Energy: a reckless gamble

21/09/2021

Yesterday, Kwasi Kwarteng told parliament that: "there is absolutely no question of the lights going out or people being unable to heat their homes. There will be no three-day working weeks or a throwback to the 1970s. Such thinking is alarmist, unhelpful and completely misguided".

The thing is that, even if we wanted to believe this, from the same man we also heard:

Our security of gas supply is robust, but it is the case that the UK is still too reliant on fossil fuels. Our exposure to volatile global gas prices underscores the importance of our plan to build a strong, home-grown renewable energy sector to strengthen our energy security into the future.

Given that one of the significant causes of the supply crisis (reflected in the record spot prices) is the under-performance of the wind fleet, forcing us to rely on gas generation without sufficient stocks of gas to support the increased production. Our generation strategy, therefore, is dangerously unbalanced and, increased reliance on renewables would simply add to our problems.

To give a clearer indication of the nature of the problem, we need to look at how gas prices have varied for the all-important "day ahead" wholesale contracts – the so-called spot market.

According to Ofgem, gas prices for these contracts stood at a record low of 11.39 p/therm in January 2020, rising steadily to 90.88p in July of this year and then reaching 138.75p in the week ending 10 September and then peaking at more than 165p on the 15th. This represents a more than 14-fold increase in the space of 20 months.

The low in January 2020 reflected the reduced global demand arising from the Covid-19 pandemic. Had bulk purchases been made then – and it is precisely the function of strategic storage to allow this to happen – then the later release into the market could then stabilise prices and act as a hedge against the massive increases recently experienced.

However, with storage capacity of less than two percent of annual consumption of just over 100 billion cubic metres – the amount laid down by the UK is so small that it would be quickly exhausted (in less than six days) and have minimal influence on the wholesale market. And therein lies the major part of the problem.

The point here is that the problem has been widely foreseen for well over two decades and, despite repeated warnings from a number of sources, the government not to intervene in the storage market – a stance based on a number of assumptions that have not proved to be valid.

The problem has not been helped by the over-rapid and almost complete elimination of coal-fired electricity generation or the failure of the nuclear power replacement programme. But, as long as the government – as a matter of policy – has chosen to rely on gas generation to provide back-up for shortfalls in renewables generation, then an essential part of the mix should have been the maintenance of strategic stock of gas.

As to the Russian situation, for the UK this is largely a red herring when it comes to the current crisis. As has often been pointed out, we do not rely on Russian supplies – the account only for 8 percent of our annual consumption – and the Nord Stream is only just beginning to bite. Had we sufficient strategic storage in place, it should have been recharged by now and we would be largely immune to Russian manoeuvring.

The reason why it matters to us now is that, by default, we are reliant on European stocks to provide us with gas through the peaks of the winter when, temporarily, demand exceeds production. But, since our European suppliers are having difficulty recharging their more extensive storage facilities, if they go short over the winter, we too will go short.

This is, of course, another reason why Kwasi Kwarteng is being substantially less than honest. The security of the UK's gas supply is not robust. Since we are no longer self-sufficient, producing less than 40 percent of our annual consumption, we are entirely dependent on imports to keep the lights on.

The point here – as the government is keen to tell us, 22 million households are connected to the gas grid and in 2020, 38 percent of the UK's gas demand was used for domestic heating, 29 percent for electricity generation and 11 percent for industrial and commercial use.

What it doesn't say is that by far the bulk of the 38 percent used for domestic heating is consumed during the winter months, the bulk of that in the colder months of January, February and March, when the daily peak consumption can be double the annual average. This obviously leaves less for electricity generation, and even less for industrial and commercial use – which, as we have seen with the CF fertiliser plants – is first to get the chop.

But if a cold spell coincides with a long spell of calm weather – as it typical of anticyclonic conditions in the UK during winter – then the demand for gas-generated electricity can outstrip the resources available. Thus, in March 2018, the National Grid was forced to issue a gas deficit warning following the "Beast from the East" which had plunged the UK into a cold spell lasting for several weeks.

What surprised researchers during that period was the significant variation in gas demand during the day, which was at its maximum during the hours of 10am and 3pm, but also with an immense increase in gas consumption between the hours of 5am and 8am.

Given a repeat of these conditions – with the overlay of Covid-19 creating additional uncertainty – there may be periods when the demand for gas from electricity generators cannot be met from domestic resources.

That makes the UK's gas supply situation extremely fragile. It will be dependent on the willingness of Russia to keep Germany and its other European customers supplied, which in turn will determine how much gas can be released to the UK through the interconnectors.

As it stands, though, the Russian situation does not look as if it is going to be resolved in a hurry. According to RIA Novosti, at the heart of the dispute is the EU's updated Gas Directive which entered into force on 23 May 2019, remains unresolved.

This applies competition law applicable to pipelines within the EU to third country pipelines, thus requiring that Nord Stream 2 must either be partially filled by an alternative supplier, or that the ownership of the section in the EU must be divested to third-party company, forcing Gazprom to sell off its share.

When the pipeline was being planned, Brussels was forced to admit that the existing Gas Directive (2009/73/EC) did not apply, whence the EU went out of it way to pass an amended directive, specifically to bring it within the scope of EU law.

Russia, says Novosti – with an almost British level of understatement – "is not satisfied with this", having tried and failed to challenge the law in a German court. By the time the directive was updated, billions of dollars in investments had been made in the project, taking into account the previous legal situation, only now to be put at risk by the new law.

For all the dark mutterings about Putin's determination to undermine western economies, Gazprom denies it is short changing its European customers and it has to be conceded that the Russians have a point. The EU's action is precisely the sort of bad faith that has been one of the drivers of Brexit. We can hardly be surprised when Russia reacts adversely.

The fact is, therefore, that Kwasi Kwarteng's assurances are reliant on two factors which are entirely outside his control – the weather, and an early resolution of the Russian-EU dispute. And there is a third – the availability of top-up supplies of LNG. With the stiff competition from the Asian market, this looks increasingly unlikely.

All in all, therefore, it is evident that Kwarteng is playing games – the usual Tory trick of treating the electorate as fools, in the expectation that he will not be outed by the legacy media. To an extent, that's working. If in the coming months we see power cuts and shortages, the Telegraph mildly says, then the government will have been very complacent indeed.

This, though, is something much more than complacency. It is a considerable gamble – some might say reckless. And if they get away with it this time, there is always the winter after next.

Also published on Turbulent Times.