Chapter 2: The UK's energy market
The UK energy mix
5. The energy market in the UK is
being reshaped by three distinct factors. First, on the supply
side, North Sea oil and gas output is declining. Production of
oil and natural gas liquids fell by 9 per cent in 2013, and gas
by 6 per cent. Total output has fallen by almost 40 per cent since
2010. The Government
are seeking to revive output and have adopted the proposals of
the Wood report for simpler regulation.
The industry response, however, remains uncertain. Figure 1 shows
the range of DECC's production forecasts over the next five years.
North Sea Production
Source: Oil and Gas UK, DECC
Imports of both oil and gas have grown
over the last decade as North Sea output has declined. Even if
North Sea oil and gas production can be stabilised for a period,
import requirements are likely to grow further over the next two
6. The second factor shaping the
market is a long term shift in the UK's energy mix. The share
of total energy demand provided by electricity and gas has grown
as the role of manufacturing in the economy has declined. Since
1970 gas consumption has grown from 14.4 million tonnes of oil
equivalent (mtoe) to 47.1 mtoe in 2012. Figure 2 shows trends
in fuel consumption over the last four decades.
Final energy consumption
by fuel, UK (1970 to 2012)
Source: DECC, ECUK Table 1.06
7. Figure 3 below illustrates the
sources and uses of energy within the UK economy.
Energy Flow Chart 2012
DECC, National Statistics
The impact of policy commitments
to renewable and low-carbon energy
8. The third factor shaping the
UK's energy mix is Government policy, including the Climate Change
Act 2008 and the Energy Act 2013. This legislation reflects the
UK's commitment to a long term reduction in carbon emissions by
2050 with intermediate targets for 2020, to be achieved by reduced
use of coal and gas in power generation (except if carbon capture
and storage technology can be used) and by supporting development
of low carbon sources of supply including onshore and offshore
wind power, solar, biofuels, and new nuclear.
9. The development of alternative
sources of energy will displace some gas. But, according to the
most recent estimates from National Grid, substantial volumes
of gas will still be needed over several decades for home heating
and as back up supply in the power sector, where supplies from
renewable sources such as wind and solar are inevitably intermittent.
Even if gas fired power generation is replaced over time by renewables
and new nuclear, gas is likely to remain the main source of heat
in the UK's economy. Mr Ken Cronin of the UK Onshore Operators'
Group (UKOOG) reminded us that "Some 80% of our heat comes
10. Renewables are therefore likely
to complement rather than completely displace gas in the UK energy
market. Natural gas remains an attractive and flexible fuel, capable
of providing heat and power at a relatively low cost, thanks to
advances in generation technology over the last twenty years and
to the UK's established gas infrastructure including a comprehensive
transmission grid with links to Europe. Gas also produces 28 per
cent fewer emissions per unit of electricity produced than oil,
and 45 per cent less than coal.
Regardless of whether the UK develops indigenous shale gas reserves,
the UK is likely to be a substantial consumer of global shale
gas as new supplies encourage gas-to-gas competition.
11. Gas prices have historically
been set by long term contracts with producersin the North
Sea and elsewherewith prices traditionally linked to movements
in the international oil price. In recent years, however, this
link has begun to break down and more gas is bought and sold at
spot prices as the international trade in liquefied natural gas
(LNG) has grown. In the short term prices have been falling, first
in the US as shale gas development provided new and low cost sources
of supply and more recently in Europe where gas to gas competition
is undermining contracts which traditionally linked gas and oil
prices. In a complex market, however, no particular trend can
be guaranteed to persist.
Future price trends
12. There are widely divergent views
on the future of global gas prices. A DECC report of July 2013
"Fossil Fuel Projections" argued that gas prices are
expected to settle at 73.8 pence per therm
in the 2020s, compared to 63.6 pence per therm now.
A second DECC report, commissioned from consultancy Navigant in
2012, estimated that 2030 prices would be in the range 50 to 80
pence per therm.
By contrast Professor Dieter Helm of Oxford University saw
"no particular reason for believing that the gas price is
going to go up in the medium term. There are quite good reasons
for thinking that it is going to go down. It is abundant in supply".
Costs of renewables
13. The change of the energy mix
in favour of low carbon supplies as laid down by Government policy
is not cost free. Hopes that the costs of renewables would fall
materially as a result of large scale application have so far
been disappointed, and the costs of new nuclear have risen dramatically
to the point where the proposed new nuclear station at Hinkley
Point will require a support price of £92.50 per megawatt
hour, double the current wholesale price. The support price will
be guaranteed and index-linked for 35 years after the station
comes on stream. Critics of Government policy foresee a UK and
European energy market locked into high cost renewables while
global energy prices fall due to abundant new supplies of shale
gas. Mr Peter Atherton of Liberum Capital said
is enjoying abundant and relatively cheap fossil fuels and very
few of our major competitors have followed us on the decarbonisation
strategy, so all the public is seeing is the costs and none of
those benefits, it will be extraordinarily hard for policymakers
to hold the current line on European energy policy."
