Vision Accendo

Contact us on: 0845 519 0203

Read the latest news and stay informed.

News

What’s the future likely to hold for pricing and supply of power in the UK?
Mar
07

What’s the future likely to hold for pricing and supply of power in the UK?

Introduction

 

The UK market for energy efficient projects in 2010 was estimated at circa £ 4.3 billion with predicted growth of 10% p.a. to £ 6.9 billion by 2015. The chart below shows that these projects anticipate significant annual savings, mostly based on lower power consumption,  (SDLC 2010), but do we know if the annual savings will remain constant over the investment period?

 

 

 

When Vision Accendo is asked to submit proposals to our clients for new LED lighting solutions to reduce power & maintenance costs and carbon emissions we are often asked to estimate overall savings in the future to enable our clients to establish a return on their investment. One of the imponderables is to try and second-guess the likely savings based on electricity charges three to five years out.

 

We have set out below some background information on the interlinking elements that need to be considered when making an analysis of the future pricing of electricity in the UK.

 

Growing Global Demand and Energy Pricing.

 

Based on figures from the Department of Energy and Climate Control’s 2010 UK Energy Brief, “electricity prices increased in 2009 (from 2008) by 7% in real terms, and were 73% higher than ten years earlier in 1999”.

 

The major contributor to the rise in electricity prices has been the rise in the cost of fossil fuels due to growing global demand. In the UK over the last ten years overall electricity consumption has steadily decreased in the industrial sector as we export manufacturing capacity and run more fuel-efficient plant and machinery. On the other hand domestic consumption has grown during the same period with some annual variations based on winter climate conditions.  The net effect being that total electricity consumption is running at around 330 Twh in 2009 about 97% of the levels consumed in 1999.

 

The global picture is very different. It is estimated than in Asia over a billion people will move from farming to city environments within next 20 years. In China alone 18 million people are moving from rural to urban areas per annum.

 

An illustration of the effect is that in 1990 China was a net exporter of oil and by 2006 it was the third largest importer of oil and after being self-sufficient in coal for years, China has begun to import coal. In 2009/10, it imported 150 metric tons, which is double last year's total. It may seem a molehill compared with what it burns, but that molehill is about 60% of Australia's coal exports – and Australia is one of the world's largest coal exporters.

 

The new emerging industrial nations along with China such as India and Brazil are similarly increasing their demand for energy in both the domestic and industrial sector. It has been observed that within a single generation, China, India and Brazil will more than double their energy consumption.

 

The issue is compounded by the fact that a number of emerging markets are running inefficient energy technologies. In Europe in 2009, Denmark, one of the most efficient energy markets, generated $ 17,761 of GDP per tonne of oil consumed whereas the Ukraine, which is one of the least energy efficient countries, only generates $ 903 of GDP per tonne of oil consumed.

 

Of course, these inefficiencies can be addressed, Robert Taylor of the World Bank, and leader of the “3 country energy efficiency project” estimates that China, Brazil and India could cut current energy consumption by 25% by implementing fairly straightforward energy improvements in their buildings and industrial infrastructure.

 

However, with other countries, such as Korea, Iran, etc (the N11 emerging economies as defined by Goldman Sachs) also growing their industrial base this trend of growing global demand for energy is likely to continue and will impact prices as fossil fuel extractions are depleted.

 

Energy security.

 

In the 1970s the UK was a net importer of “energy”. Following oil and gas production in the North Sea the UK became a net exporter of energy. North Sea oil production peaked in 1999 and as a result the UK has been a net importer of energy since 2004.

 

Over reliance on imports from friendly and not so friendly or unstable countries to generate the majority of a nation’s power requirements has to be of strategic importance. It was estimated in the EC in 2006 that 30% of energy was generated by imported fuels and that this would increase to 80% within 30 years (M. Dominique de Villepin, at the tenth International Bertelsmann Forum, 2006). 

