The UK’s Energy Supply: security or independence?

Memorandum submitted by Shell (UKES 49)

Executive Summary

· The greatest resilience in terms of energy security is achieved through diversity throughout the full supply chain, a key feature of current global oil and gas markets. The UK oil and gas industry has had a strong track record when it comes to delivering secure supplies and the investment needed to respond to the declining indigenous production.

· The UK and wider Europe benefit from abundance, accessibility and diversity of natural gas supplies. In particular, the game-changing effect of the development of unconventional gas globally means that there is now at least 250 years of global natural gas supply at current rates of production.

· Priority should be given to further strengthening gas infrastructure and interconnectors to ensure that the UK and Europe benefit from diversity and enhanced supply security from LNG.

· Concerns about gas price volatility and oil linkage are misplaced and overstated. For example, when oil prices averaged $130/barrel in summer of 2008, the gas price did not exceed the equivalent of $90/barrel. The structure of gas contracts tends to limit gas prices when oil prices are high by, for example, having fixed or variable pricing and other smoothing mechanisms.

· Maintaining investment in the UK Continental Shelf (UKCS) will be critical for realising the UK’s domestic oil and gas production potential and therefore ensuring that domestic supplies contribute to the UK’s energy security for several years. The recent Budget increase to the Supplementary Charge on North Sea production risks long lasting detrimental impacts on investment in the UKCS.

Q1. How resilient is the UK energy system to future changes in fossil fuel and uranium prices?

1. Oil price volatility is often cited as a threat to energy security. Prices tend to be set by the marginal cost of production. Short-term volatility however cannot be ruled out given the risks around geopolitical and supply disruptions. In addition, oil prices respond not only in cases of actual supply disruptions but also in cases of perceived threats to supplies, reflected for example in price premia at times of geopolitical instability. Improved vehicle efficiency, further use of biofuels, use of new technologies and electrification in transportation can all help mitigate then impact of oil price volatility on the UK economy. So can efforts to improve transparency in markets and promote dialogue between consuming and producing nations, reducing any barriers to timely supply development.

2. There have recently been concerns raised about gas price volatility, particularly in the context of the UK moving towards greater dependence on gas imports. However, the past few years have seen a spectacular improvement in gas supplies from two key sources: unconventional/tight gas and liquefied natural gas (LNG). The IEA now estimates around 380 tcm of unconventional gas reserves are recoverable, which in addition to conventional recoverable resources of 405 tcm, means there are now over 250 years of gas resources at current production rates. These effects have created a well supplied market and had a moderating impact on prices.

3. The projected rapid growth in upstream gas supplies over the next 10-20 years can probably be achieved at costs below $10/MMBtu on average. Given the resource base available, there is more than 100 years of current world consumption available at this cost level (see Figure 1).

Figure 1: Estimated long-term supply cost curve for recoverable natural gas resources

Despite the reasonable costs of producing gas there is a widespread perception that future gas prices will be very volatile. Gas price contract indexation to oil is often seen as the key problem. However, in reality:

· Gas prices have historically been competitive to oil prices (on a thermal parity basis).

· Gas prices indexed to oil have been less volatile than gas prices linked to NBP [1] or HH [2] .

4. Short-term volatility is best, and powerfully, avoided through having a diverse mix of gas supplies, sufficient storage capacity and an interconnected, reversible-flow pipeline network allowing gas to flow when and where required. Increased European gas market liberalisation will enhance all these characteristics. The UK is one of the best examples of a country with very diverse gas sources. For example, in 2009 the UK imported gas from 10 different countries: piped gas from Norway, the Netherlands and Belgium and LNG from Algeria, Trinidad and Tobago, Qatar, Egypt, Norway, the USA and Australia.

5. Moreover, there are many mechanisms in use in the gas market today to smooth price volatility for gas buyers and consumers such as a fixed priced deals (up to 3 years), flexible pricing (e.g. linked to the NBP or similar) or a variable price with the option to additionally hedge a proportion of the contract and other smoothing mechanisms such as S-curves or indexation to other commodities. So even if oil prices are high, gas prices do not necessarily follow. For example, when oil prices averaged $130/barrel in summer of 2008, the gas price did not exceed the equivalent of $90/barrel.

