Examination of Witnesses (Questions 220-236)|
TUESDAY 13 NOVEMBER 2001
220. Presumably it cuts both ways which is that
if you store it it could be worth more when you take it out than
when you put it in.
(Dr Watkins) It could, but unfortunately the gas business
in the UK has been a major success story, not only are we delivering
twice the volume we were ten years ago, but in real terms the
price of gas today to the producers, what the producer realises,
is about half of what it was in the late 1980s.
221. Do you think that it is about right at
the moment but needs to be watched?
(Dr Watkins) I think that people will go into gas
storage at some point. I should not like to predict when and it
does come down to economics, unless of course it was felt that
this was such an important part of the mix that again you were
going to put something in there that underpinned it.
222. When you talk about there being natural
storage under the ground, how long does it take to get it? Just
say we were short of gas and we needed it quickly. How long does
it take to get it from the ground?
(Mr Odling) It depends on where the storage is.
(Dr Watkins) And also what pressure it is under.
(Mr Odling) There is offshore storage at the moment
in the old Rough field and it takes just a few hours. It is not
instantaneous. Gas travels relatively slowly down pipes and it
trundles along at about 25 miles per hour.
223. Mr Odling was going to come back on the
number of days.
(Mr Odling) That is a policy decision, is it not,
as to just what policymakers believe is the appropriate buffer?
224. But do you have an actual figure for now.
(Mr Odling) No, I do not; I am sorry. By international
standards we have relatively low storage in this country.
225. Can you quantify that?
(Mr Odling) I think most European countries have three
to four times what we have. Then they do not have reservoirs just
three hours off the coast, that is the difference or even 15 hours
off the coast.
226. Would you think that if our dependence
on imported gas increased, it would be prudent for us to increase
our storage capacity?
(Mr Odling) Sounds logical to me, certainly.
(Dr Watkins) That is where economics come into play
and the extent to which the market can actually sustain putting
gas into storage and bringing it out and covering the costs. If
not, then it becomes a policy decision as to whether some percentage
of gas wants to be subsidised to do that.
227. We do have oil operating in that way at
the present moment, do we not? We have storage of oil for 90 days.
(Mr Odling) If I remember rightly, that came out of
the second 1970s oil crisis, did it not? The International Energy
Agency was set up after the first one and its modus operandi
was pretty much fixed during the second crisis. The 90 days was
fixed at that time. The market is a very different place now from
what it was 20-plus years ago in terms of its flexibility, the
variety of supplies, the different routes by which both oil and
gas travel around the world. It is hugely different now.
Chairman: We shall leave that one there, but
it may be something we would want to come back to you about because
it is an issue which is going to loom large in the debate.
228. How are you involved in the PILOT initiative
to maximise energy production from the North Sea?
(Dr Watkins) I am not directly involved. There are
about 10 or 12 executive officers of UKOOA and about half of those
sit on PILOT. In terms of going to the meetings, I am not directly
involved. In terms of discussing and supporting the initiatives
which come out of PILOT, in terms of Logic and the industry technology
facilitator, pretty much all the companies support those sorts
of initiatives. Ray is involved, as is David, so perhaps I could
ask them to say something more.
(Mr Hall) I do not directly sit on PILOT but I chair
the economic advisory group which gives advice and information
to PILOT. One could talk to a number of achievements of PILOT.
