Ireland in the European Court again, now over gas

The EU energy policey of competition for natural utilities is a sick joke on us all , not only is it a sick joke but also a energy disaster zone.
When you have “competition” for such natural monopolies the surplus will be extracted and spent on consumption elsewhere – the capital is not recycled , its extracted over time.

Nation state control over these areas was far more effective during the post 1970s oil crisis era – the real investments back then contributed to the 1980s oil glut – these were then privatised and progressively ran down to express false profits in the 90s & 00s
The situation is almost identical to the banking fiasco and indeed is closely linked.

@John Foody,

You pose an excellent question and it is not as off topicish as you might think. From the mid-90s (before the CER was established in 1999) until the early 2000s the ESB (and BGE) applied a price freeze. BGE did it largely on a ‘me-to’ basis, but the government intent was to squeeze revenues and profits to squeeze wage costs. And to a large extent it worked. The ESB was able to slim its workforce considerably and BGE, while not having as much fat, outsourced a lot of its activities and, for its size and range of activities became one of the most operationally efficient gas utiltities.

However, the effect of these price freezes was to boost demand – and the demand for investment in generation and networks. (There can be no doubt that some of the big IT players were attracted to Ireland by low electricity and gas prices in additional to all the other inducements.)

But the reduced cash flow (and the previous abandonment of the ESB’s double depreciation technique – a depreciation charge plus a charge to build up a sinking fund) starved the company of investment finance and a huge investment backlog built up.

The ’97-’02 government wasn’t going to invest directly, it didn’t want to take the flak from increasing prices and it had to implement the darned 1996 EU Electricity Directive which was the first step to constructing the EU’s optical illusion of a competitive electricity market.

Enter the CER. It would be ‘independent’ of government, regulate the industry and ‘keep the lights on’. The EU rules meant that the ESB’s monopoly in generation had to be reduced so it couldn’t build and operate the new egneration capacity so badly required. The CER had to sanction high prices to induce new generators to invest.

And there was a requirement for huge investment in the networks. The CER revalued the assets on a current cost basis which majicked up a value for assets that had already been depreciated. Consumers ended up paying the the full return on and the full return of all the assets (some depreciated, some partly depreciated and new assets). There was no doubt that prices needed to increase, but these two interventions by the CER drove prices probably 20% higher than they needed to be.

The bottom line is, whatever revenues the ESB wants the ESB gets. It’s hard to know if it was to cut a dash with the EU or for some other reason, but the ’02-’07 government decided to redcue the ESB’s share of generation on the isalnd to 40%. To get the ESB to consent to this they were allowed to expand their empire-building inside and outside Ireland and the CER was expected to ensure it had the cashflow to part finance this ventures.

As an example of this, at the end of 2010 when it was setting the allowed electricity network revenues for 2011-2015 and while the ESB was in the process of taking over the Northern Ireland electricity networks, the CER seemed to forget temporarily that its job was to ensure it extracted sufficient revenue from consumers to finance the ESB’s empire building. It proposed a rate of return (or Weighted Average Cost of Capital (WACC)) that the ESB deemed too low to generate the cash flow it required to finance its NI acquisition. All hell broke loose and the CER was forced to recant and award the WACC the ESB demanded.

As a former CEO of BGE once observed: “The ESB sets energy policy; the Department implements it.” It’s the CER’s job now.

And so we have consumers paying through the nose.

@Sarah Carey,

Yes, gas prices move up and down but the basic factor that keeps Irish prices relative to other EU prices is the hidden ESB and BGE financing tax to compensate for the state’s failure to finance investment directly or to arrange efficient financing.

Restructuring the ESB and BGE and privatising them would release significant proceeds that government could use to pay down debt and to finance new productive investments, would massively increase the efficiency of investment financing in these businesses and would reduce prices to final consumers (which would boost real disposable incomes and economic activity).

But we couldn’t sell the ‘family silver’ could we?

And it’s disappointing to see you swallowing the usual media line about the ESB staff. Why is it that labour is seen as the only factor of production? Why this weird ‘labour theory of costs’? Why do workers in the public or semi-state sectors need the stick, but those in the provate sector need carrots? One of the front men for the ESB Group of Unions, Brendan Ogle, has admitted they get ‘gravy’, but even if this gravy were removed it would have a negligible impact on final prices.