6. Long-term contracts can incorporate a mix of these mechanisms, where the supplier or intermediary is managing both supply risk and mitigating contract price volatility. Long-term contracts provide benefits in two ways: the buyer is assured of supply, and can negotiate on price and terms to reduce volatility. The supplier is committed to supply even if the price in that market is less favourable than achievable elsewhere.

7. Positive political messaging between supplying and consuming countries can support the development of long-term partnerships and contracts.

8. It should also be noted that greater reliance on intermittent renewable generation in the electricity market is very likely to increase electricity price volatility with prices even being negative when there is too much wind generation on the system. A greater role for gas in the generation mix would offer additional supply flexibility and therefore help to balance supply and demand.

9. The UK’s efforts to meet its 2020 and 2050 carbon targets will further diversify its energy mix in all sectors of the economy. Diversification will aid resilience and provide a hedge against cost and technical and political uncertainties.  This applies to sources of primary energy, to energy conversion and to energy transmission, transportation and distribution. Within any primary energy source, diversification of sources of supply is also needed. Diversification is relevant both to geographic sources and to methods of transportation.

Q2. How sensitive is the UK’s energy security to investment (or lack of investment) in energy infrastructure, including transmission, distribution and storage?

10. Investment in energy infrastructure along the whole supply chain from production to distribution in all forms of energy is key to maintaining UK energy security.

11. Maintaining investment in the UKCS will be critical for maximising the UK’s domestic oil and gas production and therefore ensuring that domestic supplies contribute to the UK’s energy security for several years. In 2010 the industry invested £6 billion of capital and £6.9 billion in operating costs which contributed to the discovery of another 300-400 million barrels of oil equivalent and initiated the development of 13 new fields and four major incremental fields [3] . The increased investment plans for the UKCS could halve the decline rate of the UKCS over the next five years from 6.5% per annum seen over the last decade to around 3%. If maintained, the recent rise in investment, could have a significant impact on the contribution that domestic resources make to the UK’s future energy supply. However, the recent Budget announcement of the increase in the Supplementary Charge on North Sea production from 20% to 32% could put this at risk and hence as a consequence reduce longer term production. Prior to the new tax changes it was estimated that investment in oil and gas production would increase to £8 billion in 2011, but the recent rise is making companies re-assess their plans. If not mitigated, the tax rise could lead to a loss of planned investment and thus indigenous oil and gas production which increased imports may need to replace.

12. It is also important to note that energy infrastructure projects have a multi-decade lifespan often with very long pay-back periods. Uncertainty over the fiscal, regulatory and market environment could delay or deter such projects coming forward.

13. The UK and European markets have already begun to effectively address the inevitable long-term decline in domestic oil and gas supplies. Europe – including the UK - is within economic distance of 70% of global gas resources. Europe already has an extensive and well-established network of gas infrastructure including many LNG regasification terminals as well as various long-haul pipeline connections for the North, East and South. At the same time, the diversification of pipeline supplies into Europe continues, although the total amount of pipeline supplies is expected to remain fairly constant. This gradually reduces transit risk and the reliance on single pipelines. The majority of the projected European gas demand growth is therefore expected to be met by LNG. This has led many countries already to build their own regasification facilities, sourcing their gas directly and thus avoiding any possible transit issues, while also gaining access to the international spot LNG market. The IEA’s projection of inter-regional trade flows clearly demonstrates the strongly growing degree of global interconnectivity, with new (mostly LNG) supply corridors opening up from Africa, the Middle East, the Caspian region and even South America.

14. In addition, political signals from consumer governments to major resource holders such as Russia and Qatar will also play a powerful role in encouraging continued investment and alleviating their concerns over demand security. Clear messages to these producing partners that, even as European countries transition to low carbon economies, gas will continue to play a key role in their future energy mixes both in the short to medium term and with CO2 mitigation as a long term option, will be helpful in this context.

15. In the UK, there has been accordingy to DECC figures a 500% increase in gas import capacity in the last decade, the majority of which has been built since the winter of 2005/06. UK infrastructure is now capable of importing around 125% of annual gross demand. Storage capacity in the UK has increased by 25% over the last decade and there are around 22 more storage projects planned, though the increase in LNG flows during the winter may jeopardise some of the storage economics. Increases in the UK’s re-gasification capacity as well as strong interconnection with Europe has widened the diversity and availability of sources of gas supply. The improving physical interconnection between European market regions is an essential factor for enhancing security of supply. As seen in the UK during winter 2009/2010 when there were technical supply constraints from Norway coinciding with record gas demand, and the UK relied on increased imports from the continent to successfully help make up the shortfall.

