By : David Varney Chief Executive, BG Group plc. In this important and comprehensible lecture , the ex Chief Executive of BG talks about the future of the gas industry.
Good morning, ladies and gentlemen. May I add my own warm words of welcome to those of your President, James Kwan. It is indeed a pleasure for me to give this address this morning. This is particularly the case on the occasion of your first conference of the new Millennium and my last as Chief Executive of the BG Group.
Because of this I would like to use the opportunity to review some of the profound changes the gas industry worldwide has undergone while I have been at the helm of BG, and to discuss some of the forces of change that are likely to shape its future.
In doing so, I will necessarily touch upon many of the issues that this conference is going to address over the next two days. I also hope that I provide some food for thought, both for the conference and beyond.
From a BG Group perspective, we enter the new Millennium in a position of strength. Our proposed de-merger is one born out of the successful development of Transco and BG International since the British Gas de-merger in early 1997.
Both are managed as separate businesses and will benefit from single-minded focus on the growth opportunities in their different fields and markets. In doing so, both these more specialized businesses should have greater scope for acquisitions, mergers or alliances. For investors, the proposed demerger will create two investment vehicles with different risk/reward characteristics to replace the present hybrid. To reinforce their performance cultures, it will be easier to align their reward systems with the prime performance objectives.
Of course, I am a relative newcomer to the British gas industry. My origins, as you will know, are in Shell. Many of you will also be aware of Shell's tradition as a leading proponent of scenario planning.
However, at a time of intense change and technological advance, it is particularly hard to construct relevant future scenarios as a basis for decision making. Instead, I believe we are better advised to understand the forces at work today in an attempt better to envisage, and prepare for, the challenges that lie ahead. Here, we see gas industries - both in the UK, and overseas - undergoing change as never before.
What then are the forces of change and the new challenges which they are likely to pose? In my view, there is no better way of appreciating the forces of change which are reshaping the gas industry today than to consider how much has changed in the very recent past.
After nearly thirty years in the international oil industry, I joined British Gas in mid 1996, eight months prior to its demerger. Four years is next to no time in an industry which can trace its origins back some 200 years. However, it is salutary to reflect on how much has changed in my four years 'on the bridge' and to realize how quickly we can forget the way our world looked just a short time ago.
It was indeed only four years ago that British Gas plc was mired in the problems of rapid transition from its well-established monopoly regime to the fast-moving, liberalized, plural British gas industry of today. Directly stemming from this was the great 'fat cat' row, and the customer service and billing problems caused by new computer systems.
The big issue of the day was the unwinding of the company's long term take-or-pay supply contracts with the producers. Stimulated by market liberalisation and the 'dash for gas' there was a considerable surplus of gas production potential from UK waters. Gas prices were weak in an over-supplied buyers' market. As free market economists contended, balancing the liberalising market was only a question of price.
The thrust of regulatory policy was to push forward with fully opening the market to competition so that consumers would benefit from the lower prices. Shippers were optimistic that they could build profitable businesses in a very short period of time, while trading was almost non-existent.
The Regulator was the controller of the industry in Britain. On the supply side, the Interconnector was seen as the means of exporting substantial quantities of plentiful British gas to Continental Europe for years to come - and, by British Gas, as a partial solution to the stranding of its 'take-or-pay' contracts.
How different things look now. The analysis contained in Transco's latest 10-Year Statement published last autumn indicated a potential supply deficit as early as this coming winter. This compared with the 1998 projection that foresaw a surplus of supply until at least 2004/05.
Work currently in progress on this year's analysis shows no easing of the outlook of prospective supply tightness. The growth of gas demand remains buoyant in spite of the Government's soon-to-be-abandoned 'stricter consents policy' for new gas-fired power stations.
On the supply side, gas development activity remains depressed despite the sharp hike of oil prices. Beyond the Elgin/Franklin development no big new gas developments are on the stocks, and there have been no major gas discoveries to underpin new projects. Meanwhile, with oil-related gas prices in Continental European markets high, the Interconnector has come into its own as an export line.
Last winter's demand peak was well short of the '1 in 20' contingency for which the gas industry has historically been prepared, but even so there have been indications of limited peak supplies. Against this, the liberalised market has created more scope for demand-side flexibility, with interruptibility becoming a traded commodity.
In all, it seems difficult to avoid the conclusion that Britain will become a net importer of gas within the next year or two; and - barring major new gas discoveries and developments - on a steadily increasing scale thereafter.
Four years ago the overhang of surplus British gas production potential was reinforced by substantial excess supply potential from Norway and Russia.
Norway continues to do well, but what of Russia - Europe's prime source of imported gas? In spite of its huge gas reserves, Russian gas production has declined by 20 percent over the past four years.