You are probably familiar with the vision which has been established
for 2010 for both production and capital expenditure. There is
a vision of three million barrels of oil equivalent per day as
a target for 2010 compared with production today of about 4.5
million barrels a day. Currently when that target was put in place
two years ago there was a gap. It is a challenging target and
even two years on we still cannot see how the gap can be closed
although we have made some progress. It was a target which was
set by a wide body of people involved, company, government, industry,
contractors, trade unions; a wide canvass of people involved in
the industry who took part in that. Since PILOT has been established
there have been various initiatives and work groups which have
focused on specific areas each year. There has been a number of
those for this year, for example various groups across industry
looking at how they can best improve the recovery in existing
fields. One of the big prizes in the North Sea is maximising the
reserves in existing fields. Typically across the industry, the
recovery on average in oil fields is around 40 per cent. There
is a huge quantity left in the ground. To the extent that we can
share best practice, apply new technology, we can increase that
proportion, but there is a ticking clock in the sense that a lot
of these fields are not going to last much longer, so we have
to deal with these things as soon as we can. The interesting question
is: what would have happened had PILOT not been there? That is
an impossible question to answer. Generally what PILOT is doing
is making things happen faster than might otherwise have been
the case. That would be a big win for the industry because it
would mean that we can get a number of these smaller fields developed
before the infrastructure is taken away. Once the infrastructure
is removed, it is much more difficult to develop these small fields.
There is a number of areas where PILOT has been and continues
to be successful.
(Mr Odling) The other area it is perhaps worth mentioning
is the industry's image and attracting new talent. One thing we
are conscious of is the need to renew the talent in the industry.
PILOT has helped provide a broader mechanism for achieving some
of that. There is a whole series of co-operative activities which
have arisen out of its work which in their own modest way are
moving the whole thing forward and giving it a bigger impetus
than would otherwise have been the case.
(Dr Watkins) We sometimes tend to talk about PILOT
as industry and government, but what it has also created which
did not really exist before is a forum where sectors in the industry,
the operators, the contractors and service companies, get together
and discuss what is going on in the industry, which is clearly
beneficial. That did not exist before.
229. You did mention the role of government.
I was looking at your answer to the Committee's reference in our
call for evidence to the change of Government policy or how Government
can influence commercial decisions. You say ". . . we do
believe that there is a significant role for Government both in
achieving the maximum recovery of UKCS reserves and in ensuring
reliable market access to longer-term, international sources of
supply". But your very last serious comment is, "Beyond
these policy considerations and setting the right framework, Government
should be extremely careful. The history of intervention and influence
in commercial decisions is fraught with difficulties and disappointments".
I just wondered where you saw the Government role in this. It
seemed to me those statements were a bit contradictory.
(Dr Watkins) Yes, I can see that. It goes back to
what I was trying to say before around the issue of renewables.
An intervention by Government to set a policy target of 10 per
cent of renewables in the energy sector is a very legitimate role
of Government because otherwise who knows whether that would happen
or not. Then leaving it to the market and commercial terms within
the market and companies within the market in terms of the choice
of how those targets are met, is how I would interpret those two
paragraphs. I am not sure they are as well written as they might
(Mr Odling) Or perhaps look at it in the international
context. We talked about getting access to some of those supplies
from further east. Government has a role in getting through any
political trading barriers which may exist. It is the industry's
job to deliver the gas or the oil, to spend the money, to invest
and get the stuff to market. That is the distinction we were trying
230. That is what you mean by the framework.
(Mr Odling) Yes.
Sir Robert Smith
231. Does the Government have a role, or is
this something which has come up in PILOT, in sorting out the
regulatory regime and the hourly balancing and the offshore metering
and the relationship with Ofgem, or is that something you hope
you just solve directly with Ofgem?
(Dr Watkins) That is a very good question. Ofgem is
set up as an independent regulator. Therefore it is difficult
for Government to intervene, short of changing the role of the
regulator. That is a fairly drastic thing to do. Where Government
can have a role to play through agencies like the DTI is to help
bring the parties together which they do in order to explore the
issues, not just what is the issue but what is behind the issue,
which is not always that clear.
232. In your memorandum you expressed that there
were risks associated with inadequate regulatory signals to support
investment in the Transco system.
(Dr Watkins) Yes.
233. I would find it helpful if you could say
what you think those risks are. What are the downside risks? How
do they manifest themselves? Are they commercial risks in the
sense of increased costs to consumers resulting from that or are
they supply risks and constraints or interruptions of supply or
risks to security. What are the risks?
