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Energy Insights: Energy News: Focus: Crisis in the pipeline - UK and EU

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Focus: Crisis in the pipeline - UK and EU


08-01-2006

TimesOnline.co.uk

Britain escaped the effects of the gas row between Ukraine and Russia. But our own supply is on a knife-edge. In a long cold spell, demand would outstrip supply, with disastrous results. By Dominic O'Connell and Dan Drillsma-Milgrom

In the summer of 1980 Margaret Thatcher sat down to dinner with Chancellor Helmut Schmidt at the German embassy in London. They were guests of honour at a ceremony to award Henry Moore, the famed British sculptor, the German order of merit.

In the course of the conversation, Schmidt mentioned that Germany had just signed gas-supply contracts that meant 14% of its daily needs would come from Russia. Lord Howell, then UK energy secretary and present at the dinner, remembers Thatcher's horrified reaction.

She put down her coffee cup with a clatter. "Helmut, this is very dangerous," she said.

Schmidt puffed on his pipe, Howell recalls, and tried to reassure her. The Russians needed to sell the gas and, in any event, Austria's reliance on imports was already much higher.

Thatcher was not convinced, and made a point of telling Howell he should ensure Britain was never put in such a position.

Schmidt's successors must wish he had heeded Thatcher's advice. Last week's spat between Russia and Ukraine over gas supplies underlined the Continent's reliance on Russian exports. Germany now depends on Russia for 30% of its gas. Western Europe draws one quarter of its supply from the same source.

When Russia turned off the tap to Ukraine last week, the Ukrainians diverted gas that was supposed to head further west - the pipelines cross its territory - meaning fearful shivers were felt in Berlin and Rome as well as Kiev. The potential disruption of supplies to the heart of the EU was severely embarrassing to Russia, and helped force the hasty peace deal on Wednesday in which Ukraine agreed to pay a higher price for its gas.

Thanks to Britain's North Sea riches, Thatcher and her successors had little fear of the Russian bear. Now that happy feeling of security has gone. Domestic production is in rapid decline, and this year for the first time Britain has been a net importer of gas, something that was unthinkable in the heyday of North Sea production. Within 15 years, according to energy minister Malcom Wicks, 80% of Britain's gas needs will be met by imports.

But, thanks to a fine balance between supply and demand, small reserves and Britain's open energy markets, the gas crunch could come sooner than expected - perhaps, if the weather turns nasty, as soon as the next few weeks.

British production has tailed off so quickly, and our reserves are so slim, that a serious cold spell could spark cuts in supply to industrial users. Gas prices are already so high that some industrial users have voluntarily curtailed production - Terra Nitrogen, for example, closed its Teesside ammonia plant indefinitely in November.

Experts said cuts in supply to domestic users are unlikely, but, if the cold weather lasted for several weeks into February, supplies to gas-fired power stations could be hit, leaving the public facing power cuts or "brownouts", where the voltage of domestic power supplies is reduced.

The government has played down the risks, but British energy policy is now rapidly being reviewed. Tony Blair announced the policy revamp in November, two years after the publication of the government's previous energy white paper.

Whitehall sources said the new policy is likely to be rushed out by the middle of the year, and will stress the need for measures to ensure security of supply, and may include the go-ahead for the construction of nuclear power stations.

Energy experts said the Ukraine row has highlighted Britain's need to act. "The Russian situation has definitely been a wake-up call for Europe and for Britain," said Berthold Hannes, energy expert at the consultancy AT Kearney. "The UK does not rely on imports right now, but it will do in the future. It is very short-sighted to think that because Russia sent gas during the cold war, it always will. Then they had military power, now they have energy power."

Hannes said policymakers must wake up to the highly competitive nature of the market. "The other argument is that Russia will always send gas to Europe because it needs the money. But China and India are in the market now - Russia might well be able to find other buyers."

THE decline of North Sea output is not new. Labour's much-trumpeted energy white paper, released in February 2003 after what one former civil servant called "the longest consultation and preparation of a policy I have ever known", made no bones about the dangers facing the nation.

"By 2020 we could be dependent on imported energy for three-quarters of our total primary energy needs ... we may become potentially more vulnerable to price fluctuations and interruptions to supply caused by regulatory failures, political instability or conflict in other parts of the world," it said.

This warning was largely overlooked. Instead, politicians and commentators spent most of their time on the white paper's top line - the need to embrace renewable energy to meet commitments to cut greenhouse-gas emissions.

