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Market planning at the National Coal Board
46
0024-6301/86 $3.00 + .OO Pergamon Journals Ltd.
Long Range Planning, Vol. 19, No. 3, pp. 46 to 50, 1986 Printed in Great Britain
Market Planning Coal Board
at the National
M. J. Edwards
The author describes the nature and working of the coalmarket showing how formal market planning is of secondary importance to the study of customer requirements, which is the controlling factor. The unplanned and unplannable will occur, as the author illustrates, but the experienced buyer in the commodity market is concerned with expecting the unexpected and relies, in his turn, on the substantial experience of the seller. The article is based on an address made by the author before the recent turmoil in the oil market which has only served to emphasize the problems associated with energy market planning.
with chlorine of up to 0.4 per cent, and limited supplies of up to 0.6 per cent, but are very reluctant to go above that level. If the phosphorus content in Cwm foundry coking smalls rises above 0.05 per cent the coke will be unsuitable for certain castings. Meeting the specific quality requirements of customers is therefore an essential element in commercial planning of the coal market.
30 Key Customers The U.K. Coal Market To understand how the markets for coal are planned at a commercial level, it is essential to understand the nature of the coal market and how it works in practice.
600 Coals Nobody buys ‘coal’ as such. Rather we sell some 600 named qualities, normally under contracts which specify a named coal with a standard analysis from a named pit, and we can only supply a substitute coal if the customer agrees. Although we normally sell coal on a pithead price basis, we have to take account of transport costs in selecting the best source of supply. Finally, the analyses of our coals and their suitability for particular customers vary widely. The differences are wide not only in heat content, for steam coal typically between 190 and 280 therms a tonne, but in other key factors. The following examples illustrate this. The conversion of the oil-fired power station at Kilroot in Northern Ireland, announced recently, is based on coal with high ash fusion, i.e. the temperature when the ash melts; low ash fusion would cut the electricity output substantially. The Central Electricity Board (CEGB) will accept coals The author is Commercial Director of the National Coal Board.
The market for British coal is highly concentrated: about 30 final customers buy nearly 90 per cent of what the NCB sells and if you include first buyers as well, then less than 40 buy 95 per cent. These large buyers purchase on a national basis, normally for many locations-most obviously the Generating Boards, who buy centrally for all their individual power stations; or the three cement companies for their nationwide spread of works. At the other end of the spectrum we have 25,000 consuming points in the industrial and public authority market and 6m homes use domestic coal and smokeless fuel. That end of our business is in every sense a retail operation. In round figures, we sell 80m tonnes a year to the Generating Boards, 10m to industry, 5m for metallurgical coke manufacture, 10m to domestic and anything between 4m and 8m for overseas. Our buyers, except the domestic consumer and small industrial users buying for space heating only, do not consume our coal in a literal sense; they all use it to produce something else that they in turn have to sell. Most conspicuous are the Generating Boards who are essentially fuel processors.
Competitive
Pricing
About 95 per cent of the U.K. coal market is supplied by the NCB or with coal which the NCB licenses. Our main marketing priority is to avoid the down-side risk of loss of this very high market share, and here competitive pricing is crucial. There is no
Market Planning at the National Coal Board Government control over coal imports and U.K. coal consumers are entirely capable of buying bulk minerals like coal from overseas. It is our job to persuade them that they are better off buying British. We do this by offering a special combination of quality and convenience in coal supplies, backed up by an in-depth service on combustion technology, and a willingness to respond to major shifts in international coal prices delivered to Western Europe. A great part of our sales are broadly aligned to international coal prices delivered U.K. We believe that we will need to continue this policy of broad price alignment, but international prices are difficult to predict, not only because of currency movements, but also because of fluctuations in world coal trade. Most coal worldwide is burnt close to where it is mined. Only about 3 per cent of steam coal is traded internationally; the reverse of oil. The home economy in the coal producing countries is vital. Total imports of steam coal into Western Europe are only 10 per cent of what is burnt by the U.S. power utilities. As home economies breathe in and out, so more or less coal becomes available. Both the leading producers of international coal and the leading importers are developed countries and share the same economic circumstances. More coal therefore becomes available on the international market as consumption falls and vice versa. Add to this, the special riddle of the coal market-stock appraisal. Stock is perceived as winter weeks consumption. If consumption forecasts are reduced, no buyer wants too much cash tied up in stocks but if forecasts are raised, Boards of Management panic about security. Therefore, three major influences work in unison and the result is the violent swings in the international coal market as perceived in Rotterdam on both volume and price. In addition to competing with internationally traded coal to maintain our share of the U.K. coal market, we also operate in a competitive U.K. energy market. Our dominance in the U.K. coal market and statutory monopoly of coal production does not shield us from competition. Therefore coal has to compete with oil which, although sold at prices determined by high international prices, is still strongly entrenched in the industrial market. We compete also with a strong natural gas industry, and a relatively weak nuclear industry which nevertheless has strong political backing for its promises to do better.
