting planning permission in Belgium and the investors in the interconnector reaching agreement and putting it in place. The other point is that Transco is not involved in that process and that is a commercial decision for the shareholders in the interconnector.
  (Mr Wybrew) One of the tricky questions here is that you have 20 owners of the interconnector. As far as British consumers are concerned, we particularly want as an insurance policy to increase the import capacity, maybe for a few days in a year, because that is when it is required. If you are looking at it as an investor, three days a year of extra usage is hardly worthwhile, it may not justify your investment. There is a real interplay and trade-off between an insurance requirement for consumers as against the factors which determine investments in the marketplace.

  670. In a sense Ofgem are moving on but there has been a lot of criticism of the auctions at St Fergus for landing onto the beach. Did you share that concern that it was not sending the right signals offshore?
  (Mr Bolt) There are issues with the current auctions which are essentially short-term auctions for six months in advance. That is essentially allocating existing capacity and it is saying more about the state of the gas market and the concern of producers to secure energy capacity in the short term than necessarily anything about longer term investment needs. As part of the current discussions with Ofgem, we are looking at a framework for longer term auctions which will go ten, 15 years into the future. Those will do two things. Firstly, they will enable producers and shippers to give a much clearer signal about where they think production is going to be landed in the UK and provide information to us for our investment planning. The other side of it is that it will give them the opportunity to contract longer term for energy capacity, whether it is at St Fergus or Bacton or wherever, if that is something which will provide greater assurance to them to underpin offshore developments.


  671. On this question of the longer-term contracts, there are some people who are negotiating very long term contracts with the Norwegians, admittedly from your point of view it would not come through Bacton but there could doubtless be a case for additional landfalls of pipelines. Have you been giving any thought? One of your predecessor organisations in the past got themselves into difficulty when they had a whole plethora of take-or-pay contracts. Is there a cultural antagonism towards that within your organisation or are you giving this thought and if you are, what are you doing about it?
  (Mr Wybrew) We do not have a supply role. Our sole concern is transporting gas efficiently and offering the network for use by people like Centrica, our sister company, who would be a natural company to undertake a long-term contract with the Norwegians. BP was the particular case you referred to. Listening to BP and particularly StatOil, their prime producer, StatOil would see the British market as a prime outlet for their gas, indeed we should do everything in our power to attract them because it is an ideal medium-term source to supplement the needs of the British market. They themselves have been expressing concerns about the need to resolve the auction issue we have just been talking about, the uncertainties arising from the early use of market mechanisms until things settle down and they have greater clarity as to what it is going to cost them to get their gas into the British system and indeed through the British system. One of the issues for Government, regulator and all of us is creating circumstances which are conducive to long-term contracting with countries like Norway, a prime source within Europe.

Mrs Lawrence

  672. May we turn to fuel poverty? I notice in paragraph 16 of your evidence that you warn against the use of cross-subsidy to tackle fuel poverty. How would you address this problem?
  (Mr Wybrew) We have done a great deal of work in this field on a pilot basis and we are not suppliers but we have been pioneers in demonstrating that if you replace inefficient existing systems in households which are suffering fuel poverty with the latest and most efficient gas fired equipment, the savings of fuel alone through the greater efficiency are sufficient to underwrite a long-term lease. If you use your capital strength and your credit worthiness in capital markets to get leasing at the lowest possible rates, you can put together a leasing arrangement which is economic in its own right. One of the problems which has existed as we have tried to apply this in practice is that there is not a really effective end-to-end process as you might describe it in business, which starts with the various sources of contribution to the problem and links it up with the needs of consumers in the marketplace or the fuel poor in ways which are efficient. We have been leading a scheme in Stockton where an intermediary company has been formed to link up efficiently the aggregation of demand in the marketplace from the fuel poor with various sources of supply and tapping different sources of money available to tackle the problem. We are now sure that the real barrier to progress in this area is not lack of cross-subsidy so much as creating effective mechanisms or institutional arrangements which link up the different schemes now available from Government and business with the needs of the fuel poor.
  (Mr Bolt) There is also an issue raised by energywatch that an explicit cross-subsidy through final tariffs may have unintended and undesirable impacts on different customer groups. That does not rule out the possibility that you will have some sort of averaging of transportation charges across customers. One issue is whether there is a case for further investment in extending the gas network to locations which do not have gas supplies at the moment and if so, how that is achieved. One approach is that that is included as part of Transco's investment plan funded through general transportation charges rather than being charged to the individual households who would benefit.