This a conspiracy between successive goverments, their officials, the CER, the ESB, BGE (with the tacit consent of other industry participants and quangos) to hose consumers. The workers and their unions benefit as well, but they are not driving it. And the ESB management are adept at using the Group of Unions to keep governments and the CER in line.

@Paul

Well, I began by acknowledging that gas was a factor, so labour not the “only” factor of production.

Other points:

Who says Private Sector workers only get the carrot? It entirely depends on sector and even individual company (culture, profitability) etc. I’ve worked in some companies where profit-sharing/share options are an incentive and others where one is reminded that being employed at all is a privilege.

You say there is a conspiracy. I agree! And the driving force was the government/management/union troika. Didn’t I say that? And btw, whenever I wrote about this, it wasn’t just a question of lazy FnFers buying industrial peace + votes, but the Greens were remarkably laissez faire about it too, content to rattle on about stupid expensive wind power.

I agree with Dork.

– the Irish market is too small for genuine competition in energy generation and distribution – the barriers to entry are just too great.
– we should have a state ESB BUT BUT BUT it has to be managed BY the state FOR the state and if that means Ministers showing up at board meetings demanding lower prices for consumers/industry then great. We all benefit.

As it is, we lose. You have a management under no pressure from any source, either shareholder, customer or competitor.

And Padraig and his buddies win.

200k p/a.

As a PENSION.

And down the line it goes.

But hey, it’s just a media line, right?

@Yields or Bust
In my previous post (linked above), I argue that the LNG terminal will not improve competition. It will simply crowd out the gas interconnector. Unless, of course, regulations change.

@Richard

You’re assuming Euopean and US gas prices and product are fungible – they are anything but.

The US has been a net importer of LNG for the best part of 40 years – the very recent shale gas glut is I believe a significant game changer in terms of the commodity on a world wide basis (and partly the reason why the US economy has stabalised over the past 9 months or so) because the belief is (in the US at any rate) that shale gas will be the next really big thing as new nuclear plants, windfarms, tidal projects etc in the US are being cancelled or deferred at a very impressive rate.

There really is something in them there hills and its shale gas.

To see a nuclear plant project being deferred is a really big deal – just think of the planning involved etc and yet many of them have gone this way in the US over the past year.

US Natural Gas prices are lower today than they were over a decade ago and yet European gas prices continue to track Crude Oil prices – this is very odd and an significant price arbitrage is in the offing – if the damn thing could only be shipped in enough quantity to have a market impact on this side of the Atlantic.

And that’s the problem there has been little or no export of US LNG for decades and as a result zero investment in infrastructure for export purposes over that time. So we now have the US as potentailly a really significant net exporter of LNG for years to come but no way of putting the physical product on the wider world market. Yet.

So I disagree – the driver here will not be a crowding out effect at a higher price level it will in fact (in time) be a lower commodity price full stop.

@Sarah

I’m open to correction but I had thought that LNG was not subject to excise duties and therefore comparisons with taxes in NI are really a VAT issue where I think we’re pretty close. So taxes are no doubt an issue but definately not the main one. Corrib gas will no doubt be priced off European gas prices which as noted above continues to track crude oil prices – so bully for Shell and the Govt but consumers likely to take it up the ass – Russian style.

@Sarah
I’ve not seen the commercial plans of Corrib, but I would guess that they will supply at or close to the market price. Shell will be a price follower in the spot market because the pressure in the field is too high to play quantity games.

There seems to be some confusion between LPG (Liquid Petroleum Gas) which is extracted from raw oil or gas production or produced in the oil refining process and LNG (Liquified Natural Gas) which is natural gas cooled to around -165 C when it becomes liquid, is transported on specially deisgned refrigerated ships, stored at the import point temporarily and then re-gassified and injected into transmission system for delivery the same as all other natural gas inputs to consumers.

Shannon LNG is what it says on the tin – and import, storage and re-gas facility on the Shannon estuary with a pipeline line to BGE’s transmission system.

@Sarah,

Richard is correct. Both the Shell Consortium and Shannon LNG ( if or when it come on stream) will be price-takers since the bulk price in Ireland is determined by the price at the virtual UK National Balancing Point (NBP) which is the most liquid trading hub in North West Europe.

