Select Committee on Trade and Industry Appendices to the Minutes of Evidence


Memorandum by Centrica plc


  1.  Centrica plc was created in February 1997 out of the demerger of British Gas plc. In the UK it trades under its brand names—the AA, British Gas (Scottish Gas), Goldfish and One.Tel. It supplies around 13.5 million residential customers with gas and has built up an electricity business of around five million customers since the market opened to competition. The company is also active in the industrial and commercial gas markets.

  2.  Centrica owns both electricity and gas upstream production assets to support its supply businesses. The balance of gas and electricity that the company requires to supply its customers is acquired through a mixture of short and long-term contracts or in the wholesale gas and electricity markets. Centrica is one of the leading energy traders in the UK and suppliers through the interconnector.

  3.  Centrica welcomes the Select Committee Inquiry as it is essential to have access to diverse, secure and competitive sources of electricity and gas to supply our customers. Our response covers views on the likely growth of gas generation, overall gas demand and supply, the need for imports and how security can be underpinned in such a regime. It also covers energy efficiency and fuel poverty. The key points we would like to emphasise in our response are:

    —  Full support for a liberalised energy regime in the UK. The policy has brought substantial benefits in terms of economic efficiency, the environment and security of supply. We would be concerned to see a movement away from a market-based policy,

    —  In terms of electricity generation, there is clearly no problem in diversity at present and there is not likely to be a significant problem in the foreseeable future. This is therefore not the right time for large scale intervention.

    —  Whilst the UK will become a gas importer, we believe the majority of supplies can be sourced from the UKCS until beyond 2010, particularly given the right fiscal regime.

    —  Gas importation is certainly not a difficulty in principle and should not be viewed as a strategic danger to the UK. Reserves that could supply the European market are robust and European imports have proved to be secure in the past. Centrica is confident about contracting for such gas in future, provided that there are no barriers to development of the necessary infrastructure.

    —  There are a number of important measures that can be pursued that would facilitate import security. These include, vitally, liberalising the Continental gas market, achieving greater gas interconnectivity, providing sufficient investment in the UK off and onshore transportation system and the right storage regime.

    —  The introduction of competition into the domestic energy markets has delivered significant reductions in the cost of energy for consumers. However, if energy prices were to increase significantly as a result of such external forces, there will need to be greater emphasis placed on alternative measures to tackle fuel poverty such as improved housing.

    —  While in the short term the development of renewable energy will not have an impact on security of supply, in the medium to long-term, security of supply should benefit from well-managed and varied renewable sources of energy produced within the UK.

    —  There needs to be close co-ordination of environmental and energy objectives. Market mechanisms are best able to deliver defined policy goals.

Given the imminent dependence of the UK on energy imports, how can the UK maintain a secure energy supply? What mix of fuels would maximise security?


  4.  We are now at a point where there are roughly equal amounts of gas, nuclear and coal generation. This is the most balanced power generation market we have had in UK history although it is inevitable that going forward there will be some increase in dependence on gas for power generation. However, this is unlikely on current market forecasts to be as sudden or as dramatic as some have predicted, and we will certainly not reach the level of dependence on gas that we had on coal in previous decades.

  5.  Longer term, replacement of the aging nuclear and coal fleets will be required. On current market economics, this would largely come from gas. However, history has shown that applying current market economics to long-term future events rarely turns out to be correct. New technology or changes in market conditions can result in rapid and fundamental changes to the equation. The current emphasis on renewables may be one such driver for change. One concern is that currently, owners of power stations only have to give NGC six months notice of closure and no notice of "mothballing".

  6.  Despite some initial technology problems with many of the new gas fired power stations, we have also seen the lead time between a project being conceived and commercial power production getting shorter. It is now possible to get from feasibility into production in three years. With many designed and (partially or wholly) consented projects awaiting development, it would be possible to get to production even more quickly.

  7.  Capacity margins (the excess of installed capacity above peak winter demand) are high, with NGC forecasting 26 per cent for 2002 and 31 per cent for 2005 (on their middle scenario). The combination of short development lead-times and existing high capacity margins suggests that the market is in a strong position, and we are unlikely to find ourselves short of power in the coming years.

