Briefing paper
Flexibility in Great Britain’s gas networks: analysis of linepack
May 2019
In my 2018 report ‘Future UK Gas Security: A Position Paper’ I concluded: “Gas will continue to flow post-Brexit, but consumers may have to pay more for it to guarantee security. Longer term, it is not the outcome of Brexit that poses a threat to UK gas security, but the failure of the Government to provide a clear roadmap for the role of gas in the Iow carbon transition.”
This weekend the Business and Energy Secretary Kwasi Kwarteng has been in emergency talks with leaders from the energy industry and major gas consumers as gas prices (and with them electricity prices) soar to more than three times the level of this time last year. There are growing concerns about the physical security of gas supplies this winter, and industries that are reliant on gas are curtailing production, threatening various supply chains. Domestic consumers are facing significant price increases and Ofgem has already had to raise its price cap and may have to do so again. Some smaller energy companies have gone out of business and others may follow. Amidst all this, BEIS (the Department of Business, Energy and Industrial Strategy) continues to maintain that the UK benefits from a diversity of sources of supply of natural gas. This is true, but…
In recent years, production from the UK’s continental shelf (UKCS) has covered about half of our domestic consumption, a further third comes from Norway delivered by pipelines directly to the UK, the remainder either comes in the form of liquefied natural gas (LNG) or from continental Europe via the two interconnectors linking the UK to gas markets in Belgium and the Netherlands. The supply of LNG has proved highly variable, but in recent years the dominance of Qatari supply (over 98% in 2011) has been diluted by the development of LNG capacity in the US and Russia. In 2020, 48% of UK LNG imports came from Qatar, 27% from the US and 12% from Russia. The UK has three LNG terminals, one at the Isle of Grain in Kent and two at Milford Haven in Wales. It is this LNG supply chain that connects the UK to global gas markets, while imports from Norway and via the interconnectors link us to the NW European gas market.
To understand the current situation, it is important to distinguish between ‘physical security of supply’ and ‘price security of supply.’ The former requires having a diversity of sources of supply and adequate infrastructure to deliver gas to consumers – as BEIS asserts, the UK has this. The latter relates to the price that consumers must pay to attract sufficient gas to the UK to satisfy demand and here is where the current problem lies.
The current situation is a ‘perfect storm’ of events usually relegated to ‘highly unlikely’ in any scenario analysis. The problems started back in 2020 when the pandemic resulted in very low demand, low gas prices and delayed maintenance work and investment along global supply chains. This has also impacted the UK’s domestic production from the UKCS. Then in early 2021 a very cold winter in Asia prompted a dramatic spike in LNG spot prices, this was followed by a hot summer with associated electricity demand for cooling, and the resulting high LNG prices meant limited deliveries came to Europe. At the same time, as lockdowns were lifted and economies recovered, so energy demand has increased. Traditionally, Europe uses the summer, when gas prices are lower due to limited heating demand, to fill storage for the winter. Following the closure of the Rough facility in 2017, the UK no longer has any long-term storage to fill. In addition, over the summer the level of wind power generation remained lower than average due to calm weather, and this together with high carbon prices in the EU (which reduced the level of coal-fired power generation), has meant that more gas than usual has been used to generate electricity, leaving less gas to go into storage.
This is where things get more complicated, as there are now allegations that over the summer Russia deliberately held back supplies of gas to NW Europe as a tactic to ensure the timely approval of the recently completed, but highly controversial, Nordstream 2 pipeline linking Russia to Germany via the Baltic. Gazprom and the Kremlin deny this, stating that they have met all contractual requirements, however, evidence suggests that pipeline deliveries to NW Europe over the summer have been lower than previous levels.
Part of the explanation probably also lies with a lack of investment in Russia’s upstream in reaction to Europe’s continuing ambivalence to Russian gas imports and uncertainty over the future role of gas in EU energy strategy. Not surprisingly, Gazprom has prioritised filling domestic storage and the high price means that it can make plenty of money with lower volumes of exports to Europe. The conspiracy theory gained greater credence last weekend when a Kremlin spokesperson suggested that European gas markets would balance once Nordstream 2 was operational. At the same time, the head of Gazprom, Alexi Miller, suggested that the company would be able to meet Europe’s winter demand.
Washington has always been opposed to the Nordstream 2 project and President Trump encouraged Europe to buy ‘freedom LNG’ from the US to reduce its dependence on Russia. However, US LNG exports have been attracted to the higher prices in Asia and more recently the lasting impact of the pandemic on shale production has been complicated by the damage caused by Hurricane Ida. As a result, US domestic gas prices are very high and LNG exports have been reduced. All of this is likely to be short-term, but the bulk of US LNG export capacity does lie within ‘hurricane ally.’
So, where does this leave UK gas security? In the wake of the closure of the Rough storage facility and the ‘Beast from the East’ in the spring of 2018, the energy intensive industries lobby argued that the Government should support investment in new long-term storage. The UK currently has very modest amount of storage less than 6% of annual demand, compared to Germany, France, and Italy where storage covers about 20% of annual demand.
In 2017, BEIS published a study by Cambridge Economic Policy Associates into gas security of supply in GB’s gas market. The study concluded that “The GB system is resilient to almost all significant individual shocks under normal demand conditions.” They then considered two scenarios, one a prolonged disruption to global LNG supply and two a prolonged disruption in supplies of Russian pipeline gas. In each case, they concluded that UK gas demand was likely to be met if “GB consumers are willing to pay for it.” They did not think it likely that both shocks would happen simultaneously, yet this is just what has happened, and although it is unlikely to last for a prolonged period, it is impacting on prices this coming winter.