Sir Robert Smith

  673. You are opposed to cross-subsidy in general but would you be opposed to that?
  (Mr Bolt) What we were saying in our evidence is that if you are going to have that sort of arrangement, you need to be clear that you are not undermining the supply end of the competitive market with the benefits that has produced, but there are ways which might be direct support for that sort of investment if you thought it was appropriate in terms both of environmental and fuel poverty objectives or you could look at some sort of arrangements for smearing the transportation charges in a way which did not undermine the benefits of the competitive market.

Richard Burden

  674. In your evidence you say that although increased competition can partly serve the country's requirements for the gas industry, there are still going to be dangers of environmental and social consequences of supply failures. The implication, if I have read it right, is that market mechanisms on their own do not sort that out. You also suggest the decoupling of the competition markets from regulatory and public policy frameworks. It just seemed there was a kind of contradiction there. Am I right? Is there a contradiction?
  (Mr Bolt) I do not think there is a contradiction there. In some respects it is building on the previous points. You want to maintain the benefits of competition at the supply end of the market where that is seen as working well or to address problems if there are problems. You also want to make sure that if you have identified requirements for investment or security of supply standards that those are provided in a way which gets the best solution from the competitive market if you can achieve that. What we are saying essentially is that you cannot rely on market mechanisms alone to determine those standards. One question is: if you ran a long-term auction for entry capacity to Transco's network, would that automatically tell you exactly how much to provide at particular locations or would it only provide a signal with a need to look beyond that at other measures of potential future requirements? Our position is very clearly that you cannot rely on market mechanisms alone, that that is likely to under-provide for the low probability events, which, as has been seen in California and we saw last year with the fuel crisis, can lead to significant economic and social impacts if you are under-providing. In a sense what we are saying is that the market mechanism will not necessarily tell you exactly how much to invest and there probably is a good case in terms of promoting the interests of consumers to provide a little bit of insurance in terms of extra capacity, extra flexibility in the network over and above what the market would otherwise indicate.

  675. In practical terms how do you decouple competition markets from regulation and public policy frameworks?
  (Mr Bolt) The basic way of doing it is to say that both for security of supply, for example through potential obligations on suppliers in respect of storage provision and on transporters in terms of the standards for providing capacity in the network, those sorts of standards need to be set through the regulatory framework as a matter of public policy. Having set those standards, you then want the market mechanisms to deliver them in the most efficient way. You would not say, if you have a security of supply standard for storage as a matter of Government policy, build another Rough facility, develop another salt cavern: you would say let us have a standard of service for security of supply and then leave it up to suppliers through the commercial environment to determine the most effective way of meeting that, which may be a combination of additional UK storage, it may be contracting with other European countries to provide additional peak supplies through the interconnector. There is also likely to be an element of demand-side management in this, that some large industrial consumers may be able to interrupt at peak times even though they currently have firm supplies. You want to be able to exploit those benefits of the market but to provide assurance that you have the underpinning of the security standard to protect domestic consumers in particular.


  676. Who would determine this underpinning, this compensation for potential market failure? Would it be the Government or would it be Transco as the owner of the pipes?
  (Mr Bolt) It is not Transco. We would be part of that market mechanism for delivering it in an efficient way. Ultimately it has to be for Government, whether the Department, whether Ofgem, whether an energy agency, as part of the discussions which are taking place as part of the energy review.
  (Mr Wybrew) This is not just a matter of public policy objectives in the UK. Inevitably when we are talking about gas looking ahead it is a matter of looking at convergence across Europe on some of these key points. It is for European governments working together to try to ensure that their collective requirements are catered for efficiently.
  (Mr Bolt) This is something which the European Commission is looking at in the development of a new gas directive.