16. In terms of electricity markets, significant investment is needed to meet the UK’s 2020 and 2050 carbon targets both to decarbonise the generation sector but also potentially double the electricity supply by 2050 as the heat and transport sectors move towards electrification. Ofgem have estimated that at least £110 billion of investment is required in new generation and transmission assets in electricity – over double the rate of the last decade. Switching from coal to gas is the fastest and most cost-effective way of reducing carbon emissions in the power sector. Using gas also relies less on further development of emerging technologies and therefore presents less uncertainty around implementation. Having gas in the generation mix would also require less build out of transmission capacity. An EU level study [4] showed that pursuing a future generation mix that has a strong role for gas would require 25-40% lower build up of transmission capacity across the EU over the period 2010-2030, in itself saving between €30-50bn.

Q3. What impact could increased levels of electrification of the transport and heat sectors have on energy security?

17. The Department of Energy and Climate Change (DECC) has suggested that electricity generation may have to be close to zero-carbon by 2030. In addition to this challenge, power sector demand may double by 2050, as decarbonisation of the heat and transport sectors means increased use of electricity.

18. Energy security must not be defined solely on the level of reliance on imported fuels, but on the ability of the entire energy supply chain to balance supply and demand at a reasonable cost. Though increased electrification provides further diversity of fuel sources to the transport and heat sectors and as such will increase energy security in these sectors, there will be a challenge to overall security of supply if the electricity system is not resilient.

19. So developments in electrification in the heat and transport sector have to happen in parallel with the appropriate investment in the UK’s electricity generation and transmission capacity. The electricity capacity margin must remain sufficient to keep the lights on even in a situation with higher demand and greater renewable generation on the system. Though technological developments may enhance the ability of the electricity system to deal with greater intermittency, there will be a continued need for some form of flexible, reliable generation.

20. CCGTs as well as gas with Carbon Capture and Storage (CCS) could provide this flexibility, though there is concern that the future structure of the market may limit the periods when their flexibility is rewarded through peak prices. The role of capacity mechanisms should be considered in this context and we have provided further detail to this effect in our response to DECC’s consultation on Electricity Market Reform.

Q4. To what extent does the UK’s future energy security rely on the success of energy efficiency schemes?

21. Much improved energy efficiency is vital not just in tackling climate change but in supporting economic development and enhancing energy security. The European Commission, alongside its publication of the 2050 Roadmap highlighted that although the EU is making good progress on the 2020 carbon and renewables targets, the EU is currently only halfway towards the third goal for 2020 - improving energy efficiency by 20% and that much greater efforts will be needed to meet this target.

22. Energy efficiency will also help meet our climate and energy security targets at least cost. DECC’s estimates of the costs to the consumer of decarbonising the electricity sector for example rely heavily on assumptions made about the uptake of energy efficiency measures and the impact it will have on demand. It is crucial therefore for the UK’s competitiveness that progress is made in this area.

23. In developing policy to promote energy efficiency, consideration needs to be given to the fact that the price signal for energy may be too muted to have sufficient impact on energy efficiency and using price alone to impact energy demand could be regressive.  Standards and regulations in transport, buildings, industrial processes and appliances therefore have a critical role to play in encouraging efficiency.

Q5. What will be the impact on energy security of trying to meet the UK’s targets for greenhouse gas emissions reductions as well as increased penetration of renewables in the energy sector?

24. Diversification of energy sources and energy technologies will increase the resilience of the UK electricity sector, but there is a serious risk that an excessively target/volume driven focus on delivery of renewable technologies could create a much more expensive system than is necessary with the costs borne by the consumer and taxpayer. It is not clear that the intermediate 2020 target of 15% renewables for the UK economy is a cost effective or attainable way of meeting the 2050 carbon targets.

