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 namesthe 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
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
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
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
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
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
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
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.
MAXIMISING UK RESERVES
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
Reduce UK-Continental energy market
distortions that arise from the different market structures and
Enable existing infrastructure to
be used more efficiently.
Allow gas to be moved more easily
Through unbundling and transparency,
enable transportation and storage capacity to be more readily
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
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
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
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
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
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
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"
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
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
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
issuenot 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 sourceslone 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'tthis,
in turn, means they do not qualify for HEES, and in future HEEC
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.