Rt. Hon. Helen Liddell - Former Minister for Energy and Competitiveness in Europe (Jul 1999 - Jun 2001)

Energy Industry & Market Restructuring

Let me take up three issues:

• Oil industry mergers and acquisitions;
• Oil markets; and
• Energy Market liberalisation.

Michael Lynch has prepared an excellent background paper for which I am grateful, and it contains a useful history of how we got to where we are today. His paper points out that merged oil companies seem able to reap the rewards associated with increased size when in many other industries, the opposite has happened.

It would suggest that in the oil business, size has impact for both economic and political reasons. Much of the new non-OPEC exploration and development in West Coast Africa and China, for example, involves both high economic risks, and even higher capital costs. Very few companies are big enough to afford these, even though the rewards can be enormous. Indeed, many of the oil majors are having considerable success in most of the recently "opened" oil sectors.

However, despite this trend, I hope opportunities will remain for smaller companies to develop their specialist skills in niche markets. I have some concerns. The first is that the oil majors could squeeze out some of the innovative small companies. These are important to the industry - especially to the more mature sectors like the North Sea - because they undertake much activity that would not form part of the majors plans. In some ways, they represent the "value-added" to the oil industry.

Next, is the conundrum that the newly merged oil companies, to date, are producing less, and investing less, than they did separately before the merger. In the belief that their stock prices will fall if significant savings don't materialise, they appear to have switched their focus away from investment to cost cutting, and adopted that "just-in-time" approach to business management, that Michael Lynch mentions in his paper, that involves reduced surge capacity and lower stocks.

The outcome has been that companies have found themselves unable to respond adequately to changing demand for crude and/or petroleum products. This has contributed to increased market instability and occasional severe price reactions. And it could ultimately also jeopardise energy security, as many governments rely on the oil companies through their infrastructure to hold stocks for emergencies.

The recent sharp and substantial rise in world crude oil prices is a major concern of the United Kingdom. Prices have reached a peak that cannot be sustained. High prices pose a threat to global growth. This is in the interests of neither producers nor consumers. As producers themselves acknowledge, high oil prices have already had damaging effects on the global economy, especially in developing countries who are more dependant on oil, and therefore, more vulnerable to oil price shocks. And, in Europe, high oil prices have triggered mass protests against high petrol prices.

Over the past six months, there has been concentrated attention on the strategic importance of oil, the politics of global energy pricing and security of supply, which has been further heightened by tension in the Middle East. It is important that OPEC's commitments to continue to raise production quotas should oil prices stay high are fulfilled because, to help restore confidence in the oil market, we now need to see a period of lower, more stable prices.

The working paper produced by the OPEC Secretariat for this Forum is welcome because it recognises that. Their assessment of oil market developments over the period 2000-2010 uses a price in the range $20-23 per barrel, significantly below current levels. There will be continued debate about the sustainability of particular prices, but it is now clear that we have shared objectives in lower, more stable, oil prices.

More stability in the oil price is essential. Stability will significantly assist planning by both companies and governments. Oil companies will be helped to invest more because they can better predict their returns/profits. Oil consumers and governments benefit because oil prices then won't contribute to unpredictable surges in cost inflation, thus damaging economic growth prospects. And, those governments which rely heavily on oil revenues for budgetary purposes can plan ahead with greater confidence of meeting revenue targets.

But promoting price stability does not mean accepting price fixing, or the establishment of price bands to try to achieve greater stability. There will always be some price volatility as supply and demand take account of different global circumstances. This is unavoidable, and demonstrates that the market is functioning as it should. To help achieve greater price stability, we need to ensure that the market functions even more efficiently. There are key issues such as providing better data and improving transparency, and by reducing or removing any actions (like government intervention) which cause uncertainty and speculation. We very much hope that the discussions at this meeting, building on the recent work of the IEA, will bring early progress on this important issue. If it can improve the functioning of the oil market, we all stand to gain.

Issues relating to the oil market and energy security pose important challenges to all governments. One of the most important is the challenge to protect the global environment. It is clear that we are already emitting greenhouse gases at an unsustainable rate, and global emissions are projected to grow further. Any longer-term strategy must address this. We have begun to take steps in this, and we will need to do significantly more. But I would stress that our immediate objectives are not inconsistent. To achieve a smooth, gradual transition to lower dependence on fossil fuels we need a background of price stability, not the volatility we have experienced recently.

Governments continually face difficult decisions in a complex world. The spread of globalisation has taught us that to operate effectively in the international marketplace, we must be clear on the aims of economic policy. For the UK, this means providing a better deal for consumers through lower prices, greater choice and higher quality. We have found that the most effective way to achieve this is through competition and through diversification.

These two concepts are clearly related. Liberalisation encourages companies and countries to become more efficient and innovative, to develop environmentally friendly renewable technologies, and press other players to raise their game too. Greater efficiency should bring lower costs, and improved competitiveness, which is crucial in an increasingly global market. Many companies have accepted the challenge posed by liberalisation; those that choose not to may find it difficult to survive.

Inevitably, the process of liberalisation in the UK has generated social and environmental concerns. Some of these have been addressed, and continue to be addressed, through regulation and other policy instruments. A competitive market, within the right regulatory framework, has brought wider social benefits -with greater choice and falling prices benefiting all consumers.

We want to see these benefits in a wider arena. The process of economic reform agreed at the Lisbon EU summit last March is crucial to delivering these outcomes. We want to see gas and electricity markets opened up across Europe, as they have been in the UK, and the creation of a genuine single energy market. At present Europe's industries have to pay 30% more for their energy than those in the United States, which is a huge competitive disadvantage.

The process of diversification is already well underway, triggered in part by the 1970s oil crisis. Since then, greater emphasis has been placed on other fuels, especially gas. Energy efficiency and new technology, particularly renewables and vehicle design, are also playing a role. I am very pleased that the International Energy Agency supports diversification and, in particular, the importance of long-term policies for reducing oil dependency, improving energy efficiency, diversifying supplies and accelerating technological development.

Liberalisation and diversification can also bring significant long-term benefits to oil producing countries. Those governments which, during the 1990s, adopted a more open and liberal approach to foreign investment in the oil sector are already reaping the benefits. Increased diversification of economic activity can also provide significant long-term benefits to producing countries, by reducing their reliance on (sometimes) unstable and unpredictable commodity markets. I am sure the dual challenges of liberalisation and diversification will prove more difficult for some countries than for others. But, I am equally convinced of the political and economic benefits achievable from both.

I am not unmindful of the challenges posed to many Governments by these changes, and I don't have a monopoly on all the answers. But I hope that through discussion now, we might move our analysis along a bit further.

Other speeches by Rt. Hon. Helen Liddell - Former Minister for Energy and Competitiveness in Europe (Jul 1999 - Jun 2001)

(the following are available from the archive)
• BNES/BNIF Nuclear Congress 2000 (06/12/00)
• Launch of the 3e's Initiative (21/09/00)
• Offshore Northern Seas 2000 Conference (23/08/00)
• The Franco-British Club For Higher Education And Training In Entrepreneurship (02/12/99)
• Energy Policy Conference National Assembly (19/10/99)