Prospects for Energy Prices

1. Prospects for Energy Prices Presented to Sustainable Energy Ireland by Dr Gareth Davies, Managing Consultant Thursday July 22nd 2004

2. Overview • recent trends in European energy prices • implications of liberalisation? • where next? • identifying the drivers of energy prices • impacts on different cost components of bills • path of cost drivers in Ireland • what does this mean for end-user prices? • competition or regulation?

3. Recent Price Trends

4. I&C Electricity Prices 2003 (£/MWh)

5. European Electricity Price Trends Large users (24GWh/yr)1 Small commercial users (50GWh/yr)

6. I&C Gas Prices 2003 (p/therm)

7. European Gas Price Trends Small commercial users (~120GWh/yr)1

8. Electricity Price Drivers

9. costs represented in the bills generation network charges retail costs broad categories of drivers market fundamentals policy requirements regulatory regime Composition of Bills

10. Wholesale Generation Costs • supply–demand balance • strong demand growth • new investment in generation • volume and mix • short-term and long-term adequacy • input fuel costs • growing reliance on gas-fired generation • the EU ETS • new trading arrangements • scope for competition? • increase in risk?

11. Generation Adequacy

12. Emissions Trading • cost of the EU ETS is influenced by • carbon intensity of generation mix • cost of carbon in traded market • structure of national allocation plans • cost pass-through is influenced by • level/form of competition • wholesale and retail levels • regulatory intervention?

13. Comparison of European Fuel Mixes (%)

14. Carbon Price 2005 (€/tCO2)

15. Retail Costs • impact of competition • positive • more choice • more efficient pricing signals • removal of cost inefficiencies • negative • higher marketing costs • more risk (and hence required return) • cost pass-through more likely (greater volatility in prices)

16. Summary • drivers for increased prices • continuing generation adequacy pressures • adverse impact of the EU ETS • uncertainty and risk introduced by new trading arrangements • drivers for lower prices (or smaller increases) • regulatory intervention? • lack of competition? • conflict between competition and competitiveness?

17. Gas Price Drivers

18. costs represented in the bills gas purchase costs balancing and storage network charges retail costs broad categories of drivers market fundamentals policy requirements regulatory regime Composition of Bills

19. Gas Purchase Costs • supply–demand balance • shift in import dependence • potential benefit of Corrib • timing • still importing at the margin • GB as marginal supply source • GB gas price drivers important

20. Gas Demand Growth

21. Current Gas Supply Position

22. GB Wholesale Gas Price Drivers (I) • supply–demand balance • expectation of ‘tighter’ GB position in short to medium term • additional anticipated infrastructure investment will ease the position in medium to long term • rising import dependence • marginal supply source • increasing use of non-EU/EEA supply sources • higher transport costs • greater supply risk  need for broad-based import infrastructure (eg, LNG, pipeline, offshore storage)

23. GB Wholesale Gas Price Drivers (II) • UK–EU gas price covariance • Bacton–Zeebrugge interconnector  price arbitrage • from net exports to net imports • gas-on-gas competition • direct impact of crude oil price increases due to predominance of long-term, indexed take-or-pay contracts in the EU NBP forward curve indicates 29–31p/therm to 2005/06

24. Increasing Import Dependence • UK import dependence rising faster than for the EU • UK import dependence to increase from 9% to 40% in the period 2004–10 • EU import dependence to increase from 43% to 49% in the same period • UK and EU increasingly bidding for the same imported gas • NBP and ZH spot prices show that • net UK exports resulted in historically lower prices compared with the EU • net UK imports are expected to give higher UK prices compared with the EU in future • if total UK import capacity (ie, pipeline, interconnector, and LNG) does not keep up with gas demand, UK price competitiveness will deteriorate dramatically (ie, UK becomes a gas ‘island’)

25. Gas Spot Market Differentials

26. Gas-on-gas Competition • EU Gas Directive1 expected to result in • greater TPA • ‘eligibility’ extended to all gas consumers by 2007 • unclear what the actual timescale for greater upstream competition is, but moving in this direction • increased competition between gas producers/ shippers expected to be further enhanced by • standard terms for transmission access • promotion of cross-border trade • main obstacle to gas-on-gas competition is high wholesale market concentration in many EU countries

27. Retailing Costs and Price–Cost Margins • retail competition may increase supply costs • greater marketing effort to gain and retain customers • higher levels of bad debt • front-loading of depreciation charges due to more aggressive adoption of IT • increased financing charges due to higher business risk • ie, a higher cost of capital • retail costs should be mitigated by efficiency gains • switching by customers to drive wholesale cost reductions

28. Summary • strong gas demand growth expected • import dependence remains • prices driven by arbitrage considerations with GB • but increasingly linked to continental prices • slow gas-on-gas competition development • GB and Ireland at extremities of the transportation network • issues for security of supply?

29. Thank you www.oxera.co.uk