The SPE London Section was delighted to welcome Cedric Brown as its after dinner speaker on 22 October at the Café Royal. Drawing on his experiences during a long career with British Gas and as current president of the Institution of Gas Engineers, he reviewed the restructuring of the UK gas industry and considered the benefits to consumers and stockholders. His presentation is reproduced in this article.

You have invited me to comment, amongst other matters, on what is described as the ìcurrent turmoil in the UK gas marketî. It is indeed easy for the onlooker, especially one who acquires his or her information mainly from the media, to see the industry as being very turbulent. Since November two years ago, when my salary and those of my fellow directors became something of a shock-horror sensation, we have had a hail of headline stories about the industry.

This kind of reporting is particularly unhelpful when things are happening very quickly. The audience has no chance to absorb the facts about one event before it is overtaken by another. But in fact, if you read the full story, you will see that there are logical connections. Indeed, you will see that virtually all the apparent turmoil in the industry actually stems from a single source: the governmentís programme for competition.

This is not a complaint: it is a fact. Compared with all the other major privatised utilities, British Gas has faced a higher degree of competition and a much faster timetable for its introduction. While the regional water and electricity companies kept their monopolies, the industrial and commercial gas market was quickly opened to competition. Now, less than ten years after privatisation, we have a pilot programme introducing competition to the domestic gas market as well. By 1998, all 19 million domestic customers will be free to choose their gas supplier. That is an unprecedented move anywhere in the world.

How did this happen so quickly? In the past ten years, the governmentís timescale for full competition has been dramatically foreshortened. At privatisation in 1986, ìSidî was promised up to 25 years of monopoly in domestic gas supply. In 1993, the MMC recommended that full competition should be completed by 2002 ñ which would still have been 16 years after privatisation. But a few months later, the government brought the deadline for full completion of a free market forward to 1998, with the trials beginning this year.

We can date the beginning of the upheaval in the UK gas industry pretty accurately from the Secretary of Stateís announcement in December 1993. It unleashed a massive process of change on British Gas, its employees and its customers. And many aspects of this change were unplanned, in the sense that the government had made no provisions for restructuring the market so radically. The implications of that decision have been headline news every since.

Take for example, the 28,000 jobs which have been lost at British Gas in the past three years. Job losses on such a scale are always a heavy price to pay, whatever the benefits to other stakeholders. But in the case of British Gas, they were unavoidable. It was the only way the company could cut its costs enough to survive the loss of market share which would inevitably follow the accelerated introduction of competition in the domestic markets.

Unfortunately, a huge corporate restructuring accompanied by massive job losses in the space of three years cannot be achieved without some impact on service levels. Before the reorganisation of British Gas began ñ in other words when services were provided through twelve long-established regions ñ the company was second only to Marks and Spencer in the customerís eyes.

But people dislike change which is too rapid and radical for comfort. When a company is moving very fast, its customers often donít realise how or why the goalposts have shifted, until it is too late. By then, the damage is done; the customer is upset, the switchboard is jammed, and the companyís reputation is damaged. There are never any excuses for a dissatisfied customer, and there are always lessons to be learned ñ but the fact is that, with more time, British Gas could have lessened the impact of restructuring on its customers.

Another fallout from the accelerated programme for competition are the notorious take-or-pay contracts between British Gas and the producers. As Iím sure you know, British Gas originally built up a portfolio of long-term gas purchase contracts to meet its obligations as a monopoly supplier. This in turn gave the offshore producers a secure market which underpinned their investment in developing gas fields in the North Sea. This was an excellent structure which enabled the British natural gas market to grow rapidly and become one of the most successful in the world.

However, even though competition has now been introduced, many of these long-term purchase contracts are still in place. At the same time, we have recently experienced a completely unprecedented fall in beach prices which has allowed our competitors to buy and sell gas at much lower prices. So producers are holding British Gas to high-priced, long-term purchase contracts dating back to the monopoly era, while at the same time selling gas at lower prices to their own supply arms ñ which are competing with British Gas. This problem need never have arisen if the government had thought about the implications of competition much earlier ñpreferably at, or even before, privatisation.

There have of course also been some good news stories to emerge from the restructuring. The most triumphant is the introduction of the ìnetwork codeî in advance of the domestic competition trials. The code is a completely new legal and operating framework, which makes competition possible by giving all suppliers open and equal access to the British Gas pipeline system. Developed by TransCo, which runs the national transmission network, it is an important piece of legal history for our industry, both in the UK and as a model for other countries.

Because the timescale allocated by government to commence the pilot programme was so short, the complex computer systems needed to support the network code and run the daily balancing system had to be designed, installed, tested and operational more quickly than most of us would consider wise.

We hear from the media that a small number of customers in the pilot area have been billed incorrectly in the changeover to new suppliers. That is of course not a good thing. But, given the speed with which the new systems had to be in place, there have actually been very few mishaps. In my view, the people who performed this near-miracle deserve bouquets, not brickbats.

You may also find it somewhat miraculous that in handing out those bouquets I would also give one to the regulator. The whole industry pulled together to make the network code happen, and the regulator should be credited as part of that effort. It is a pity that the same cannot be said for some other aspects of regulation in our industry.

You will of course be aware that, for the second time in four years, British Gas and Ofgas are going to the MMC, this time regarding price controls on TransCo. TransCo is the core of the UK gas industry. It is a capital-intensive business responsible for 267,000 kilometres of pipeline which make up the national gas transmission and distribution system. Ofgas has made final proposals for the price controls which dictate how much TransCo can charge for its services over the next five years. These proposals provide for substantial price reductions to the final customer. But British Gas has rejected them on the grounds that they do not allow an adequate return to shareholders.