Plans as Political Commitments Against this background, planning our market involves researching our customers in great depth. Given that a small number of customers can exercise great power over our future, we cannot afford misjudgment about their prospects and intentions. On the other hand, we are averse to planning in the
47
sense of cosmic interlocking projections creating rigid guidelines to determine action. Unfortunately the coal industry has always had a high political profile and plans of this variety have often been demanded by Government, and then endowed with a finality and solidity which they did not merit. The Plan for Coal, never a robust document, is now universally criticized but for the wrong reasons. It was constructed in 1973 to show what markets could be available if the industry modernized itself, particularly in view of the likelihood of some oil price increase. This modernization was endorsed politically and economically following the OPEC increases of 1973-1974. The only serious fault was that we failed to forecast the abruptness and scale of the second oil price rise of 1979-1980 and its disastrous effects on the world and U.K. economies. To have made such a prediction of the second oil ‘shock’, however, would have required the services of an astrologer and would have been derided by every commentator and politician. Such events cannot be forecast, yet they are overwhelming in their importance. But a real virtue of NCB processes is that we did not create the Plan for Coal and then commit all the investment designed to realize it. As soon as it became obvious, as it did in 1978 with coking coal, that the forecasts would not come to pass, we altered our position. Our investment decisions are made singly over time. Our present assessments of what we need to do are based on a cautious view of the future. It is clear that we shall have to restore our profitability by means of cost reductions rather than price increases. We have now a special opportunity to get the broad level of costs once again below our proceeds by restructuring our primary capacity. Equally we have to assure our customers that we are providing to cover all their conceivable needs and can be relied upon-they do not need a strategic second source.
The Folly of Extrapolation Extrapolation seems to me the nemesis of market planning. Success in the energy business is success with timing. The decisions themselves are large in size but not intellectually difficult. All the success and failure really turns on management judgement. The forces that collide in the energy market are diverse in origin. The future movement of some is calculable but judgement about interaction can only be made close to the event and these are the key judgements for the health of the business. They are rarely 100 per cent or even 75 per cent commercial in any definition of that word. In our business, as in many commodity transactions, they are also political, budgetary on a national scale, deeply related to the perception of public opinion at the time and requiring anticipation of major international shifts in economic relationships, to be seen in its unpredictable form in the movement in exchange rates. Let me take a current example causing me concern.
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Long Range Planning Vol. 19
June 1986
We have now had 5 years when the energy intensity in the economy has been declining at a rate of about 2 per cent per annum. I have seen many analyses by the highest authorities in the forecasting of energy demand. Without exception, they extrapolate this trend and extended over another 5 years and certainly 10, it has a dramatic effect. All my instincts now lead me to believe the reverse about present forecasts. I suspect that the decline in the energy ratio in the U.K. economy is soon about to ease and my current contingency is an upside and not a downside one in this respect. So in my business, formal market planning means in practice relatively little, but study of the customer means everything. The crucial importance of judgement can be best illustrated from experience.
Extrapolating
the Demand for Coal
Firstly, two failures, going back to 1970. Oil prices did not rise until late 1973 but energy supply and demand were tightening up in 1968 and 1969. Demand in the West was outstripping the shortterm growth available from fossil fuels, principally because of the rundown in world coal. Nuclear had not got going. In the U.K., coal output was falling rapidly. With the further steep rundown of capacity after the 1967 White Paper, but with continued growth in electricity sales, coal demand suddenly outran supply. In the 2 years to early 2971 we cleared 20m tonnes of stock which had been around since the late 1950s. The reaction in the NCB at the time was unwise and led to two disastrous decisions. All commercial discounts under industrial contracts were to be withdrawn as soon as was legally possible. Alone of the major nationalized industries, the NCB had taken the decision in the late 1950s to meet competition in the market with commercially negotiated contracts and we held on to more industrial business for coal than anywhere in Western Europe. In 1970, with oil prices still low, limited industrial gas available but at low prices, the NCB suddenly changed gear to the total alarm of their industrial customers. Within 6 months irrevocable decisions were made to convert away from coal by a string of major customers. Most were two-thirds of the way through conversion when oil prices went up fourfold in 19731974. It is just those customers that we are now getting back, 15 years later. Their alarm had been caused by a basic change in our stance, more than by the money involved.
The CEGB
Counter Attack
The second disaster was to give the Generating Boards an opportunity to counter-attack. Throughout the 1960s with surplus coal and falling real costs and prices, Governments gave a strong lead that,
AGRs apart, power station investment should be directed to the lower cost British coals. The guidance given on the Longannet Complex of power station and pit was a case-that investment and others proved enormously beneficial after 1973. However, relations between the NCB and the CEGB during the 1960s were unbelievably bad. With the disappearance of the accumulated coal stocks and a happy projection of 5 per cent p.a. growth cumulative in electricity sales, the CEGB saw a golden opportunity in 1970 to reduce their dependence on coal and they obtained Government authorization to build three large oil-fired power stations, the design of which was such that they could not be switched to coal unless they were virtually rebuilt. As is the custom in electricity circles, the Scottish and the Ulster Boards had to have one of them too. The result was that six brand new oil-&d stations with a capacity of 2Om tonnes of coal equivalent were half built when oil prices rose in g973-1974. A little more tact, a little more care, could have meant that they would have been designed for both coal and oil. We would have sold more coal and the country would have saved vast sums after 1973. These were two large decisions about the management of the market which went disastrously wrong.