(Dr Watkins) The risk I would talk to first is the
risk to supply. I was saying earlier that the gas industry has
been very successful for the UK in terms of delivering greater
volumes and for lower price in real terms. Part of the result
of that higher gas demand is that the higher gas demand is throughout
the year. As a consequence the offshore plant and facilities are
now operated on much higher load factors, so there is an operating
risk. Where this comes into play onshore is being certain that
Transco has sufficient capacity in the NTS system, in the transmission
system, to cover not only the maximum possible daily production
which is needed by the market, but also a measure of flexibility
as to where that is delivered. We have a number of terminals onshore
ranging from St Fergus down to Bacton and one over in the west
also. If you have a constraint in one of those terminals, particularly
in one which is as large as St Fergus, you may not be able to
make up the supply from the others. If you look at the rules under
which Transco are required to operate, their principal operating
factor is that they have to meter for a one-in-20-years cold winter,
which is a volume issue rather than a flexibility issue. We put
it in our memorandum in the terms that the cost of over-investment
to be able to transmit supply onshore is almost certainly less
than the cost of not having adequate investment and capacity when
you need it.
234. In order to deal with that how effective
are the published proposals on Transco's price control in the
next period in trying to address that kind of signal? Is that
going to be a substantive benefit in dealing with this?
(Dr Watkins) We as the offshore producers have a difference
of view with Ofgem about how this should be regulated. We agree
with Ofgem that we should move from short-term contract periods
to longer-term contract periods. Then the issue is on what basis
that capacity is allocated. UKOOAs position is that the basis
for allocating that capacity would be on nominated volume by the
producers or by the shippers, on the basis that they will be having
to pay for that volume when it is available. Ofgem are saying
they want to stick with bidding for capacity on the basis of price
and if everybody bids very high then clearly there is a need for
more capacity. Our difficulty with that is that over the last
18 months, the bids at some of those auctions, albeit short term,
have been very high. They have been substantially higher than
they have ever been in the past, yet that really does not seem
to have changed the investment pace within Transco.
235. Let me see if I am staying with this. By
implication what is published in relation to price control between
the Government and Transco is not necessarily in your view going
then to translate into investment changes, you actually need to
change the structure of the way in which Transco is obliged to
contract with you?
(Dr Watkins) Yes, that is our position.
236. You did mention some of the proposals.
I hesitate because it says they are too detailed for inclusion.
If they are too detailed for inclusion in the written material
to us they are certainly too much for me to comprehend here. Can
you give us a flavour? If we were to be discussing with Ofgem
later, as perhaps we will, or with others, are they proposals
which in your view are moving in the right direction and would
therefore offset some of the regulatory problems you would otherwise
see in capacity and flexibility?
(Mr Odling) It would be true to say that they are
moving slowly in the right direction. We seem to have got accepted
the concept that, call it an auction, call it an allocation system,
the volume is going to have to vary if you are looking long term.
Investment can take place and it can change what is available.
In the short term you cannot because it takes too long to invest.
We seem to have got over that concept and just about everybody
is now agreed that has to be built into the system somewhere.
Exactly how it is built into the system and therefore the method
or the way the auction systemI am using those words somewhat
guardedlyworks is still far from clear and there is an
obvious tension in it because the conceptual side of it does seem
to be different. If you think of it as an auction, essentially
auctions are about what the price is for a limited good: a country
mansion, a work of art or what have you. We see it more as an
allocation system, albeit with money attached, because the money
has to go to fund the new investment. Unfortunately from our perspective
there is still conceptually some difference which we have not
(Dr Watkins) David did a good job there in explaining.
I hope what you got out of that was that, in terms of there needing
to be change and what the issues are, we are in reasonable agreement
with Ofgem. It is just how you do it, the conceptual piece, where
there are differences.
Chairman: Thank you, we are grateful for the
evidence today. We shall finish there for the moment. We may come
back to you on one or two points regarding your estimates but
we shall do that in writing. Thank you very much gentlemen for
your time and your trouble.