TRADE AND INDUSTRY COMMITTEE
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PN 32 of Session 2004-05
Publication of Report on Fuel prices
The Trade & Industry Select Committee is issuing its Twelfth Report of Session 2004-05, on Fuel prices (HC 432), in typescript today.
During the summer and autumn of 2004, the UK witnessed rapid and substantial increases in the wholesale price of gas. This resulted not only in significant increases in retail gas prices for both domestic and industrial and commercial customers, but also, because about 40% of electricity generation in England and Wales is gas-fired, in rising electricity prices too.
The Committee decided to undertake an inquiry into the price increases, focussing on the effects of the price increases on all types of energy customers, and in particular to try to determine whether the rises were a temporary response to short-term supply problems or are the start of a long-term increase in UK energy prices and to suggest what Ofgem's and the DTI's responses to the problem should be.
Amongst its conclusions are:
Over this and perhaps the next two winters, the UK will be in the uncomfortable position of having a relatively small surplus of gas over normal winter demand. Because supply cannot be increased measures may have to be taken to decrease demand-which means that customers with interruptible supply contracts may find their gas supply temporarily suspended.
Because of the difficulties in extracting the-substantial-remaining reserves of gas from the UKCS, it is not at all clear that the decrease in production will take place in a managed and predictable way. This simply highlights two points: the need urgently to put in place infrastructure to ensure that adequate supplies can be imported into and stored in the UK to meet any shortfalls from the UKCS; and the need for sufficient information to be supplied to the market about why production rates are lower than expected, in order that the market players can then take a more rational view of pricing.
The Committee received no evidence that producers have withheld supply from the market to drive prices up. None of its witnesses suggested collusion or any other illegal behaviour in the offshore production market; nor that the sharing of information between companies owning or making use of the same facilities is improper or unnecessary. However, the structure of the UKCS production market does mean that participants in it have access to significantly more knowledge than those to whom they are selling their gas. Also in the past there have been allegations that the oil majors have shown a disinclination to share infrastructure with newer market entrants. These factors, together with the fact that the big gas production companies also act as shippers, result in a market where actual competition appears less than might be expected from the number of players and market share.
There is a serious shortage of companies willing to sell gas in the wholesale market when prices are high. Unfortunately, because of the tight supply situation, prices are likely to remain high over the next two years. This does not bode well for I&C customers. Price spikes are more and more frequent, and they seem to be higher each time. Much of the volatility can be attributed to real difficulties in balancing supply and demand, but the scale of the peaks will remain high until more traders are encouraged to sell short.
Without further real (not just cosmetic) liberalisation of the European gas market, the wholesale market in the UK will malfunction: it will continue to be difficult for buyers to access adequate supply and, because of this and other distortions caused by the mismatch between the liberalised market in the UK and the more rigid contractual arrangements on the Continent, there will be a tendency for prices to diverge significantly. The Committee therefore welcomes the European Commission's announcement of inquiries into competition within the European gas and electricity markets, and looks forward to the completion of both inquiries by the end of 2006. However, it recognises that both the Commission and the UK Government will need to exercise considerable persuasive powers to convince other Member States of the need to take prompt action.
Even on the most optimistic forecast, it is unlikely that the Continental market will be functioning as a fully liberalised one before about the end of this decade. Moreover, liberalisation does not, of itself, lead to lower prices. Rather it enables the cost of energy to be determined more efficiently. European liberalisation is not a complete answer to the problems in the UK gas wholesale market.
The electricity price rises are a direct result of the increase in the cost of the main generating fuels, coal and-especially-gas. The variations in price rises from company to company can be explained in part by the differences in their portfolios of generating plant and the degree to which they have been able to offset the gas price rises by changing to cheaper fuels; and in part by the different commercial approaches they have adopted (whether they have chosen to increase prices across the board or to shelter some customers from the full effects of the price rises, for example).
However, the effect of the price increases on customers has been significant, and further increases are inevitable, given that the cost of environmental legislation has yet to be passed through to customers. Although fluctuations in fuel costs will occur, over the medium to long-term electricity is unlikely to be as cheap in real terms as it has been over the last six years. I&C customers have considerable incentives to reduce their energy use. As a result, the Committee thinks that it is now time for the Government to re-examine the operation of the Climate Change Levy, and in particular to consider the scope for reducing it to help UK industry during its present difficulties.
The Chairman of the Committee, Mr Martin O'Neill, said: "We cannot take the Panglossian view of the gas wholesale market that the DTI and Ofgem appear to hold. There are failures in the market which arise from significant problems with physical supply, the lack of information about supply available to participants, the difficulties caused by operating a liberalised market (the UK) alongside a relatively unliberalised market (Continental Europe), and the dearth of traders willing to sell gas into the forward market. These problems are serious enough for us to conclude that the autumn 2004 price spike, and the recent spike in late February, will be repeated over the next two years.
"There are encouraging developments - companies are planning to construct much more import and gas storage capacity, the production companies have agreed to provide more information to traders in the gas market, and the European Commission is taking the problems with competition in the Continental markets much more seriously
"Although all the problems with the market could, and probably will, be solved eventually, customers-and especially I&C customers-will face serious disadvantages in the meantime. The DTI is placing heavy reliance on customers changing their buying practices: avoiding the October bunching, and purchasing gas on short-term markets when forward prices seem excessive. We think that this is going to be difficult for companies, especially the SMEs whose interests the DTI has pledged itself to take particularly into account."
Copies of this Report will be posted to all those who submitted evidence to the Committee. If you wish instead to collect your copy on publication, please telephone the Committee's offices. No advance or embargoed copies will be available for this Report.
The Report will be published by The Stationery Office after Easter; a press notice giving details will be issued in due course. The Report will be available on our website soon after publication by The Stationery Office.
For further information please call the Committee Office on 020 7219 5777/5779.
23 March 2005