Memorandum by the Lattice Group plc
1. Transco, the Lattice Group's biggest
subsidiary, is the owner and operator of the National Transmission
System (NTS), which transports around half of the country's primary
energy. The related commercial arrangements and information systems
operated by Transco provide the basis for the liberalised competitive
gas market. This infrastructure plays a key role in maintaining
gas supply security.
2. Lattice welcomes the opportunity to present
evidence to the House of Commons Trade and Industry Committee
in respect of its inquiry into Energy Policy. Alongside the Performance
and Innovation Unit's Review of Energy Policy, Ofgem's final consideration
of how appropriate investment in the gas infrastructure network
can be encouraged through incentives on Transco's System Operator,
and the House of Lords inquiry into EU Security of Supply, a review
of related issues by the House of Commons is welcome and timely.
3. Given the increased dominance of gas
as an energy source, the medium term supply/demand outlook for
UK gas supplies is an important consideration when developing
policy measures to deliver a range of objectives, in particular
those relating to security of supply and environmental considerations.
On 31 October 2001, Transco published its Ten Year Statement,
setting out the detailed supply/demand forecasts that are expected
to form the basis of its investment plans in the NTS.
4. The main relevant points from the Ten
Year Statement and other published forecasts are:
Around one third of the UK's gas
demand will need to be met from imports by 2010. Some forecasts
place this figure as high as 90 per cent by 2020.
Although there are ample supplies
of gas worldwide, there is increased uncertainty regarding the
medium to long-term source of future imports (Norway, Russia,
Algeria, LNG or others) and their precise entry points to Transco's
Continental gas prices tend to be
heavily influenced by international oil prices. Consequently,
the gas Interconnector to Europe has had a marked impact on the
pattern of UK supply and demand, both in terms of the increased
uncertainty presented by the coupling of UK and continental markets,
and in a changed demand pattern on the NTS.
Up to 9GW of nuclear electricity
generating plant is expected to close in a 5-15 year time to horizon.
This represents around 12.5 per cent of currently installed electricity
generating capacity, and is against a background of continued
annual electricity demand growth of 1-2 per cent per annum.
5. Lattice believes that the future outlook
for gas supply and demand gives rise to a number of policy implications.
In our various submissions to Ofgem as part of Transco's Periodic
Price Control review and our submission to the PIU's Review of
Energy Policy, we have generally restricted our comment to tackling
these issues directly.
6. Our submission to the PIU is attached
as Appendix 1 to this evidence, and provides a more detailed reflection
of our views on specific regulatory issues. In the following answers
to the specific questions put by the Trade and Industry Committee,
we have sought to address some of the wider regulatory and public
Q: 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?
7. Lattice believes that there is fundamental
incompatibility between the use of competitive markets, and diversity
and security of supply. However, there is a significant question
as to whether the foreign markets on which the UK will increasingly
depend are themselves sufficiently liberalised to provide diverse,
reliable and accessible sources of energy. In the case of gas,
future supplies will almost certainly need to be sourced from
the continent, and in part, across the continent from Russia.
This points to two key areas for considerationthe impact
of slow European liberalisation and the ability to gain access
to the European gas network in order to source future supplies
from Europe's eastern borders.
8. The extent and pace of European gas liberalisation
is a principal consideration in formulating future policy. If
the UK maintains a philosophy of being driven principally by competition
and market mechanisms, with few administered safeguards against
exceptional circumstances, this is less likely to deliver a range
of policy objectives as the proportion of the market supplied
from less liberal regimes increases.
9. As liberalisation has developed, the
UK has dismantled many of the institutions and safeguards that
still exist in its likely future supply source markets. As the
relative proportion of UK demand met by these markets increases,
the risk of adverse consequences from administrative constraints
and political intervention may also increase.
10. As a comparison with other fuels, and
largely arising from historic supply shocks, oil producers are
required to keep up to 90 days of oil stocks, and the Secretary
of State can mandate minimum levels of fuel stocks at power stations.
In the absence of any similar requirements in gas, the transfer
in the generating fuel mix from coal to gas has effectively depleted
electricity generating fuel reserves.
11. In order to safeguard against possible
future administrative and political intervention outside UK control,
Lattice believes the following measures should be adopted:
As a principal policy, continued
advocacy of a pan-European gas liberalisation model, featuring
the mandatory separation of monopoly transportation
from gas supply
open access and non-discriminatory access to
transmission, transit and storage facilities.
the development of large, liquid, gas trading
hubs across Europe
the removal of practical barriers arising from
differences in gas quality and operating practices
given the likelihood of future dependency on
Russian supplies, the adoption of consistent security standards
across Europe, and consideration of inter-governmental agreements
with other EU Member States to avoid diversion of transit supplies
to interposing domestic markets in times of supply shortages.
In the UK the application, though
licences, of specific security standards that deliver a desired
level of supply security. In practice these should:
Adopt a precautionary approach to network investment
that 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.
Consider placing minimum storage inventory obligations
on gas suppliers similar to those that exist in oil and for Coal-fired
An urgent review of the vulnerability
of the UK gas market given the likely continued slow pace of liberalisation
12. Turning to fuel mix, Lattice does not
believe that a pre-defined percentage fuel mix would enhance security
of supply. Continued market liberalisation supplemented by safeguards
to cover against severe supply circumstances is likely to be the
best way to create diversity and security of supply. In practice,
many fuels are subject to similar potential for political and
administrative intervention. Consequently, the key question is
not so much the fuel type, but the impact of an increasing proportion
of supply being sourced from markets that are relatively non-liberalised
when compared to indigenous supplies.
