Oil & Gas Markets

UK Gas Market and Prices

The gas market has undergone unprecedented changes in the past two years and, in particular, the past 12 months. During the period 2004-6, wholesale gas prices in Great Britain rose significantly on the back of high oil prices and an expectation of supply-demand tightness during winter, especially the one of 2005-6, combined with rigidities in the European market¹. In the event, that winter was especially difficult for industry with high, peak prices occurring both early on (late November – early December) and towards the end (late February – early March); in addition, prices generally were at or above those on the continent of Europe, where oil indexation is the normal means of pricing gas. High gas prices also affected electricity prices in Britain, because of the extent to which electricity is produced from gas. For domestic and most commercial consumers, although gas prices rose appreciably, there was not the same exposure to short term fluctuations, because these markets are mainly supplied through longer term contractual arrangements which dampen price movements.

However, in the past 12 months, wholesale gas prices in Britain have fallen substantially, as new supplies have come on-stream with the completion of two new pipelines, one from Norway and one The Netherlands. Through a very mild winter, 2006-7, these pipelines have delivered much new gas to the market (see Figure 19), such that wholesale prices have fallen to less than half of those indicated by oil indexation. This is good news for all UK consumers, but less good for producers, especially those with interests in the gas-only provinces of the southern North and Irish Seas, and those trying to develop gas west of Shetland where no pipelines exist to bring the gas to market. It also creates an awkward differentiation with the central and northern North Sea, where oil predominates. However, overall costs are being driven mainly by the search for and development of higher priced oil, at the expense of gas further south and west.

Figure 19: UK’s Sources of Gas, Winters 2005-6 and 2006-7

Meanwhile, demand for gas has been reduced by higher prices in recent years, but it is expected to resume an upward trend, with more gas fired electricity generation replacing nuclear and coal fired power stations which are coming to the end of their lives on account of both age and, for coal, tighter environmental limits. With the planned increase use of renewable sources (mainly wind) in electricity generation, it will be essential that new gas (and, in future, “clean” coal) power stations replace much of the existing generating plant in the coming years, so that the electrical stability of the national grid system can be maintained to guarantee continuity of supply and prevent interruptions.

Figure 20: UK Gas Demand by Sector 1985-2005

The volatility of gas prices in recent years may be seen in Figure 21 below which shows the prompt (day ahead) price and forward prices² for the first quarters of 2006, 2007, 2008 and 2009 (the prices in the first quarter, encompassing mid-winter, are the highest quarterly prices in any year). The reduction in prices, both prompt and forward, during the past year has been substantial, with the commissioning of new pipeline supplies. Further import projects due on-stream in the next 12-18 months, mostly of LNG, should help stabilise the market even further.

Figure 21: UK Wholesale Gas Prices 2004-2007

With various new import projects coming to fruition (see Figure 23), the UK is, once again, enjoying wholesale prices below those in mainland Europe, where oil indexation of gas prices rules. Nonetheless, as may be seen in Figure 22, gas prices for commercial and industrial customers throughout Europe have, in the main, fallen slightly during the past year. With the price of oil having risen again in the early months of 2007, there is the prospect that all end users in the UK will soon enjoy lower prices than in the rest of the EU, as was the case for almost all of the years since market liberalisation in Britain in the mid-1990s.

Figure 22: European Gas Prices, April 2006 - April 2007

Contrary to the normal rules of competition, though, there has been clear evidence of intervention by the authorities in France and Spain to restrict price rises artificially; also, in Germany, it is noteworthy that small and medium users pay the highest prices among the countries surveyed and yet, strangely, large users are much lower down the scale. It remains to be seen whether the European Commission can succeed in driving through liberalisation of both gas and electricity markets throughout the EU and, therefore, whether true competition in energy is allowed to develop. Security of energy supply is a major concern in the minds of many politicians and market participants, and the concept of open markets is not seen in much of mainland Europe as a means of achieving security of supply, in the way that it is in the UK and by the Commission.

Figure 23 lists the import projects which are either under development or have recently been completed to supply the British market. Given that annual demand is approximately 100 billion cubic metres (bcm), this is a most impressive list of new investments. It is also worth noting the diversity of these projects, such that the potential sources of gas to feed this capacity are many and various (see Section 3 above, Security of Energy Supply).

Figure 23: New UK Gas Import Projects

Furthermore, it is known that Norway is examining various options for the construction of another pipeline to deliver further gas to either mainland Europe or Britain. The outcome is likely to be known by the end of 2007.

In a broader context, some 70% of the world's proven gas reserves are within economic transport distance of the EU, within which the largest markets are the UK, Germany, Italy and Spain (in descending order). Figure 24 shows possible annual flows from the various sources where these reserves are located. Pipelines will remain the principal means by which such gas will reach the EU's markets, but LNG will play an increasing role and will provide an important and price sensitive degree of flexibility, thus aiding security of supply.

Figure 24: Map of potential Gas Supplies for Europe, 2010-20 (bcm/yr)

¹ The European Commission issued the final report of its investigations in January 2007. Back

² It should be noted that a forward price is not a prediction of the price at a future date, but a price which may be fixed in advance for the delivery of gas (or any other good or commodity) at a date in the future, in this instance in the first quarter of each of the years shown. Back