  8.  There were some fears that the lifting of the gas moratorium would see a further "dash for gas" with a wave of new stations being built. The combination of high capacity margins, low forward electricity prices and high gas prices have meant that new entry economics are not favourable at present. To our knowledge, no new CCGT stations have gone into construction since the lifting of the moratorium. Interest in new gas supplies and power sales from new potential developers has also dropped off. Given an approximate new build timetable of three years, this suggests that new entry will be very low for the next three years or more.

  9.  Our analysis suggests that the scaling back of CCGT development will result in CCGTs staying below 40 per cent of installed generation capacity for the next five years. Longer term, an increased proportion of electricity from CCGTs will depend both on new build economics, plant retirement and increased renewable generation capacity. The most significant question will be the timetable on which the nuclear fleet is phased out, and what steps in to take its place. However, significant closures of' nuclear plant (with the exception of a minority of the Magnox stations) are not planned between now and 2010. We also believe that UK coal stations with appropriate emission controls will continue to have a role post 2010.


  10.  Centrica is the leading buyer of gas for the UK market. The company is in continual discussions with UKCS producers and others who may be able to meet the companies supply needs into the future. Our assessment is that the UK will continue to be a net exporter of gas through to the middle of this decade.

  11.  Centrica expects sufficient new UKCS gas discoveries to limit imports to around 20 per cent of annual usage in 2010. This would be less as a proportion of UK demand than the country was importing in the mid 1980s. As we move through to 2020 there is greater uncertainty regarding UKCS supply availability and demand. An import requirement of 50 per cent to 70 per cent could be envisaged.

  12.  Regarding peak supplies, we are already importing from Europe during the winter period. The requirement for imported winter/peak gas is expected to grow faster as the more flexible, high swing, existing UKCS fields are replaced by less flexible fields.


  13.  Whilst recognising the physical need for gas imports, growth in imports will also be driven by market factors with gas from Europe being potentially cheaper than yet-to-be-developed UKCS gas, particularly where new transportation infrastructure is required. Fiscal, regulatory and other measures to encourage recovery of all gas from the UKCS should be developed and implemented. These should include continued Government/industry initiatives such as PILOT, supplemented by any necessary changes to the licencing and offshore regulatory regimes.

  14.  Centrica urges the UK government to ensure that a supportive tax regime is in place that recognises UKCS maturity. It should seek to maximise UKCS developments and exploration. A supportive regulatory regime for developments that are brought to market is also essential. We support the concept that "the onus should be on ensuring that there are no Government policies or distortions in the tax system that might discourage private-sector development and production of the UK's oil and gas reserves or of [relevant] technologies".

  15.  Centrica is concerned that elements of the UK's offshore taxation regime may discourage incremental investment in mature fields. As mature fields approach the end of their economic lives high tax rates provide disincentives for new investments to prolong their field lives. We understand that other countries have recently recognised the need for lower tax on mature fields, and would encourage the UK Government to consider specific measures in this area.


  16.  In the longer term the UK will inevitably be a significant net importer of gas and should therefore prepare for this. The UK has in the past successfully imported large volumes of gas and in principle should be able to do so in future. In addition the wider European market has always been heavily import dependent which has proved reliable.

  17.  World gas reserves remain very significant and there are strong incentives on producers to make these available to the European market. The gas market is becoming increasingly global with strong growth both in pipelines and the LNG trade. Centrica expects this trend to continue.

  18.  Centrica is in discussions with a number of overseas companies that would potentially provide large volume, long-term supply contracts to us. In principle there is no reason why such discussions will not be concluded successfully. However, the terms on which they can be concluded will, as discussed elsewhere in this note, be very dependent on the availability of and terms of access to UK off and onshore transportation capacity, new interconnector capacity and European transit capacity and to the pace of progress generally of European market liberalisation.

  19.  However, it could be costly for Centrica, and hence the UK domestic market, if the costs under new contracts are inflated. This could occur either by non-cost-reflective transportation costs from other countries or by the need to compete with other potential gas buyers who may be able to pass high costs onto a less-liberalised and less-competitive market.

