The real risks to the UK's energy supply in 2015

Peter Nisbet -

Discussions surrounding the real risks to the UK’s energy supply are not new. Each year, we see a plethora of outlooks and analysis pieces examining the current risk and they often come to the same conclusion. This winter ‘the lights will go out’ – but it hasn’t happened yet.

Recent market trends mean that there is a real risk to supply; how much of a risk still remains to be seen.

We have analysed the key factors impacting energy supply this winter in an attempt to evaluate the real risks and the wider economic impact a shortage could have in 2015.

Gas supply and demand

The UK has no shortage of gas; indeed it can call on hugely diversified supplies, from North Sea production, pipeline imports from Europe and LNG cargoes from as far afield as Nigeria and Qatar.

Whereas the UK has struggled to attract sufficient imports in recent years, the balance for the UK gas market has changed; demand is still in the doldrums, with total consumption down 17% year-on-year in the first half of 2014, but supplies have improved in line with slowing Asian demand and a 50% cut in Asia spot LNG prices.

LNG cargoes have turned around with European gas hubs the destination of last resort. The sharp summer sell-off evidence of this shift.

This turn around has changed the dynamics of the power generation sector too.  Gas generators have struggled in recent years. The US shale boom has displaced coal in its own energy mix. The increased amount of US coal being exported to Europe has meant coal generation makes more economic sense for the UK. 
Meanwhile, the collapse of carbon prices and the diversification of renewable energy generation have made it tough for gas-fired generators to compete.  Latest Government figures show gas use for power generation down 12% against year ago levels, for the first six months of 2014.

In Europe, the problem is even worse, with gas generators barely recovering production costs let alone making a profit.

However, this summer the pattern was reversed. Instead, falling gas prices and the numerous outages we saw in nuclear and coal plants meant that the demand for gas in power generation increased.

The trend has reversed again for now. The current forward market data suggests a switch back to coal as the preferred generation source in 2015 as power stations come back online following maintenance.

But slowing Asian demand and the start-up of new LNG capacity could further pressurise European gas prices, especially if a cold winter fails to materialise.

With crude oil prices now at a five year low, just above $60 a barrel, weighing on lagged long term contract indexation, it is possible Europe’s gas market could extend the current trends with an oversupply acting as a drag on prices next year; in this scenario the gas vs coal plant rebalancing act could again be a key feature next summer.

As ever winter risks prevail, the extent to which will be determined by how cold it is. The changing global LNG balance has reduced a number of the immediate risks, and storage is over 90% full. However, unexpected field outages and uncertainty around the Russia / Ukraine situation and its impact on supplies suggest we mustn’t be complacent.

The Russian-Ukraine situation

As the world’s largest energy exporter, we all know that Russia relies on oil and gas exports for about half its federal budget. The sanctions placed on Russia throughout 2014 go to the heart of Putin’s economic powerbase. However, so far the sanctions on individual companies have excluded Russia’s gas major Gazprom.

Sanctions targeting delivery of oil technology, goods and services to Russia were intended to make it all but impossible for Moscow to tap new oil sources. However, the implications of such measures could go much further for Europe looking at the year ahead, as sanctions may tempt Russia to halt flows of gas and oil.

While the current agreement between Russian and Ukraine has reduced any imminent risk to European gas supply, it has not completely vanished. The deal only covers the winter months so they will still need to reach a deal for longer-term gas supply which could provide some upside risk to European contracts from next summer.

Power supply and demand

UK power demand peaked in 2005 falling every year since except for a brief correction in 2010 and 2012. It is primarily due to the rising cost of energy, improving energy efficiency (loft insulation, boiler replacements etc), and reduced losses in the transmission and distribution network due to infrastructure upgrades.

That trend has extended into 2014 reflecting a reduction in domestic and industrial consumption and this trend is likely to continue in 2015; final consumption dropped 3.2% in the second quarter of 2014 compared to a year earlier, according to Government figures with industrial use of electricity down 4%.

In addition, UK installed capacity has been falling over the past 4 years due to the early closure of coal plants and mothballing of uneconomic gas-fired plants. Indeed, for this winter National Grid expects 71.9GW to be available – down from 74.7GW last winter and 81.3GW in winter 2011/12. With old coal plants closing (as expected), the (unexpected) mothballing and early closure of gas plants and problems with the UK’s nuclear fleet has reduced the power margin from 6% in 2013/2014 to 4% in 2015/2016, a level which puts the UK system at increasing risk in the coming years.

Making up the shortfall

In light of recent closures and unplanned outages, plant margins for this winter and the next few are likely and ensure the security of our supply. to be tight.

National Grid, the UK system operator, highlighted the risks to supply in its winter outlook report. Though the UK currently has a sufficient number of power stations, scheduled planned closures before new stations are built will mean the level of spare capacity in the market will shrink further over the coming years.

While the impact may not be immediate, we are likely to see the effects during periods of peak demand, like unexpected winter cold snaps, a problem amplified if power imports are not available.

To alleviate this, National Grid has already implemented two new balancing services, set to combat against a potential shortfall.

Combined, the Demand Side Balancing Reserve and Supplemental Balancing Reserve, are forecast to increase capacity by 1.1GW, taking our supply margins to 6.1% for this winter.

While this is low by historic standards, National Grid is confident that supplies will not be at risk, particularly under the ‘normal’ winter conditions that are forecast for the first quarter of 2015.

As we look further into the New Year, the current outlook suggests that wider economic issues caused by the recession will continue to dampen industrial demand. More energy efficiency measures, load shifting and embedded generation will also start to have an undeniable effect, all off which will soften the impact of any outages.

The fact is there will always be a risk associated with our energy supply. However when we consider our needs against current and expected supply, the UK is in a healthy position moving into 2015.

So, while the power system will be tighter this winter, it’s unlikely we’ll be plunged into darkness as the risk of lights going out remains extremely low.