Oil & Gas Markets and Security of Supply
The security of UK energy supplies is intimately related to global markets because oil and, increasingly, gas are freely traded commodities affected by world supply and demand. Renewed interest in energy policy has focused not only on the sources and security of energy supplies, but also the environmental impacts of different energy sources. As the UK moves from being an energy exporter to an importer of oil and gas the balance of trade will become more exposed to energy market forces.
Energy Prices: Figure 24 illustrates the movement in fuel prices paid by UK industry since 1988, excluding the impact of the Climate Change Levy. Until the year 2001, gas prices had fallen in real terms more than any other fuel. Prices rose in 2001 due to the increase in the global oil price and the influence of oil-indexed continental gas prices on those of the UK, via the Interconnector. During 2002 prices have moderated. However, the price benefit to industrial consumers has been offset by the impact of the 4.4p/therm Climate Change Levy which significantly increased gas prices from April 2001.
Oil
Oil Market: The volatility of oil prices seen over the past few years was maintained in 2002, as illustrated in Figure 25. The annual average price for Brent in 2002 was $25/bbl with prices fluctuating between a low of $18/bbl in January and a high of almost $32/bbl at year-end. The alternating pressures of over-supply and possible conflict in the Middle East are the main drivers for the volatility. As the year ended, the continued uncertainty over Iraq and the situation in Venezuela pushed prices to a new high for the year.
Looking to the Future: Despite having seen an average price of nearly $26/bbl over the last three years, nervousness about future prices continues and, for most companies, investment decisions are being made assuming lower prices. One reason for this is the belief that the upward pressure on prices, as a result of the uncertainty over Iraq, will be removed within the next few years. Should this occur, over-supply issues are likely to dominate market sentiment putting severe downward pressure on prices. The forward market provides another snapshot of the market's view as to the future price of oil.
Figure 26 shows the price that could be achieved in mid-December for deliveries over the next five years. Although expectations for 2003 are still in the mid $20s, the price drops rapidly to below $22 in 2004 and below $20 by 2006, much lower than the average in 2002.
For investors it is not today's price, but the perception of the future price of oil that is important. As the time lag between the decision to develop and first oil is typically 18-36 months, a field given development approval in 2003 is unlikely to provide significant revenues until 2005 and beyond.
Gas
Gas Market: Historically, in the UK, gas was regarded as a premium fuel and sold into the domestic, commercial and certain industrial markets. During the 1990s, a new market for gas opened up, using the fuel for power generation which offered higher generation efficiency, fewer carbon emissions and lower fuel costs than conventional coal-fired technology. Combined with market liberalization, the increase of gas-fired generation caused rapid growth in UK gas use, such that by 2000 demand had risen to over 10 billion cubic feet per day (bcfpd). Since 2000, growth in gas demand eased as over-capacity in the electricity generation has reduced the need for new power plant.
Final production figures for 2002 are expected to show continuation of the slowly declining trend which saw UK gas production peak in 2000 at 10.5 bcfpd and fall to 10.3 bcfpd in 2001. In 2001, gas represented almost 45% of UKCS hydrocarbon production, some 37% of UK energy production and 4.3% of world production, making the UK the fourth largest gas producer.
Unlike oil, the majority of UKCS gas produced for the UK market is sold under long and medium term contracts indexed to, but lagging inflation and energy prices. The remainder is sold directly into the wholesale spot market. Whilst there is a variety of contract prices, they tend to be lower than the spot price, which averaged 16 p/therm in 2002. The price of gas remains lower than oil's value in energy equivalent terms, despite the relative environmental premium associated with gas. Since the mid-1980s, the real price of gas supplied by UKCS producers at UK delivery points has more than halved.
Figure 28 shows gas prices as the competitive gas market has developed. UK gas began to be traded on the spot market in 1995.
Although spot gas prices fluctuate widely, both within day and seasonally, the average price has in general remained relatively weak and has declined sharply since its last peak in early 2001.
Interconnector: The Interconnector pipeline between Bacton and Zeebrugge was opened in 1998 and allows gas to flow to or from the European market. The facility has an annual export capacity of 1.9 bcfpd ( 20 bcm) or about 15% of the UK's peak demand. Although a smaller volume of gas can flow into the UK at present, the Interconnector's owners are proceeding with plans to increase import capacity from the current 0.8 bcfpd to 1.6 bcfpd (8.5 bcm to 16.5 bcm per year) in 2006.