Arguably, this is due more than anything to failing technology, lack of investment and the huge problems of transition from a command economy to a market-based economy. Vital Russian gas exports have been protected and preserved, but the longer term outlook is worrying - the more so since the big international energy companies have singularly failed to establish a successful presence in Russia, ourselves included.
Four years ago, in the midst of turbulent transition from monopoly to the liberalised British gas industry of today, we regarded the achievement of a fully open and competitive gas market as a stable and mature end state - 'the end of history'.
Now we can look back at the completion of the fully open and competitive domestic market as a huge achievement - a remarkable success story. It was a transition achieved smoothly and with preservation of the high standards of reliability and safety that are rightly taken for granted by Britain's gas customers.
Britain's highly advanced gas network now serves the diverse needs of about 60 gas shippers and suppliers and, beyond them, some 20 million consumers. Its continuous operational and commercial integrity depends on some of the largest and most complex information systems in Europe.
Transco's critical role in all this is to provide the complex interlocking array of information systems. This has, in a sense, become the essential nervous system of the liberalised, evolving, and continuously improving gas supply system. For it is information systems, as much as pipelines and compressors, that underpin the liberalised market.
But there is no sign of a stable end state - the end to further innovation and structural change - far from it. For our own part, I have already outlined the logic behind BG's latest demerger. But we can also look at Centrica, formed to provide the management skills and focus required in the deregulated world of competitively branded gas supplies to end consumers.
Here the business is no longer about the commodity but the consumer. Brand is as important - perhaps more so - as physical assets. Centrica is the archetype of the successful consumer-facing supplier of utilities, and a growing array of other services and products.
Indeed, four years ago, who would have contemplated Centrica buying the AA? Who would have foreseen the new Transco group making a substantial move into the provision of telecoms infrastructure - and seeing its stock in trade as 'world class network management'? In Britain, the utilities sector is in a turmoil of innovative change - and just at the point when web-enabled transformation promises another step change. Early harbingers of this change are new competitors offering one-stop 'e-billing' for gas, electricity and telecoms.
Four years ago when British Gas was demerging Centrica, it was still possible to regard the international gas industry as dominated by the huge and steadily growing markets of greater Europe and North America. By comparison the rest of the world was a sideshow.
No longer. The preference for gas for clean efficient power generation has opened the way to the true globalisation of the international gas industry. This has been to the great benefit of BG International with its leading capabilities in the development, management and supply of new gas industries.
Past Reflections, Future Challenges – part two:
Having given up the big and profitable Morecambe gas fields to demerged Centrica, BG inherited a miscellany of international assets which, at that time, was difficult to regard as a coherent portfolio. Now BG International is active in more than 20 countries.
But some anticipated and important aspects of change have not materialised over the past four years - at least to the extent promised. Gas market liberalisation in Continental Europe continues to be disappointingly slow. True, the European Gas Directive is now in force and in principle the way is clear for gas-to-gas competition such as we now see vigorously established in Britain.
In practice, however, monopoly instincts and behaviour die hard. Numerous practical impediments to open competition are continuing to frustrate progress. And in some countries we are seeing the flexing of union power to impede change in ways which are reminiscent of Britain in the 1970s.
Small wonder then that the European Commission is urging the British gas industry, and particularly Transco, to become the principal agent of change in the newly-formed network of European Gas Transmission System Operators. Change will come, and in all likelihood quickly, as we are seeing in the European electricity industries.
However, we are not seeing significant changes in the main upstream sources of gas imports to Europe. Here, state-owned companies continue to control supply, production, development and sales, and in future they will deal with more diverse and fragmented European gas industries.
In consequence, one of the challenges we and the other European gas industries will face is how to create the contractual conditions needed to underpin major gas import projects, whether of pipeline gas or LNG. How will the liberalised industries of Europe replace the assurance provided by the earlier long-term take-or-pay contracts with arrangements better suited to a diversity of smaller players operating on the basis of trading and short-term contracts?
What about the political dimension which has been a characteristic of the monopoly regime? Will we see consolidation and the emergence of a pan-European oligopoly to replace the old state monopolies? Europe's competition authorities will no doubt be keeping a close eye on such developments.
Here then are some of the more far-reaching - and in a good many cases, unexpected - changes which have occurred over the course of my four years at BG. As I indicated at the outset, I have no intention of making detailed forecasts. For in today's fast-moving, complex and ever more inter-connected world, that is no more than an exercise in self-delusion.
Nonetheless, I will conclude by offering a few observations on some of the more important aspects of change and challenge which are likely to confront the future leaders of the gas industry, in Britain and overseas.
The globalisation of the gas industry will continue, driven by the economic benefits of gas for power generation; its environmental attributes; and the relative success of gas exploration versus oil. The growth of world gas demand is likely to continue outstripping that for oil and coal.