The key issue is that the unit cost of the interconnectors is added to the bulk price ex-UK to give the irish bulk price and the Shell Consortium and Shannon LNG will set their prices up to this level. If the thoughput on the interconnectors falls (as it will when Corrib and, possibly, Shannon LNG come onstream) then the unit cost of the interconnectors must increase to generate the €50m a year that BGE is determined to get. If the throughput on the interconnectors falls significantly the Irish bulk price could go through the roof and the Shell Consortium and Shannon LNG would make massive unearned profits.

This is the hole into which our brilliant politicians, policy-makers, regulator and energy semi-states have dug themselves. Their first reaction was to seek to impose some of the €50m BGE wants on Shell and Shannon. That didn’t get very far. They’re working very hard now to come with some way they can lump this on to consumers but conceal the fact that will be paying for some unused and useless pipes.

And, Sarah, I’m not having a go. I’m just disappointed that sharp and intelligent commentators and opinion formers such as yourself find it so difficult to get your heads around the simply con that is being perpetrated. This interconnector racket is just the latest manifestation.

@Paul

We’re fine 🙂 But I won’t back down from my argument that the ESB ‘s status as neither a public utility exploited for the benefit of the state, nor a private company under normal shareholder or competitive pressure, means that they serve no master and operate within a comfort zone, And I won’t apologise for being deeply pissed off that profits that could go to the state and alleviate cutbacks are instead going to a shockingly generous pension scheme. I preach acceptance of the “adjustment” with an air of resignation/told you it would come to this/no point complaining etc but you can’t expect people to accept cutbacks while those pensions are being paid and it’s OUR MONEY.

Anyway, back to gas, which is the purpose of the thread..

So just to clarify with Richard –

when you say

“As there is more Corrib gas or LNG in the market, the price of UK imports will inevitably rise…..”

The price rises because there will be less flowing from east to west and the annual cost of the interconnector has to be spread over a lesser flow?

and then……
“allowing Corrib and LNG to raise their prices too and gain more market share at the same time, further reducing UK imports etc.”

Corrib/LNG will be able to raise their prices because the base price is the UK price?

Butbutbut

Where on earth then does the CER come in? If the point of competition is to REDUCE prices, but the system is set so that everyone bases their prices off the UK price, how can there ever be true competition?

Sigh.

Does the IMF have a view on this mess?

Ah Sarah, surely you’ve finally seen through the Bertie-era mantra of ‘more competition and better regulation’ – or have you not 🙂

It was, and is, all an optical illusion. Do you really believe that policy and regulatory dysfunction and failure were confined exclusively to the banking and financial sector? And that everything everywhere else is hunk-dory?

Just in the energy area alone, most people have no concept of the elaborate edifice that has been constructed to sustain this optical illusion. The CER publishes hundreds of documents a year. It would be a full time job to even begin to stay on top of it. Most people’s eyes just glaze over and they’re forced to take it on trust. Which is precisely the intention. Swamp them with (partial and self-serving) information, hide things in broad daylight and they’ll lose interest. And if something in particular does annoy them, they’ll inevitably get the wrong end of the stick and we’ll be able to deflect any criticism effortlessly.

And there’s a whole industry of researchers, analysts, PR operatives, some academics and tame consultants attached to the government machine, in the quangocracy or retained by the main market participants working feverishly to sustain this optical illusion. It’s a huge gravy-train and who, lapping it up, would contemplate de-railing it by calling it as it is. Even the ESRI, by virtue of the nature of the funding of its energy research, can’t call it.

I know you’re getting het up about the pay and pensions, but don’t attack the symptoms – go for the cause of the malaise. Then the symptoms will disappear.

@Sarah,

This ‘gas problem’ is part of a bigger problem – what to do with the energy semi-states. I had a go at the bigger problem on the Reeves-Paclic privatisation thread:
http://www.irisheconomy.ie/index.php/2012/01/31/incoherent-privatisation-policy-a-cause-for-concern/#comment-233159

This ‘gas problem’ fits within this bigger problem. Let’s start with the notion of an ‘interconnector’. It is a pipeline connecting two markets where gas is traded. It doesn’t need reverse flows (even though DG ENER of the Commission is hung up on these because of its ‘virtual’ fetish and the failure to allow for these is part of the infringement proceedings it is initiating before the ECJ – which is where we came in). All the gas could flow in one direction – say, east to west – but flows would vary in response to the difference in prices in the two markets.