25. The increased use of renewable generation will require very large changes to both the operation of the current electricity market and to the generation and networks required to maintain a balanced system. With the increasing penetration of zero marginal cost generation (nuclear and renewables) there will be increasing periods when the electricity price will be zero (or even negative), which will not provide enough reward to generators building peaking capacity, potentially affecting investment in supply. In addition, gas-fired power can be sited close to demand centres whereas accessing electricity from renewable generation located in remote areas will require strengthening the transmission system. Further international interconnection may also be required to balance a more intermittent system. Building interconnectors is a costly and slow process.

26. Last December in the UK, during the three coldest days when temperatures were below zero degrees, wind generation output only averaged 3% of metered wind capacity. Significant back-up and system flexibility will be required to mitigate against these types of shortfalls in wind generation, especially as it becomes a growing proportion of the mix. As mentioned above, gas can be a good complementary technology to intermittent renewable generation. Gas fired power is also technologically proven, has a small footprint, fits into the existing infrastructure and is relatively cheap and quick to build and by replacing coal is the fastest and surest way of making significant CO2 emission reductions. There is a need to ensure in the new market arrangements that gas-fired peaking capacity is sufficiently rewarded.

27. In the heat sector, all types of technology will be important in meeting the carbon reduction targets required. Renewables and electrification will have an important part to play in diversifying the energy sources used for heating. Conventional gas boilers will still be necessary however in areas where the other solutions are not appropriate or too costly. The benefits of Combined Heat and Power (CHP) plants should not be overlooked and a supportive policy environment must be implemented. CHP is an efficient method of producing both electricity and steam, thus leads to reductions in energy use and reduced carbon emissions.

28. Global transport fuel demand is set to rise by 45% between 2006 and 2030 therefore efforts to reduce greenhouse gas emissions and satisfy this growing demand will require all the sustainable transport fuel options available. These include efficiency improvements for internal combustion engines, progress on battery technology and plug-in hybrids, current and next generation biofuels and, in due course, hydrogen.  Given the positive contribution biofuels can make to reducing emissions, Governments should encourage and reward biofuels that demonstrate good CO2 performance and are produced from more sustainable sources. To this end, Shell encourages the adoption of international standards for sustainable sourcing and participates in several initiatives that are working on voluntary guidelines for particular feedstocks.

29. As well as being sourced from a number of regions around the world, biofuels can also be grown domestically further enhancing UK energy diversity and supply security. For example, the Ensus wheat biorefinery, in northeast England turns 3000 tonnes per day of wheat into bioethanol, high protein animal feed, and CO2 for the food and beverage sector and saves around 1 million tonnes CO2 equivalent of global GHG emissions per annum.

Q6. What would be the implications for energy security of a second dash-for-gas?

30. The term ‘dash for gas’ is often unjustifiably used with negative connotations. History shows us that the reality is very different. The increase in the use of gas in the power sector in the 1990s helped the UK meet its Kyoto targets and led to a period of relatively low electricity prices in the UK while having supply security. Despite its very significant advantages, Shell is not advocating sole reliance on any one fuel in any one sector. As noted above, the key way of ensuring the UK’s energy security of supply is maintaining diversity throughout the supply chain. There are many benefits however to the UK energy sector and wider economy in maintaining an important role for gas in the UK energy mix.

31. The benefits that the use of gas can bring from a macro-economic perspective are often underestimated. With deficits and government debt at historically high levels, there is an acute need for strict budget discipline. Most countries will find that natural gas is far more affordable than any other source of electricity, especially in front-end (capital cost) investment terms. Shell estimates that the capital cost comparison of gas-fired power versus other power sources as approximately: gas 1; coal 2-3; nuclear 5; onshore wind 7-10; offshore wind 10-15. (NB These estimates are in line with other estimates, such as those produced by Mott MacDonald and included in Figure 2 below. Moreover these estimates do not include the additional balancing and network costs that renewables would incur).

Source: Mott MacDonald for DECC

Figure 2: Costs of different generating technologies [5] [6]

32. A recent report by Redpoint for the UK Energy Networks Association [7] , found that pathways with greater ongoing gas use could offer a cost-effective solution for a low-carbon transition relative to scenarios with higher levels of electrification. Their baseline assumptions indicate potential savings to Great Britain of almost £700bn over the 2010 to 2050 period on a Net Present Value (NPV) basis – around £20,000 per household or £10,000 per person – with consequential benefits for consumers, the economy, and the competitiveness of GB industry. For the power sector the avoided costs are £244 billion over that same period. Moreover, the conclusion that more use of gas in the power sector is the lowest cost pathway is robust under different gas price sensitivities. In addition, this scenario requires the least interconnection with other countries, which can be costly and slow to build. And critically, with this pathway, the UK can still meet its CO2 emissions reduction AND renewable energy targets.

