Winter gas & power will still prove costly for UK business:
Falling wholesale energy prices have had significant column inches recently, with UK regulator Ofgem threatening to "go after" domestic retailers caught with profit-laden "jam on their fingers." While households may enjoy a welcome fall in energy bills in the New Year, British industry faces the more immediate prospect of another winter of discontent in the volatile spot and near curve markets. According to a new report, fresh price highs appear inevitable during the coming winter as the specter of supply insecurity still hangs over the wholesale market. Much has been made of the recent 20% fall in the wholesale price of gas delivery for winter 2006. Major energy users, many of whom have chosen flexible purchasing contracts to hedge their supply, may, however, exhibit less of the 'cautious' optimism currently emanating from Millbank. The wholesale cost of winter 2006 gas delivery is, after all, still more expensive than the average price witnessed during winter 2005. The underlying issues driving wholesale gas price rises in the UK namely dwindling output from the North Sea and increasing reliance on imported gas haven't gone away. The market will remain vulnerable to temporary price spikes, in the case of an unusually cold spell of weather, and a more prolonged rise in prices should aging offshore infrastructure experience a technical glitch. I&C energy contracts are far more susceptible in both these circumstances as they are directly exposed to the wholesale cost of gas for delivery tomorrow, next week or next month. Capacity does not equal volume The arrival ahead of the Langeled, BBL and expanded Interconnector pipelines undoubtedly offer a pivotal additional buffer to winter supply capacity. Increased import capacity has been a natural market response to the consistently high wholesale prices witnessed in recent years. Additional pipeline space doesn't, however, guarantee more gas will come to the UK. Price is not always the determining factor at play here. Utilizing capacity with physical gas volumes is reliant on continental shippers wanting to send gas to Britain. In France and Germany, for example, companies are under a social obligation to keep certain levels of gas in store to cover domestic demand. As recent history has shown, they will not compromise their national reputation, or risk raising the ire of their respective national governments, in a bid to make short-term international profits in the UK. National Grid and Ofgem essentially conceded this point in their Winter Outlook consultation, under which they limited their forecast for available import capacity between October-December 2006 below that seen in the previous winter. Essentially, the UK wholesale energy market is more susceptible to price spikes if a cold snap should arrive early, as it did in November last year. While these numbers may be revised by the early arrival of the Langeled pipeline, they should not be dismissed as arbitrary. The Gas Balancing Alert (GBA) mechanism, whose debut pushed the spot price to £2.50 per therm in March 2006, will be measured against these assumptions. Continental bottlenecks Physical constraints in the gas pipeline system also remain a key issue. The pipeline network in continental Europe is, in places, simply not equipped to allow the efficient flow of gas to the UK, regardless of how much we want it and how much some people want to send it to us. Even though additional import capacity is expected to come online ahead of schedule, it does not, in itself, mean more gas will flow into the UK. The gas pipeline from Norway to Britain is expected to come online before the end of the year, but the Norwegians have essentially admitted that the new capacity is not backed up by new flows, which will largely be made available in winter 2007, when the vast Ormen Lange field is brought onstream. Storage will be pivotal in the coming winter months. A well-documented fire at the Rough gas storage facility, and its subsequent extended closure, serve as strong reminder of the vulnerability of key strategic assets. It is difficult to imagine the pricing impact that an outage at Rough would have had if it occurred in November 2005, as opposed to the end of the winter period. Despite the positive spin placed on injection statistics, and the additional capacity recently offered by Centrica, the fact remains Rough will have less gas in store, in real terms, than during the previous winter. National Grid forecasts for the coming winter envisage full utilization of all storage assets at times of peak demand, suggesting these assets will need to be run extremely hard if continental imports fail to reach predicted levels. End users to bear the brunt Inevitably, as in the past, the costs associated with the risk of procuring gas and power will end up being passed onto the end user. Offshore producers will not risk selling gas too far into the future, as aging North Sea infrastructure undermines their confidence in their ability to meet contracted supplies. The majority of gas will continue to be traded on the spot gas markets, leaving major energy user (MEU) buyers, in particular, at the mercy of unpredictable winter weather and offshore glitches. Suppliers will seek to find consistent consumers of energy that will not unduly expose them to buying gas or power in volatile balancing markets. Those with poor load factors will invariably be charged more for their energy. All industry stakeholders are hoping for a mild winter, strong asset utilization, and a palatable wholesale price for gas and power. This scenario may very well materialize. A number of important issues remain, however, that could quickly undermine nascent confidence in the wholesale market and even more quickly threaten the bottom line for UK industry. 19.9.06