Ideally, traders and suppliers in both markets would book capacity on the pipeline on a long-term basis and would pay for it irrespective of the volume of gas they flowed up to their booked capacity limit. In addition, this booked capacity would be tradable so that their would be no barriers to the entry of new players or to the exit of existing players. The bookings and payments would be designed to cover the fixed costs of the pipeline and only the short run costs of moving gas would impact on suppliers and traders’ decisions as they assessed the existing or expected price differential between the markets. And, on average, the difference between the prices in both markets would be equal to the short-run (marginal) cost of moving gas between them. This is how the gas market functions in the US, so it is perfectly possible to achieve this, but it took them the best part of 100 years to get there.

The wholesale price at the notional (or virtual) Irish Balancing Point (IBP) is equal to the UK NBP price plus the full costs of transportation between the two. It is unlikely there will ever be enough liquidity at the IBP to entice traders at the UK NBP to book interconnector capacity to arbitrage the two markets and to squeeze the price differential down to the short-run costs, but every effort should be made to close the differential.

This ‘gas problem’ provides an excellent opportunity.

The first step involves reducing this €50m annual revenue requirement to, say, €45 million because the CER has overvalued the assets. (This, of course, should be done for all network assets and prices to final consumers would fall.)

For the second step, the EU has a Gas Security of Supply Directive which requires owners/operators of gas supply infrastructure to ensure that they can replace the supply of their kit falls over. The interconnectors don’t provide real security of supply becasue there is a single line to the connection on the British and they are useless if the British system falls over or there are serious upstream/off-shore supply disruptions. But it would be reasonable for Corrib and Shannon LNG to, effectively, buy insurance by booking the option on some capacity on the interconnectors. Ballpark figure might be, say, €3m a year. That means we’re down to €42m.

The next step requires some effort and calculation, but it would be necessary to form a reasonable long-term view on how much capacity would be needed on the interconnectors once Corrib and Shannon LNG came on line and pro-rating the annual revenue requirement in line with this. Just for illustration purposes let’s say this amounts to €5 million. This would also provide an estimate of the unit cost for IBP pricing purposes – and it should be lower than the current unit cost This gets us down to €37 million.

This final step leaves us with BGE looking for €37 m for unused and useless capacity. BGE, the CER and the Government would love to load this onto consumers, but the best approach would be to write the asscoiated assets off over, say, a 10 year period. Consumers would benefit eventually and BGE would have time to re-organise its finances.

Problem solved.

Apologies for the long explanation, but you did ask 🙂

PS
You could see this on a smaller scale when looking at the VRT quandary in this country.
I find it quite funny really.
The Department of Finance is freeting because consumers became more effiecent , displacing oil consumption & therefore its tax take.
The CB could not defecit spend to fill this hole created by efficiency !!

What a mad laugh.

@Sarah,

The UK NBP price is unregulated. It is transparently discovered via the interaction of supply and demand. The CER regulates the level and structure of the tariff for use of the interconnectors. So the IBP price is the unregulated UK NBP price plus whatever the CER decides to add on for the interconnectors.

When I see the difficulty a person like you seems to have getting your head around this stuff I wonder what the vast majority of consumers make of it when, if ever, they give it any consideration.

It’s not rocket science, but it has been made excessively complicated to confuse people and to compel them to take it all on trust. This is the situation when it is most dangerous for citizens, because nothing good ever comes from a situation when people are forced to take things totally on trust.

Remember the ‘world class’ bank supervision and financial regulation we enjoyed up to end-Sep 2008. We still have this ‘world class’ regulation in all other sectors. Citizens beware.

@Sarah,

You’re right about the price of the raw material used in (conventional) generation, but that is largely out of Ireland’s control. The capacity payments to generators (to recover their fixed, unavoidable, costs) and the costs of the network (which make up much of the rest of the final price to consumers) are determined by the CER. That’s where the really big rip-off is occuring.

