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Security of Supply - fact or fiction?

 Where will your light come from this winter?  

For a number of years the UK has basked in an abundance of gas supply, even while market liberalisation, new technology and low prices have driven a huge increase in UK gas demand. The largest growth has been in power generation (see figure 1) as more than 40 new gas-fired power stations have been built since 1990. New fields coming onstream led to a major oversupply of gas from 1995, which also saw gas spot market prices crashing to around 10p/therm. However, the gas bubble has been relatively short-lived, as production from the UK Continental Shelf (UKCS) peaked at 108 bcm in 2000 and has since gone in to decline. With demand continuing to grow and a supply gap emerging, there has been increasing concern in the industry, at the risk to security of supply that could be caused by a really cold spell in winter. This article considers the changing UK supply/demand match and its impact on the gas trading market, both in this and coming years.

Fig 1: UK gas consumption by sector, 1978 - 2003

Source: NationalGridTransco

Panic hit the gas spot market in September 2004 as forward prices for this winter hit nearly 80p/th, encouraging many to fear the worst should a cold winter strike. Large industrial customers were particularly hard hit as many of them traditionally renewed annual contracts in September, based on the forward curve at that time. In reality winter in the UK has been mild until this week and there has been plenty of gas around. The within-day price in January and much of February has been as low as the previous summer months, around 30p/th. Even now as we have hit a cold snap and white fluffy snow covers the UK , although prices spiked up to 77p/th within-day, the system has remained mostly balanced and within-day prices have drifted back down.

This has been just a few days of snow, however, and average temperatures have remained above freezing. In statistical terms this is nothing like a cold winter. The highest demand day so far – the 24^th February – is currently forecast at 417 mcm, but this is well short of the record system demand of 449 mcm set in January 2001, and just under 76% of the 1-in-20 peak day – the coldest day expected in twenty years, which is Transco’s system planning obligation. Questions remain as to whether the system can cope with a really cold day, or even a number of days – the so-called Siberian winter – Transco’s other planning obligation is a for 1-in-50 winter, which equates to about 10 days of -15°C, with demand each day well above 500mcm. If really cold weather hits, does the UK have sufficient gas supply and flexibility to meet demand? 

Much has been said of the UK ’s switch to being a net importer of gas, with LNG imports due to restart in April 2005 (see January’s MZINE), and import dependency forecast to reach 2/3rds of UK gas requirements by 2013. The next sections analyses analyse demand growth and import options over the next decade.  

Demand

Despite the predicted import dependency, Transco’s latest forecasts suggest that by 2013/14 annual demand will have grown by 15% and peak demand by 17% (Figure 2). This is below the rapid increase driven by the ‘dash to gas’ for power generation in the 1990s, but faster than the last two or three years, when high gas prices and low electricity prices limited prospects for new gas-fired generation.  

Figure 2: Historical and forecast annual gas demand and growth rate, 1994 - 2013

Source: NationalGridTransco  

Clearly the combination of rising demand and falling indigenous supply is going to lead to a significant import requirement. Figure 3 illustrates the extent of this import requirement, forecasted to rise rapidly to around 46% by 2010 and 67% by 2013/14.  

Source: NationalGridTransco

Supply

So where is the gas to meet this gap going to come from? As we have already mentioned, this year we see the return of LNG as imports start to arrive at the isle of Grain. But this is just the start as new opportunities have emerged following the forecasted supply gap.  

Traditionally the UK has imported gas through two pipeline systems. The Frigg Transport System (also known as Norwegian Frigg) was developed in the late 1970’s to transport gas from the Norwegian sector of the Frigg field to Scotland . Supplying at its peak around 20% of the UK demand in the mid-80’s and then declining as the UK gas bubble emerged. Since 2000, however, imports have increased again following the construction of the Vesterled connection – a pipeline linking the Frigg pipeline into the Heimdal platform and from there into the rest of the Norwegian pipeline system.  

The UK - Belgium Interconnector (which is also known as Interconnector - UK or just Interconnector) is the other major import pipeline. Commissioned in October 1998 as the first direct pipeline link between the UK and the Continental European gas grid, the Interconnector is bi-directional with gas flowing either to or from the UK depending on net nominations by capacity holders. However, as the Interconnector was initially conceived as an export route for abundant UK gas supplies in the mid-1990s, the only compressor was installed at the UK terminal at Bacton. Therefore the Interconnector currently has a forward flow (export) capacity of 20 bcm/yr and a reverse flow (import) capacity of 8.5 bcm/yr. To increase the flow of gas to the UK , two new compressors are being installed at the Zeebrugge end of the pipe hopefully by December 05, which will increase reverse flow capacity to 16.5 bcm/yr. A further two more are planned to be operational by December 06 taking the maximum import flow rate up to 23.5 bcm/yr. Plant modifications are also expected to take place sometime in the future which would bring the total amount of import up to 25 bcm/yr, although there is no time frame for this as yet. Since October 1998 flows on the Interconnector have for the most part followed price differentials between the NBP and Zeebrugge gas spot markets, with the Interconnector typically exporting gas all summer and importing gas for part of the winter, as UK gas prices are more seasonal than European long-term contract gas prices, which are indexed to oil prices.  