Extrapolating
the Demand for Steel
Next, an illustration of ‘making the best of a bad job’-BSC in 197&1980. Every year after the war, the world steel industry expanded. With it came rising demand for coking coal and as the size of blast furnaces increased, particularly in Japan, so quality standards became more exacting. It was this demand that fathered the new international coal trade. The old international coal trade died in the late 1950s. The new trade identified coal of the right quality, however remote from its market, and then used the most modem techniques of bulk haulage developed for oil to move it so that the delivered price was competitive with traditional sources. The strong demand and the need for new investment to supply it meant that coking coal had a relatively high price. Internationally in the 196Os, it was at least 50 per cent above the price of steam coal. In the U.K., the coking coal price premium was normally about 30 per cent. Our costs of producing coking coal were higher than steam coal but the higher prices produced our one consistently profitable area of business. Everywhere in the world, it was assumed that the growth in steel would be extrapolated and therefore in coking coal. We can claim to have reacted early. In 1973, BSC put forward their expansion plan and we were involved in detailed negotiations on coking coal. We just could not believe what they were
Market Planning at the National Coal Board saying and caused great concern in BSC and the Department of Industry by writing down their estimates by a third. We were wrong-it should have been two-thirds. But it was on the strength of this that BSC entered into 15 year contracts for Polish coal financed by low interest U.K. Govemment loans to help develop Polish mining capacity. After 1975, world demand for steel indeed showed signs of flagging. By 1978 it had stopped and then it fell. Coking coal prices followed. We were trapped by high U.K. inflation and the A was strong, while BSC had spent vast sums on facilities to discharge large vessels of iron ore close to its works, which could be used for imported coal. We had no alternative but to make the best of a bad job and in 1980 to align our coking coal prices fully to the international long haul level. With weak dollar prices for coking coal as a result of the world recession but with sterling then still shored up by North Sea oil, this converted a profitable part of our mining operations to a loss. We have been trying to work through the repercussions of that since. It has rendered important investment decisions worthless. The world has changed-we either fit in or close down. The total consumption of coking coal by BSC was nearly halved but we retained half of what remained and we are progressively coming auf of the loss making part of the business. The BSC story is making the best of a bad job.
Managing
the Market
Finally, two cases which can be called successful judgements on the market. The Deal with CEGB The intensely unproductive relationship between the CEGB and the NCB in the 1960s showed only a modest improvement in the 1970s. Understandably, the CEGB found it difficult to accommodate themselves to the fundamental change in the fuel market after 1973. Growth picked up again in the latter 197Os, electricity sales were high, nuclear was constrained and the only economic fuel was coal. It took one final crisis to persuade both Boards that we had to find a better way of running our mutual affairs. That was the large totally uncommercial oil price increase in 1979. We asked for a second modest coal price increase in that year, which, although totally justified by the economics of the world fuel market, caused CEGB some alarm, and made them seek some protection on future coal price movement. We judged that although our sales were high then, the fuel market in total could contract, and therefore we would need a higher share to maintain our sales. It was in our interest to obtain an underwriting of the high tonnages then being supplied by the NCB.