This would be forced out in to the open if the relevant Oireachtas Cttee was able to give the Minister and his officals, special advisers and tame consultants a good ragging and if consumers had effective statutory representation in the CER’s decision-making processes. The media shouldn’t be trying to provide a forum for these conflicts; it should be reporting on them. Just think of the entertainment value. A spluttering minister or a regulator confronted with irrefutable evidence that the former was indirectly and the latter directly authorising the hosing of consumers to keep the ESB and BGE in the style to which they have become accustomed.

So should we be surprised that an Oireachtas Cttee confronting a minister resembles the ‘savaging by a dead sheep’ that Dennis Healey used to describe an attack from Goeffrey Howe or that the ‘public consultations’ on a proposed decision by the CER (or indeed any economic regulator) are so farcical as to be beyond parody.

But don’t despair. Optical illusions can never be sustained indefinitely.

@John A.,

‘“If Shannon LNG charges the same price as UK imports of gas to Ireland, then Shannon LNG cannot gain market share”.’

But if it prices up to, but not at or above, this price it should. How much below this price they must go to secure the market share they desire is for them to find out, but consumers should benefit.

The issue here is BGE’s determination to secure a secure and certain amount of annual revenue on the interconnectors regardless of how much capacity is used or useful.

I’m not sure what point you’re trying to make.

@John A,

As is so often the case on this blog I’m fully exposed, but I have no idea with whom I’m engaging, but such is life in this miserably closed and self-censoring society…

You seem to be au fait with a number of the issues, but you also seem to be operating under a couple of delusions.

I’m not sure who developed the notion of a ‘diversity premium’ but it is very helpful for what I call the Quadrumvirate (the Department, the CER, BGE and the ESB (which will also benefit if the other three get their way)).

This so-called ‘diversity premium’ is, in actual fact, a ‘lack of an Irish liquid market penalty’. If such a liquid market existed at the IBP then the difference in prices between the UK NBP and the IBP would, on average, be equal to the short-run (marginal) cost (SRMC) of increasing or decreasing gas flows on the interconnectors. But it doesn’t – and is unlikely ever to emerge – so the import price will be NBP price plus some interconnector unit cost that is higher than the SRMC.

The policy objective should be to push the interconnector unit cost as close to the SRMC as possible so that Irish consumers experience the benefits of the market arrangements being as close as possible to a single market on these islands.

Relating this unit cost (and capping it) to the actual future usage of the interconnector is probably the best sub-optimal outcome available. But this leaves BGE with a fairly big chunk of unrecovered revenue on the interconnectors. This might be reduced a little, but only a little, if the prospective new suppliers were to pay annually for an option to use intereconnector capacity if their kit were to fall over (in line with the EU gas security of supply directive).

I understand that the ESRI has previously suggested that BGE’s directly unrecoverable interconnector revenue should be loaded on the postalised exit charges. I’m not sure if they are still advocating this, though I gather they are continuing to advise the CER. I understand that Colm McCarthy, in a report for Shannon LNG, is recommending something similar, but that it should be written down progressively from 2015.

This is probably the key element of this best sub-optimal solution, because consumers are already being taxed implicitly to finance BGE network investment, they have contributed more than enough to finance and then fully recover these investments and they more than deserve the prospect of fully benefitting eventually from the supply diversity that is being offered.

BGE will simply have to have re-organise the financing of its activities as this stream of revenue declines. It might be useful for BGE to recognise that it exists to serve network users and the consumers it supplies directly. If it is pursuing, or desires to pursue, activities beyond these they should be financed independently and not rely on cross-subsidies from its network business.

You also seem to think that there is potential for supplies into Ireland from Britain that would not be priced off the UK NBP price (or on some future or foward arrangements related to the NBP price). This is extremely unlikely and for planning and policy purposes the price of supplies from Britain will be the NBP price plus whatever interconnector unit cost is decided – and this will be the IBP price.

The best way to minimise any windfall gain that Shannon LNG or the Shell Consortium might secure is to minimise the interconnector unit cost. To secure whatever market share it desires, Shannon LNG (and the Shell Consortium) will have to beat the IBP price. I just can’t see how either (or Shannon LNG in particular) would have a monopoly. They should be able to sell as much as they want but they would have to price it below the IBP price. It’s impossible to say by how much, but consumers should benefit.

@John A.,

Thank you. I think we have both been able to clarify our respective position and we may not be that far apart. However, I still have some issues with your notions of a ‘diversity premium’, ‘windfall gains’, ‘monopoly’ and a ‘level playing field’.

