Supply security — a better candidate for UK state intervention?

The pledge to cap retail energy prices in UK prime minister Theresa May’s ill-starred 2017 election campaign was a distinct departure from Conservative Party economic orthodoxy. Intended to appeal to the working class heartlands of the opposition Labour Party, it was at the centre of a manifesto widely decried by the business community as the Tories’ most “anti-business” ever.

It remains to be seen how the policy will work in practice, given May’s continuing struggle to reach an accommodation with Northern Ireland’s Democratic Unionists following the Conservatives’ loss of their parliamentary majority. But it is highly likely that retail price caps will have some sort of detrimental effect on the efficiency of the wholesale market.

If the next government is committed to reversing the light-touch approach to the UK energy market adopted by successive administrations since the completion of full liberalisation in the early 2000s, it may have unintentionally found an easier, if somewhat less obviously populist, place to start than retail price caps. The announcement today by UK gas firm Centrica that it will permanently shutter its 2.8bn m³ Rough storage facility offers a potentially simpler, if no less interventionist, opportunity for state involvement.

Rough is the UK’s only seasonal storage unit — that is, it is the only facility where its economics depend more on the so-called “intrinsic value” of injecting gas in the summer, when prices tend to be cheaper because of lower demand, and withdrawing it in the higher priced winter period. All other UK storage sites are smaller and much more flexible, whose users aim to capture “extrinsic value” from short-term price fluctuations, for example injecting gas at the weekend to withdraw it during the working week.

New investment in small, flexible storage has proven feasible in the UK’s liberalised gas market, with Petronas’ Humbly Grove, Statoil’s Aldbrough, Uniper’s Holford and Engie’s Stublach units all arriving since the turn of the century, and EdF Trading extending its Hole House Farm facility. But it has proven very difficult to make an investment case for more UK seasonal storage to sit alongside Rough, which was commissioned as a storage site back in the old British Gas monopoly days in 1985.

There have been candidates for a second Rough — Italy’s Eni bought the Hewett field from UK independent Tullow in 2008 with plans to convert it into a 5bn m³ capacity unit. Centrica and UK independent Stag Energy struggled to progress their respective Baird and Gateway projects. And Argus understands that BP in the late 2000s looked at up to three of its Dimlington and Easington gas fields, close to Rough, for their suitability for conversion to storage.

One factor impacting the investment case for seasonal storage is that the UK is tied by pipeline links with Belgium and the Netherlands to the wider northwest European gas market, which is oversupplied with storage capacity. Facilities in Germany have been closing amid industry calls for government assistance on security of supply grounds, while units in other countries such as France have seen capacity utilisation rates fall. In effect, the UK can export gas, most usually through the Interconnector to Zeebrugge and then across Belgium into German storage, in times of surplus, then import it back during periods of high demand.

The other disincentive to invest in seasonal facilities is the “storage paradox”, where the addition of new capacity reduces prices in the peak winter period, because storage can deliver greater supply, and pushes up the price in the summer, when injections bolster demand.

In short, the very existence of the new storage unit compresses the summer-winter price differential on which it depends to be economic.

Overcapacity in the northwest European market as a whole has put UK summer-winter price spreads under pressure for a number of years. Yesterday, the Argus assessment of the spread between the summer 2018 and first quarter 2019, the peak winter demand period, was just 18pc of the value of the latter contract. The same differential stood at 38pc 10 years ago.

The only significant seasonal storage facility delivered in the liberalised European market is the Netherlands’ 46TW Bergermeer facility. It is owned by Abu Dhabi sovereign wealth fund-backed Taqa, with its core customer — Russia’s state-controlled Gazprom — needing greater access to flexibility in western Europe as its contractual relationship with its key customers evolves. It is safe to say that the business case underpinning Bergermeer is different to that of any firm looking to build a new Rough in the UK on purely economic grounds.

It would be unduly alarmist to suggest that Brexit and the, as yet, unclear way that the UK and European gas markets will interact after the UK’s departure from the EU poses a serious risk to the country’s reliance on continental European storage. But the beginning of those negotiations this week hard on the heels of a Gulf Co-operation Council spat with Qatar — a major gas exporter to the UK — which has caused ripples of uncertainty in the global LNG market, serve as timely reminders that we are living in an increasingly uncertain world.

With summer-winter economics making no compelling investment case for a new Rough, the UK government may see fit to look into the options for providing state aid to see that one is built. Whether such a project would prove value for money or risk becoming another Hinkley Point is a matter of debate. Alternatively, it could plough money into efficiency measures that would reduce the UK’s peak gas demand to levels more easily supported by the smaller, more flexible facilities that remain economically viable in their own right.

If the new administration feels that it must do something, action on supply security would be a more useful intervention for an efficient wholesale market — which should, in theory at least, ultimately benefit all consumers — than the introduction of retail price caps.

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