New players cut a swath in U.K.'s liberalized gas market

Opening of the first corner of U.K.'s residential market to competition in April inspired promotional stunts, as nine new suppliers sought to lure customers away from British Gas plc. Here Carol Ellis, regional gas main manager for Calor Gas/Texaco joint venture Calortex, and Malcolm Beacham, manager of the Calor Gas center at Bridgwater, Somerset, "turn on" a prop gas main in Bridgwater. Photo courtesy Calor Gas.

Exact assessment of the current state of the market is impossible. Industry regulator Office of Gas Supply (Ofgas) will not issue figures showing the breakdown of which company holds what market share, saying the information is commercially sensitive.

The companies also claim commercial sensitivity when refusing to disclose their own market shares, although the more successful ones are less shy about their positions.

Following the measured pace of earlier deregulation of Britain's telephone network, the government's liberalization of both gas and the sometimes related electricity markets appears to have been rushed in some ways. One source said all sectors of the liberalized gas market are experiencing teething problems, with government and the regulator each having a vision of what they want that differs from the reality.

Former gas monopolist British Gas plc is protesting against many of the measures being forced upon it by Ofgas, and market entrants are complaining that British Gas was given too little time to prepare itself for radical change, to the detriment of all players.

In the latest Ofgas/British Gas spat, the regulator has called in government's Monopolies & Mergers Commission to adjudicate in a row over how much British Gas can charge third parties to use its national gas grid (see related story, p. 24).

The liberalized gas market is certainly changing shape, and while too many factors are affecting its development to allow precise predictions about its eventual form, a number of main trends have emerged.

Milestones

The Gas Act of 1986 paved the way for the demise of the state gas industry by vesting all assets and liabilities of state-owned British Gas Corp. in newly formed British Gas plc.

On Dec. 8, 1986, about £ 9 billion ($13.5 billion) worth of shares in the public limited company were sold on London, European continent, U.S., Canadian, and Tokyo stock exchanges.

This was the world's largest ever public float at the time and prepared the way for government to take gas supply contracts away from British Gas in three stages: industrial, then commercial, then residential.

In March 1992, government ordered British Gas to open at least 60% of the industrial gas supply market-categorized as those customers that use more than 2,500 MMBTU/year-to competition.

In July that year, the government moved the goal posts, saying British Gas must surrender at least 45% of the industrial and commercial market-the latter being users of 250-2,500 MMBTU/year-to competitors by 1995.

U.K. Department of Trade & Industry (DTI) said that by yearend 1994, competitors had indeed exceeded the 45% target in the market above 250 MMBTU/year, but virtually all of this was in the firm gas market.

In 1995, said DTI, British Gas' competitors made inroads into the interruptible gas market.

"At the end of 1995, 40 suppliers were active in the contract market, and in September 1995, British Gas acknowledged that its share of the industrial and commercial market had fallen from virtually 100% to around 35%."

In April this year residential customers in the Southwest U.K. were given the choice of gas supplier for the first time, in the first move towards complete opening of the U.K. residential market in 1998.

Gas for customers of the new suppliers is provided through the British Gas grid, which is to continue under operation by the company's main revenue earner, its TransCo division.

Residential sector

Beginning Apr. 29 in Devon, Cornwall, and Somerset, the government started a pilot scheme under which 500,000 householders were offered a choice of new suppliers in competition with British Gas.

Initially 28,500 households chose a new supplier, and now Ofgas reckons more than 70,000 customers have deserted British Gas in favor of one of nine rivals licensed to provide gas in the pilot area.

The new suppliers are: Amerada Hess Gas (Domestic) Ltd., British Fuel (Oils) Ltd., Eastern Natural Gas (Retail) Ltd., London Total Energy Co. Ltd., Northern Electric plc, Norweb Gas Ltd., Southern & Phillips Gas Ltd., Texaco Ltd./Calor Gas Ltd. (Calortex), and Western Gas Ltd.

Recently Ofgas unveiled plans to offer a choice of gas supplier to a further 1.5 million residential customers beginning January 1997.