It is not my province to comment in detail on the differences between Ofgas and British Gas. But it is important to understand that the conflict hinges on the issue of providing adequate future investment in the pipeline system. Government and regulator should consider the impact which under-investment can have in a critical infrastructure industry.

We have seen what happened in the water industry: the rate of loss from the mains after decades of inadequate investment would seem to be as high as 25 per cent. That compares with a current rate of loss from the gas mains of only one per cent. For gas, of course, any higher level of leakage would be not only economically damaging, but intolerable from a public safety point of view.

Similarly, supply shortages are not, and cannot become, a feature of the gas industry in this country. There must always be adequate gas to meet peak demand. Otherwise, pressure might fall to a level where gas could not be driven through the system, and consumersí appliances would fail.

This country has an exceptional record in gas safety, with a remarkably low level of incidents. But continuing to take money out of TransCo is, potentially, a dangerous process. There comes a point when something gives, and in the gas industry we cannot afford to be cavalier about this. Letís hope there does not have to be a tragedy before this is fully understood by government and regulator.

It is unfortunate that the nature of regulation in this country is basically adversarial. The politics of confrontation is not helpful to the gas industry, which needs stability and certainty to plan for the longer term. It is unfortunate, too, that this confrontation should set up the customerís interests against those of the shareholder, when in practice they ought to be one and the same.

In the case of TransCo, and in many other regulatory battles, British Gas is fighting not for the short-term interests of shareholders, customers, or, in an election year, the government ñ but for the companyís long-term health and growth. We are no longer in the bonanza era of the 1980s. Investing in British Gas, and regulating the UK gas industry, are serious issues for the future.

I hope that the proposed demerger of British Gas next year will serve to refocus attitudes amongst all interested parties. There will then no longer be a British Gas as we know it. Instead, there will be two companies of very different character. The two businesses have entirely different opportunities to grasp and problems to tackle, and after the demerger will be free to pursue separate strategies and aims.

One of the two proposed companies, at present known as British Gas Energy, will be focusing its resources on competing in the UK gas supply market, and particularly the market for domestic gas. The other, at present known as TransCo International, will encompass not only the UK transmission system but also British Gasís international activities and most of its exploration and production operations.

Both, in my view, have excellent prospects as independent companies. We already have encouraging evidence of this. Now that the trading arm of British Gas has worked its way through the restructuring, we are beginning to see the responsive, market-oriented culture which I for one had intended to create. Just one case in point is the companyís entry into the financial services market with the high-profile launch of the ìGoldfishî card.

For TransCo International, the opportunities for developing worldwide business are very real. They start closer to home than you might think, with the huge continental European market lying just across the Channel. The Interconnector pipeline, which will link the UK to the continental gas supply network, comes on stream in 1998 and will have the capacity to export significant volumes. Already, British Gas has signed a contract to sell around 20 billion cubic metres of gas to Wingas over ten years from that date. This is just the beginning.

Further afield, natural gas meets the prime requirements for a burgeoning world population. It will not only increase overall energy availability, but also broaden the mix of hydrocarbons, helping nations to hedge the risks of over-dependence on oil and to treat the environment with respect. Above all, gas is an affordable fuel. On the relative scale of energy costs, gas will show economies over most of its rivals. For example, a modern gas-fired power plant is cheaper to build and cheaper to run than an equivalent coal-fired plant.

There is plenty of gas available to meet this demand. Three years ago, the World Energy Councilís Commission on Energy for Tomorrowís World produced a very comprehensive study of supply and demand to the year 2020. Its estimate of 1990 natural gas reserves was 108 gigatonnes oil equivalent, compared with 137 gigatonnes of oil and a massive 606 gigatonnes of coal and lignite. This gave a reserves to production ratio ñ the likely lifetime for natural gas ñ of 56 years. However, the Commission also thought that, over time, there will actually be twice this amount of recoverable gas.

Frankly, nobody knows how long gas will last. For all practical purposes I think we can assume that, worldwide, supplies will certainly be good for 50 years which is longer than the estimates for oil. For this reason alone, natural gas is a rising star in the worldís energy portfolio, and is destined to grow proportionally faster than most other parts of the energy business.

This is why I believe that TransCo International has excellent prospects, provided that it focuses its efforts correctly. British Gas has established a tremendous worldwide reputation for its expertise along the entire gas chain, from exploration and production through power generation, national and inter-national transmission, to local distribution. But natural gas projects, upstream and down-stream, are capital intensive and require enormous investments over substantial periods of time.

The key now is to concentrate resources on developing projects which can access viable long-term markets, in regions and countries where there are attractive conditions for investment and good opportunities for sound local partnerships. As one example, in September the contract was signed which will make British Gas a key operator in the project to develop a natural gas pipeline linking Bolivian gas reserves with south-eastern Brazil. This is part of a massive project embracing every link in the gas chain, and exactly the sort of project where TransCo International can excel.

I have covered a fair amount of ground in a short time ñ from domestic gas competition trials in the south west of England to huge international pipelines in South America. But remember that the natural gas industry, like oil, is a great and global industry. If we see no further than the UK, we will see only a successful, but mature market with limited prospects for further growth. If we look beyond these shores, we will see unlimited opportunities which, as one of the worldís most experienced gas industries, Britain is in a superb position to capture.

SPE London Section : Return to home page