49
Bargains have to be struck at a moment in time and they are then subjected to the unpredictable interactions ofgreat economic forces and are judged with the total certainty of hindsight. We got an undertaking that CEGB would take 75m tonnes a year from us. In return, we underwrote price movements not greater than RPI when most commentators believed that energy prices would continue to rise rapidly in real terms. There was much criticism at the time of both parties, but, most important of all, at long last a proper commercial relationship was established between the two Boards on which it was possible to build. As demand for electricity, and for coal, fell in 1980 and 1981, the high value of sterling made imported coal look interesting and the deal came under pressure. On the other hand, only Thames-side stations can be supplied from overseas efficiently, as most of the coal burning capacity is in the centre of the country not readily accessible to imported coal. We took the view that it was in our long-term interests to meet the competition at the margin where it was real. We agreed a discount on a small tonnage within the terms of the then existing Understanding. The whole issue of coal pricing for power stations was thrashed out in the following year when the Understanding came up for formal renegotiation. We made a proposal that while recognising that the size of the transaction between the CEGB and ourselves was the largest fuel deal in the Western world, in essence it was not a uniquely British headache. Rather it was analagous to the relationship between many U.S. utilities and local pits. Here too there is a degree of practical monopoly; even if the infrastructure is there, the penalties for buying coal from mines other than those that supply or for those mines to sell their coal to other utilities are enormous and only a small amount of flexibility in practice is possible. In the free U.S. economy, a trading relationship had been worked out. The two Boards agreed on a deal which adapted this to the small economy of the U.K.; a 2-part tariff with a base tonnage whose price moved annually by rather less than RPI and a second tier price aligned to imported coal for those tonnages which in practice could be imported on the Thames where NCB coal carries by far its highest transport cost of anywhere in the U.K. This deal has withstood the most severe strain in the past 18 months because it reflects the commercial reality of the relationship. It is a relationship which is capable of adaptation in the face of the vast economic commercial and political pressures which assail the two Boards and which are in essence unpredictable. Above all, it provides a framework within which to advance our joint markets. It could be a fundamental part of a solution to the pricing of electricity for the tiny number of very large high-
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Long Range Planning Vol. 19
June 1986
load industrial consumers who now pay more for electricity in the U.K. than in the rest of Europe. The settlement of the basic commercial relationship has also enabled us to co-operate in a creative way in dealing with one of the most serious problems we both face-the immense pressure, which originated in a political accident in Germany, to control stack emissions of SO, and Nox. Existing technology, gas cleaning after combustion, costs a great deal to install and reduces efficiency. Against that present certainty, the two Boards have joined to validate what is now only a probability that pressurised fluid bed combined cycle will not only clean up the emissions but will raise the efficiency of power generation by four percentage points, say 10 per cent. This co-operation was mooted 20 years ago and failed because of the political and commercial divide between the two Boards. If it succeeds now it will be because the common nature of our business interests and our joint market have been properly identified. The Deal
with Industrial
Consumers
The second success story is the recovery of the industrial market by coal. We came to a conclusion in 1970 when, as I have described, we lost many big consumers, that we would have to get them back and more besides. To hang on with inertia on your side is one thing, to regain in the face of recent investment is quite different. We judged that only if we followed a very forward marketing policy, not selling coal but selling low cost energy to industry, would we have a chance of success. First priority was a large programme to develop new combustion technology and especially new handling and storage techniques and new control equipment. The boiler industry stopped work on coal in the late 1950s and there were no resources and no will to restart. We were driven back on our own resources. Our Research Establishment was progressively brought under commercial direction and indeed is now responsible to the commercial function of the Board. A great deal had to be learnt the hard way but eventually a creative relationship was worked out with the manufacturers. We did the basic research which the manufacturers could not afford. They did the engineering development and we came back in to do the testing and validation. The equipment was then introduced to the market by the manufacturers sales teams and our own 120 outside reps. The selling of coal is almost incidental. It is this that has brought us success where industrial coal in the U.S., essentially much lower in cost, has not been a success as indeed it has failed in most of Europe. Progress was slow after the first oil price increase, the new equipment was not complete and there was a belief that coal prices would rise to match oil and as so much money had been so recently spent on
moving to oil, no more action was really justified. We had retained part of our industrial market, and these consumers enjoyed lower running costs, but the real psychological shock came with the oil price increase of 1979. It had its sharpest effect on the biggest private energy consumer in the U.K., ICI. We finally made a deal with ICI to move them back to coal. If ICI complete all their current plans they will have committed gross capital of LlOOm on conversion to coal in a period of 5 years. The example of ICI has been followed by others: Ford, Monsanto, Unilever and so on. Most industrial coal consumers were kept supplied during the strike, and this was vital in securing customer confidence without which no supplier can hope to progress. The Notts and Midlands coalfields stood by their customers and as a direct result of this, industry will stand by them in the most practical way-by burning their coal. In the meantime, the techniques of coal burning have been progressing apace; everywhere what is on offer to industrialists has been transformed and every conversion now taking place incorporates major technology just not there 5 years ago. The key has now been found to unlock for the industrial user the cheaper therms which everyone readily accepts is in coal as distinct from any other fossil fuels. British industrial coal combustion technology now leads the world.
The Unplanned and The Unplannable Coal is a traded commodity and has to be marketed as such. Of U.K. business transactions, by far the greatest weight of money is tied up with the transfer of major commodities between organizations. Certainly product claims must be made clear, PR is vital, but the essence of these sales is to satisfy a small number of professional buyers that you can and will in fact do what you say you will do, and that they are dealing with principals of substance who are involved personally in the spirit of a transaction. If the transaction is competently designed, then if circumstances remain broadly unchanged, no one will be greatly interested until renegotiation comes around. The experienced buyer however, will already be concerned about what could happen if and when unexpected difficulties arise. Boards of Directors then become agitated and the buyer will seek to make additions or alterations which are not provided for in the letter of agreement but which he believes are necessary to bring it in line with the spirit of the original transaction. Therefore, if he is an experienced buyer, his judgment right at the start of negotiations will have been determined by whether he views the seller as a principal of substance and more particularly, a principal who is sufficiently close to the vital parts of the supply organization to make things happen when the unplanned and the unplannable occur.