Figure 29 indicates that export gas flow continues to predominate, especially in the summer months. This summer the importance of the market link to the Continent provided by the Interconnector was highlighted when it was forced to shut down for a period due to liquids contamination. As a result of this, spot gas prices briefly fell below 2p/therm. UK gas supplies are forecast to begin to decline below UK demand and imports through the Interconnector can be expected to rise later in this decade.
Gas Supply and Demand:
Figure 30 shows the potential gas production from the UKOOA activity survey and compares this with current UK demand. This year's survey has revealed a significant near-term decrease (over 2 TCF or 57 bcm by 2010) in projected gas production, such that it now seems unlikely that self-sufficiency will be sustained beyond 2004. It is possible, however, that the decline from this date will not be as steep as the illustration represents if additional projects emerge as company planning horizons are extended. Some contribution can also be expected to result from future exploration efforts, although this is unlikely to impact production much before 2007/2008. Unless there is some recovery in exploration activity it is doubtful that the contribution from future discoveries will be material in the medium term.
Energy policy and regulation influence supply and demand and will help to determine when the UK becomes a net importer of gas. The regulatory regime downstream also affects the ability of the upstream to extend UK self-sufficiency. For example, there was concern that the capacity regime that existed until year-end 2002 did not work in the nation's best interest because it did not provide appropriate investment signals to Transco, the onshore pipeline monopoly, nor encouragement for producers. This was explained by UKOOA in its submission to the Energy Policy Review, emphasizing that regulatory uncertainty can inhibit the maximum recovery of UKCS reserves.
It is vitally important that there is sufficient investment in the National Transmission System (NTS) to ensure that there is sufficient pipeline capacity onshore.
Given this availability, complex technological advances offshore will be progressed as required. The risk to the UK's economy of under-investment in the NTS would far outweigh the cost of some over-investment. This point was recognised by the Trade and Industry Select Committee of the House of Commons, in its Report of 7th February 2002, and by leading industry experts. The NTS capacity regime has been changed from 1st January 2003 and it remains to be seen whether these changes fully address the concerns. If they do not, there must be flexibility to review the regime and to make further changes if needed.
Energy Policy Review
UKOOA welcomed the UK Energy Review, published in February 2002, and the opportunity to contribute to the consultation on Energy Policy which followed. The industry acknowledged the importance of maximising the potential of current and future energy supplies for the UK.
One of the key issues concerning policy makers is the outlook for UKCS gas supplies and the inevitability of imports within the next few years. Figure 31 illustrates the evolution of the UK supply demand balance since 1990 and predicts the gradual shift to gas imports over the next 30 years. This is not a cause for alarm, since the...
...UK is well placed to import gas from a diversity of countries.
FootNotes
¹Dieter Helm, Investment in Energy Networks: Auctions, Regulation and Planning, April 2002, and Alex Kemp and Linda Stephen, UK Gas Production, Imports and Networks: Response to PIU Report, July 2002
²The UK Government's Performance and Innovation Unit's Energy Review, February 2002.
Globally, gas resources are abundant; the issue for policy makers is to establish an enabling regulatory/fiscal climate that encourages investment in infrastructure and networks. The UK has imported significant gas volumes in the past, for example, from Frigg in the 1970s and 1980s, though at the time gas consumption was much lower than today. Gas remains the fuel of choice as we move towards a lower carbon economy. Demand for gas in the UK almost doubled in the 1990s and continued growth in demand is forecast on the back of further market penetration by gas-fired electricity generation, though at a slower pace than in the 1990s. The prospects for nuclear generation will have a critical bearing on gas demand. Gas-fired generation is the natural replacement if the nuclear option is progressively withdrawn.
The Performance and Innovation Unit's Energy Review reflected the industry's view that there were no pressing problems connected with increased dependence on gas, including gas imported from overseas. It has been estimated that some 70% of global proved gas reserves (5500 tcf) lie within economic transportation distance of the EU. The announcement in 2002 of plans to import LNG from Qatar is evidence that Middle Eastern gas reserves can be delivered to the UK. As long as there is reasonable access to European pipeline infrastructure, with investment and regulation support for the development of new infrastructure, reserves required to meet UK demand can be obtained. Figure 32 identifies some of these reserves that could be accessed.
In the medium term it is clear that the UK's gas import requirements will be sourced, as before, mainly from Norway. Gas resources are available and the Norwegians are eager to re-establish their strategic position as a major supplier to the UK. From a UK perspective this also makes good business sense when considering the available capacity developing in existing infrastructure. Figure 33 illustrates the potential spare capacity in existing Central and Northern North Sea gas pipelines.
Economic Report 2002 Index
