Back in the spring, weathermen noticed unusually low sea temperatures around Iceland and the Azores. This gave warning of a phenomenon known as the ‘North Atlantic Oscillation’. It has resulted in some of the harshest winters on record, including the ‘big freeze’ of 1963.
Now the Met Office has issued an amber alert, and told the London Resilience Forum to brace the capital for ice and snow. But it’s already too late for the Government to fix its shortsighted energy policy.
“If it is cold this winter I promise we are going to run out of fuel,” says Sir Digby Jones, Chief of the Confederation of British Industry. “Businesses will have to close and that means that people will lose their jobs. We are very worried.”
Why is Britain so low on gas?
From the interwar period until about 20 years ago, gas was used to provide only domestic heating. But following the privatisation of the electricity industry in the late 1980s, it became a low-cost alternative to coal for power stations. Back then, nearly 80% of our electricity was produced by coal. The remainder came from nuclear power stations. But this changed in the 1990s when there was a ‘dash for gas’.
This shift made economic sense; oil prices were falling sharply in the mid-1980s. But it also made political sense in the wake of the 1984 miners’ strike. This preference was then compounded by a growing awareness of gas’s environmental advantages. It produces fewer hazardous emissions than coal. So now, we rely on gas for 40% of our electricity today.
Our gas used to be a by-product of North Sea oil production. And when Britain had large amounts of readily available North Sea gas, it was able to produce in greater or lesser quantities to meet variations in demand. Hence there was no need for storage facilities. On the other hand, Continental European countries have always been highly dependent on foreign sources of natural gas. Worried about supply disruptions, they built up storage capacity accordingly. But Britain’s position is changing. As our gas supplies have fallen, Britain’s capacity to vary output to match demand has also diminished. Imported gas does not have the same flexibility as the UK production it has replaced. New pipelines cannot provide the winter capacity needed – double the capacity required for most of the year. Meanwhile several terminals built to receive shipments of Liquid Natural Gas (LNG) are unlikely to have any spare capacity during periods of peak demand.
In other words, Britain is beginning to look more like a European country – lacking its own domestic gas supplies – but without the storage capacity. And while the UK may have enough gas to meet demand in an average winter, we are totally unprepared for a harsh one. In its Winter Energy Outlook, published last month, The Office of Gas and Electricity Markets (OFGEM) forecast an available daily gas supply of 476 million cubic metres. This is below last year’s figure of 488mcm. And it leaves little margin over the highest recorded daily demand of 449mcm. Such has been the decline of North Sea production.
While OFGEM will not use the word ‘shortage’, it admits that even in an average winter demand can only be met “with a small amount of demand reduction from large gas users.” This means business users and in particular, electricity companies.
In an exceptional winter, OFGEM believes, we can make up the deficit by switching electricity supply away from gasfired power stations to nuclear, coal or oil-fired facilities. National Grid, the pipeline operator, has also said that in a severe winter, industrial users and power stations would have to cut back their use. And as a rule of thumb if we were to have a one-in-10 cold winter, industrial gas demand would have to be cut by 30% for up to 40 days in order to keep the system in balance and prevent power cuts to domestic users – the ‘sacred cow’ of Britain’s woefully inadequate energy politics.
Blackouts and job losses loom
So in fact, this is a shortage by any other name. And the worse the weather, the more business and industry will be made to suffer. Already, large users like the chemical industry have studied their gas supply contracts, and discovered legal clauses that require them to cut back if supplies come under pressure.
But will this be enough to keep your home heated and your hot water running? Lord Woolmer of Leeds, Chairman of the House of Lords European Union Committee, has said that too much reliance is being placed upon cutting back supplies to industrial users. And when you learn what other expert commentators are saying, the picture worsens.
The Chief Executive of major gas producer Tullow Oil says: “A lot of people think there will be a blackout this winter and next. I think there is a good chance of that happening.”
The next few weeks will show who has been complacent and who is alarmist. Because if the Meteorological Office has got it right, this country’s ability to pump enough gas could collapse in the New Year. And the situation won’t get any easier in 2007 or beyond.
Gas – now a political weapon
In less than FIVE years’ time the UK will be importing around half its gas requirement from some of the most politically unstable and potentially hostile counties around. From Algeria, to the Middle East and the Caspian Basin... by 2010/11 we will be relying on imported gas to meet half our needs. That figure is set to reach 70% in 2020. That means relying on tankers of LNG and imports from as far afield as Algeria, Russia, and Norway – all piped through unstable countries such as the Ukraine.
Moreover, the gas must be transported to Europe via long pipelines vulnerable to terrorist attack. Not only this, but Britain sits on the extreme periphery of the European gas network. So there is a real risk that in the event of a gas shortage, Britain might find it impossible to get adequate supplies.