The reality is that faced with tight supplies of LNG on global markets and lower exports of Russian pipeline gas into NW Europe, the spot market has performed in textbook fashion and traders are having to pay very high prices to attract deliveries to the UK. Checking National Grid’s Gas Prevailing View website this week shows that LNG storage levels in the UK are significantly lower than this time last year.
The security of the UK’s LNG supply is even more precarious because very little, if any, of the LNG delivered to the UK is under firm contracts. A study currently being conducted by UKERC and the Oxford Institute for Energy Studies into the role of LNG in UK gas security suggests that the only long-term contract is between Centrica and Qatargas, a five-year agreement signed in January 2019 for supply of up to 2 million tons of LNG a year. However, the exact status of that contract is unclear, and it is still possible that supplies could be diverted elsewhere in a tight market.
In 2019, the UK imported 18.7 billion cubic metres of LNG, accounting for 39% of natural gas imports and one-fifth of total supply . This would suggest that most UK LNG imports must be sourced on short-term spot markets. For a variety of reasons, the UK is not considered an attractive market for LNG traders and is often seen as a market of last resort where excess cargoes are delivered when the market is is over-supplied. It is true that Qatar Petroleum has built an integrated supply chain to deliver LNG to its South Hook terminal at Milford Haven, but there is no evidence of a firm commitment to supply LNG to the UK in emergency situations. Just as Japan found out in the wake of Fukushima 10 years ago, an emergency means ‘emergency prices.’ It is also important to note that it takes two weeks for an LNG cargo to get to the UK from Qatar, not exactly a quick fix in a gas emergency.
A final factor is Brexit. The UK is no longer part of the single European Energy Market, and it is unclear what this means in the context of gas emergency. The EU’s so-called ‘solidarity mechanism’ suggests that EU member states should help their neighbours in times of a supply crisis. The UK is now a third-party outside the EU, although it stands between the EU and the Republic of Ireland, that relies on the UK for most of its gas supplies. Thus, stopping EU gas exports to the UK would impact an EU member state. Already, the UK’s domestic gas price the National Balancing Point (NBP) has lost its status as Europe’s benchmark gas price to the Dutch Title Transfer Facility (TTF) and LNG traders prefer to sell into the UK based on the TTF price, not the NBP. This is contributing to the falling liquidity and status of the NBP, making it more difficult to attract gas to the UK market.
So, what could have been different? Back in 2017-18 the Government decided against supporting the construction of new gas storage, fearing that it might distort the market and suggesting that if it was supported by the market then industry would build it. The market has not taken this up and numerous storage projects remain on the shelf. However, the industry is investing in additional LNG storage capacity both at National Grid’s LNG terminal and Qatar Petroleum’s South Hook terminal. This seems strange given that current terminal capacity is under-utilised and the UK’s energy strategy, such that it is, suggests continued and accelerating reductions in future gas demand.
Even before the Government’s Net-Zero declaration in 2019 and the Climate Change Committee’s 6th Carbon Budget recommendations, there was great uncertainty about the future role of gas in the UK. In simple terms, we can think of an ‘electrification’ pathway with a very limited role of natural gas in the future; and a ‘hydrogen pathway’ with an initial focus on ‘blue hydrogen’ using natural gas alongside carbon capture and storage. The reality seems a confused mixture of the two as the Government’s recent ‘Hydrogen Strategy’ sees an early role of blue hydrogen that will sustain gas demand. However, the problem here is that gas production from the UKCS is forecast to continue to fall and the Oil and Gas Authority predicts that the level of gas import dependence could reach 69% in 2030 and 83% in 2040. The question of future investment in the UKCS and the compatibility of the policy of ‘Maximising Economic Recovery’ with ‘Net-Zero’ by 2050 is a source of growing controversy. In such a case, maybe the Government needs to acknowledge the current vulnerability of UK gas supplies and revisit the need for long-term gas storage or rethink the development of blue hydrogen?
The current gas crisis has shone the spotlight on the lack of a coherent strategy to manage the changing role of the gas industry as the UK transitions to a net-zero economy. The reality is that there is no business case to invest in new long-term storage in the UK, especially in the context of declining gas demand. In recent decades various UK governments have placed huge faith in market mechanisms to deliver UK gas security, assuming that sufficient gas would always be there by default. Now UK consumers are having to pay the cost of such an approach and this winter promises to be a challenging time.
Those that call for an acceleration of the expansion of renewable power generation forget that natural gas provides essential ‘energy system services’ such as inter-seasonal storage and back-up for renewable intermittency, for which there is presently no low-carbon alternative. Thus, a significant level of gas demand is here to stay for some while and even when the current emergency recedes, the underlying precarity of UK gas supplies will remain.
Thus, what is required is ‘gas by design,’ a comprehensive strategy that charts the role of natural gas in the UK’s energy transition that encompasses the full supply chain from the future of the upstream and the UKCS, through the midstream of the pipeline system, storage, and the LNG terminals, to the downstream in relation to future demand as the energy system decarbonises. Without this, winter gas emergencies may become more common, and the consumer will continue to have to pay.
A shorter version of this article was also published in The Conversation.