Aswathe of UK manufacturingcould go to the wall because of gas prices which have more than doubled since the beginning of last year.
Most at risk are the energy-intensive sectors — steel, chemicals, aluminium, cement, and paper. They are faced with increases to their input costs which are jeopardising the viability of their operations.
The dramatic rise in gas prices has eroded the one competitive advantage UK firms had over their counterparts elsewhere in Europe. Cheaper gas had to some extent mitigated the adverse impact of the exchange rate between sterling and the euro and would have lessened the burden of the Climate Change Levy (CCL), or energy tax, which UK companies will start paying in April.
In addition to the UK losing its advantage, over the last three months industrial gas consumers on the Continent have been enjoying appreciably cheaper spot prices than their UK competitors. The UK forward daily price (for daily purchases one month in advance) rose from 21.3p a therm in September/October to 25.3p a therm in October/November and 28.4p a therm in November/December, compared with a quarterly average on the Continent of 22.8p. Long-term contract prices, meanwhile, are now about the same throughout Europe.
Big gas users are doubly infuriated because there is no logical reason for the increases. They blame market distortion in the UK gas supply system and exports through the UK-Europe Interconnector. The Energy Intensive Users Group (EIUG), the umbrella body for all the large-user associations, has been campaigning for the government and the industry regulator Ofgem to act before British industry isirreparably damaged.
The chemical industry is the UK’s largest sectoral consumer of gas, and it is facing an increase in fuel costs which will dwarf its obligations under the CCL. Keith Wey, economic adviser to the Chemical Industries Association (CIA), says the prices in gas supply contracts currently on offer to member companies would add around £350m to the sector’s costs over the coming year. This is 10 times more than it was expecting to pay under the levy.
The sector has already suffered one conspicuous casualty: the ICI methanol production plant at Billingham will close next year with the loss of 70 jobs. Neither Methanex, which last week completed its purchase of the rest of ICI’s methanol business, nor other potential buyers considered it had an economically viable future.
Kiss of death
While there were undoubtedly other factors contributing to this assessment, it seems clear that the current gas prices put the kiss of death on the UK’s last methanol-producing unit. John Stoney, managing director of the methanol business, conceded that the huge increase in fuel costs had been ‘the straw that broke the camel’s back and made the decision to close absolutely certain’.
Other energy-intensive industries are expected to start scaling back operations.
While again there are other reasons behind the threat by steel giant Corus to shut one of its UK plants, the upward trend in UK gas prices this year is understood to have convinced the company to review its future investment strategy, and it is increasingly focusing its interest in continental Europe.
A senior executive at Corus told the Department of Trade and Industry in December that the company’s gas bill for that month alone would be £6m more than in the same month in 1999.
The pulp and paper manufacturing sector, with 95 production units in the UK and a turnover of £3.3bn a year, also looks particularly vulnerable.
David Gillett, head of environment at the Paper Federation of Great Britain, says one mill went into receivership in early December and others are expected to follow shortly. ‘There is real pain out there. No question about that.’
Gillett says the rocketing gas price came as a killer blow to an industry that was already losing its competitive edge to continental European rivals as a result of the currency situation.
He adds that casualties in the industry, which has already seen 12 mills close with the loss of 3,000 jobs over the last two years, will rise early this year as many companies come to the end of existing gas supply contracts and either have to negotiate new ones, or live off the spot market.
The experience of Rigid Paper, a small firm in Selby, north Yorkshire, illustrates the point. Managing director Frank Holden says the one-year supply contract he signed recently for firm and interruptible supplies in the year ahead have a capped price of 27p a therm compared with 14p in the deal that has just expired. He says the differential adds £1m to the annual costs of the company, whose turnover is only £16m.
But what has really angered the energy-intensive manufacturers is that there is no rational market explanation for the doubling of gas prices. There is no shortage of offshore supplies in the North Sea, and UK demand, in a mature market, is growing at the rate of just 1% a year.
In fact, for the first 12 days in December last, UK gas consumption was significantly lower than in 1999, when the country was hit by particularly cold weather. Figures from the national pipeline operator Transco show that total consumption over the period in 2000 was 3,609 million m3 compared with 4,215 million m3 for the same period the year before.
