Entering the U.K. Upstream Gas Business: A Generator's View

Abstract

Abstract In the early 1990's, the removal of restrictions on the use of gas for power generation and the privatisation of the UK electricity supply industry prompted the rapid introduction of gas as a fuel of choice for new power plant. Much of this gas has been purchased under long term contracts with the owners of offshore gas fields or from British Gas plc. More recently the two major power generators have entered the upstream gas business directly. This paper reviews entry strategies to the upstream gas business seen from the perspective of a power generator – PowerGen plc. It begins by examining the company's rationale for moving from contracting for gas supplies to direct ownership of gas, and outlines the objectives set for entry. Alternative entry strategies are compared and contrasted, and the distinctive features of the chosen strategy are reviewed. Finally some of the key events in implementing the chosen strategy are described culminating in two recent acquisitions. Background – Rationale for Diversification PowerGen is set to become the largest user of gas in the UK. From 1996 it will have in operation some 3000 Mwe of CCGT plant, fuelled entirely by gas contracted directly with offshore producers and equivalent to more than 10% of all UK daily gas supplies. Even without further CCGT plant, these supplies will have to be replaced as the initial contracts decline. In addition, PowerGen is developing new businesses in gas transportation and marketing (Kinetica Limited – a joint venture with Conoco (UK) Limited); in combined heat and power (through PowerGen GHP Limited); and in international power generation (through PowerGen International). These businesses are likely to increase substantially the company's long run demand for gas. Whilst some of this need will continue to be met from contracted gas, there is a clear rationale for extending PowerGen's capability to direct ownership of gas: To support the core and core-related new businesses by securing gas at lower cost than direct purchase.To benefit the company's position as a purchaser by improving its understanding of contract terms and producer costs and increasing its contractual flexibility.To support the other gas consuming and trading businesses so as to add value to the core business.To allow smoothing of earnings by "hedging" gas generation earnings with gas production earnings. A key reason for pursuing this limited diversification to upstream gas is to create a source of good quality earnings from a closely related business, during a period when the core business is likely to come under increasing competitive and regulatory pressure.