0024-6301/86 $3.00 + .OO Pergamon Journals Ltd.
Long Range Planning, Vol. 19, No. 3, pp. 46 to 50, 1986 Printed in Great Britain
Market Planning Coal Board
at the National
M. J. Edwards
The author describes the nature and working of the coalmarket showing how formal market planning is of secondary importance to the study of customer requirements, which is the controlling factor. The unplanned and unplannable will occur, as the author illustrates, but the experienced buyer in the commodity market is concerned with expecting the unexpected and relies, in his turn, on the substantial experience of the seller. The article is based on an address made by the author before the recent turmoil in the oil market which has only served to emphasize the problems associated with energy market planning.
with chlorine of up to 0.4 per cent, and limited supplies of up to 0.6 per cent, but are very reluctant to go above that level. If the phosphorus content in Cwm foundry coking smalls rises above 0.05 per cent the coke will be unsuitable for certain castings. Meeting the specific quality requirements of customers is therefore an essential element in commercial planning of the coal market.
30 Key Customers The U.K. Coal Market To understand how the markets for coal are planned at a commercial level, it is essential to understand the nature of the coal market and how it works in practice.
600 Coals Nobody buys ‘coal’ as such. Rather we sell some 600 named qualities, normally under contracts which specify a named coal with a standard analysis from a named pit, and we can only supply a substitute coal if the customer agrees. Although we normally sell coal on a pithead price basis, we have to take account of transport costs in selecting the best source of supply. Finally, the analyses of our coals and their suitability for particular customers vary widely. The differences are wide not only in heat content, for steam coal typically between 190 and 280 therms a tonne, but in other key factors. The following examples illustrate this. The conversion of the oil-fired power station at Kilroot in Northern Ireland, announced recently, is based on coal with high ash fusion, i.e. the temperature when the ash melts; low ash fusion would cut the electricity output substantially. The Central Electricity Board (CEGB) will accept coals The author is Commercial Director of the National Coal Board.
The market for British coal is highly concentrated: about 30 final customers buy nearly 90 per cent of what the NCB sells and if you include first buyers as well, then less than 40 buy 95 per cent. These large buyers purchase on a national basis, normally for many locations-most obviously the Generating Boards, who buy centrally for all their individual power stations; or the three cement companies for their nationwide spread of works. At the other end of the spectrum we have 25,000 consuming points in the industrial and public authority market and 6m homes use domestic coal and smokeless fuel. That end of our business is in every sense a retail operation. In round figures, we sell 80m tonnes a year to the Generating Boards, 10m to industry, 5m for metallurgical coke manufacture, 10m to domestic and anything between 4m and 8m for overseas. Our buyers, except the domestic consumer and small industrial users buying for space heating only, do not consume our coal in a literal sense; they all use it to produce something else that they in turn have to sell. Most conspicuous are the Generating Boards who are essentially fuel processors.
Competitive
Pricing
About 95 per cent of the U.K. coal market is supplied by the NCB or with coal which the NCB licenses. Our main marketing priority is to avoid the down-side risk of loss of this very high market share, and here competitive pricing is crucial. There is no
Market Planning at the National Coal Board Government control over coal imports and U.K. coal consumers are entirely capable of buying bulk minerals like coal from overseas. It is our job to persuade them that they are better off buying British. We do this by offering a special combination of quality and convenience in coal supplies, backed up by an in-depth service on combustion technology, and a willingness to respond to major shifts in international coal prices delivered to Western Europe. A great part of our sales are broadly aligned to international coal prices delivered U.K. We believe that we will need to continue this policy of broad price alignment, but international prices are difficult to predict, not only because of currency movements, but also because of fluctuations in world coal trade. Most coal worldwide is burnt close to where it is mined. Only about 3 per cent of steam coal is traded internationally; the reverse of oil. The home economy in the coal producing countries is vital. Total imports of steam coal into Western Europe are only 10 per cent of what is burnt by the U.S. power utilities. As home economies breathe in and out, so more or less coal becomes available. Both the leading producers of international coal and the leading importers are developed countries and share the same economic circumstances. More coal therefore becomes available on the international market as consumption falls and vice versa. Add to this, the special riddle of the coal market-stock appraisal. Stock is perceived as winter weeks consumption. If consumption forecasts are reduced, no buyer wants too much cash tied up in stocks but if forecasts are raised, Boards of Management panic about security. Therefore, three major influences work in unison and the result is the violent swings in the international coal market as perceived in Rotterdam on both volume and price. In addition to competing with internationally traded coal to maintain our share of the U.K. coal market, we also operate in a competitive U.K. energy market. Our dominance in the U.K. coal market and statutory monopoly of coal production does not shield us from competition. Therefore coal has to compete with oil which, although sold at prices determined by high international prices, is still strongly entrenched in the industrial market. We compete also with a strong natural gas industry, and a relatively weak nuclear industry which nevertheless has strong political backing for its promises to do better.