33. Similarly a study [8] from the European Gas Advocacy Forum (a group of European gas companies) [9] supported by McKinsey, shows that the EU can meet its 2020 targets [10] and an 80% CO2 emissions reduction in 2050 by adopting a pathway that maintains a strong place for gas in the energy mix. Compared to the pathway with 60% renewables by 2050 presented in the European Climate Foundation (ECF) Roadmap 2050 work [11] , the pathway with a stronger gas component would reduce investment costs by €450-550 bln in the period to 2030. This translates into a €150-250 saving per household per year and will help preserve Europe’s economic competitiveness. In comparison, a 60% renewable pathway would have a direct impact on energy intensive industries in Europe, reducing their margins by 5-10% and putting 20-25 million jobs at risk. Adopting this optimised pathway leaves several technology options that can each deliver the 2050 reductions but does not lock Europe into reliance on a small set of costly technologies.

34. The major energy transformations that are required both in the UK and the rest of the Europe to meet both climate and energy security goals carry significant risks and uncertainties. A key way to mitigate these is to incorporate into the transition process the knowledge gained as sector learning curves develop and supply chains evolve. Growth in gas-fired power in the short to medium term enables a more measured transition to renewables and nuclear, allowing the optimisation of technology and driving down of cost. Some government policies at present effectively "over-subsidise" renewables, involving very substantial investment in early generation wind turbines and solar panels well beyond the pace needed to provide an efficient learning curve for the sector. A more calibrated approach could deliver the same capacity in 10-20 years time at significantly lower cost and with increased reliability and efficiency.

35. Similarly, the supply side of renewable and nuclear sectors risks being overextended as supply chain may not be able to track the growth in demand sufficiently fast, leading to significant cost inflation. Slower build-up in demand would enable significant cost savings as more capacity would be provided later by a deeper, more efficient and lower cost supply chain.

36. One of the main challenges to the case for growth or maintenance of gas in the power generation mix is the perceived likelihood of ‘lock-in’ of fossil fuel technology and their respective CO2 emissions, or the "stranded asset" problem – ie constructing plant which becomes redundant when more stringent CO2 regulation is implemented. Neither scenario need be the case. First, it is coal-fired power which is currently responsible for the fastest sector growth in CO2 emissions worldwide. Modern gas-fired plants emit between 50% and 70% less CO2 than coal plants per kilowatt hour of electricity generated. So replacing coal with natural gas is the surest, fastest and cheapest way to reduce CO2 emissions over the next ten vital years. For the UK, Shell analysis shows that, replacing existing coal with gas power plants would lead to a 24% cumulative reduction in UK CO2 emissions by 2050 (see Figure 3).

Source: Shell internal analysis

Figure 3: UK electricity CO2 emissions under different scenarios

37. Longer-term, gas power plants should and can be retrofitted with CCS which reduces emissions by 90%. CCS is technically established (all elements are well proven) but the market still has to see scaled-up demonstration and then widespread application. There is very little reason to doubt this is achievable by 2020 and, provided the appropriate regulatory framework is established, we should see large scale CCS take off by 2030. Mott Macdonald (2010) predicts that the premium for CCS versus unabated plants is £32-38/MWh, although the carbon penalty on the unabated coal and gas plants will be in the order of £40/MWh and £15/MWh, respectively (for projects started in 2009). In the longer term, as these technologies move to "nth of a kind status" (or mature status), the levelised costs of CCS equipped plant are predicted to undercut those for unabated plant and CCS equipped plants will see levelised costs of £105-115/MWh with gas at the lower end, and coal at the upper end of the range [12] .

38. So over the long term, retrofitted gas CCS is cost-competitive with coal-CCS. Moreover, Shell estimates that at $60-120/tonne CO2, retrofitting CCS to modern CCGT power stations will be very cost competitive with new wind and solar – even post 2030 after allowing for their respective learning curves. For example, it costs roughly three-and-a-half to five times as much to reduce CO2 emissions through offshore wind – at $275-$400 per tonne. Even if gas prices more than doubled from today’s levels, according to the Mott MacDonald report gas-CCS would still be cheaper than offshore wind (gas prices would have to be higher than $19/MMBtu for gas-CCS to be more expensive than offshore wind).