Electricity generation: the investment
14. The economics of power generation
are heavily dependent on high load factors. The shift to renewable
sources is not only expensive for consumers but also imposes a
burden on other generators. Wind and solar power are by their
nature intermittent. Constant supply of current requires back
up generating capacity from conventional sources. Its limited
usage can make it an unattractive investment. Professor Helm
told us that once intermittent generation from sources such as
solar and wind provides a substantial proportion of electricity,
everything else on the system becomes intermittent as well. Gas
fired capacity is used for only part of the time, undermining
the economics and discouraging investment.
15. Uncertainty over the economics
of new conventional generating capacity and more generally about
future public energy policy is discouraging investment at a time
when older stations are reaching the end of their working lives
or, in the case of coal fired stations, being decommissioned under
environmental regulations. Viscount (Matt) Ridley, a science journalist,
said, "Our policy is that, when somebody wants to make electricity,
they will take the wind power first and the gas second. They will
only take the gas if the wind is not blowing. As a result, they
are not going to build the gas plant because they cannot run it
all the time."
OFGEM reported in 2009 that £200 billion would be needed
by 2020 to ensure that capacity could meet demand.
More recently, the Government have estimated the electricity sector's
investment needs at £110 billion over the next decade.
The slow pace at which that investment is proceeding is arousing
serious concerns about the ability of generators to maintain sufficient
supply to meet demand, particularly during periods of high use.
16. According to OFGEM's most recent
Electricity Capacity Assessment report, the probability of a large
shortfall requiring the controlled disconnection of customers,
involving industrial and commercial sites before households, will
increase from around 1 in 47 years in the last winter to 1 in
12 in 2015/16. This
will increase to 1 in 4 if anticipated demand reductions resulting
from increased efficiency do not materialise.
There is a concern that inadequate capacity could lead to cuts
in supply to business and industry which would have serious economic
17. Professor Helm described
the situation as a "very slow-motion car crash"
and warned that
"by 2015 or 2016, the capacity
margin in this country will be very close to zero; in fact, I
have done some numbers which suggests that it might be below zero.
What is going to fill the gap in 2017, 2018, 2019 and 2020? We
will be lucky if Hinkley is on the system by 2022 or 2023. More
nuclear power stations are coming off between now and then. Most
of the coal, through emissions control, thankfully, is being closed.
There are not enough wind farms and solar panels to fill that
gap in a credible way
it is inescapable that gas is a transitionary
fuel and can actually make a big impact quickly."
18. There is a growing risk of
power cuts in the UK as the margin of electricity generating capacity
over peak demand shrinks. It reflects a lack of clarity and consistency
in energy policy over many years. UK-produced shale gas could
not, of course, contribute to a short term solution. Its development
is a separate issue. Indigenous shale gas could, however, provide
in the medium term an additional source of supply which, combined
with policy changes to encourage investment in generating capacity,
could help ensure that competitively priced electricity supplies
are maintained at an adequate level for many years to come.
Security of supply
19. In the absence of shale gas
development, imports will rise. By 2030, DECC has forecast that
the UK could be importing three quarters of its gas.
The Institute of Directors estimates the costs of such imports
at £15 billion per annum.
The IoD report's central scenario for UK shale gas production
suggests that gas imported could be reduced to 37 per cent of
consumption in 2030, with the cost of imports falling to £7.5
billion which "would assist with the UK's balance of payments
and support energy security".
20. Some witnesses believed that
even without domestic shale gas, the UK was well placed to withstand
any disruption in supply. E.ON wrote that the UK is part of a
"well connected and liquid market [therefore] relatively
insulated from supply-side shocks."
Mr Richard Sarsfield-Hall said that Poyry International Consulting
Engineers "did some work for the Government a couple of years
ago that looked at the security of gas supply. We identified that
broadly because of its diversity, it looked very secure."
Policy Exchange thought that arguments about energy security have
"tended to be overplayed in the UK policy context."
21. DECC wrote that increasing reliance
on imported gas "can expose the UK to new gas supply risks,
whether from geopolitical events
or from diversions of
gas supplies driven by higher prices in other markets
unconventional production could mitigate these risks."
The Chemicals Industries Association (CIA) expressed the view
that development of the UK's indigenous shale gas would "certainly"
have a positive impact on security of supply, not least because,
when supplies are tight, LNG shipments are always liable to be
diverted from the UK to markets willing to pay a higher price.
22. INEOS highlighted the strategic
risks associated with import dependence on supplies from the Middle
East and Russia.
Recent events in Ukraine and the resulting tensions between Europe
and Russia demonstrate how real these risks are. Europe imports
over 25 per cent of its total energy needs and over 30 per cent
of its gas supplies from Russia.
The UK is not directly dependent on Russian supplies but in an
integrated market we would not be immune from shortages or price
increases across the European Union. After the US and European
Union imposed sanctions on Moscow, the Minister for Energy reportedly
described the situation in Ukraine as "a wake-up call to
Europe of the need to develop more energy sources of all kinds.