Plans as Political Commitments Against this background, planning our market involves researching our customers in great depth. Given that a small number of customers can exercise great power over our future, we cannot afford misjudgment about their prospects and intentions. On the other hand, we are averse to planning in the
47
sense of cosmic interlocking projections creating rigid guidelines to determine action. Unfortunately the coal industry has always had a high political profile and plans of this variety have often been demanded by Government, and then endowed with a finality and solidity which they did not merit. The Plan for Coal, never a robust document, is now universally criticized but for the wrong reasons. It was constructed in 1973 to show what markets could be available if the industry modernized itself, particularly in view of the likelihood of some oil price increase. This modernization was endorsed politically and economically following the OPEC increases of 1973-1974. The only serious fault was that we failed to forecast the abruptness and scale of the second oil price rise of 1979-1980 and its disastrous effects on the world and U.K. economies. To have made such a prediction of the second oil ‘shock’, however, would have required the services of an astrologer and would have been derided by every commentator and politician. Such events cannot be forecast, yet they are overwhelming in their importance. But a real virtue of NCB processes is that we did not create the Plan for Coal and then commit all the investment designed to realize it. As soon as it became obvious, as it did in 1978 with coking coal, that the forecasts would not come to pass, we altered our position. Our investment decisions are made singly over time. Our present assessments of what we need to do are based on a cautious view of the future. It is clear that we shall have to restore our profitability by means of cost reductions rather than price increases. We have now a special opportunity to get the broad level of costs once again below our proceeds by restructuring our primary capacity. Equally we have to assure our customers that we are providing to cover all their conceivable needs and can be relied upon-they do not need a strategic second source.
The Folly of Extrapolation Extrapolation seems to me the nemesis of market planning. Success in the energy business is success with timing. The decisions themselves are large in size but not intellectually difficult. All the success and failure really turns on management judgement. The forces that collide in the energy market are diverse in origin. The future movement of some is calculable but judgement about interaction can only be made close to the event and these are the key judgements for the health of the business. They are rarely 100 per cent or even 75 per cent commercial in any definition of that word. In our business, as in many commodity transactions, they are also political, budgetary on a national scale, deeply related to the perception of public opinion at the time and requiring anticipation of major international shifts in economic relationships, to be seen in its unpredictable form in the movement in exchange rates. Let me take a current example causing me concern.
48
Long Range Planning Vol. 19
June 1986
We have now had 5 years when the energy intensity in the economy has been declining at a rate of about 2 per cent per annum. I have seen many analyses by the highest authorities in the forecasting of energy demand. Without exception, they extrapolate this trend and extended over another 5 years and certainly 10, it has a dramatic effect. All my instincts now lead me to believe the reverse about present forecasts. I suspect that the decline in the energy ratio in the U.K. economy is soon about to ease and my current contingency is an upside and not a downside one in this respect. So in my business, formal market planning means in practice relatively little, but study of the customer means everything. The crucial importance of judgement can be best illustrated from experience.
Extrapolating
the Demand for Coal
Firstly, two failures, going back to 1970. Oil prices did not rise until late 1973 but energy supply and demand were tightening up in 1968 and 1969. Demand in the West was outstripping the shortterm growth available from fossil fuels, principally because of the rundown in world coal. Nuclear had not got going. In the U.K., coal output was falling rapidly. With the further steep rundown of capacity after the 1967 White Paper, but with continued growth in electricity sales, coal demand suddenly outran supply. In the 2 years to early 2971 we cleared 20m tonnes of stock which had been around since the late 1950s. The reaction in the NCB at the time was unwise and led to two disastrous decisions. All commercial discounts under industrial contracts were to be withdrawn as soon as was legally possible. Alone of the major nationalized industries, the NCB had taken the decision in the late 1950s to meet competition in the market with commercially negotiated contracts and we held on to more industrial business for coal than anywhere in Western Europe. In 1970, with oil prices still low, limited industrial gas available but at low prices, the NCB suddenly changed gear to the total alarm of their industrial customers. Within 6 months irrevocable decisions were made to convert away from coal by a string of major customers. Most were two-thirds of the way through conversion when oil prices went up fourfold in 19731974. It is just those customers that we are now getting back, 15 years later. Their alarm had been caused by a basic change in our stance, more than by the money involved.
The CEGB
Counter Attack
The second disaster was to give the Generating Boards an opportunity to counter-attack. Throughout the 1960s with surplus coal and falling real costs and prices, Governments gave a strong lead that,
AGRs apart, power station investment should be directed to the lower cost British coals. The guidance given on the Longannet Complex of power station and pit was a case-that investment and others proved enormously beneficial after 1973. However, relations between the NCB and the CEGB during the 1960s were unbelievably bad. With the disappearance of the accumulated coal stocks and a happy projection of 5 per cent p.a. growth cumulative in electricity sales, the CEGB saw a golden opportunity in 1970 to reduce their dependence on coal and they obtained Government authorization to build three large oil-fired power stations, the design of which was such that they could not be switched to coal unless they were virtually rebuilt. As is the custom in electricity circles, the Scottish and the Ulster Boards had to have one of them too. The result was that six brand new oil-&d stations with a capacity of 2Om tonnes of coal equivalent were half built when oil prices rose in g973-1974. A little more tact, a little more care, could have meant that they would have been designed for both coal and oil. We would have sold more coal and the country would have saved vast sums after 1973. These were two large decisions about the management of the market which went disastrously wrong.