39. In addition to the ability to capture the emissions from gas-fired power stations through CCS, there is a vital long term role for gas in a low-carbon power sector as the natural complement to intermittent renewables which need back-up power. Figure 4 below simulates the variability of wind generation in the UK assuming 43 GW of wind capacity installed and real weather experienced in the winter of 2008/9. These facts clearly indicate the need for additional generation that can respond during the extended periods when the electricity output from wind decreases.

Source: Poyry Energy Consulting

Figure 4: Simulated wind generation assuming 43 GW installed

Q7. How exposed is the UK’s energy security of supply to international events?

40. The post-quake humanitarian emergency in Japan and current unrest in the Middle East and North Africa are stark reminders that the energy sector operates in a volatile world and the UK must be ready to respond to external events. But there are many factors which can help mitigate the impact on the supply of fossil fuels.

41. First, the growth in available gas resources – alongside continuing growth in global LNG production capacity - has radically changed the global gas market picture both in terms of supply security and diversity, and price outlook. The risks to the UK of negative gas market shocks are therefore much diminished given this additional global gas market resilience.

42. Second, oil is easily transported and stored.  In addition there are many sources of supply.  Therefore, in normal circumstances, physical security of supply should not be a problem because supply is likely to be available at market price. International cooperation and an efficient market would ensure that in times of disruptions spare production and refining capacity in the oil market is made available. A robust global supply chain alongside the appropriate use of stocks can help mitigate most supply disruption scenarios.

43. Even with a successful transition in the UK to a low carbon economy by 2050, we are still likely to be increasingly reliant on imports of oil and in some scenarios gas as well over this period. The new DECC 2050 Pathways show that for most scenarios there is a significant increase in oil imports in the period to 2020, and even out to 2050 there are numerous scenarios under which oil imports continue to grow (see Figure 5). Hence, under most credible scenarios the UK will always need to participate in global energy markets and is very unlikely to ever be energy independent. Energy interdependence is a key driver in international relations and energy security will benefit from greater dialogue and a mutual recognition of demand and supply interests.

 Source: DECC

Figure 5: Estimated UK oil imports under different possible pathways to 2050

Q8. Is the UK’s energy security policy sufficiently robust to be able to deal with uncertainties and risks inherent in all of the above areas? If not, how could this be improved?

44. The UK’s energy policy since market liberalisation has been very effective in delivering secure, affordable supplies and ensuring that the UK meets all its energy needs and broader energy sector objectives. There have been no interruptions to supplies in the recent past and the UK has enjoyed some of the most competitive energy prices in the EU.

45. However, it is clear that with interventions in the market already underway with the introduction of a carbon price floor and proposals in the Electricity Market Reform Consultation, UK policy is shifting away from the fully liberalised model. Within this context Shell believes the following key actions and considerations are needed to underpin the resilience of the UK’s energy sector:

· Recognise the significance of oil and gas production within the UK for a secure energy supply and generate a stable and supportive environment for continued investments in oil and gas production and infrastructure (see further detail in Question 9 below).

· Encourage investments in producer and transit countries by making clear and consistent statements about the important and continued role for gas in the UK and European energy mix.

· Resolve planning issues for gas infrastructure such as pipelines, regasification terminals, underground storage and CCS.

· Focus on harmonised implementation and effectiveness of existing European legislation/regulation.

· Strengthen the incentives for low-carbon investment, through a robust carbon price and targeted support for early-stage, non-commercial technologies. But take account of the risk that substantial support to nuclear and offshore wind may reduce the attractiveness of, and thus crowd out, investment in gas-fired generation.

· Strengthen the EU ETS in a multilateral way as the best approach to meeting the UK and Europe’s carbon targets and maintaining the market incentives to maintain secure supplies. We recommend that the Government urgently pursues two actions on the ETS with the EU and other Member States:

o A balanced reduction of available credits from Phase III of the ETS.

o Early action on Phase IV, including the announcement of a reserve price on auctions.

