Energy Prices, Fuel Poverty and Ofgem

Part of Estimates Day — [1st Allotted Day] — Vote on Account, 2009-10 — Office of Gas and Electricity Markets – in the House of Commons at 7:06 pm on 16th December 2008.

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Photo of Nick Ainger Nick Ainger Labour, Carmarthen West and South Pembrokeshire 7:06 pm, 16th December 2008

I have been involved in the oil industry since 1973, first working in it and from 1992 representing Milford Haven, the largest UK oil port. When I saw crude oil prices starting to rise in the middle of 2007, peaking at $147 a barrel in July 2008, I scratched my bald head and thought, "What on earth is going on?" Since 1973, I have seen middle east crises, the straits of Hormuz closed, the Iran-Iraq war, problems in Nigeria and hurricanes in the gulf of Mexico that have taken out significant proportions of the American refining industry. However, I have never seen the price of crude oil double, as it did between the summer of 2007 and the summer of 2008, or fall to around $40 a barrel, as it then did in the space of six months.

The effect of that has been catastrophic. We have been talking about fuel poverty and the fact that since around the beginning of 2007, 2 million more people are likely to be in fuel poverty than before. We have seen riots around the world and the beginning of a huge global downturn, the like of which the Chancellor of the Exchequer believes we have not seen for 60 years. We have seen a huge hike in energy prices, coupled with the credit crunch—I want to link the two, because I believe that they are absolutely interconnected—and now we are facing a severe downturn.

When I undertook some research in February and March on why the price of crude oil was doing what it was doing, I discovered that the US Congress was conducting exactly the same sort of investigation and taking evidence, so I have used quite a bit of that research. It appears that approximately five years ago, commodity index funds started to grow quite substantially. Between 2003 and July 2008, trade in commodity index funds in a range of commodities, not just oil, grew from $13 billion to $317 billion. Taking into account not just trading on the exchanges, but all the over-the-counter trading taking place, the Bank for International Settlements believes that there is some $9 trillion involved in commodity futures and speculation.

In the summer of 2007, when the credit crunch began, investors abandoned stocks and shares—certainly banks' stocks and shares—and sought an investment market that appeared to them to be safe and profitable. They alighted on commodity index funds for understandable reasons: these were pension funds, university endowments and the funds of insurance companies. The investors needed a safe income, and, believing that commodity index funds would provide it, they piled into them. As a result, we saw a huge growth in the market for commodity index funds. I am certain that the link exists—that the consequence of that huge influx of funds was the remarkable speculative spike that has caused so much damage.

It is interesting to learn the views of people who would be expected to know something about such matters. In April 2008, in a report, Citigroup spoke of

"A Tidal Wave of Fund Flow—Despite the economic gloom many commodity prices hit new highs in recent weeks, driven largely by investment inflows."

George Soros, who certainly knows all about these matters, said in April 2008:

"You have a generalized commodity bubble due to commodities having become an asset class that institutions use to an increasing extent."

Goldman Sachs, one of the biggest players in the commodity index funds market, said:

"Without question increased fund flow into commodities has boosted prices."

An even more famous organisation, Lehman Brothers, said:

"We have argued recently that some of the price buoyancy during Q1 reflected financial flows and investments in oil and other commodities... Our study indicated that for every $100 million in new inflows, WTI"

—this was a reference to West Texas Intermediate oil—

"prices increase by 1.6 per cent... Our conclusion for this study is that we are seeing the classic ingredients of an asset bubble."

The financiers were saying "We have now spotted what is happening. We are in an asset bubble."

At the same time, on the other side of the coin, the oil industry—certainly the Saudi energy Minister, and many other energy Ministers in OPEC—were saying "Don't blame us, guv. We do not envisage a fundamental problem between supply and demand." In fact, Members may recall that Saudi Arabia was prepared to increase its output by 500,000 barrels a day back in May and June. There was not really a problem of tight supply. I have concluded that while China and India were certainly playing a role in increasing demand, that did not justify the level of increase that we saw between the summer of 2007 and the summer of 2008.