But North Sea production has declined more quickly than was thought possible - at about 10% a year. The tightness of Britain's gas market has been dramatically revealed in a series of sharp and unforeseen spikes in energy prices.

Wholesale gas prices have more than tripled in the past three years - from about 20p a therm (a unit of energy) to the current level of 70p. A cold snap in February and March last year sent prices rocketing past 100p, and periods of cold weather since have done the same.

"They have gone higher than we ever thought they could," said Nigel Cornwall, of Cornwall Energy Associates, an independent energy consultancy. "We are talking about prices that are a factor of 10 higher than they were four years ago, all without actual scarcity of supply."

Domestic consumers have felt the effect through steady if modest price rises. Big industrial users of gas have borne the brunt. They buy in the wholesale market, and have in many cases been forced to halt production in the face of surging tariffs.

Terra Nitrogen's ammonia plant on Teesside, for example, seems unlikely to reopen in the near future. The company said it "did not anticipate resuming production ... until UK natural-gas costs decrease to a level that allows the ammonia unit to operate with positive cashflow".

Other energy-intensive industries - those making paper, steel, bricks, and chemicals - fall into this category and face similar tough decisions.

Sir Digby Jones, director-general of the CBI, the employers' body, recently told The Sunday Times that energy prices were the "biggest immediate issue" facing British business. "What the civil servants have failed to realise is that many of these companies have production sites across Europe or across the world. They can choose to switch production away from Britain, and once it is gone it's not likely to come back."

High energy prices can have unlikely knock-on effects. Ammonia, for example, is the raw material for most commercial fertilisers. Farmers face steep price hikes. "Fertiliser prices are currently 170 a tonne compared with just over 140 a tonne this time last year," said David Handley, chairman of Farmers For Action.

 Phil Hudson, chief horticultural adviser for the National Farmers' Union, confirmed the exposure of some types of farming to the price of gas. "Gas prices remain of real concern, especially for farmers who grow crops under cover," he said. "For some, energy accounts for up to 50% of their costs. We have pointed out the impact of gas-price rises to the government but they have indicated to us that even if there were something they could do, they wouldn't be prepared to do it."

The official view of the gas supply for this winter is contained in the National Grid's annual winter outlook paper. It notes that Britain's reliance on imports makes the outlook "uncertain", but concludes "our analysis shows that over the winter period even in '1 in 50' cold weather, there will be sufficient gas to maintain supplies to domestic and other non-daily metered customers".

Some big industrial users, which are involved daily in gas buying, are not so sanguine. In evidence to the Trade and Industry select committee last month - MPs on the committee have held two inquiries into the gas-supply situation in the past 12 months - chemicals group Ineos Chlor warned that the situation was more desperate than most assumed.

Ineos identified what it said was a weakness in the National Grid argument. It had assumed that the interconnector, a pipe that transports gas between Britain and the Continent, would push gas into Britain. "We believe the assumption that the interconnector will be almost full to capacity is unsafe. The only time this has been tested in cold conditions (last February/March) the flows through the interconnector fell to almost zero."

Other energy experts agree and argue that if it is cold in Britain, it will be just as cold on the Continent. French and German utilities, rather than sell gas to Britain, will husband reserves, even if the price in Britain is higher.

Ineos went further. "In the event of very credible temperature scenarios, the interaction of the UK and European gas markets can result in very severe gas shortages in the UK leading to the wholesale closure, for significant periods of time, of vast sections of UK industry ... in our view it is unacceptable to balance supply and demand by closure of massive sections of the UK's industrial base or by putting vulnerable households at risk."

One industry assessment seen by The Sunday Times underlines the fragility of gas supply. Britain needs about 400m cubic metres (mcm) of gas a day to meet its normal winter demand. This rises by 10mcm a day for every degree by which temperatures drop below normal.

In a "1 in 20" cold winter, for example, demand will rise to 500mcm a day. Unfortunately for Britain, the available supply is estimated at only 400mcm a day - just enough to meet normal winter demand. If there is extra demand - if the long-forecast cold spell occurs - or if there are hiccups in supply, and the interconnector does not behave as predicted, supply cuts will be necessary.

If the worst came to the worst, Ofgem and National Grid could declare a "National Gas Deficit Emergency". Special powers can be invoked that would allow National Grid to take control of gas-field production and storage facilities, and even turn off supplies to industry.

