Select Committee on Trade and Industry Written Evidence


Memorandum by the Energy Information Centre Ltd


  1.  EIC is writing in response to the Trade and Industry Select Committee's request for submissions pertaining to "the implications of increasing dependence on gas imports", as detailed in Question 3 of the Government's Energy Review. EIC welcomes the opportunity to respond to this request, and would be happy to discuss this with you in depth at a future date if required.

  2.  As the UK's leading independent consultancy to industrial, commercial and public sector energy users, EIC was established in 1975 and currently represents over 600 industrial and commercial customers—including 40% of the FTSE-100 companies.


  3.  The decline of the UK's indigenous gas production is now seen as inevitable, with output from the UK Continental Shelf (UKCS) past its peak, and the country having become a net importer of gas in 2004 for the first time since 1996.

  4.  However, unlike in previous years, the UK is experiencing a structural shift in its energy balance and—assuming that the country wishes to continue using gas on its current scale—increased import dependence seems inevitable. As such, if we accept this viewpoint, then the key issue is how the UK manages the situation to ensure that it is not unduly disadvantaged.

  5.  The gas dispute between Russia and the Ukraine has highlighted the extent to which dependence on a single source of gas can prove to be a major disadvantage. In this regard, the UK is fortunate in that its imports of gas will be sourced from a range of nations. However, the press hysteria surrounding the consequences of the Russia-Ukraine dispute almost completely overlooked the fact that the UK receives no gas directly from Russia, and only a small percentage of its gas indirectly from the country.

  6.  Unfortunately, this has not prevented media and political commentators from making the customary unjustified comments about relying on supplies from "politically unstable" nations. This draws attention away from the greater issue of ensuring that any import infrastructure is adequately utilised, and that measures must be in place on a national and European level to guarantee that this is the case. At face value, a greater number of supply sources should imply greater supply security.


  7.  Looking at pipeline infrastructure to begin with, the existing Bacton-Zeebrugge Interconnector will have its reverse flow—or UK import—capacity increased in two stages by the end of 2006. At present, the pipeline has a forward flow (UK export) capacity of 20 billion cubic metres per year (bcm/yr), and a reverse flow capacity of 16.5 bcm/yr. However, an increase in the number of compressors at Zeebrugge by pipeline operators, Interconnector UK, will see the UK's import capacity increased to 23.5 bcm/yr by December 2006.

  8.  Looking further ahead, the next pipeline development on the starting grid will be the Bacton-Balgzand Line (BBL), which will provide imports to the UK from the Dutch gas market. Designed with an import capacity of 16 bcm/yr, the pipeline is being developed by Dutch company Gasunie with a projected start date of Q406, although it will reportedly take until Q107 for the pipeline to reach full capacity. The pipeline operators have already indicated that they will undertake the auction for pipeline capacity in April, while rumours of the possibility of bi-directional flows continue.

  9.  Due online in late 2007, the Langeled pipeline from the Norwegian Continental Shelf (NCS) to the Easington terminal will provide 25 bcm/yr of gas to the UK from the Ormen Lange field, which is located of the northeast coast of Norway. This development is currently the world's longest undersea gas pipeline, approximately 1,200 kilometres long—and will be constructed in three stages.

  10.  Gas from the Ormen Lange field will actually be transported to processing facilities at Nyhamma in Norway, which will also serve as the Norwegian link of the Langeled pipeline. Langeled itself will be constructed in two phases. The first stage of the transit process is from Nyhamma to the Sleipner field in the North Sea, although this will actually be completed last—having an expected completion date of autumn 2007.

  11.  The second phase of the transportation process, which is currently well under construction, will tie in the Sleipner field to the Easington gas terminal on the North Sea coast. This is due online in autumn 2006, and will actually allow some flows into the UK from existing infrastructure ahead of first flows from Ormen Lange itself in late 2007. Estimates of flows from Ormen Lange are in the region of 20 to 25 bcm/yr.

  12.  The completion of the Langeled pipeline will boost the UK's imports from Norway from their current levels, as the existing Vesterled pipeline into St Fergus provides 13 bcm/yr of supplies from the NCS. In addition, 2007 will see the start of flows through the new Tampen Link that will connect Norway's Statfjord field to the UK's FLAGS pipeline infrastructure. Some estimates have flows through the Tampen link of approximately 10 bcm/yr, although others show less than half that figure.

  13.  However, the UK is also assuming more of a role in the global energy sector with its increasing reliance on liquefied natural gas (LNG), opening energy prices in the UK to a whole new set of price drivers.

  14.  The first of the UK's LNG terminals is already up and running, and has been a valuable contributor to the country's supply-demand balance this winter. The Isle of Grain, which has been converted by National Grid from its original use as a peak storage facility, is located on the Thames Estuary.

