Energy policy is rapidly rising up the political agenda. High prices and a growing dependence on imports are forcing the governments of energy consuming nations to take a more active interest in the subject after decades of neglect. With oil and gas prices at record levels, many observers are questioning whether markets alone can deliver secure supplies at competitive prices especially in the UK, where gas prices this past winter surged to their highest level since before the market was liberalised.
The UK is the first country in Europe to have created a fully liberalised market for gas. During the 1990s, the tight grip of the incumbent monopoly British Gas was gradually unpicked under pressure from both government and the competition authorities. By 1998, all gas customers were able to choose their supplier, the Network Code guaranteed third-party access rights to the National Transmission System (NTS), British Gas had been broken up into separate parts upstream, downstream, transportation and storage and long-term contracts between gas producers and Centrica, the downstream marketing arm of the former incumbent, had been renegotiated. The immediate benefit to consumers was much lower gas prices, as growing offshore supplies from producers were able to compete for customers instead of being purchased by a monopoly buyer (see Figure 1). The price of gas on the newly created beach spot market at the Bacton entry terminal more than halved, dropping from 20 pence a therm to 10p/therm between the end of 1994 and mid-1995. At the same time, UK gas demand was growing rapidly as a string of combined-cycle gas-fired power stations was brought on line to supply the newly privatised electricity market.
However, the independence of the UK gas market did not last long. In October 1998, the Interconnector pipeline connecting Bacton with Zeebrugge in Belgium opened up a physical link with the still un-liberalised gas market in Continental Europe. Instead of exporting competition to Europe as some observers had naively expected the Interconnector pipeline imported higher European gas prices into the UK, which were linked to oil through the price formulae embedded in long-term contracts. Since then, oil prices have set a floor under UK gas prices, draining any surplus gas from the UK when Continental prices are higher especially during the summer months. In the same way, rapidly rising oil prices over the past three years have dragged up the general level of gas prices in the UK.
Although the European gas directives are trying to create a more liberalised gas market in Continental Europe, progress is very slow because of resistance from incumbents. Third-party access to pipeline capacity especially across national borders remains very difficult and most of the gas is still being bought under longterm contracts at oil-linked prices. Short-term trading is on a very small-scale compared with the UK and few customers have any real choice about their supplier. Like the UK and the US before it the regulatory authorities are coming to understand that tough action will be required to achieve the goal of a truly competitive market for gas across the entire European Union.
However, while a lack of competition in Continental Europe certainly contributed to surging gas prices in the UK last winter, this was not the primary cause. The UK currently faces a serious problem meeting peak winter demand because of a general lack of storage capacity. In the past, the UK relied heavily on flexible dry gas fields especially those in the southern North Sea to provide the necessary swing capacity to meet peak winter demand, but these fields are becoming much less flexible as they go into decline and producers are unwilling to sell gas on swing contracts for fear of losing output permanently as water floods into idle wells. In addition, more offshore gas is produced in association with oil, limiting flexibility as supplies are determined by the operational requirements of oil fields.
Storage now plays a key role in meeting winter demand in the UK. Over the last winter (1 October 2005 to 31 March 2006), storage gas provided 5% of UK supplies which may not sound like much, but still represents a marked increase from the previous winter when the weather was warmer and beach supplies more flexible. Significantly, on the peak demand day (2nd of February, 2006), 17% of UK gas supplies came from storage a rate of withdrawal that can only be sustained for about 10 days before triggering a network gas supply emergency and cannot be exceeded for more than two or three days which goes a long way towards explaining why UK gas prices surged to such high levels last winter.