The United Kingdom, like many other regions, has seen its energy prices rise dramatically over the past few years. And along with that have come increasing worries about the security of its energy flows, with some forecasters even predicting power shortages this winter. This article reviews the situation’s underlying causes, with suggestions for improvement.

National Grid, the U.K. gas and power system operator, recently suggested in its Winter Outlook Report 2008/9 that the grid had a small amount of spare capacity. Within hours, electricity prices for November delivery increased by some 7 percent. Gas prices also surged. In response, National Grid reiterated that it had some 4 gigawatts of surplus power capacity as emergency backup and dismissed the possibility of supply difficulties. It subsequently backtracked, reducing the expected surplus for November to less than 1 GW (well below the 5 GW expected for that time of year) and leaving little room for unplanned outages. As in recent winters, power and gas supplies could actually be adequate or inadequate, depending on when new gas delivery capacity comes online.

The potential power shortage is partly an issue of available capacity and partly one of competing fuel prices linked to the availability of gas supply. For gas, the problems are uncertainties about available supplies (which are strongly dependent on gas prices in continental Europe), international LNG demand and price, and the intensity of Europe’s winter. The U.K. power industry sees gas as part of an energy portfolio that includes coal, nuclear, and renewables, with emergency short-term power provided by diesel-fired generators.

There are power capacity concerns regarding two nuclear power stations, Heysham and Hartlepool, that are out of service; the risk is that they may not be back online for peak winter demand. Forward prices available in early October suggested that generators would have better profits from burning coal than gas. Most U.K. coal plants have completed retrofits of their stations to reduce sulfur emissions, but E.U. regulations restrict the number of hours coal plants can now be run. Substantially increased wind power capacity does not ease the situation; it can only provide an unpredictable load factor of 35 percent during peak winter months and therefore is of peripheral value. Some gas-fired power plants can run on distillate, but that only works during times of high gas prices and for a few days, since the distillate supply held at each plant is limited.

Meanwhile U.K. domestic gas production is expected to fall by 10 percent from last winter, which follows a well-established decline trend, widening the supply gap and increasing the need for additional gas imports. This year, the U.K. has imported about 40 percent of its gas; this is expected to rise to 50 percent by 2010, with imports reaching 150 million cubic meters per day by 2015. Domestic supplies are expected to be about 70 mcm/d by that time. Where will those imports come from and what price can secure them? Options are through existing pipelines from Norway, Belgium, and Holland; by LNG through existing terminals, Grain and Teesside; and perhaps through two new terminals, South Hook and Dragon, and the Grain phase II expansion, (all substantially delayed in their commissioning, though now expected by year’s end). The projects should allow plenty of import capacity; the challenge is to secure enough supplies.

Langeled, the world's longest undersea pipeline, links the U.K. with Norway's giant Ormen Lange gas field. However, with the leaking Kvitebjorn pipeline in Norway shut down for repairs until 2009, Norway’s production is at less than full capacity and must meet contract demand of its larger continental European customers.

LNG imports remain uncertain, and delays in the new LNG terminals are only part of the problem. It is also unclear whether the U.K. will be able to bid cargoes away from Asia’s lucrative LNG markets. In its latest forecast, National Grid is not expecting much LNG to arrive, nor should it, based on deliveries received over the past two years.

Gas suppliers and utilities prefer to store gas in Europe rather than in the U.K. because it has more storage capacity and gas production. U.K. gas market suppliers respond to price signals, whereas European prices are driven by long-term contracts and indexation mainly to crude oil and oil products. In order to secure or divert gas supply from Europe, the U.K. wholesale gas price has become oil-indexed by its connection with the European gas market.

Some analysts have blamed the U.K.’s high gas prices on the poor progress of Europe’s gas market liberalization. However, naïve politicians and utility executives are also to blame for their belief that building gas infrastructure capacity alone would solve the underlying supply, contract, and market issues. Indeed, a key problem is that the U.K. gas and power market is still highly concentrated among six major utilities: Centrica, EDF Energy, E.ON U.K., RWE, Scottish Power, and Scottish & Southern Energy.

Ofgem, the U.K. energy regulator, uses the Herfindahl-Hirschman Indices to gauge competition in the marketplace. An H.H.I. rating of less than 1,000 is considered competitive, with anything over 1,800 a highly concentrated market. According to Ofgem, the U.K.’s power market has an H.H.I. rating of 3,137 and the gas market has a rating of 3,356. That type of market concentration leaves the U.K. vulnerable to market manipulation.

Symbolic gestures do not guarantee sustained supply

October 1 marked the beginning of the U.K.’s contract years for power and gas, and the higher prices usually attract a surge in physical delivery. This did indeed occur, initiated by the Langeled pipeline, which saw gas flows increase by about one-third. This caused a dip in prices but few believe that this will be sustained, as the gas is being supplied when continental Europe’s gas demand is relatively low. The surge of new gas from the Langeled and other pipelines overwhelmed the market two years ago, but supply was not sustained. Rather, the surge is now viewed as a signal from suppliers to customers that short-term gas is available if the price is right. Similar gestures may occur before the end of 2008 if LNG cargoes are able to reach any of their terminals. Once they arrive, these cargoes may have a significant short-term downward impact on the prevailing gas price. However, the number of cargoes that are landed over the winter will determine whether U.K. peak winter demand can be met by LNG at a price power generators find commercially viable for stabilizing U.K. gas and power prices. Many doubt this will happen.

More gas storage capacity and balanced contracting required

The fact that the U.K. has precious little gas storage capacity makes the above factors all the more problematic. The U.K. has the lowest gas storage capacity of all major E.U. economies, about 5 percent of its annual demand. One company, Centrica, holds most of that, 3.5 million cubic meters, in the offshore Rough field. Construction on nine leached salt storage caverns is underway at the Aldbrough facility, which will add about 420,000 cubic meters of capacity. When finished this year it will be the U.K.’s largest onshore facility. Other storage projects are progressing. Centrica plans to convert its Bains field in the Irish Sea into a 567,000 cubic meter storage reservoir. The company also plans to have another onshore field online by 2011.

However, expanded storage capacity, along with increased pipeline and LNG receiving capacity, will probably not guarantee the U.K. sustainable long-term supplies of winter gas at stable prices. The U.K. needs to move beyond the system in place, which is dominated by short-term gas trading done by a small group of suppliers and utilities. It needs a combination of short, medium, and long-term contracts among a range of pipeline and LNG suppliers and a more diversified group of gas shippers and physical traders with access to additional storage, LNG, and pipeline capacity. This would encourage the commitment of actual gas to the U.K. before winter, rather than having it languish in Europe until a lack of gas in the U.K. pushes prices up to an attractive point for suppliers and utilities. However, the challenge remains to secure gas under that more sustainable contractual framework at commercially viable prices for utilities and consumers.