Q: What scope is there for further energy conservation?
13. Lattice does not have any detailed research
in this area to put forward. However, we would simply note that
gas-based technology solutions are amongst the most energy efficient
means of providing domestic space heating, for example modern
condensing gas boilers and the newly-emerging Micro-CHP schemes.
Q: What impact would any changes have on industrial
competitiveness and on efforts to tackle fuel poverty?
14. There is little doubt that industrial
competitiveness has been improved by the lower prices resulting
from the introduction of competition into the gas and electricity
markets. To the extent that measures to enhance security standards
compared to the status quo involve additional cost, there may
be a marginal effect on industrial competitiveness. However, any
widespread supply failure would have serious implications for
industrial competitiveness, and this assertion is borne out by
the experiences of a number of industries following the electricity
supply crisis in California. Consequently, a suitable combination
of incentives and obligations to provide supply cover against
exceptional circumstances would involve small relative additional
cost, but provide insurance against the serious consequences of
15. In tackling fuel poverty, low energy
prices clearly play an important role. However, the introduction
of wider objectives into Energy Policy could place upward pressure
on prices, and run counter to measures to relieve fuel poverty.
16. Specifically in the gas industry, extending
the gas network and providing gas burning equipment as a means
of relieving fuel poverty cannot, in many cases, be justified
solely on economic grounds, even once social and environmental
benefits have been monetarised and factored in. Consequently,
additional explicit funding is needed and the issue then becomes
one of social policy for government. To effect cross-subsidy by
implementing measures in the gas industry would run counter to
using competition as the primary means of protecting consumer
interests. It would also put further upwards pressure on prices,
thereby working against the grain of relieving fuel poverty. Consequently,
Lattice believes that, where cross-subsidy is needed to tackle
measures such as relieving fuel poverty, this should take place
in a way that does not unnecessarily distort the effective operation
of the competitive market. In practice this may mean raising funding
through public sources, rather than introducing changes to the
operation of the competitive energy markets.
Q: Is any change of government policy necessary?
How could/should the government influence commercial decisions
in order to achieve a secure and diverse supply of energy?
17. Competition and market mechanisms have
delivered many benefits to the UK energy industry. Prices have
fallen, all consumers have choice of supply in both gas and electricity
and CO2 emissions have reduced significantly. Whilst acknowledging
these benefits, it is becoming increasingly clear that future
energy policy entails a more pluralist set of objectives.
18. Many of the consequences of widespread
supply failure would be social and environmental, as well as entailing
knock-on effects throughout the economy. Much of the resultant
cost would not fall to those participating in the energy market.
Consequently, individual market participants are unlikely to invest
in the extra capacity needed to secure against infrequent but
severe supply/demand scenarios as the consequential costs of failure
are not their own. Even where market participants are directly
confronted with a potential cost consequence, they may not be
willing to insure voluntarily against unlikely events in the face
of short-term competitive pressures. Similarly, social and environmental
objectives are only partly served by the increased use of competition.
19. Lattice believes that direct Government
influence over individual commercial decisions should be minimised
if competition is to continue to deliver the many benefits that
have arisen since its introduction, including a diverse and secure
energy supply. However, it is important to recognise the boundary
between markets on the one hand and public policy on the other.
For example, markets may work well in delivering supply security
standards but should not be left on their own to set those standards.
Consequently, Government should set a regulatory and public policy
framework that delivers a desired level of security, leaving competition
and markets as the primary means of delivery.
20. Where Government can and should play
an important role is in examining and, if necessary, redefining
the framework of regulatory institutions, their duties and obligations.
This should be done with a view to ensuring that the institutions
have suitable duties and objectives, and the necessary tools to
deliver a wider set of objectives without unduly distorting the
operation of the competitive markets. Given the increasing importance
of Europe for future UK energy supplies, this examination should
also consider the international perspective of UK regulation,
with a view to ensuring sufficient duties, obligations and tools
to participate fully in the development of European competition.
21. In summary, Lattice believes that Government
Continue to promote competition as
the primary means for meeting consumer demand for energy.
Recognise that, due to a number of
externalities, competition and market mechanisms cannot be exclusively
relied upon to meet wider policy objectives, such as security
of supply as well as social and environmental objectives.
Set a regulatory and public framework
that delivers a desired level of security, leaving competition
and markets as the primary means of delivery.
Examine the institutional framework,
its duties and obligations with a view to ensuring they can deliver
a wider set of policy objectives.
Ensure that, in delivering a wider
set of policy objectives, any required cross-subsidies are introduced
in a way that avoids distorting the operation of competitive markets.
Continue to push for increased liberalisation
in Europe. At the same time, to recognise the likely continued
slow pace of European liberalisation and undertake an urgent review
of the resultant vulnerability of the UK gas market.
Investigate the feasibility of introducing
minimum storage inventory obligations on suppliers, similar to
those that exist in the oil industry and for coal-fired power
1 Ref: Running Short of Gas: The outlook for UK and
Irish Gas Markets. A Multi-client Study. (Wood MacKenzie, September
Ref: National Grid Company plc Seven Year Statement 2001. Back
Ref: Electricity Act 1989, Section 34 & 35. Back