A new consultation document proposes opening the residential markets in Dorset and Avon to competition beginning Jan. 13, 1997, and in Kent and East and West Sussex beginning Feb. 7, 1997.

The regulator said all nine new suppliers are offering gas cheaper than does British Gas, and sometime in 1998 the remainder of the U.K. market will be opened to competitive gas supply.

Once liberalization is completed in 1998, said Ofgas, almost 19 million residential gas customers throughout England, Scotland, and Wales will have a choice of supplier.

Comments on the document were required by Oct. 9, but no problems are anticipated with the proposed dates, an Ofgas official said.

Once the document is accepted, the official said it will likely be 3-4 weeks before a deadline is set for applications for licenses to supply gas in the new areas.

The regulator expects many of the nine companies currently supplying under the pilot scheme to apply for licenses in the new areas.

On Oct. 7 a new player entered the residential fray: Beacon Gas Ltd., a joint venture of Amoco (U.K.) Ltd. and electricity utility Seeboard plc, became the first to announce its intention to solicit business in Kent, Sussex, Dorset, and Avon.

Seeboard already supplies electricity to 2 million homes in Southeast England and to industrial and commercial customers throughout England and Wales.

Amoco said it will supply competitively priced gas to Beacon in the long term from its portfolio of North Sea gas fields, several of which it operates and others in which it has interests.

Other potential residential suppliers have given no indication of intentions, but are thought to be watching keenly developments in the residential market.

Two views

Anne Quinn, managing director of BP Gas Marketing Ltd., said the company is happy not to have participated in the pilot scheme: "And we haven't announced entry to the second scheme, either. We will definitely be in the residential market, but we are discussing how best to gain access."

Jim Whelan, director of gas and energy management at Eastern Natural Gas, unit of a regional electricity utility, sees residential gas supply as an opportunity to build on strengths in the electricity sector.

Quinn said BP is concerned about the sheer dominance of British Gas in the U.K.-"it still has 70% of the market"-while other issues are the different speeds of deregulation of gas and electricity, creating different playing fields.

"BP Gas is assessing infrastructure support," said Quinn. "We have been in joint ventures with electricity supplier Manweb and Calor Gas Ltd., but we came out of these, for differing reasons.

"Servicing a couple of million residential customers requires a capability BP doesn't have yet. Some companies have taken a greenfield approach and found this more cost-effective."

Quinn said opening up the U.K. gas market so far has been a major achievement, but Britain still has a long way to go compared with the U.S.

The U.K. government underestimated the difficulty of putting into place such a decentralized system, she said, contending the supply/demand balancing computer system was not properly tested before it was started up.

This has led to recent embarrassing press coverage for British Gas after an estimated 12,000 residential customers were sent inaccurate bills, and many were subsequently threatened with disconnection.

British Gas responded to critics by claiming the computer system that monitors shipments had been built in only 18 months, rather than the 4 years allowed during liberalization of the telecommunications market.

So far more than 70 modifications have been proposed for the supply/ demand balancing computer system, according to Quinn, but it is proving difficult to get a consensus for changes: "We're at the beginning of the journey, not the end."

The system is often out of balance, she added, yet suppliers are lucky if they can find out about it: "Information is not flowing around. In this situation the objective should be to provide incentives to make the system work. Providing incentives to TransCo would help."

Whelan also noted problems with supply/demand balancing but was sympathetic with TransCo because of the short time allotted for developing the computer system.

"Every supplier has TransCo problems," said Whelan, "but it would be wrong to criticize. The problems stem from earlier lack of recognition of the magnitude of the problem TransCo would have to manage.

"There are lots of meter sites across a broad range of suppliers, and TransCo has a difficult task making sure all the information is in place at the right time."

Eastern has built a gas supply portfolio totaling 200 million MMBTU/ year, said Whelan, of which retail customers account for one half and power generation and wholesale gas supply the other half.

Eastern claims 15,000 customers in the gas markets, across 20,000 sites, of which about 5,000 are residential customers in the pilot scheme.