We have already seen how key gas-producing nations may choose to exercise their political muscle in the future. In 2004, relations between the Ukraine and Russia became strained. The pro-Western opposition party led by Mr Yushchenko beat the Russian-backed incumbent Mr Yanukovych in a general election. By spring this year, the Ukraine economy was crippled by a petrol shortage.
Coincidence? While two of the Ukraine’s six refineries were closed for repairs and maintenance by their Russian owners, the Russian oil giants Lukoil, Tatneft and TNK-BP suspended their supplies to a third refinery.
Thus it appears that Russia used its energy muscle to teach a neighbour a lesson. And it worked. Although Victor Yushchenko came to power on the back of Western money and influence, he now realises on which side his bread is buttered. He knows that Brussels is not going to fast-track Ukraine’s EU membership any more. So he has switched horses in order to get back into Moscow’s good books, and appointed an ethnic Russian as his Prime Minister.
Meanwhile, do not be surprised if the UK Foreign Office rolls out the red carpet for President Putin just as it did for the Saudi oil sheiks in the 1970s.
Outbidding Britain for energy
“We are in for years of volatility,” said Roland Wessel, Chief Executive of Star Energy, when he spoke to us late last month. He runs the domestic UK energy play we’d like to recommend you buy once again today. Wessel points out that LNG supplies have already been interrupted by this autumn’s hurricanes in the Gulf of Mexico. Britain is also in competition for scarce LNG shipments with the United States, which is banking on them to fill its own energy gap as Dan Denning reported for DailyReckoning.co.uk earlier this year:
“The 16 June edition of the London Times reported that recent cargoes of LNG, originally destined for the UK, have been diverted to the US,” wrote Dan, “where the gas commands higher prices. LNG analyst Steven Smith said, ‘The mix of gas supply is changing. If America pays more and LNG is diverted, we [the UK] will be worse off.’”
To be fair, the UK Government does recognise that security of supply is a strategic issue. Last year, John Prescott overturned the decision of local planners to permit the construction of an underground gas store in salt caverns below Cheshire. But your heating, hot water and electricity supplies also face a practical problem this winter: There is no guarantee the required gas imports will be available or can be managed in the market place to balance the network on a daily basis. After all, cold weather will tend to affect most European countries at the same time. And the UK, remember, sits at the end of the pipeline.
Expect gas shortages this winter
Britain’s lack of gas storage is already hitting the bottom line for British businesses. A combination of low stocks, fears of supply disruptions, and the threat of a cold winter are, themselves, factors pushing up gas prices. Kevin Farrell, Chief Executive of the British Ceramics Federation reckons that his members are paying 50% more for their energy than two years ago. That situation will only worsen when the weather turns cold.
At present, storage capacity is dominated by the Rough facility in the Southern North Sea, operated by Centrica. But now other players are sensing the opportunity. E.On bought Scottish Power’s Byley project in Cheshire in July. And a recent stock market flyer has been AIM-listed Egdon Resources, which has a project centred under Portland on the South Coast that could be large enough to hold 1% of the UK’s annual gas consumption.
Egdon is seeking planning permission, but even after that it will take seven years to bring the total storage facility onstream. The problem? Egdon’s project also involves storing gas in underground salt caverns. So first of all, the salt must be leached out into the sea.
There are three other forms of gas storage besides salt caverns. There are gasometers or ‘cryogenic tanks’, built above ground. France stores the bulk of its gas in underground aquifers. And there are depleted hydrocarbon reservoirs, former oil or gas caves long since emptied. These have the advantage of proven reservoir integrity; they kept hold of oil or gas for many thousands of years. But they also take longer to fill and discharge gas than do salt caverns.
The UK has only 11 days’ supply!
Undoubtedly, getting more gas storage will be part of the UK’s solution. The country uses about twice as much gas in the winter as it does in the summer. So not only does it make strategic sense to store it when the weather is warm and the price is cheap, but there is also a massive arbitrage opportunity. Selling stored gas when the cold winds blow means big potential profit.
In the past three years, the spread between summer and winter gas prices has gone through the roof, up from as little as 6.5 per therm to more than 45p. This has clearly boosted the value of gas storage as a business. Before Centrica bought the giant gas storage facility at Rough near Hull in 2002, the price of one standard bundled unit of storage at the facility was 10p. The average cost of storage this year has been 37p per unit, while the price quoted for storage next year exceeds 70p, at times rising to more than a £1.
Rudimentary economics tells us that when something is in short supply the price can skyrocket if demand suddenly increases. And gas supply conditions in Britain are unbelievably tight compared to other major European economies, where gas storage is well established.
Germany, Italy and France have always had to rely on imported gas. They now have storage capacity equivalent to 20%-25% of annual consumption. But the figure for the UK is only 3.3%. That’s enough to provide just 11 days of supply if the taps are turned off at the other end of the pipeline.
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