From Russia with love

Britain’s energy market has had a challenging end to winter when a near perfect storm of severe cold weather and supply disruptions forced National Grid to issue a rare gas supply warning as gas prices for immediate delivery spiked at 350 pence per therm, up from 63 pence per therm the previous week. The knock-on effect also saw the electricity system price surge to £990/MWh, around ten times the typical level.

Unsurprisingly there have been calls for urgent action to mitigate a repeat scenario next winter, with the focus on gas storage. Britain’s storage capacity lags well behind most European countries, with Germany’s storage capacity 17 times that of Britain’s, while some European countries also have strategic gas reserves. The closure of Centrica’s Rough storage in June last year, due to uneconomic operating costs, reduced Britain’s storage capacity from 15 days to just five days of peak winter demand.

Britain’s historical lack of investment in gas storage is largely due to indigenous gas production from the UK Continental Shelf (UKCS), which accounted for almost two- thirds of Britain’s gas demand just a decade ago. But this fell to less than half demand in 2017 and, according to National Grid, could supply less than 10% of demand by 2040.

Gas storage operators, potential storage developers and gas-dependent industries have been calling for a government inquiry on gas supply security through the winter, with last month’s supply tightness raising the urgency for an inquiry. The government, however, continues to resist an investigation, arguing that the market should determine whether to make new gas storage investment decisions and that supply shortages will increase gas prices to attract alternative supplies.

Supporters of storage investment have accused the government of complacency in rejecting an inquiry, yet a blinkered focus on storage development alone would not provide a panacea for Britain’s gas supply. Not only are storage sites limited in the volume of gas that can be withdrawn on a daily basis, but the economic attractiveness of storage is also receding.

The economic rationale behind storage is to inject cheap gas during the summer and then withdraw the gas in the winter when the price of gas increases with higher demand. But the price differential between summer and winter is receding with the current winter premium over summer at around 7 pence per therm, compared with almost 16 pence per therm a decade ago.

This being so, the economic value of storage as a flexible supply provider is reducing. Indeed, the UK Interconnector with Belgium and the BBL pipeline with the Netherlands are the main providers of supply flexibility with import volumes increasing with a widening NBP premium over the Zeebrugge and TTF hubs. Additionally, higher NBP prices also divert some Norwegian gas exports from the continent to Britain. Consequently the government’s supply rationale that higher gas prices will attract additional supplies is proven.

The recent freezing weather from Siberia and the ongoing tensions with Russia should serve less as a wake-up call on gas storage but rather shift the focus toward future gas supply diversity. Depleting UKCS supply means that Britain is increasingly becoming gas import dependent. Storage proponents will argue that this import dependence justifies increased investment in storage capacity, as per Germany, or even a strategic gas reserve, as in Italy. And if there was a strong winter premium over summer gas this argument would have a robust economic rationale, except the gas being injected into storage still has to be sourced from somewhere. So investment in additional storage capacity would have to be derivative to new gas supply sources.

One possible solution to the gas storage conundrum could be the development of a capacity market similar to that operating in the electricity market, with this idea already put forward by potential storage site investors. While in theory such a market could work to smooth gas prices during peak demand periods, it would not be the most cost effective. Indeed proponents of a gas capacity market are seeking a guaranteed gas price to underpin investment in gas storage that could conceivably be under used if future gas for generation demand lowers with increased renewable production, further investment in new nuclear capacity and increases in energy efficiency.

Rather than additional sources of supply flexibility during peak demand periods the gas supply focus should be directed to baseload supply, and essentially there are two supply sources that can be developed and expanded to meet this requirement; liquefied natural gas (LNG) regasification capacity and shale gas.

Increased supply availability of LNG has moved the market away from long-term take or pay contracts and towards spot contracts with US shale LNG and Russian LNG augmenting supplies from Africa, Asia, Australia and the Middle East. And the future development of an Asia LNG derivatives market is expected to increase pricing transparency and could enable greater LNG cargo certainty into Britain that could provide stable increased send-out rates, with LNG acting more as an integral baseload supply source as opposed to more of a back-up supply source.

But the greatest supply security potential is provided by shale gas. According to a report by the British Geological Survey in 2013, Britain is sitting on shale gas deposits that could supply the UK for 25 years with an area from Lancashire to Yorkshire and Lincolnshire holding at least 1300 trillion cubic feet of gas.

If we put aside the environmental protests and focus solely on the supply potential of shale gas, the government has to decide the role that shale gas can play in Britain’s gas market and whether shale gas can compete on costs with other imported sources of gas. Only after the government’s approach to shale gas has been determined, and Britain’s long-term gas requirements quantified, can there be a meaningful debate on supplementary gas supply sources, including from storage, to provide the necessary peak demand supply flexibility.

Indeed if the government is keen to distance itself from any Russian gas reliance, either directly in the form of LNG cargoes or indirectly through pipeline imports from Europe, then shale gas is arguably the way forward. 

Jeremy Wilcox is managing director of the Energy Partnership, an independent Thailand-based energy and environment consulting firm.