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Gold/Mining/Energy : Oil & Gas Exploration & Production Co.'s

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From: Ed Ajootian1/4/2008 12:07:11 PM
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UK energy prices rise in 2007, drive retail tariff rise

London (Platts)--4Jan2008
Wholesale gas and power prices in the UK have risen steadily during the
12 months since the round of retail price cuts in early 2007, an analysis of
Platts' data shows. UK utilities have pointed to rising wholesale prices as
the basis for a new round of retail price tariff hikes.

UK utility RWE Npower said Friday it would announce retail price rises
later in the day, and its fellow utility Centrica said in its trading update
in December that rising wholesale prices had squeezed margins. If high
wholesale prices continued, they would "create a more difficult environment"
in 2008, Centrica said, adding: "We will continue to monitor this with regard
to future pricing policy."

The last round of domestic price changes from UK utilities began at the
end of 2006, when Centrica announced the first price cut after several years
of price rises. Scottish and Southern followed in January, with other
utilities promising price matching or special cheaper tariffs.

Last winter UK gas and power prices had been falling steadily for several
months, partly because of two new major pipelines bringing gas from Norway and
the Netherlands. In addition to the extra supply, the UK experienced an
extremely mild winter season, lowering demand and hence price.

At the start of 2006 prompt gas prices had spiked in response to supply
problems, with day-ahead reaching as high as 187.5 pence/therm in March 2006,
and the front month contract above 100 p/th at points during the winter.

But with the new supplies online at the end of 2006, and low demand, gas
prices plummeted. Day-ahead traded below 30 p/th for almost the whole of
the first quarter of 2007. Similarly, the month-ahead contract fell steadily
from above 50 p/th at the start of winter 2006 to under 30 p/th in January
2007, usually a peak period.

UK power prices tend to track UK gas prices because the marginal power
generation supply in the country is largely gas-fired. So with gas prices
fairly low, power prices followed. And that improved utilities' margins
significantly, creating a strong rationale for price cuts.

During the course of 2007, however, the bearish wholesale trend reversed.
To some extent this was due to a rising oil price. At the start of 2007 the
dated Brent crude oil contract was at just above $50/barrel. But by July it
was up to $77/b, and on the first trading day of 2008 it hit $100/b for the
first time ever.

Gas contracts on the Continent tend to be indexed to oil products, with a
six-month delay. So the steady rise in the oil price caused a steady rise in
European gas prices over the course of the year from July onwards. With
European gas prices rising, producers could choose to send gas to the
continent in preference to the UK, so UK gas prices also rose.

Compounding matters, there were several incidents of North Sea
infrastructure problems, including the extended outage at BP's CATS pipeline.
The weather was also an important factor with the UK experiencing a fairly
mild summer and then a rash of colder-than-normal weeks towards the end of the
year, raising demand.

In July, the UK gas day-ahead price stuck close to the 30 p/th mark, up
from the sub-20 p/th level seen in April despite the summer's traditionally
lower demand. As the year wore on and the market entered the higher demand
winter period, prompt prices rose further and day-ahead traded above 50 p/th
for much of November and December, almost double the level seen in early 2007.

By the start of 2008, infrastructure problems, higher demand than
expected and the rising oil price had combined to raise market expectations of
future prices. The winter 07 contract had closed in September at 43.75 p/th.
But January 3, the winter 08 gas contract was 50% higher than this, at 61.6
p/th.

On the power side, as well as the rising gas price pushing up power
prices, nuclear plant problems added extra bullish spice. Four of British
Energy's nuclear power units, two at Hartlepool and two at its Heysham-1
plant, have been out of action since October 22 after the generator found a
wiring problem at Hartlepool-1. All the units have a similar design, and
therefore the three other units have been kept offline for further checks.

The four units together generate 2,360 MW of power and they are usually
run on a constant baseload shape, since marginal costs are relatively low
compared to gas and coal plants.

Traders said the nuclear outages brought up prompt power prices as well
as forward prices for November and December 2007, a period when demand
increases due to the colder winter weather. The average daily baseload power
price in November 2007 was GBP44/MWh, 57% higher than November 2006. In
December 2007, day-ahead power was 39% more expensive year-on-year, at an
average of GBP51/MWh.

Finally, in addition to other factors, the start of 2008 saw the onset of
the second phase of the EU's Emissions Trading Scheme. Phase 1 was
oversupplied with carbon certificates, leading to an EUA price of under 10
euro cent equivalent to 1 mt of CO2. But Phase 2 is widely expected to be
short and the current December 2008 EUA price is Eur23.50/mt CO2e. That makes
generating power using fossil fuels such as coal and gas more expensive, hence
raising power prices further.

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