This blog has been somewhat overtaken by events. The CER has announced a decision, which I will come to later. First, why would the two solutions proposed by CER to their deficit problem be unusually bad for our pharmaceutical factory and the employees who work there?
Well, our factory currently relies on two things to keep its energy costs competitive:
I. Real-time trading: It is very difficult to predict precisely how much gas capacity the factory requires in advance and the further ahead of real-time any prediction is made, the less accurate it will be. ‘Within-day’ capacity purchases are, as the name suggests, made very close to real time and this means that the supplier, who buys gas capacity on behalf of our factory, can make sure our business isn’t paying for more than it needs.
On the other hand, ‘day-ahead’ capacity purchases aren’t all that close to real‑time in practical terms and if our factory gets its production forecast wrong for any reason, they’ll pay a very large penalty for any additional gas capacity they use. This penalty is called an ‘overrun charge’. So, what makes sense for our factory? They’ll err on the side of caution and make sure they purchase more capacity than they expect to need – overpaying for gas capacity is not good news when your market is global and competitive.
II. Money back for unused capacity: If our factory does end up booking lots of capacity that it turns out not to need (say for example, an order is cancelled), then secondary capacity transfers provide an opportunity to recoup some of the excess cost – the business can ‘trade out’ of its position. Conversely, this arrangement provides an alternative source of gas capacity if production needs to be increased on a particular day. If another company has some spare capacity, our factory’s supplier can match this additional requirement with another company.
If secondary capacity transfers aren’t available, then any capacity booked in excess of our factory’s actual need is essentially a needless overhead. These days, most orders are ‘just in time’ and our factory doesn’t want to produce inventory for storage.
So, removing either of one of these capacity optimisation tools would be bad news for our factory. Removing both would be very bad indeed. Of course, the decision facing the Regulator isn’t quite that straightforward.
The gas network has to be paid for, so if our factory can take advantage of arrangements that will reduce the amount it pays, other customers will have to pay more. Removing the above capacity ‘flexing’ arrangements would mean that our factory would book and pay for lots more annual capacity, even if it turns out that it doesn’t need it.
But the annual product (which is booked for domestic customers and those industrial and commercial customers with steady loads) would cost less. For these latter customers, this would offset some of the pain that will be caused by the tariff deficit I mentioned last time. For example, prices for domestic customers might only need rise by 4%, rather than 7%, because some of the cost of the gas network has been shifted onto variable customers and power stations.
Anyone for more gas capacity?
So, how to decide what to do?
Well, I obviously have a view. I can see the attraction of shifting some of the pain onto customers whose tariff increases won’t be announced in the papers. However, I also worry about competitiveness and efficient network investment:
- Our pharmaceutical factory is competing against other pharmaceutical factories in other jurisdictions that purchase their gas transportation service according to a different formula. Economic regulators in other countries have split out ‘commodity’ and ‘capacity’ charges in a way that means 60% of customers’ costs are close to fixed and 40% are variable; in Ireland the proportions are 90% and 10% respectively.
Other regulators don’t care that this isn’t cost reflective because, for various reasons, they want to ensure their big gas customers can compete in the global marketplace;the logic of this perspective being that small gas customers tend to sell into the domestic market, while big gas customers are producing for global markets. Competitiveness is therefore more of an issue for big, gas-using customers.
Allowing big customers in Ireland access to products that provide some flexibility in for their purchase of gas capacity partially compensates for the advantage that companies in other countries have.
- By removing products that customers actually want to purchase, you force them to purchase more of a product that they don’t really want.
Purchasing annual gas capacity is the best option for customers who know roughly how much gas they’ll be using. These customers receive the best price because Bord Gáis Networks likes customers whose payments are predictable and the cost of the capacity they buy is spread over something close to the maximum amount of gas this amount of capacity could transport over the year. It’s not so good for customers whose consumption is more variable.
To use a fruity metaphor – the proposed changes to gas capacity arrangements mean that companies are being forced to start buying lots of apples, when they’d rather keep on buying the bananas that they used to buy. If fruit purchases were the issue, the grower would adapt production and plant more orchards to meet the increased demand for apples. But unfortunately, more orchards aren’t really required. By restricting availability of the product customers actually want, the producer ends up with a perverse signal that inevitably leads to investment in greater capacity to deliver apples that customers don’t want.
In the long run, the impact is more serious with gas pipelines than with orchards. If you have too many orchards, people tend to get cheap apples for a while (or rotten apples, if they aren’t hungry). If you have too many gas pipelines, everyone gets expensive gas.
I suppose we could make cider
On balance I believe that these two considerations, of competitiveness and efficient network investment signals, are the most important. So to fix transmission charging, I would look at changing the products on offer to reflect changing customer demand. This would have required more thought and analysis, but you would have ended up with a daily product that our big factories and power plants would actually like to buy.
I’d hoped that the CER had thought about their deficit problem in a similar way to me, but with the decision now published and real-time trading and secondary capacity transfers both removed, it appears as though they came to a very different conclusion.
Factories and certain types of power plant will struggle with these two options removed, so the customer base of the gas network will become slightly narrower (that means, some factories/power plants will close, or not open in the first place). Similarly, the information used to plan the network will be further from reality, so we may end up with gas pipelines that don’t necessarily see all that much use over their 50 or 100 year lifetime. A short term fix for a long term cost.