Extrapolating
the Demand for Steel
Next, an illustration of ‘making the best of a bad job’-BSC in 197&1980. Every year after the war, the world steel industry expanded. With it came rising demand for coking coal and as the size of blast furnaces increased, particularly in Japan, so quality standards became more exacting. It was this demand that fathered the new international coal trade. The old international coal trade died in the late 1950s. The new trade identified coal of the right quality, however remote from its market, and then used the most modem techniques of bulk haulage developed for oil to move it so that the delivered price was competitive with traditional sources. The strong demand and the need for new investment to supply it meant that coking coal had a relatively high price. Internationally in the 196Os, it was at least 50 per cent above the price of steam coal. In the U.K., the coking coal price premium was normally about 30 per cent. Our costs of producing coking coal were higher than steam coal but the higher prices produced our one consistently profitable area of business. Everywhere in the world, it was assumed that the growth in steel would be extrapolated and therefore in coking coal. We can claim to have reacted early. In 1973, BSC put forward their expansion plan and we were involved in detailed negotiations on coking coal. We just could not believe what they were
Market Planning at the National Coal Board saying and caused great concern in BSC and the Department of Industry by writing down their estimates by a third. We were wrong-it should have been two-thirds. But it was on the strength of this that BSC entered into 15 year contracts for Polish coal financed by low interest U.K. Govemment loans to help develop Polish mining capacity. After 1975, world demand for steel indeed showed signs of flagging. By 1978 it had stopped and then it fell. Coking coal prices followed. We were trapped by high U.K. inflation and the A was strong, while BSC had spent vast sums on facilities to discharge large vessels of iron ore close to its works, which could be used for imported coal. We had no alternative but to make the best of a bad job and in 1980 to align our coking coal prices fully to the international long haul level. With weak dollar prices for coking coal as a result of the world recession but with sterling then still shored up by North Sea oil, this converted a profitable part of our mining operations to a loss. We have been trying to work through the repercussions of that since. It has rendered important investment decisions worthless. The world has changed-we either fit in or close down. The total consumption of coking coal by BSC was nearly halved but we retained half of what remained and we are progressively coming auf of the loss making part of the business. The BSC story is making the best of a bad job.
Managing
the Market
Finally, two cases which can be called successful judgements on the market. The Deal with CEGB The intensely unproductive relationship between the CEGB and the NCB in the 1960s showed only a modest improvement in the 1970s. Understandably, the CEGB found it difficult to accommodate themselves to the fundamental change in the fuel market after 1973. Growth picked up again in the latter 197Os, electricity sales were high, nuclear was constrained and the only economic fuel was coal. It took one final crisis to persuade both Boards that we had to find a better way of running our mutual affairs. That was the large totally uncommercial oil price increase in 1979. We asked for a second modest coal price increase in that year, which, although totally justified by the economics of the world fuel market, caused CEGB some alarm, and made them seek some protection on future coal price movement. We judged that although our sales were high then, the fuel market in total could contract, and therefore we would need a higher share to maintain our sales. It was in our interest to obtain an underwriting of the high tonnages then being supplied by the NCB.