We can't be more and more dependent on imports from unstable regions
We have to develop more home grown energy like shale."
Compatibility with development
of low carbon forms of energy
23. Concerns have been expressed
by NGOs that development of the UK's indigenous shale gas resource
could lead to higher carbon emissions and lock the UK into a gas
based economy for longer than compatible with the Government's
targets for emissions reductions. Mr Nick Molho of WWF-UK
said "Our organisations are opposed to the development of
shale gas in the UK mainly on grounds relating to climate change".
"To the extent that those [UK]
reserves are brought out of the ground and encouraged to be used
in our gas power stations and gas infrastructure, the most likely
scenario is that this will displace low-carbon generation
[It would be]
a very dangerous mistake to associate exaggerated
hopes on the future of UK shale gas exploitation with a policy
that will encourage the construction of excessive amounts of new
gas infrastructure, because the most likely outcome will be a
continued high dependency on imports".
We address the topic of shale gas and
carbon emissions more fully in Chapter 6.
24. Some witnesses took the view
that exploitation of the UK's own shale gas resource would displace
imported gas rather than renewable energy. Mr Dan Lewis,
CEO of Future Energy Strategies, said his company's economic modelling
indicated that shale gas imports would be displaced by indigenous
shale gas production, while renewables and nuclear would not be
displaced because of the levels of subsidy for those forms of
electricity generation through the Electricity Market Reform (EMR).
Mr Ken Cronin of the UK Onshore Operators' Association (UKOOG)
said that the renewables industry should not have any fear of
shale gas development: "Shale gas will give the opportunity
for a transition to enable renewable energy to become cost-competitive."
25. Dr Figueira of the Office
of Unconventional Oil and Gas (OUOG) explained that "in terms
of decarbonising the electricity system
there will be a
continued need for gas in the decarbonisation efforts".
Mr Cronin told us that "the facts are that we will need
low-carbon forms of energy for the future
They are quite
expensive at the moment, and we need to have a transition. The
transition has to be gas, and it will have to be shale gas."
Gas prices and energy intensive
26. Substitution of locally produced
gas for imports could also have some effect on prices due to the
added costs of processing and transporting imported LNG. Mr Dorner
of the International Energy Association told us that "the
cost of transporting gas is about seven times that of transporting
oil on an energy-equivalent basis" and that the costs involved
in transport would continue to be the main factor causing final
gas prices to diverge between one region and another.
Gas prices and the wider economic impact are discussed more fully
in Chapter 5.
27. Rising energy costs pose a particular
challenge for energy intensive sectors such as metals and for
the petrochemicals industry, where gas is a feedstock. The International
Energy Agency published a study in 2013 that showed how far European
costs have risen and diverged from those in other parts of the
world and warned of the risk that industries could move to areas
where energy costs are lower.
Mr Tom Crotty of INEOS said "we have to sell our products
globally. Today, the cost of energy in the UK is three times that
in the US and three times that in the Middle East. They are our
two major competitors for the manufacture of petrochemicals."
28. Development of shale gas
in the UK on a significant scale could provide substantial benefits:
· enhancement of energy
security through a decreased reliance on imports;
· an affordable bridge fuel
towards renewables-based electricity generation;
· enable decommissioning
of high-emission coal fired generating capacity;
· reduce the risk of gas
price increases or even lead to falls in prices;
· reduced costs for energy
intensive businesses and the petrochemicals sector that also use
gas as a feedstock.
5 Sir Ian Wood (2014) UKCS Maximising Recovery Review:
Final Report. Back
The UK's climate change objectives are discussed further at paragraph 118. Back
National Grid (2013) UK Future Energy Scenarios. Back
Q 58. Back
DEFRA (2012) Greenhouse house gas factors for corporate reporting. Back
A unit of heat equivalent to 100,000 British thermal units. Back
DECC (2013) Fossil Fuel Price Projections. Back
Rathbone, P., and Bass, R. (2012) Unconventional Gas, Navigant. Back
Q 117. Back
Q 199. Back
Q 125. Back
Q 153. Back
OFGEM (2009) Project Discovery, Energy Market Scenarios,
9 October. Back
for the Government's estimate. Back
OFGEM (2013) Electricity Capacity Assessment Report 2013. Back
Q 125. Back
Q 121. Back
Taylor, C. Lewis, D. (2013) Infrastructure for Business: Getting
shale gas working, Institute of Directors. Back
Q 16. Back
Policy Exchange. Back
Chemical Industries Association. Back
BP (2013) BP Statistical Review of World Energy June 2013. Back
Critchlow, A. (2014) 'Fallon calls for refocus on 'homegrown'
shale energy', Daily Telegraph, 23 March. Back
Q 33. Back
QQ 43-44. Back
Q 66. Back
Q 179. Back
Q 62. Back
Q 98. Back
International Energy Agency (2013) World Energy Outlook. Back
Q 89. Back