I think we are agreed that, for the foreseeable future, the price of imports from Britain (delivered at the virtual IBP) will be the UK NBP price plus some measure of the unit cost of transmission on the interconnectors. It doesn’t matter who’s doing the importing from Ireland or the exporting from Britain, that’s the reference price they’ll be working with. And I think we are also agreed that this unit cost of interconnector transmission should be as low as possible consistent with providing BGE appropriate and adequate compensation for the transmission services provided.

The problem that arises is that this compensation is likely to fall far short of the €50m a year to which BGE believes it is entitled. All the other issues you raise fall away at this point. I have no knoweldge whatesover of the detailed economics of the Shannon LNG project, nor of the commercial assumptions or parameters they are using. But I would be very surprised if they were not doing their economics on the basis that the IBP reference price would be UK NBP plus a ‘little’ (to cover the interconnectors). I doubt very much if they did their calculations on the basis that the government and the CER would be so determined to ensure that BGE got its €50m a year on the interconnectors that they would allow the interconnector unit cost to shoot through the roof and drive the IBP reference price up.

It is this possibility that has finally energised the Department and the CER. They want BGE to be able to recover the €50m a year, but they don’t want to drive the IBP reference price up with both the Shell Consortium and Shannon LNG capturing an unearned margin. They can’t have both. And it is highlighting the folly of building the second interconnector in the first place.

So the solution has to be comprised of relating BGE’s interconnector revenues to the services actually provided, putting a cap on the unit cost (so that the IBP reference price is more or less a small fixed margin over the UK NBP price), moving the interconnector revenues not recovered from entry charges to the exit charge and writing down over time the value of the assets not providing used or useful capacity.

Let the Shell Consortium and Shannon LNG sell whatever amount of gas they can as they price in relation to, but always below, the IBP reference price.

@BigEnd,

Good point. The hedging and forward purchasing certainly come in to it, but these, and the futures contracts, comprise the layer of commercial positioning that all market participants engage in and this layer sits on top of the NBP ‘spot’ or ‘prompt’ (day-ahead) reference price. All these contracts are related to, marked to or settled at the NBP price. I certainly have doubts about the liquidity and depth of the NBP market and about how genuinely transparent the price discovery is – and I know these doubts are shared by others, but it is a key reference price for the North West European regional gas market that comprises, in addition to the NBP, the PEG Nord in France, the Zeebruge physical hub, the Dutch Title Transfer Facility (TTF) and two virtual German hubs.

The reality is that, at the margin, if a supplier/trader in Ireland wishes to buy some gas promptly in addition to what it might have already contracted, gas is readily accessible at the NBP at the prompt price.

So we have to take that as the reference price and not worry about the commercial machinations that take place around it – as I sometimes doubt that those who claim to know what they are doing actually do and it would be futile to second guess them.

And then we get back to the key questions: how much ‘unit cost’ should be added to this to generate the IBP reference price? And how should any ‘costs’ not recovered by the application of this ‘unit cost’ be recovered, if at all?

From Radio Kerry:

7 Feb 2012
Draft proposal recommends Shannon LNG pays for gas interconnectors

A draft proposal is recommending Shannon LNG pays a tariff for gas interconnectors. The proposal is contained in a draft document from the Commission for Energy Regulation. The Commission is recommending a fixed charge for all energy companies regardless of whether they use the gas interconnectors or not and will depend on their size. The interconnectors are part of Ireland’s gas transmission network. Shannon LNG which is planning to build a 600 million euro liquefied natural gas terminal on the Tarbert Ballylongford landbank says it will not be using these interconnectors and therefore shouldn’t have to pay. However the Commission for Energy Regulation says companies not using the interconnectors will still benefit in terms of security of supply. It adds if the tariffs are not applied and new sources of gas come on stream, gas prices for consumers will rise. Shannon LNG has rejected this claim and says the proposal is contrary to EU and Irish legislation. There are fears if the tariff is applied to the company, then the north Kerry project could be in doubt. A public forum will be held by the Commission for Energy Regulation in Dublin around March 1st. The commission is also accepting submissions from the public on the draft from now until March 16th, details can be found at http://www.cer.ie