  20.  There are a number of important developments that would facilitate the importation of gas and aid long term security of supply where import reliance was increasing. These include European liberalisation, greater interconnectivity, the right obligations and adequate financial rewards for the UK transportation system and the right storage regime.


  21.  Speedy and effective liberalisation of the gas and electricity markets in continental Europe would help deliver greater security and efficiency of gas supplies to the UK. This is of fundamental importance as, for example, liberalisation would:

    —  Reduce UK-Continental energy market distortions that arise from the different market structures and price mechanisms.

    —  Enable existing infrastructure to be used more efficiently.

    —  Allow gas to be moved more easily between networks.

    —  Through unbundling and transparency, enable transportation and storage capacity to be more readily available.

    —  Provide clearer price signals that facilitate investment in new infrastructure.

    —  Permit large companies to choose their own security levels and even contribute to security of supply by selling gas back to the market.

    —  Provide enhanced security of supply at off-peak times through the linkage of gas and electricity markets which unlocks the reserve capacity in each network.

  22.  Liberalisation is also a vital tool in weakening the dependence on oil indexed contracts. Liberalisation facilitates the development of traded gas markets, and this in turn facilitates a weakening on the dependence on oil-price linked contracts. As traded markets develop the "gas-on-gas" competition brings traditional contracts under pressure, both in prices and volumes. Efficient liquid traded markets and associated trading exchanges also create the price transparency which enables gas market-linked pricing under long-term contracts.


  23.  Based on proximity and existing infrastructure, the most cost efficient source of imports for the UK in the near term is Norway. The UK therefore needs to ensure that sufficient capacity is available at terminals and in the NTS to land and distribute such Norwegian supplies. The DTI response to the PIU review identifies issues relating to possible pipeline gas imports from Norway. This raises key investment issues, notably what form of obligations and financial incentives a dominant transporter (Transco) should be given taking into account the uncertainties as to future requirements, both quantitative and locational. There is a risk that regulation of Transco may produce sub-optimal (low) transportation prices at the expense of high gas commodity prices as a result of capacity restrictions and limited options for gas importation routes.

  24.  Greater connectivity with mainland Europe is required through increasing the reverse flow capacity of the existing interconnector and, desirably, a second interconnector. Such developments would help the UK with additional flexibility and peak gas potential which is unlikely to be available from Norway but could potentially be provided by the Netherlands. Greater linkage with Europe would also help to develop a single European gas market. Without efficient interconnection it would be possible for the UK and Europe to have different prices and thereby mean that UK industry may have different cost bases to Europe. Interconnection also reduces the risk of supply problems, increases security of supply and allows efficient arbitrage.

  25.  Finally, it is important to remember that in the medium to long-term, security of supply should benefit from well-managed and varied renewable sources of energy produced within the UK. While short-term dependence on current renewable technologies may hinder security of supply because of predictability issues, greater investment and improvements in renewable technology can provide a reliable source of energy in the medium to long-term.

Is there a conflict between achieving security of supply and environmental policy? What is the role for renewables, and Combined Heat and Power schemes?

  26.  Centrica recognise that renewable energy sources have an important role to play in long-term security of supply but that in order to do so there must be a significant increase in installed capacity. It is unlikely that such capacity will be available in the short-term and therefore the contribution of renewables is currently limited by its lack of predictability and flexibility to meet peak energy requirements.

  27.  The new market structures for promoting renewable generation are a major step in the right direction in our view. It is yet to be seen whether or not the £30/MWh buy out price and the associated recycling mechanism will stimulate the appropriate level of new entry of renewable generation. However, it would be wrong to draw any conclusions too early, since the market needs to be started and bedded in before the market will begin to react.

  28.  Our analysis suggests that significant new wind generation will be possible at this buyout price. Depressed market power prices for wind generation will not kill off the new entry economics. It is appropriate that intermittent generation technologies should attract a lower market power price.

  29.  Given the prominent role we expect wind technology to play in providing renewable energy it is important that the Government carries out research on the predictability of wind, and whether it is possible to determine wind speed, say, 4-6 hours ahead. If wind technology fails to provide consistent power then large amounts of fossil plant will be needed on standby.