In extreme conditions National Grid could turn off supplies to the gas-fired power stations that together generate about 40% of Britain's electricity. This would lead to power cuts for domestic consumers or at best "brownouts".

EVENTS have quickly overtaken the 2003 White Paper. In November Blair used his keynote speech to the CBI conference to announce a wide-ranging review of energy policy. "Round the world you can sense feverish rethinking. Energy prices have risen. Energy supply is under threat," he said.

Industry experts said the review must focus on ensuring security of supply - and this, as Blair implied, means a diversity of energy sources. "What the government has to decide is whether diversity and security of supply is at risk, and if it is, what action should it take?" said Mark Hughes, European utilities leader at Price Waterhouse Coopers.

One way the government could intervene would be to encourage home-grown energy supplies, ones not at risk of being cut off by foreign events. This would mean a new focus on wind and tidal power, the embracing of "clean" coal-burning technology and, most controversially of all, nuclear power stations.

Britain has big coal reserves, but coal has a reputation as an unfashionable dirty fuel. Its proponents say new technology can cut emissions greatly. Mike Farley, director of policy liaison at the engineering group Mitsui Babcock, said exhaust gases can be cleaned up. In the longer term, coal stations could be made completely clean by capturing all carbon dioxide emissions. "I think the energy review will find a place for clean coal. And unlike gas, you can just pile coal up - that 's security of supply," said Farley.

Nuclear could be more problematic, but most experts expect Blair's energy review to come up with a mechanism to foster the construction of new plants. The government could assume responsibility for the cost of waste treatment, and take on the planning risks faced by power-station builders. The switch to nuclear would draw howls of protest from environmentalists, but surveys - mostly by pro- nuclear groups - appear to show the public marginally supportive of new reactors. A freezing winter, with the attendant squeeze on gas supplies and possible power cuts, could make the results even more positive.

Britain's headlong rush to prepare for more imports

BRITAIN generates a small amount of its electricity from oil and some renewable sources, but most of it comes from gas, coal and nuclear power.

Of the three, gas is the most important, accounting for 40% of electricity generation. As Britain's ageing nuclear-power stations have come offline, the share of electricity they generate has fallen from 24% in 1994 to 19%, with coal-fired stations increasing their share from 28% to 33% over the same period. But coal is also on the wane - emissions directives mean that about half the current coal-fired capacity will be shut down by 2015.

For years the North Sea fields provided a cheap, secure supply of oil and gas. This is no longer the case. In December 2004, Britain became a net importer.

Although most of our gas still comes from the North Sea, Britain is dependent on imports to meet full demand and this need is all the more pressing when oil or gas platforms in the North Sea go offline, as happened towards the end of November when maintenance had to be done.

Gas is imported from the Continent through a pipeline that runs from Zeebrugge, Belgium, to Bacton, Norfolk. In addition, since December supplies have been brought by sea to the liquefied natural gas (LNG) terminal at the Isle of Grain in Kent. Several projects are under way to boost the amount of gas that can be imported.

The existing pipeline is to be expanded and two new ones - from Norway's Ormen Lange field and between Bacton and Balgzand in the Netherlands - are due to be fully operational by 2007. Two new LNG terminals in Milford Haven, South Wales, should be fully up and running by 2010 and 2012.

However, some argue that this new capacity is just the bare minimum and that gas supplies cannot be secured without a transparent, fully liberalised energy market in the European Union.

Large users of energy suspect that there is enough gas on the Continent to ease the current crisis but the opaque nature of European markets makes it hard to tell if large energy companies are holding gas back for domestic supply.

Ofgem, the British regulator, wrote to the European Commission in November asking it to investigate why more gas had not flowed through the pipeline even though prices in Britain were higher than on the Continent.

A commission spokesman said: 'We are looking into whether there is enough capacity in the Belgian and other European gas networks to move gas to Zeebrugge, so it can flow into Britain. What is clear is that a lot of the problems in the market are long term and structural, and there's no quick fix.'

The Energy Intensive Users Group has called for the role of Ofgem to be extended.

'We have always been in favour of a liberal energy market,' said Jeremy Nicholson, the group's director. 'However, our policy was developed under a certain set of assumptions about the EU market.

'As well as compensating large industrial gas users in the event of emergency supply interruptions, we think we may need some sort of transitional arrangements while the EU falls into step. Major pipelines and import terminals should all be brought under the remit of Ofgem.'

Additional reporting by J Padmabriya

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