Another factor that had an impact, according to pundits, was the fluctuation in exchange rates—the weakness of the dollar in relation to the euro, and so on. Again, that will have been a factor, but it does not account for the huge spike that we saw. That is true not only of oil but of many other commodities. Once the impact of high energy prices had had its effect on the global economy and we started to see the beginning of the downturn, the fundamentals kicked in, and we saw the collapse of not only crude oil prices but metal prices, and even food prices, as people withdrew from commodity index funds.

A number of Members have said that we will come out of the present situation, and that the days of cheap oil will never return. What we must prevent is a recurrence of what we saw in 2008. I think that the only way in which to do that is to ensure proper regulation of vital markets, not just in oil—important though that is—but in metal and other commodities. We need full transparency, not only in relation to commodities traded on the exchanges but in all the over-the-counter deals which are, in effect, unregulated and have a huge impact on the prices of commodities. We also need to return to the situation that existed probably 10 years ago, and had certainly existed since the 1930s, in which position limits were placed on those in the market.

Ten years ago, producers and suppliers of oil were the main players in the exchanges. Perhaps 60 per cent. of trading was carried out by people who had a direct impact; the other 40 per cent. was carried out by those who provided liquidity. Their trading involved speculation, but it was necessary to provide the opportunity to hedge prices on those exchanges. Now the ratio has reversed. The majority of traders do not want to buy a pork belly, a bushel of grain or a barrel of oil. They are there to make money, from their pension funds, their university endowments or their insurance companies. I believe that until we return that ratio to where it was, the risk will remain that we will face yet another speculative spike in the future, and the only way in which to deal with that is through global regulation.

I am very pleased that the Prime Minister is considering all those issues. It is clear that not just the financial sector but the commodity markets need global regulation. I understand that the United States Congress is beginning to consider the matter seriously, and we need to persuade our regulator—the Financial Services Authority, which looks after the ISAs futures market—that it should take it seriously as well. The Treasury Committee, of which I am a member, is looking at the issue, although we currently have other problems on our hands involving the banking crisis. I should like to know what my hon. and learned Friend the Minister thinks about the need for greater regulation of the commodity markets to prevent a repeat of what happened this year.

My second point relates to rural energy customers. I wrote to my hon. and learned Friend enclosing two letters forwarded to me by constituents. Both were customers of Flogas, from which they had bought liquefied petroleum gas. One of the letters, dated 1 October 2008, began

"Dear Customer

Price fix for the winter".

The first constituent was offered a guarantee that the price of his LPG would be increased by 3p per litre, but that it would be fixed until 31 March 2009. Flogas wrote a similar letter to his neighbour on 2 October offering to increase his tariff by not 3p but 5p per litre.

That suggests two things to me. First, on 1 October we had experienced nearly four months—certainly three months—of dramatic falls in the price of oil. LPG is tied directly to the price of oil: it is almost like a by-product of the refining process. Yet the company was telling its customers that despite those three or four months of dramatic falls, its price would increase and would be fixed until 31 March next year. I think that that is outrageous. It is clear that no proper market is operating in the LPG sector in rural areas. Furthermore, those two neighbours knew each other and were able to determine that they were being charged different tariffs even though they lived 100 yd apart.

My hon. and learned Friend the Minister gave me an excellent response on what is being done to try to increase competition, not only in the LPG market but in the heating oil market. Heating oil is actually kerosene; it is jet fuel, in effect. It is used to heat a very large number of rural homes that cannot get a connection to the gas main. I am certain that British Airways and other airlines have seen dramatic reductions in the price of jet fuel—that is, kerosene—recently, but I am also pretty certain that domestic users of kerosene have seen nowhere near that level of reduction.

This comes back to the suppliers. I am not talking about the relatively small businesses that deliver the kerosene. I mean the larger suppliers—the energy companies and the oil companies. I do not believe that there is genuine competition in relation to the delivery of heating oil and LPG. Many of the distribution companies that I have spoken to tell me that the price to the consumer for both those products goes up immediately when the price of crude goes up, but that there is an awfully long time lag before any reductions are passed on. That should not be the case. I can understand it happening in the gas and electricity supply markets, but not in the LPG and heating oil markets. The price should fall as quickly as it rises, if it is keeping pace with the price of crude oil. Ofgem—or perhaps the Department itself—needs to look into what can be done to achieve proper competition in the supply of heating oil and LPG in rural areas.

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