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Bargains have to be struck at a moment in time and they are then subjected to the unpredictable interactions ofgreat economic forces and are judged with the total certainty of hindsight. We got an undertaking that CEGB would take 75m tonnes a year from us. In return, we underwrote price movements not greater than RPI when most commentators believed that energy prices would continue to rise rapidly in real terms. There was much criticism at the time of both parties, but, most important of all, at long last a proper commercial relationship was established between the two Boards on which it was possible to build. As demand for electricity, and for coal, fell in 1980 and 1981, the high value of sterling made imported coal look interesting and the deal came under pressure. On the other hand, only Thames-side stations can be supplied from overseas efficiently, as most of the coal burning capacity is in the centre of the country not readily accessible to imported coal. We took the view that it was in our long-term interests to meet the competition at the margin where it was real. We agreed a discount on a small tonnage within the terms of the then existing Understanding. The whole issue of coal pricing for power stations was thrashed out in the following year when the Understanding came up for formal renegotiation. We made a proposal that while recognising that the size of the transaction between the CEGB and ourselves was the largest fuel deal in the Western world, in essence it was not a uniquely British headache. Rather it was analagous to the relationship between many U.S. utilities and local pits. Here too there is a degree of practical monopoly; even if the infrastructure is there, the penalties for buying coal from mines other than those that supply or for those mines to sell their coal to other utilities are enormous and only a small amount of flexibility in practice is possible. In the free U.S. economy, a trading relationship had been worked out. The two Boards agreed on a deal which adapted this to the small economy of the U.K.; a 2-part tariff with a base tonnage whose price moved annually by rather less than RPI and a second tier price aligned to imported coal for those tonnages which in practice could be imported on the Thames where NCB coal carries by far its highest transport cost of anywhere in the U.K. This deal has withstood the most severe strain in the past 18 months because it reflects the commercial reality of the relationship. It is a relationship which is capable of adaptation in the face of the vast economic commercial and political pressures which assail the two Boards and which are in essence unpredictable. Above all, it provides a framework within which to advance our joint markets. It could be a fundamental part of a solution to the pricing of electricity for the tiny number of very large high-
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Long Range Planning Vol. 19
June 1986
load industrial consumers who now pay more for electricity in the U.K. than in the rest of Europe. The settlement of the basic commercial relationship has also enabled us to co-operate in a creative way in dealing with one of the most serious problems we both face-the immense pressure, which originated in a political accident in Germany, to control stack emissions of SO, and Nox. Existing technology, gas cleaning after combustion, costs a great deal to install and reduces efficiency. Against that present certainty, the two Boards have joined to validate what is now only a probability that pressurised fluid bed combined cycle will not only clean up the emissions but will raise the efficiency of power generation by four percentage points, say 10 per cent. This co-operation was mooted 20 years ago and failed because of the political and commercial divide between the two Boards. If it succeeds now it will be because the common nature of our business interests and our joint market have been properly identified. The Deal
with Industrial
Consumers
The second success story is the recovery of the industrial market by coal. We came to a conclusion in 1970 when, as I have described, we lost many big consumers, that we would have to get them back and more besides. To hang on with inertia on your side is one thing, to regain in the face of recent investment is quite different. We judged that only if we followed a very forward marketing policy, not selling coal but selling low cost energy to industry, would we have a chance of success. First priority was a large programme to develop new combustion technology and especially new handling and storage techniques and new control equipment. The boiler industry stopped work on coal in the late 1950s and there were no resources and no will to restart. We were driven back on our own resources. Our Research Establishment was progressively brought under commercial direction and indeed is now responsible to the commercial function of the Board. A great deal had to be learnt the hard way but eventually a creative relationship was worked out with the manufacturers. We did the basic research which the manufacturers could not afford. They did the engineering development and we came back in to do the testing and validation. The equipment was then introduced to the market by the manufacturers sales teams and our own 120 outside reps. The selling of coal is almost incidental. It is this that has brought us success where industrial coal in the U.S., essentially much lower in cost, has not been a success as indeed it has failed in most of Europe. Progress was slow after the first oil price increase, the new equipment was not complete and there was a belief that coal prices would rise to match oil and as so much money had been so recently spent on
moving to oil, no more action was really justified. We had retained part of our industrial market, and these consumers enjoyed lower running costs, but the real psychological shock came with the oil price increase of 1979. It had its sharpest effect on the biggest private energy consumer in the U.K., ICI. We finally made a deal with ICI to move them back to coal. If ICI complete all their current plans they will have committed gross capital of LlOOm on conversion to coal in a period of 5 years. The example of ICI has been followed by others: Ford, Monsanto, Unilever and so on. Most industrial coal consumers were kept supplied during the strike, and this was vital in securing customer confidence without which no supplier can hope to progress. The Notts and Midlands coalfields stood by their customers and as a direct result of this, industry will stand by them in the most practical way-by burning their coal. In the meantime, the techniques of coal burning have been progressing apace; everywhere what is on offer to industrialists has been transformed and every conversion now taking place incorporates major technology just not there 5 years ago. The key has now been found to unlock for the industrial user the cheaper therms which everyone readily accepts is in coal as distinct from any other fossil fuels. British industrial coal combustion technology now leads the world.
The Unplanned and The Unplannable Coal is a traded commodity and has to be marketed as such. Of U.K. business transactions, by far the greatest weight of money is tied up with the transfer of major commodities between organizations. Certainly product claims must be made clear, PR is vital, but the essence of these sales is to satisfy a small number of professional buyers that you can and will in fact do what you say you will do, and that they are dealing with principals of substance who are involved personally in the spirit of a transaction. If the transaction is competently designed, then if circumstances remain broadly unchanged, no one will be greatly interested until renegotiation comes around. The experienced buyer however, will already be concerned about what could happen if and when unexpected difficulties arise. Boards of Directors then become agitated and the buyer will seek to make additions or alterations which are not provided for in the letter of agreement but which he believes are necessary to bring it in line with the spirit of the original transaction. Therefore, if he is an experienced buyer, his judgment right at the start of negotiations will have been determined by whether he views the seller as a principal of substance and more particularly, a principal who is sufficiently close to the vital parts of the supply organization to make things happen when the unplanned and the unplannable occur.