Gas will have to play a critical part in bridging the period of decades between now and a much more sustainable state of human activity. The British gas industry and its suppliers have leading capabilities and experience to contribute to the continuing development of the international gas industry.
The recent hike of wholesale gas prices in the British market may well presage a structural shift from an oversupplied buyers' market, to a supply-tight sellers' market. Supply security and reliability are likely to reassert themselves in the priorities of gas consumers, and hence of their governments and regulators.
The regulatory preoccupation with driving down prices as the dominant priority may have to change to reflect new concerns about supply security for a British market increasingly dependent on gas imports in a turbulent, politically shock-prone, world. It is far from clear how this would be achieved in the current market structure. We are likely to have to look for novel solutions to this and other challenges that the new market poses.
More generally, as I have already indicated, there will be no end to structural change and innovation released by the forces of liberalisation throughout the utilities sector. Multi-utility developments are only in their earliest infancy.
Systems and networks will become ever more complex, inter-connected and interactive with the empowered consumer. Indeed, the empowered consumer, supported by internet-enabled smart energy management systems, will be the king - the main dynamic in the market. Brands, reputation and customer relationships will matter as never before.
It is also the case that, rather more rapidly than anyone might have imagined, the 'old economy' companies have either embraced, or will rapidly need to embrace, 'new economy' attributes and techniques. This is simply because if they don't, they won't survive. Internet-enabled transformation is inescapable.
Britain's new plural gas industry has, thus far, shown itself well capable of establishing a competitive and efficient supply market. It has yet to prove to itself and the public at large that it is fully capable of responding to the challenges posed by the intrinsic limitations of the liberalised industry structure.
Here, I am thinking particularly of all aspects of safety and the closely-related fields of training and continuing professional development. Nor should we forget advancing technology and the need to keep pace with the highest international standards and the related operational practices. In these vital areas, I believe our industry has the capabilities and resources, but we have yet to show the will to respond collectively and cohesively.
Thus far we have only made rather tentative, albeit encouraging, steps in respect of the issues which must be addressed by the Gas Industry Safety Group, the Gas Industry National Training Organisation and the Gas Industry Emergency Committee.
Helen Liddell's comments at your recent Awards Ceremony praising and encouraging our continued commitment to the Gas Industry Safety Group should be reminder enough that, if we do not address these issues voluntarily, we will be made to address them, and not necessarily in the manner of our choosing.
In reality, much remains to be done before the mantle previously carried by the monopoly British Gas is shared fairly and fully by the liberalised industry with its many participants. Specifically, carbon monoxide poisonings remind us all that there is still unfinished business in the need to ensure the safe use of the essential product we provide.
In this last regard, and in addressing the other aspects of change I have outlined, the need for gas industry skills and professionalism will remain as ever - hence the vital role of the IGE in underpinning the continuous innovative development of the gas industry's human capital. The gas industry's professional engineers have, over the years, shown themselves adept at confronting challenges and building a better gas industry as a result.
In the professional lives of many present here today, we have seen the advent of imports of gas to Canvey Island aboard the Methane Pioneer, the construction of the National Transmission System, and the conversion of the nation to natural gas.
If recent changes have been more market-driven and underpinned by information technology, rather than advances in engineering, then we should not overlook the continuing need for professionalism throughout the industry. The reputation of gas as a safe fuel has been developed over many decades. It behoves us all to ensure that it remains that way.
Talking of the industry's reputation, let me offer a BG perspective. One of the most difficult challenges the Company faces is to maintain the confidence and trust of gas consumers and the public at large through our reputation for operational and commercial integrity of the highest order. Unfortunately, reputation has a mercurial quality, and there can never be grounds for complacency.
We have worked hard at rebuilding the reputation of BG, and more specifically Transco. The task is never finished. For a utility which is inherently dangerous, especially when supply fails, we depend crucially on the high standards of conduct of our employees at all times.
Also, we are caught up in the changing public attitudes to risk and risk management, the latest examples of which are the perceived shortcomings of the medical profession, and the current inquiry into the circumstances of the Paddington rail crash. For BG, as for the other participants in the British gas industry, we will face the continuing challenge of responding to these concerns in a sensitive and sensible manner.
In concluding, I would like to say that it has been a unique experience and a privilege to have had the opportunity to contribute to the leadership of the British gas industry during a period of unprecedented change. It is a period in which our industry has led the rest of the world in opening new horizons.
I also believe we have laid the foundations for continuing success, always provided that we are ready to respond to the challenges which lie ahead. On a personal level, I wish the Institution of Gas Engineers well in its transformation and its continuing contribution to the success of the industry. My sincere thanks to its Presidents, past and present, and to members for their unfailing support and encouragement over the last four years.
© 2000 Mena Report (www.menareport.com)