Will market forces be enough to ensure security of gas supply this winter and into the medium term for the UK? Or should the government introduce additional support measures to beef up storage and flexibility since the closure of its main storage facility Rough? That is the question under consideration by a government select committee following a meeting with major energy users at the end of October.
Major industrial energy users and employee organisations represented by the Gas Security Group (GSG) say consumers are facing the risk of rocketing prices again this winter because the closure of Rough and Hole House means that the UK has one of the lowest levels of gas storage relative to demand; about 2% of the UK’s annual demand compared with 25% across the EU. Also demand dynamics have changed as gas often takes over from coal as the marginal fuel and intermittent renewable power generation is growing, while production from the UK Continental Shelf, Norway and the Netherlands decline. The good news is the interconnector with Belgium has introduced some new sales channels which give shippers additional flexibility to secure capacity going forward and a slowing in Asian demand combined with high freight rates may divert some LNG cargoes back to Europe. But will this be enough to prevent sudden price spikes?
Consultants Cambridge Economic Policy Associates concluded in a study on behalf of the UK government that the country’s gas supply system is “robust” even in the event of bad weather. But the official definition of gas security takes no account of the impact of shortages on energy prices – price security is as important as physical security, says Clive Moffatt, Chairman of the GSG. “The IEA defines energy security as ‘the uninterrupted availability of energy resources at an affordable price’. The GSG believes that the UK should adopt a similar definition.”
System operator National Grid also projects that there will be sufficient gas from a variety of sources to meet demand this winter, as set out in its Winter Outlook published in October. “The strength of the UK gas supply lies in its diversity,” said spokesman David Lavender. It forecasts gas demand to be lower this winter than last year because higher prices will mean that coal-fired generation will be competitive against less efficient gas plants. Carbon allowance prices are rising but they increase costs for gas generation too, albeit not to the same extent, and they are not high enough to incentivise generators to turn off more efficient coal. And the government aims to phase out coal entirely by 2025.
So while the UK will have enough gas, with less storage it is more vulnerable to volatility and higher prices, which will prolong the viability of dirtier coal-fired generation.
“Whilst the loss of these important storage facilities in the UK has increased NBP seasonal price spreads and price volatility, it remains to be seen if there is sufficient incentive for investors to build new gas storage plants in the UK,” write Wood Mackenzie consultants in a recent report. “The extreme cold weather at the beginning of March 2018 resulted in a market side response and short-term pricing spike, however, the overall market reaction has been pretty muted considering the dramatic change.”
Gas markets are cyclical, featuring extended periods of either low or high prices as market signals are sometimes not enough to give adequate warning that new infrastructure is required in the medium term, and then supply tightens and subsequent high prices result in overbuild. It is up to the government to decide whether the closure of Rough warrants additional support mechanisms or whether to rely on the market to deliver supply security with potential price spikes.
“New storage takes years to build and to ensure we have adequate flexibility of gas supplies in the future we need action now,” Moffatt says.
But seasonal spreads are likely to remain well below the level required to incentivise storage investment, according to Wood Mackenzie, and new projects will require government intervention in the form of either financial and/or regulatory support. “This may increase costs of delivery to end consumers, however, it may also reduce the levels of volatility and price uncertainty in the wholesale market, which may result in lower average wholesale prices, which would be a benefit to consumers,” the report concludes.
The government has the option of making small changes to market rules which could improve how flexibly the market functions and how easily flexibility providers can respond to shippers’ changing needs. But here is the dilemma: if it tampers too much in response to end-user concerns, it will mute the price signals that are required for private investment.
“There were good reasons not to intervene to support storage when the government last considered this in 2013 and they remain today,” says David Stokes, Managing Director at consultants Timera Energy. “UK market price signals for new supply flex have recovered significantly in the last two years helping to support additional investment in UK supply flex into next decade. Government intervention is likely to act as a powerful long-term disincentive for private capital looking to invest in UK gas flex.”
Fortunately, the UK is linked to Europe’s more extensive storage network via two interconnectors, one with Belgium and one with the Netherlands. Brexit may complicate logistics but at the moment supply disruptions are not envisaged.
Ample storage capacity is available on the continent, which can be accessed in a cost-efficient manner via the Interconnector UK (IUK). Flows on the UK/Belgium interconnector have become more seasonal since the closure of Rough, says Sarah Cooper, Commercial Manager at IUK. By a timely coincidence, 20-year long-term capacity contracts ended this October and it is now easier for new shippers to secure transportation. Capacity can now be purchased via two allocation methods, PRISMA and implicit allocation. The PRISMA mechanism is not ideal for forward planning as shippers can buy quarterly capacity only in the current gas year. So for example, Q4 2019 cannot be secured until August 2019. A new system known as implicit allocation was launched in April, which allows more flexibility and purchasing much further in advance.
Other differences in the two systems include that the PRISMA auction is bundled, meaning the shipper also buys onward capacity with the system operator at the point of delivery, while with implicit allocation onward capacity is not included.
‘This fits more with how shippers buy gas, but some people still prefer doing it all at once,’ Sarah says. Originally only 50% of capacity was available through implicit allocation but IUK is consulting on that being increased to 75%.
Capacity will no longer be considered a sunk cost and so differentials will need to be a little higher to make transfers worthwhile. When long-term contracts expired on the UK/Netherlands interconnector BBL at the end of 2016, supplies to the UK were reduced, the National Grid report points out.
While the UK still has plenty of energy supply options, these will narrow as coal-fired generation is phased out. And although the interconnectors and LNG terminals can plug the gap, the question will be: At what price? Having capacity is not the same as having physical gas supplies, which the UK will have to compete for in an ever-hungrier gas consuming world.
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