Providing for the UK’s Energy Needs

UK Gas Market and Prices

The gas markets are currently undergoing some significant changes. The UK is becoming more dependent on imports, having for 10 years been a net exporter, and the price has been driven up by a combination of high oil prices, tight supplies in relation to demand allied to market sentiment and certain rigidities in the European market³ , all of which have led to volatility in wholesale prices at the National Balancing Point (NBP – the main trading point), where liquidity is good for short term, but poor for longer term trading.

High prices have led to a flattening of demand in recent years. During the winter of 2005-6 there was a reduction in demand for gas, as major users – especially power generators – switched to alternative fuels or curtailed production. It is likely that this will happen again during the winter of 2006-7. Looking further ahead, however, it is expected that growth in demand for gas will resume, as the retirement programme for nuclear power stations continues and large scale decommissioning of coal fired power plant occurs, on account of both age and increasing limits on environmental emissions. Within this timeframe (the next 10 – 15 years), only gas fired generation is capable of providing the bulk volumes of electricity required⁴ , while simultaneously keeping environmental emissions low, using proven technology and at an affordable cost.

Figure 19: Gas Demand by Sector 1985-2004

Imports: The market is responding to these trends and, although the UK remains and will remain a significant producer of gas for years to come, extremely large investment (c. £10 billion) in new supplies of gas from a variety of international sources is now well underway (see the table below):

• pipeline gas from Norway and Netherlands (both large exporters of gas) and mainland Europe via the Belgium – Bacton Interconnector;
• Liquid Natural Gas (LNG) from Qatar, Egypt, Algeria, Nigeria and Trinidad.

Importantly, through such diversity of supply comes security of supply.

This list of projects is also a demonstration of the value to be derived from the technology and expertise which has been developed during 40 years of oil and gas activity on north-west Europe’s continental shelf.

Figure 20: New UK Gas Import Projects

Name of Project	Target Date(s)	Capacity (bcm/year)
Langeled Pipeline (Omen Lange)	2006 & 7 (note a)	23
Bacton Interconnector Upgrading (note b)	Phase 1 complete	8
	Phase 2 2006	7
BBL Pipeline	2006 - 7	14
Isle of Grain LNG	Phase 1 complete	4
	Phase 2 2008	9
(Phase 3 under construction)	Phase 3 2010	7
Tampen Pipeline (Statfjord - FLAGS)	2007	10
South Hook LNG	Phase 1 2007 - 8	11
(Milford Haven)	Phase 2 2008 - 9	10
Dragon LNG	Phase 1 2007	6
(Milford Haven)	Phase 2 2010 - 12	6
Canvey Island LNG (Planning Submission)	2010 - 11?	5
TOTALS		83 - 210 (note c)

Notes: (a) Southern leg of pipeline (from Sleipner) on-stream in 2006, Ormen Lange field and remainder of pipeline in 2007
(b) Original import capacity of Interconnector = 8.5 bcm/year
(c) Figure of 83 applies without Canvey Island and Phases 2 and 3 of other LNG projects
Current demand in the UK is ~100 bcm/year, bcm = billion cubic metres

Therefore, it is possible that over the next few years the UK will again have a surplus of gas although, with the Bacton Interconnector’s ability to flow gas in both directions (and perhaps the BBL pipeline similarly at some future date), the market will no doubt balance supply in accordance with demand throughout an increasingly interconnected north-west Europe.

It should also be noted that none of this list of import projects directly involves Russian gas supplies, although indirectly some such gas is probably being delivered via the Bacton Interconnector today and, if the proposed North European Gas Line through the Baltic Sea comes to fruition, Russian gas is likely to gain access to the UK via the BBL.

The rise in the LNG market in recent years has introduced a new and flexible dimension to international gas trading. It is expected that LNG will see a four-fold growth in shipments worldwide between 2000 and 2020 (and five-fold by 2030), albeit from a low starting point. While the UK will have to compete for LNG with other countries in Europe and North America, it has different supply characteristics from pipeline gas which will add to security of gas supplies.

Prices: The price volatility at the NBP mentioned above is demonstrated in figure 21 below for both the prompt (day ahead) and forward markets (first quarter of each of the four years, 2005-8, shown for illustrative purposes). However, the prompt price also shows periods of significant stability, interspersed by volatility, while the forward prices generally show a rising trend as a result of the rising oil price and concerns about supply versus demand in winter. It should be noted, though, that the price for gas in the first quarter of 2008 is below that for the first quarter of 2007, reflecting the effects of the new imports. It is expected that greater stability should be restored as increasing imports of gas find their way to the UK’s market.