  30.  Global warming is a global problem. An international approach to promotion of renewables is appropriate, and will lead to the least cost, most effective and least environmentally damaging outcome. It would be wrong to avoid internationally tradable green certificates on the basis of promotion of UK technology development.

  31.  When considering the interaction of CHP, and indeed unpredictable forms of generations, with NETA, it is important to remember that throughout the development of NETA it was always recognised that the new arrangements would reduce the value of unpredictable generation when compared to predictable generation. Indeed this was a design principle of NETA. By their very nature some of the renewable technologies and CHP plants fall into the category of intermittent generation and as such some reduction in output value should be expected.

  32.  NETA is going well and has delivered lower prices. Prices in the balancing mechanism have become much more cost reflective. The embryo of genuine trading market is up and running and the systems are working well. We do not believe that major adjustments to NETA should be made to accommodate unpredictable generation and support Ofgem's position on this. Electricity is a product that is consumed instantly that needs to be produced instantly. Consequently, unpredictable generation has much lower value.

  33.  Nevertheless, there may be changes than can be considered which would not fundamentally effect the market structure. These were set out in the recent Government consultation document. We support this approach.

  34.  If Government wants to provide more significant support for renewables/small generators then it must support them outside of the market structure or help fund technological change. We support the full exemption of good quality CHP from the CCL.

  35.  It should also be borne in mind that CHP is only one way to produce carbon savings. Before major intervention is considered to support the industry the cost effectiveness of intervention in terms of carbon saving from CHP should be carefully examined. We would oppose an obligation to source a proportion of electricity from CHP.

What scope is there for further energy conservation?

  36.  Centrica supports the view that energy efficiency has a role to play in meeting environmental, social and supply security objectives. However, the UK currently lacks a coherent energy efficiency strategy in terms of the targets to be delivered and the most cost-effective way of doing so in each sector. There are currently a variety of institutions including the EST, the Carbon Trust, local authorities, Ofgem, private companies, HEES contractors etc) pursuing various initiatives (including HEES, CCL, ESSOPS, EEC etc).

  37.  Centrica believes that current policy initiatives and institutions are unlikely to deliver the scale of savings that would make a major impact on emissions or security. (The possible exception to this is the CCL which is likely to see significant energy saving but not necessarily in the most efficient way).

  38.  If the Government is serious about the promotion of energy efficiency, it is likely that a more comprehensive and radical package will be necessary. In this context, Centrica believes the following could be considered:

    —  Reduced rate of VAT on high efficiency domestic condensing boilers. The turnover in the boiler stock is low and it is therefore important that incentives can be provided to encourage the uptake of the most efficient boilers on the market as soon as possible.

    —  Reduced council tax rates for energy efficient homes.

    —  Reduced stamp duty on the sale of energy efficient homes.

    —  Compulsory energy audits as part of home sales.

    —  Obligations as landlords for energy audits in the private rented sector.

    —  Improvements in building regulations.

    —  Encouragement for dCHP technology and market development.

  39.  These measures would need to be supplemented by a significant change in customer awareness and attitude. The capacity of the Energy Efficiency industry would also have to be expanded. This is currently a significant supply side constraint.

  40.  Next year Centrica will be investing around £3.60 per fuel per customer in energy efficiency although under the EEC scheme the majority will be targeted at fuel poverty rather than emission savings. We believe that there will be issues of customer legitimacy if the present EEC expenditure levels were significantly increased. Centrica also believes that any significant increase in energy prices in the domestic sector to improve customer energy habits would be unlikely to succeed. Price elasticity of demand for gas and electricity is very low and there could be social issues associated with such an environmental increase.

  41.  More widely, Centrica would like to see more coherent integration of environmental and energy policies. The California experience clearly demonstrates the interconnection between issues such as planning permission regimes and supply security. Whenever possible it should be left to the market to deliver policy objectives and we believe the current renewables obligations is a good example of this. At a more micro level, Centrica would like to see much greater co-ordination of various "green" plans, such as CCL, renewables, supplier EEC schemes and emissions trading, etc. This would encourage the lowest cost solutions to emerge.