Whelan said the company will apply for supply licenses as new areas are opened to competition and will be keen to persuade a large proportion of its electricity customers in eastern England to buy gas, too.

"Size is important in residential gas supply," said Whelan. "We wouldn't want to supply a few thousand homes; we need a substantial number of customers so we can bring economies of scale."

Industrial sector

An Ofgas official told OGJ major petroleum companies have taken a substantial share of the industrial and commercial gas supply market.

The new gas shippers and suppliers have formed an association, the Gas Forum, based in London, to act as a link between government, Ofgas, and the Gas Consumers Council and as the principal forum for steering development of the industry.

So far the forum has 33 members, of which about half are units of oil and gas companies and about one third are units of U.K. electricity generators and suppliers.

Units of companies familiar with the oil and gas industry include Amerada Hess Gas, Amoco Western Europe Gas Ltd., BP Gas Marketing Ltd., Enron Europe Ltd., Kerr-McGee Gas Ltd., Mobil Gas Marketing Ltd., Texaco Ltd., and Total Gas Marketing Ltd.

Joint ventures including oil and gas industry companies include: Kinetica Ltd. joint venture of Conoco (U.K.) Ltd. and electricity generator Powergen plc; Beacon Gas joint venture of Amoco and Seeboard; and Quadrant Gas Ltd. joint venture of Shell U.K. Ltd. and Esso U.K. plc.

BP Gas, the company set up to market all of BP's U.K. North Sea gas production, is one of the biggest players after British Gas, claiming an 11% share of the industrial and commercial sector, serving 12,000 premises throughout the U.K.

BP Gas says its sales to commercial, industrial and power markets total 170 million MMBTU/year, while BP produces about 1.05 bcfd of gas, or about 13% of total U.K. supply.

BP's entry to the liberalized gas market was as a 50% interest holder in Alliance Gas Ltd. with partners Statoil (U.K.) Ltd. 40% and Norsk Hydro AS 10%.

Earlier this year the partners split the company, with BP forming BP Gas, Statoil taking over Alliance Gas, and Hydro pulling out of U.K. gas supply (OGJ, May 27, p. 28).

Quinn said the demerger came about because the objectives of the partners had changed since the inception of Alliance Gas in 1992.

"BP increasingly saw a need to work with its own portfolio of equity gas," said Quinn, "and have the freedom to market it how it sees fit. BP Gas is looking for continental sales and to power generation. We will sell our 10% share of the Interconnector volumes without any trouble."

BP and Statoil split the old Alliance's customers between them equally, with the aid of an outside consultant. The division took place in 10 weeks beginning Aug. 1 and involved replication of computer systems and training of new staff.

Power generation

Liberalization of electricity and gas markets has led to plans for 12 new gas-fired power stations, with generating capacity of 6.5 million kw filed since March.

Generating capacity of England and Wales, where the proposed U.K. plants would be sited, amounts to 60 million kw. A further 10 million kw of electric power demand is expected to be added by April 1997.

Much of the new capacity is expected to start up in 1998 and 1999, but there is said to be overcapacity in the system at present of 10-14 million kw, leading analysts to predict a dramatic fall in electricity prices if the proposed plants are built.

Most recently, BP Gas announced negotiations with Entergy Corp., New Orleans, over construction of a combined cycle gas turbine power plant at the Saltend, U.K., site of BP Chemicals.

The companies envisage building a three-train power station, burning as much as 150 MMcfd of gas to generate as much as 1.1 million kw of electric power. Power not used by BP would be sold to other customers.

Entergy would own and operate the £ 300 million ($450 million) power plant, while BP Gas would supply feedstock gas from its portfolio of North Sea gas fields.

Quinn said power generation is the market sector expected to grow most rapidly: "I'm not sure all project proposals announced will come to fruition-there may be too much capacity with them all-but there appears to be a lot of potential."

BP Gas plans to supply gas to some of the proposed projects and already supplies Bruce field gas to Corby power station, Miller field gas to Peterhead plant, Pickerill field gas to Killingholme plant, Andrew field gas to generator Scottish Power plc, and general portfolio gas to generate power at the Rocksavage chemicals plant of Imperial Chemical Industries plc (ICI).