New infrastructure

With the anticipation of the growing UK gas supply deficit, a number of import projects have been proposed.  

Source: NationalGridTransco  

2004 saw the uncertainty of which projects would go ahead partly resolved as projects firmed up and construction commenced (see Figure 5). If all the planned projects are completed then the UK ’s capacity to import gas would increase from 18 bcm/yr in 2004 to over 100 bcm/yr by 2010. The greatest areas of uncertainty though are with the second expansion phases of the South Hook, Dragon and Grain LNG import projects.  

Figure 5: UK gas import projects

Source: NationalGridTransco  

These projects will of course have effects on the terminals (Figure 6) as gas deliveries increase at Bacton (via the Interconnector), Easington (Ormen Lange gas via LangeLed) and to the new LNG import terminals at Grain and Milford Haven.  

Source: NationalGridTransco  

The scale of these projects is enormous, but as the UK seeks to maintain its lifestyle fuelled by gas, we see that after a few years of decline how a gas bubble rises up and refuses to die. Current forecasting suggests that from 2006 onwards the UK will have a considerable surplus of gas again (Figure 7). The exact level of the surplus will clearly depend on a number of factors, such as potential delays to completion of new infrastructure, and the ability of LNG import capacity holders to divert supplies to alternative markets, should prices be higher elsewhere. This surplus could be as great as 60bcm/yr around 2007/08. Clearly much of this relates to the capacity of the Interconnector, which by 2007 could have a net impact anywhere between +25 bcm/yr (imports to the UK at full capacity all year as assumed in Figure 7) and -20 bcm/yr (exporting to Belgium at full capacity all year).  

Figure 7: UK gas supply surplus, 2003/04 – 2013/14

Source: NationalGridTransco  

Peak gas

The analysis above has focused on the need for new imports to the UK ’s forecast annual gas supply gap. However, this is only one side of the issue. Having sufficient annual supplies of gas through imports is not enough to ensure UK homes stay warm and the lights stay on in a cold winter. The key issue is the peak supply/demand match – whether there is sufficient deliverability of gas from the UK Continental Shelf, import pipelines, LNG terminals, storage facilities, and demand-side management, to meet UK demand on a very cold day. Figure 8 shows Transco’s latest forecast for meeting a 1-in-20 peak day demand over the coming years. As can be seen, there is in fact a significant peak day supply deficit in 2004/05 and a much smaller deficit in 2005/06, before the commissioning of new import and storage infrastructure removes the deficit from 2006/07 onwards. In other words, if it had been cold this winter, things weren’t looking good at all. This short-term deficit has had a number of impacts, including a change to the gas supply security regime in October 2004 intended to encourage non-interruptible gas users to switch gas in a shortage in order to exploit high spot market prices. It has also been a factor in the very high forward prices for winter 2004/05 witnessed around September/October 2004. Although the impact on the value of flexibility going forward is uncertain, the arrival of new sources of supply from 2006 onwards, seems likely to depress the value of flexibility somewhat from its historical peak in 2004/05.  

Figure 8: Peak UK demand and supplies available by terminal, 2003/04 to 2013/14

Source: NationalGridTransco  

Projected outcome  

The projected outcome indicates that we can look forward to a significant surplus of gas arriving in the UK from 2006 onwards. The abundance of gas should have a bearish impact on UK gas prices, mitigating the impact of price spikes in winter. In the summer there may well be a very significant downwards pressure on prices as gas supplies, particularly LNG deliveries into Milford Haven, are expected to continue at high rates. Surplus gas is expected to be exported to Continental markets via the Interconnector. However, where the surplus of gas exceeds the export capacity of the Interconnector there is the possibility of a significant price crash.  

Figure 9: Interconnector flows and NBP and Zeebrugge prices, Summer 2002

Source: MJMENERGY  

This is illustrated by Figure 9 which shows the impact on price of an interruption in flows on the Interconnector in July and August 2002. Gas prices at the NBP and Zeebrugge were very close as usual until the Interconnector broke down on 1^st July. Exports through the Interconnector were suspended for all of July, and NBP prices crashed as low as 5p/th (and even 1p/th within-day on one occasion). Where the Interconnector becomes full in either export or import mode, a similar price divergence could be expected.  

Time will tell how this will all unfold over the next few years, but one thing seems to be certain. Although price levels may shift as the supply/demand match varies, price volatility is here to stay.  

Written by: Nick F White and Paul Cassar.  

NationalGridTransco graphs taken from NationalGridTransco’s Ten Year Statement, 2004.