  15.  Owned and operated by Grain LNG, the facility has a capacity of 3.3 million tonnes of LNG per annum (mtpa)—equivalent to approximately 4.5 bcm/yr—in the first stage of its development. This first phase of capacity has already been sold by auction to a joint venture established by BP and the Algerian company, Sonatrach, for a period of 20 years. As a result, the companies have exclusive rights for the unloading and storage of LNG of this capacity, and its subsequent regasification, for this period. The second phase of the project, due online in 2008, is for a further 8.5 bcm/yr of capacity. This has also been sold by a similar process to Centrica, Gaz de France and Sonatrach, on a similar long-term basis.

  16.  The next two LNG projects are due onstream in 2007 or 2008, and are both located at Milford Haven in Wales. The Dragon LNG project is a joint venture between the Dutch company Petroplus, the UK's BG Group, and the Malaysian company, Petronas. As with the Grain site, the project at Waterston has been converted from a pre-existing facility, in this instance a former oil refinery. The project will have a capacity of six bcm/yr, which is split equally between BG Group and Petronas. The South Hook LNG project is being developed by ExxonMobil and Qatar Petroleum, and will also be on the site of a converted oil refinery. With a capacity in its first phase of 10.5 bcm/yr, first deliveries are provisionally expected in late 2007. A second phase, also with a capacity of 10.5 bcm/yr is due online in 2009 or 2010.


  17.  It is the prospect of such large volumes of gas coming into the UK that has led to speculation that the country will face a gas "bubble" in the years to come, resulting in prices falling to the comparatively low levels of two or three years ago. However, such a viewpoint may be over-optimistic, as such a fall in prices would actually discourage imports into the UK. This implies the need for an equilibrium price that encourages imports, but does not result in such an influx of gas that prices slump. Therefore, a decrease in price over time is to be expected, although perhaps not to the extent predicted by some commentators.

  18.  A different perspective is that the imports are more likely to mitigate further price increases, rather than lead to a fall in prices per se, and that the UK gas market will achieve—for want of a better term—an import-dependent equilibrium gas price.

  19.  Therefore, the distinction needs to be made between the possibility of a gas bubble, and a bubble in import capacity—which the UK could face if all of the planned projects come onstream on schedule, and with the volumes predicted. Indeed, while it is highly unlikely that gas will flow to the maximum allowed by the import developments, consumers should be able take comfort that only a fraction of the increase in capacity is needed to meet the UK's forecast growth in gas demand.

  20.  However, while the UK looks set to remain a net exporter of gas through the summer months, it is critical to note that gas flows through almost all of the planned import projects can be diverted to alternative delivery points, or the volumes supplied can be cut in response to demand and price movements in other markets.

  21.  Likewise, the comparative lack of deregulation in Continental European energy markets means that there is no guarantee that flows will respond to the possibility of arbitrage between UK and Zeebrugge.


  22.  This is the lesson that the UK has learned the hard way in the past few months—infrastructure does not guarantee imports. There was a climate of relative optimism in the summer of 2005 regarding gas imports, although this has—for the most part—disappeared into the "black hole" (to use Ofgem's analogy) of the Interconnector.

  23.  While some participants in the industry will claim that import flows did indeed respond to price in mid-February when the Centrica-operated Rough storage facility was taken out of action by a fire, there are grounds to suggest that this was due more to the timing of the incident rather than price signals.

  24.  From the start of 2006 to 15 February, imports into the UK through the Interconnector flowed at an average of around 55% of the pipeline's 48 mcm per day capacity. However, following the closure of Rough, this has risen to more than 80%. At the same time, the absence of Rough from the market meant that the Day-ahead price for gas in the UK had risen well above the pre-closure levels, leading some commentators to suggest that increased prices had induced gas to be imported.

  25.  In the second half of February, the Day-ahead price of gas in the UK has averaged approximately 75 pence per therm. However, over the period 21 November to 5 December inclusive, the corresponding Day-Ahead price was almost 120 pence per therm but Interconnector imports were closer to 52% on average.

  26.  In this instance, gas flows clearly did not respond to price, and this was most likely due to the fact that it was too early in the winter for continental utilities to consider selling their gas from storage given their own security of supply obligations. In February, with the worst of the winter behind them, these companies would be more willing to sell their storage stocks.

  27.  This reflects the differing treatment of gas storage assets in the UK compared with Continental Europe—in the UK they are operated as commercial businesses, while on the Continent they are operated largely as strategic reserve assets. The issue of unbundling of the ownership and control of these assets is one that will be addressed by the European Commission in its price probe, as is the issue of flows through the Interconnector.

  28.  However, the issue of Interconnector capacity is one that must be addressed on the domestic front, given the UK's import dependence. In recent months, "secure" supplies of gas have seemingly become synonymous with "local" supplies of gas.