It should be noted, however, that gas traded through the markets accounts for about one third of the total volume sold. The remaining two thirds are sold under medium and long term wholesale contracts where prices are much more stable, although they have risen with energy prices generally. The gas sold under these medium and long term wholesale contracts is mainly used to supply domestic and smaller commercial customers.

Figure 21: UK Gas Prices 2004-06

Winter Supplies: During the winter of 2005-6, the UKCS delivered very much as predicted (which also happened in winter 2004-5) and, although there were inevitable short term variations, overall gas production was consistent (ref “beach” gas in figure 22 below). UKCS production of gas responds mainly to changes in demand, rather than changes in the prompt price. The winter of 2005-6 was colder in Britain than for 10 years, although no colder than average (other recent winters have been warmer than average). However, mainland Europe had a much colder than normal winter, with Eastern Europe experiencing an extremely cold winter. As a result, demand for gas was very high and so there was considerable pressure on supplies throughout Europe.

The prospects for the forthcoming winter, 2006-7, are similar to winter 2005-6 for Great Britain and Ireland (with the extent of inter-connection, the Irish market operates very much in tandem with GB’s). The natural decline in UKCS supplies should be matched by increasing imports from various sources.

Figure 22: UK Gas Supply Winter 2005-06

Bacton-Zeebrugge Interconnector: As expected, flows of gas through the Interconnector from Zeebrugge to Bacton have increased in recent winters to compensate for declining UKCS production (in this direction, it is known as “reverse” flow – gas flowing from Britain to Belgium is known as “forward” flow). The first stage of the Interconnector’s expansion of reverse flow capacity was completed one month ahead of schedule in early November 2005. It took some time for the market to respond to the availability of this extra capacity, but later in the winter in February and March 2006 much of the additional capacity was being used during colder than normal weather. However, it is clear that there are physical restraints in the pipelines on the continent feeding gas to Zeebrugge which will not be fully resolved before 2010 and it would appear that public service obligations in various European countries keep gas in store early in a winter in case of need later in the winter. These two factors, together with the early completion of the Interconnector’s expansion, probably explain the seemingly slow response to the increased capacity.

Figure 23: Monthly Interconnector Gas Flows 2001-06

Gas Demand: Because of its widespread use in space heating, demand for gas is driven largely by ambient temperatures, although business activity also has its influences. (For example, weekday demand is higher than at weekends; hence the saw-tooth nature of the demand curves shown in figure 24 below). Significantly, it can be seen that actual demand was below seasonal normal during the winter of 2005-6, even though it was an average winter overall. As mentioned above, high prices in the traded markets caused reductions in demand for gas mainly among power generators and, to a lesser extent, heavy industry (the day ahead price at the NBP is shown in blue shading at the bottom of figure 24).

Except in mild conditions, it is likely that the same will happen during the winter of 2006-7. Thereafter, the increasing availability of new imports of gas should make substantial improvements to the UK’s supplies, thus steadying the markets. It is worth noting that, at the time of writing (in late May 2006), with demand comfortably satisfied by available supply, the day ahead price at the NBP has fallen to the low to mid 30s of pence per therm which compares with an oil indexed price, typical in mainland Europe, of 45-50 p/th.

Figure 24: UK Gas Demand Winter 2005-06

European Gas Prices: As may be seen in Figure 25 below, gas prices for commercial and industrial customers throughout Europe have increased substantially in the past year, on the back of a higher oil price and increasing worldwide demand. Prices in Great Britain are among those which have risen the most, reflecting the influences described in the paragraphs above and the open nature of the UK’s market. As the large, new import projects come to fruition and more gas is delivered, it is a plausible prospect that prices in Britain will fall relative to those in mainland Europe which are indexed to the prices of oil products and, once more, prices here will become lower than elsewhere.

In this context, it is worth noting that, for the large majority of the years since our markets were liberalised in the mid-1990s, prices in the UK have been significantly lower than those in Europe. It is also worth commenting that there has been clear evidence of intervention by the authorities in France and Spain artificially restricting price rises and that, in Germany, small and medium users pay the highest prices among the countries surveyed, while large users are much lower down the scale. The consequences of oil indexation which take effect with a 6-9 month delay are likely to drive continental European gas prices even higher in the coming months.

Figure 25: European Gas Prices 2005-06

³ These are subject to an investigation by the European Commission’s Competition Directorate.Back
⁴ During last winter, 2005-6, demand for electricity in Great Britain peaked at about 60,000 Mega Watts (or the same as one thousand million 60 watt light bulbs burning).Back