· For CCS, ensure the four-project UK demonstration programme is delivered through effective funding/financing and with greater clarity on the relationship with the mechanisms proposed to support low-carbon technology.

· Introduce some form of capacity mechanism that offers appropriate incentives to maintain capacity on the system to ensure security of electricity supply. Under the envisaged market structure described in the latest electricity market reform proposals, flexible peaking plant may not be sufficiently remunerated.

· For biofuels, support the introduction of mandatory sustainability criteria and encourage the adoption of international standards for sustainable sourcing.

Q9. Are there any other issues relating to the security of the UK’s energy supply that you think the Committee should be aware of?

46. The UK’s domestic oil and gas resources, even in decline, significantly contribute to greater energy security. Maximising remaining production must be a priority. The recent Budget increase to the Supplementary Charge on North Sea production could reduce future oil and gas production and increase the UK’s reliance on imports. In order to mitigate the impact of this tax on investment a number of key issues must be addressed. These include:

Gas: 45% of the North Sea’s output is gas, and current UK gas prices are an equivalent of about $60 a barrel - not much more than half of oil prices. Maximising recovery of the UK’s indigenous gas supplies is vital not only for our energy security at a time of concern over reliability of gas imports, but also because availability of lower carbon gas to replace coal for power generation is the quickest,  biggest and cheapest route to meeting the UK’s carbon emission targets in the short term.  The different status of, and particular threat to gas production by this rise in SCT should be addressed as a priority by the Government to ensure that investments in gas developments, in particular in "difficult" reservoirs, continue to be attractive.

Lost investment opportunity: The market for most of the industry supply chain is global, and a one-off shock in one jurisdiction at a time of higher oil prices will lead to resources (rigs, vessels, people etc ) being redeployed in higher margin/more stable jurisdictions elsewhere. Moreover, the maturity of much of the infrastructure in the North Sea means that any hiatus in planned investment could hasten decommissioning of existing infrastructure. Much of the hitherto planned investment depends on this infrastructure, and will be irretrievably lost once decommissioning sets in.

Field allowances: Investment in some of these categories (Deepwater West of Shetland; Heavy Oil and High Pressure, High Temperature gas and liquids) was partly incentivised by allowances in the pre-Budget 2011 fiscal regime. These special field allowances are at risk of being undermined by the SCT rise and a review is required to ensure that new developments will still proceed

Decommissioning: Despite the current joint government-industry process to resolve continuing uncertainty around decommissioning costs, the Budget also restricted decommissioning tax relief to the previous SCT rate of 20% alongside the SCT increase to 32%. This creates additional uncertainty on the relief for PRT fields.

Older PRT fields: These will also be hit particularly hard as the marginal tax rate increases to 81%. They are generally older, higher opex, lower unit margin fields requiring significant investments to maintain the facilities. Many of these fields have cessation of production dates looming, which may now be accelerated, bringing unnecessary loss of production and revenues.

April 2011

[1] NBP – National Balancing Point – the UK’s traded marker price.

[2] HH – Henry Hub - the USA’s primary traded marker price.

[3] Oil and Gas UK – 2011 Activity Survey .

[4] EGAF (2011).‘Making the Green Journey Work : Optimised pathways to reach 2050 abatement targets with lower costs and improved feasibility’.

[5] CCGT = Combine Cycle Gas Turbine

[6] Total costs = Capital costs + Fuel Costs + Operating Costs

[7] Redpoint (2010) – ‘Gas future scenarios project’.

[8] EGAF (2011).‘Making the Green Journey Work : Optimised pathways to reach 2050 abatement targets with lower costs and improved feasibility’.

[9] The European Gas Advocacy Forum (EGAF), is an industry group including Centrica, E.ON Ruhrgas, Eni, Gazprom Export, GDF SUEZ, Qatar Petroleum, Shell and Statoil.

[10] EU targets for 2020 are: 20% improvement in Energy Efficiency; 20% Renewables Contribution and 20% CO 2 Emissions Reduction from 1990 levels.

[11] European Climate Foundation (ECF): ‘Roadmap 2050 – A practical guide to a prosperous, low-carbon Europe’.

[12] Assuming DECC’s carbon price projection which sees EUA prices rising to £70/tonne by 2040, and CO 2 transport and storage charge of about £6/tCO 2 e.

Prepared 26th May 2011