So what other explanation is there? Four factors have been identified: the system for auctioning capacity in the national transmission system; exports of gas through the Bacton-Zeebrugge interconnector; the apparent failure of some suppliers to put their contracted amount of gas into the system during August and September last year, causing artificial shortages; and ill-explained capacity constraints at gas terminals.
The auction system by which gas shippers bid for capacity on Transco’s network, introduced in 1999, has been identified as the catalyst for the price increase in early 2000. In the second auction of capacity some paid uncommercial rates for capacity, and some suppliers clearly factored this into prices they offered clients.
Prices have moved unremittingly upwards ever since, which has led the large industrial users to claim that the market is being manipulated.
Finger of suspicion
The main focus of the market-fixing allegations has now moved to a European context with the finger of suspicion falling on purchases by continental utilities through the Bacton-Zeebrugge Interconnector.
Shipments through the Interconnector, which is owned by a consortium of big, predominantly European, suppliers, were running at approaching 40 million m3 a day through August and September 2000 — about 13% of the gas pumped into the Transco network each day. This is a doubling of the export levels during the same period of 1999, and suspicions that it has been a ploy to drive up UK prices have been lent some weight by the fact that exports continued in October and November, when prices were dearer in the UK than elsewhere in Europe.
As soon as the price in the UK became higher, one would expect gas to start to be imported from Europe to the UK rather than the other way around, complains Wey at the CIA. This did not happen until 20 November last year.
‘In an efficient market, the gas should not have been flowing out through the Interconnector in October and November,’ says the chief gas buyer of one large industrial group.
The EIUG has asked the European Commission to intervene. In the first week of December, the organisation and its various member associations made representations to Michael Albers, the head of the energy unit in the commission’s Competition Directorate. Albers has asked for more information but is expected to launch a formal investigation before the spring.
EIUG chairman Ian Blakey says of the flow of gas from a more expensive market to a cheaper one: ‘There may be an innocent reason for that — but there may not. I think the commission is certainly concerned that something a bit odd is going on.’The British government is also expected to seek the commission’s clearance to make whatever intervention it deems necessary. A DTI statement says: ‘The government is concerned at the high level of industrial gas prices. It is intolerable that a liberalised EU market should undo the benefits of competition in the UK.’
Sidebar: Shippers come under scrutiny
Two investigations are under way into possible distortions in the gas market. Ofgem is looking into ‘market irregularities’ on a number of days in August and September when it appears that some shippers did not enter their contracted volumes of gas into the national pipeline system evenly throughout the day, as they are required to do under the terms of their licences. This obliged Transco to buy significant volumes of emergency gas on the spot market to balance the system and maintain its integrity, sending the spot price of gas sky high.
Ofgem, which had been criticised in the summer for concluding that the rise in prices was down to the operation of market forces, acted initially with some urgency, demanding that shippers provide it with details of their inputs within a week.
However, the investigation has dragged on, and a spokesman said last month that it would probably not be completed until early this year. ‘We needed more information from the shippers.’ he said.
Knock-on effect feared
Ministers are concerned about what has happened to the gas market, in part because it is threatening to have a knock-on effect on domestic tariffs in April, uncomfortably close to a prospective general election date. The DTI has launched an investigation, albeit a discreet one, under the supervision of Anna Walker, the senior energy official in the department.
The regulator and DTI have been asked to look into the reason for frequent ‘capacity constraints’ at the landing points for gas in the UK — St Fergus on the east coast of Scotland, Teesside further down the coast in England, and Barrow across the Pennines on the west coast. According to Transco, since 1 October there were constraints on 42 days at St Fergus, 11 days at Teesside and nine days at Barrow.
The Energy Intensive Users Group says the reasons for these constraints — which exert upward pressure on prices by restricting supply — are often ‘opaque’, giving rise to the suspicion that some at least may be engineered. It sees this as the result of a gap in regulation of the gas market, with the DTI responsible for what happens offshore and Ofgem’s remit only starting at the beachhead.