"We supply some power plants," said Quinn, "but these contracts are beginning to diminish. In the domestic market we only participate in sales to British Gas. Now we are wondering how to replace this, since it represents half our U.K. market."

Whelan said Eastern supplies gas for three power stations operated by National Power plc and two operated by Powergen plc, with combined capacity to produce 6 million kw of electric power.

Eastern owns Peterborough combined cycle gas turbine (CCGT) plant, with capacity to generate 360,000 kw. It is also building a new gas-fired plant at King's Lynn, which will come into operation at yearend to bring Eastern generating capacity to 1 million kw.

"We are talking to a number of players in the CCGT business," said Whelan. "We are discussing potential projects where we would provide gas and bid for offtake of electricity.

"Eastern has full depletion contracts for some fields and small equity stakes in two gas fields, but we are not in the exploration and production business. Our emphasis is to create a lot of options, and call the right options at the right time."

Outlook

Quinn said Ofgas still lists 60 suppliers and 40 shippers in the U.K. gas market, but so far only about 10 significant have emerged.

"Whether the smaller players will stay in the market, maybe in production, we don't know," said Quinn, "but those intending to be supply companies will require more sophistication for operations such as daily supply/ demand forecasting.

"We expect to see more consolidation among market players, though it won't happen as fast as some people have predicted. There will always be a tail of small-scale players."

Quinn sees multi-utility companies as an interesting phenomenon, citing Scottish Power plc as one former electricity specialist that now processes more water supplies than anything else.

BP has its own unit, BP Energy, which takes on energy supply contracts for industrial customers. BP Energy runs customers' onsite power plants, typically burning whichever fuel is cheapest and buying electricity from the grid at times if necessary. BP Energy will become a part of BP Gas.

"BP Gas will always be biggest as a gas supplier," said Quinn, "but an increasing number of customers want an energy management service. We see potential in this area. We are beginning to have the aspects of a total energy company and have even done some oil and gas deals for interruptible customers."

Competition is driving down unit gas prices for customers, and this will become a major limiting factor in the market. Margins are said to have become small of late in the industrial and commercial sector, so conditions will favor large or innovative suppliers.

"We anticipate having a big presence long-term," said Quinn, "but BP Gas will have to be extremely competitive. We have to be ahead of the competition, so we will have to find ways to enable customers to lay off risks.

"Ultimately, we will see leaner margins, because this industry is about efficiency and costs. Over time, the money will increasingly be made in added-value products such as risk management."

Whelan of Eastern said his company offers risk-free hedges to electricity users in the retail and others sectors: "We're building the same model in the gas supply sector, because it is closely linked to the electricity business."

According to Whelan, many of the gas market players will have to analyze their positions before too long, so a shakeout is inevitable. He sees a niche for the smaller players as the market develops.

"Companies are forced in a competitive market to decide where are their core strengths," said Whelan. "One view is that four or five vertically integrated companies will emerge, but I don't believe this will happen.

"Gas will at first be treated as a commodity, but added-value opportunities will re-emerge. Different players in different positions will make their stay-or-quit decisions based on this, but being big will not mean a company is ideally placed.

"There will be a need for risk management skills in the future gas market, and some of the current players will not be comfortable with this. We foresee a variety of players, taking up a variety of positions.

"There will be room for companies like Eastern, with a well-balanced portfolio, taking good positions as they develop. The market will encourage these rather than large, integrated players."

BP Gas Marketing Ltd. Managing Director Anne Quinn

BP is concerned about the sheer dominance of British Gas in the U.K.-with 70% of the market-while another key concern is the different speed of deregulation for gas vs. electricity, creating different playing fields. Whether the smaller players will stay in the market, maybe in production, we don't know; but those intending to be supply companies will require more sophistication for operations such as daily supply/demand forecasting. We expect to see more consolidation among market players, though it won't happen as fast as some people have predicted. There will always be a tail of small-scale players.

Copyright 1996 Oil & Gas Journal. All Rights Reserved.