  29.  Dismissing the economics of transport, gas supplies transported long distances can be secure provided that the contractual regimes are in place to ensure utilisation of infrastructure.

  30.  This has been seen in the market this winter at the Grain LNG terminal, with Ofgem threatening to revoke the exclusivity arrangements for capacity held at the terminal by BP and Sonatrach. Clearly, the nature of the LNG business means that deliveries of cargoes to terminals such as Grain means that they will never have the flexibility of pipeline deliveries, but it does demonstrate the extent to which "use-it-or-lose-it" capacity arrangements are an integral part of ensuring the optimal utilisation of the UK's import infrastructure.


  31.  As such, the Government—either through its presence in Europe, or on a national basis—and Ofgem need to ensure that those companies that wish to import gas into the UK have the ability to do so. To achieve this, these companies will need access to unutilised capacity at the country's import terminals and its pipelines—something that will become a near prerequisite as the UK becomes more reliant on imported gas.

  32.  There is nothing wrong in principle with relying on imports, but the practice of the UK this winter is such that customers have seen more of the negative side of import dependence than the positives. This has led to UK businesses facing exponential year-on-year increases in their energy bills, jeopardising the health and the future of the economy.

  33.  While the attitude among some in Government is that this has been a "successful" winter for the UK gas network, businesses cannot continue to operate in the long-run with energy prices at or near current levels.

  34.  Indeed, Ofgem has already warned that industrial and domestic customers in the UK and Ireland could end up paying at least an additional £3 billion to secure gas over Winter 2006 if new and existing import infrastructure is not fully utilised. The regulator has pointed out that if the UK's import capacity is used next winter to the same extent that it has been so far this winter, the effect on prices could be significant.


  35.  If the UK's growing dependency on imports has highlighted any one characteristic of the country's gas market, it is its lack of gas storage. Given that the UK only has storage capacity equivalent to around 4% of its annual demand, a greater reliance on imports implies the need for a greater "safety net"—something that gas storage is well placed to provide.

  36.  The aforementioned problems experienced by Rough—the UK's largest gas storage site—in February reflect the extent to which the country is reliant on a single site for its seasonal storage requirements. However, the increasing need for fast-response storage sites is reflected in the number of new projects that are in development—underpinned by the sharp increase in the price of storage capacity over the past five years.

  37.  Invariably, gas import projects will not possess the same flexibility as the UK's own declining resources, and it will fall to gas storage projects to make up this responsiveness. However, recent problems experienced by Star Energy with its Welton site reflect the difficulty that storage developers face in getting new sites off the drawing board.

  38.  While the Government has required energy supply security to be an integral consideration in the planning process for any new energy development—such as gas storage or renewable projects—the Welton issue highlights the extent to which such delays could jeopardise the country's energy security.

  39.  Public safety is rightly a key factor in any new energy development, but the "NIMBY-ism" of wind farms now appears to have been joined by an undue level of fear about storage in the wake of the Buncefield explosion and fire.

  40.  Such issues only serve to highlight the need for an informed and non-partisan discussion about gas storage projects, and the need for Government to carefully consider any application or appeal regarding gas storage.

  41.  The need for additional gas storage resources was acutely highlighted following National Grid's decision to call a Gas Balancing Alert (GBA) on Monday 13 March. Unplanned maintenance on the NCS meant that import flows from Norway were no longer a certainty, while a similar problem emerged with supplies through the Interconnector following industrial action in France that saw union members take control of gas storage and pipeline infrastructure.

  42.  These factors jeopardised supplies at the same time that below seasonal normal temperatures increased heating demand while maintenance at coal-fired generating stations increased the demand for gas for power generating purposes.

  43.  Looking beyond the quadrupling of the Within-day gas price as a result of GBA, if the UK had a greater volume of storage capacity relative to annual demand as well as a range of storage assets in the country's portfolio, it is questionable whether the reaction (or over-reaction) from prices would have been as great.

  44.  While the UK's storage capacity has a long way to go before it reaches the level of some of its fellow EU member states—France and Germany both have storage capacity equivalent to around 20% of annual demand compared to the UK's 4%—ensuring that a suitable framework exists for the development of new storage sites is an essential element in the UK's increased gas import dependency.

  45.  Although the possibility of strategic gas storage has been raised, the funding and operation of such an asset could be problematic despite its obvious benefit to the gas network as a whole. Given that such an asset would have to co-exist with storage facilities owned and operated as commercial entities, it is unclear whether the construction of strategic storage could hamper the growth in commercial storage assets. This interaction is something that needs to be considered if strategic gas storage is to be considered.

Head, Energy Markets

Research & Briefing (R&B)

16 March 2006

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