  677. Really what you are saying is that we wait on the Commission, we come to an agreement with our neighbour, Gaz de France and we come to an accommodation.
  (Mr Wybrew) I was painting a longer-term picture. There are more immediate initiatives which might be considered and taken by the British Government. There will be certain steps which could be taken on a no-regrets basis. One could confidently anticipate the need for the next increment of storage and maybe a substantial facility and let the market determine precisely how best to do it. The picture I was painting was one of a 10 to 20-year horizon when one feels that Europe collectively is going to have to address these questions of security standards in a reasonably consistent harmonised way. Otherwise I do not see how one can sensibly manage some of the shocks to the system in ways which do not disadvantage consumers somewhere or the other.

Mr Lansley

  678. May I stay with the point which was being developed? Is it wholly true to say that market mechanisms are incapable of delivering protection against these kinds of supply failures? If one were to present a scenario in which there were very substantial penalties, in effect the social and environmental consequences which flowed from a supply failure were internalised to the supplies themselves, so there are punitive damages in that sense, but equally there were substantial rewards for making provision against those eventualities, then the market would be able to understand that and deal with it. The point I suppose you are making is that if you are capped on your return, if there are limits to what you can win by way of upside benefit, there will be limits to what you are willing to investigate in terms of downside costs.
  (Mr Wybrew) The sort of events we are talking about—and the typical standard Transco is required to work to is the worst winter in 20—is not generally speaking the sort of events which markets find it very easy to deal with, particularly in the state of development of the British market so far. Much has been achieved, but we have one very large player, Centrica, and a lot of smaller players anxious to grow and establish themselves in the marketplace and they are facing tight margins, fierce competition and there is a tendency always to cross fingers and hope for another mild winter. There is a real asymmetry of risk in a sense: on the one side if the market under-utilises capacity then the inefficiency is shared all round and nobody worries too much; but get it wrong and fail to provide for the one winter in 20 or whatever it happens to be and all hell breaks loose. One of the key differences with gas as against electricity is that once you have lost supplies to domestic and small consumers, the reinstatement is not a matter of turning on a switch but of going to every individual consumer and going through a difficult and careful process of reinstatement which is potentially hazardous and that can take weeks. We do have to be extremely careful to protect supplies to small consumers. The real asymmetry-of-risk question becomes particularly acute in the case of supplies of gas.

  679. In your memorandum to us and indeed in what Ofgem had to say to us, there seems to be some recognition that in the years up to now after privatisation RPI-X formulae have been effective in delivering cost reduction but not necessarily in stimulating precisely the investment required in the future. If it is generally agreed between yourselves and Ofgem that something is required in this direction, how far do you think Ofgem has to go in offering a regulatory structure, price control structure of the type you are describing here or future plans, raised output requirements, additional investment, for which you have to be fairly and consistently rewarded?
  (Mr Bolt) It goes back to the point I was making earlier. The existing regulatory requirement in Transco's licence is to have the capacity to meet the peak one-in-20 day. Having the assurance that we can meet a severe winter is part of the safety case rather than the licence. What we have added on to that is to say that it is very clear, given the changing way Transco's network is operated since the interconnector has been open, that we need to look at capacity in the summer, which has traditionally been a period where we carried out maintenance and investments as well as the winter. That is adding on a new measure of the required capability of the network. The question going forward is whether we have yet got a sufficiently rich description of the outputs which the network is providing and whether we need to add on not simply winter capacity and the ability to export in the summer, but measures of resilience and flexibility and how the regulatory framework deals with that to give us assurance. If we carry out investment, if, after our consultation with producers and shippers and consumers, we propose an additional investment, what we cannot tolerate is the possibility that at the next regulatory review in 2005 we find that investment being disallowed because Ofgem think at that stage it is not a worthwhile investment in terms of consumer requirements. What we need is a regulatory framework which is flexible, which develops with the changing way the network has to operate, which recognises those additional outputs and provides the assurance before we commit significant amounts to provide additional outputs, that that will be recognised by the regulatory framework. In a sense it is moving much more to an annual rolling review of the investment programme which is reflecting the increased uncertainty about whether demands and supplies are going to be met.

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