  42.  We believe that customer facing organisations, such as Centrica, should have an overall CO2 reduction target where they are free to contribute to carbon reduction through energy saving or efficiency measures. For example, a supplier with significant expertise in energy efficiency/ESCO's etc can do a better job at this "demand" end of the chain, than they can by investing in renewable capacity at the "supply" end.

  43.  Finally, we would like to see the energy efficiency strategy extended in line with the fuel poverty strategy. This would be in tune with Government policy to ensure "joined-up-Government" and while there maybe an initial conflict between environmental and fuel poverty objectives, in the long run it is possible to balance the two.

What impact would any changes have on industrial competitiveness and on efforts to tackle fuel poverty?


  44.  The introduction of competition into the domestic energy markets has delivered significant reductions in the cost of energy for consumers. Market forces should continue to maintain an efficient market that can provide low prices, however, it must also be recognised that prices are impacted by economic influences outside of the suppliers' control, such as oil and gas prices. If energy prices were to increase significantly as a result of such external forces, there will need to be greater emphasis placed on alternative and more sustainable measures to tackle fuel poverty such as improved housing stock and increased income levels.

  45.  British Gas is now the largest gas supplier and the largest domestic energy supplier in the UK. Our spend under our standards of performance is currently running at £20 million per annum. To date we have installed more than 570k measures in almost 200k households with over 70 per cent of our activity benefiting disadvantaged households.

  46.  From next April, based on current DEFRA proposals, our indicative spend will be around £65 million per annum, which equates to over 2.5 million measures, of which 50 per cent will be targeted on disadvantaged households.

  47.  Our approach to this very major level of expenditure is to turn the "obligation" into an "opportunity"-by integrating this workstream into the heart of our business within our mainstream marketing activity. We must apply the same innovative customer care and high levels of service as we do to the rest of our business. If companies see this work as simply discharging an obligation, it will always be the poor relation.

  48.  The key issue affecting fuel poverty is the condition of the housing stock. UK prices tend to be the lowest in Europe yet fuel poverty rates are amongst the highest. Although the main thrust of this has to come from local and national government, the utilities, through their obligations, will have a role. It is vital that this support is targeted accurately. This is difficult as it is not just about income. Warm Zones has taught us more about effective targeting and we are concerned that the definition of "disadvantaged" is tighter than it is under SoP3. The consequence of this is that many people who need help will neither qualify for HEES nor zero cost EEC support.

  49.  The second issue relating to fuel poverty is the capacity for related industries to deliver, for example there is a shortage of skilled gas engineers. This is a serious issue—not just for the fuel poverty initiative. We have now doubled our intake of apprentices and are working with the Government and the Gas Industry National Training Organisation to expand the recruitment sources—lone parents, ethnic minorities and women are now being targeted and the signs are encouraging.

  50.  The third crucial area relates to income and the importance of benefits health checks, particularly at a time when the benefits system is becoming more complex. Work we have done with Help the Aged indicates that more than £700 million of benefits are left unclaimed by pensioners. 670,000 pensioners are entitled to claim income support but don't—this, in turn, means they do not qualify for HEES, and in future HEEC support.

  51.  "Warm-a-life" is the British Gas initiative which seeks to address the three key issues effecting fuel poverty: quality of housing, the cost of fuel and income. Through this scheme we are finding that there are many individuals who can benefit from the rightful allocation of benefits, some gaining in excess of £1,000 per year.

  52.  We would like to see benefits health checks integrated into the HEES or EEC schemes. Just checking benefit entitlement is not enough and it is just as important to follow through and make sure that entitlements are claimed. Benefit entitlement awareness and banking facilities such as PAT 14 accounts, Universal Bank, and our own Bill Payment Account must be embraced and promoted to vulnerable households.

Is any change of Government policy necessary? How could/should Government influence commercial decisions in order to achieve a secure and diverse supply of energy?

  53.  In general we believe that the UK gas and electricity markets should be regulated lightly and consistently against a clear set of long-term and coherent principles that reflect all governmental requirements and any European aspects. It should not be driven by short term aims or suffer from multiple exposure to different regulatory bodies.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2002
Prepared 27 August 2002