Appendix 1: Full Postalised vs Irish Entry/Postalised Exit

Tariffs Regimes and the Development of Indigenous Production

Indigenous gas, for example from the Corrib field, has to compete with the price of imported gas on a delivered basis. As the delivered price of imported gas is the market price for natural gas in Ireland, indigenous gas can receive no premium over the price of imported gas. As equation (1) shows, the price of Corrib's gas at Sligo has to equal the price of imported gas at Moffat, plus the difference in transportation costs between gas from Sligo and from Moffat.

where:

P_I = price of imported gas at Moffat

P_C = price of Corrib gas at Sligo

T_I = price of transporting imported gas from Moffat to the customer

T_C = price of transporting Corrib gas from Sligo to the customer

Under a Full Postalised system the difference in transportation prices (T_I – T_C) is zero. Under the Irish Entry/Postalised Exit” proposal however, the difference in transportation prices is positive, and Corrib's gas can command a higher price. As Table A1 shows, based on charges quoted in the Bord Gais/Arthur Anderson study[1] and assuming a 100% load factor, in the year 2000 Corrib would pay 3.5p per therm in transportation costs under the Full Postalised system. By contrast, Corrib gas would pay only 2.03p per therm in transportation charges under the Irish Entry/Postalised Exit” proposal. The additional 1.47p per therm can be viewed as a tax imposed on Corrib to subsidise the interconnectors. The difference is quite a significant percentage of the current price of UK gas. On 7 March 2000, the price of gas at Bacton was 15.2p per therm. The fully postalised tariff imposes on Corrib a “tax” of almost 10% of the current UK gas price.

There are indications that this difference may be sufficient to prevent Corrib from becoming commercially viable. If under an “Irish Entry/Postalised Exit” tariff Corrib has a profit margin of 10%, the tax under the fully postalised system would completely wipe this out. Even if the Corrib field can still get developed under a Full Postalised system, the tax could significantly reduce Corrib's production.

The Full Postalised System Does Not Produce Lower Prices

Without indigenous production the Full Postalised system does not produce lower prices than the “Irish Entry/Postalised Exit system. This can be understood by considering what the tariff regimes would look like if the interconnector were the only source of gas.

Under the “Irish Entry/Postalised Exit proposal there are two separate charges. For use of the interconnector the average annual unit price should equal the cost of the interconnector divided by the volume of interconnector gas. In addition, there should be an annual average unit cost for the use of the onshore network equal to the cost of the onshore network divided by the volume of total consumption. Where the volume of gas through the interconnector is equal to total consumption - that is there is no indigenous production - these charges are exactly equal to the annual average unit cost under a Full Postalised system, as shown in equation (2).

where:

I_C = annual cost of interconnector

O_C = annual cost of onshore network

I_V = annual interconnector volumes

C_T = annual total consumption

If, however, there is indigenous natural gas production, then interconnector volumes are less than total consumption. In this case the relationship is as in equation (3):

And the interconnector volume is just some percentage less than 1, (“R”), of total consumption, so:

Equation (4) demonstrates that the only difference between annual average unit costs under a fully postalised tariff and the “Irish Entry/Postalised Exit” tariff is R, the proportion of the annual total consumption supplied by gas imported through the interconnector. Assumed indigenous volumes are entirely responsible for lowering the marginal cost of the gas passing through the interconnector under a Full Postalised tariff compared with the Irish Entry/Postalised Exit tariff.

The effect of an indigenous gas supply on prices under the alternative tariffs can be seen in Table A1 below. The Corrib field is estimated to contain 1 trillion cubic feet of gas reserves, which the Bord Gais/Arthur Anderson study assumes will be brought in over 22 years on a standard “flat” annual profile.[2] This means annual production by Corrib of 1.29 BCM or, with gas consumption in Ireland projected to climb from 4.12 BCM in 2000 to 8.26 BCM in 2010,[3] Corrib gas meeting 31% of total demand in 2000 but only 16% of total demand in 2010.

As Corrib gas becomes a smaller fraction of total gas consumption in Ireland, the Bord Gais/Arthur Anderson calculations show that the unit transportation prices under the two tariff regimes, for gas using the interconnector, begin to converge. In the year 2000 the Full Postalised unit price is 88% of the price under the “Irish Entry/Postalised Exit” proposal. By 2005 however, this ratio has risen to 92%, and by 2008 the fully postalised price is 94% of the “Irish Entry/Postalised Exit” price.