 

Consequently in 2010 an EC strategic directive was announced to improve competitiveness, security of supply and sustainability of energy sources. These are known as the three pillars of EC Energy Strategy.

 

The following section details the security of supply for each of the three key fossil fuels used in energy generation.

 

Oil.

 

Oil is the commodity that grabs most of the headlines in the UK when it comes to price volatility and global disputes. Given the existing instability and uncertainty in oil-exporting economies it is likely to continue as mainstream news as we are bound to see further disruptions of oil supply as a result of the conflict in the Middle East and North Africa.

 

The price of oil has increased steadily over the last ten years but there have also been remarkable spikes in price during that time. Oil hit an all time high of $ 147 per barrel in July 2008 driven by global demand and then fell back to under $50 as the credit crunch hit at the beginning of 2009. With the current political upheaval, oil is currently priced at just over $100. Large price gyrations are not a recent phenomenal, for instance in 1979, during the Iranian revolution, oil soared to $ 40 per barrel, which is the equivalent to-day of $ 110.

 

The Energy and Climate Change Secretary, Chris Huhne, was quoted as saying in March 2011 that the "crisis in the Middle East" means that we can no longer "afford to go on relying on such a volatile form of energy"

 

If we are looking at energy security, while oil price volatility is in vogue given the current political situation in the Middle East and the pain being suffered by the motorist as petrol prices go above £ 1.30 a litre, an increase of over 50% in the last ten years, it plays a relatively small role in providing electricity to UK industrial and domestic users. If we want to analyse the future of electricity pricing we must focus on gas and coal as these two fossil fuel sources account for about 80% of power generated in UK power stations.

 

Gas

 

In 2009 about 45% of UK energy was generated by gas and gas prices have more than doubled from 2000 to 2009 and have been even higher in the past.

 

Whilst the terrible situation unfolding in Japan is not a political event it is an excellent illustration of how our energy security can be compromised “overnight”. Within two days of the natural disaster in Japan commodity prices soared across the world as over 20% of power will be taken out of the Japanese supply chain as nuclear power stations are taken off line. Analysts forecast Japanese liquefied natural gas (LNG) demand could rise by as much as 12 billion cubic metres per year. As a result, gas for next winter in the UK shot up by nearly 7.5 per cent to its highest price since November 2008.

 

In the past the UK has been in the enviable position of being able to satisfy its demand for natural gas from its North Sea reserves but as fields are depleted we are certainly going to have to increase our reliance on imports of gas in the future. In 2000 we exported the equivalent of 120 TWh of natural gas but by 2009 we were importing over 300 Twh. About 50% of our gas is imported, up from 25% in 2007 and at current levels of growth in demand and reduction in domestic supply it is forecast that 75% of gas requirements will be imported in to the UK by 2015.

 

In a newspaper interview in March 2011 Foreign Office Minister, David Howel, said “…our dependence on natural gas, which entails less CO2 emissions, will presumably continue. Consumption of natural gas in the United Kingdom is anticipated to increase over the next ten years, and we are consequently considering several new import sources. Energy security should be further assured by the expanded diffusion of renewable energy. We want to diversify our sources for supply of natural gas. For the past 30 years, the United Kingdom has supplied all of its needs with energy from the oil and gas fields in the North Sea. Production there, however, is projected to go into decline in the future, and this is creating the need for extensive import of crude oil and natural gas."


A fine example of an over dependence on importing strategic natural resources became very evident in 2006, when a dispute over gas pricing occurred between Russia and Ukraine and as a result the Ukraine gas pipe was “switched off” leaving thousands of European Union citizens without heating, hot water and transport in the midst of a heavy cold winter.

As a result the European Union has started the construction of three alternative gas routes from Russia which should start to come on stream around 2015.

 

A new pipeline from Russian via the Netherlands is due to come on stream and land in Norfolk in 2012. Gazprom (UK) has contracted to buy 4 billion cubic metres from this source in the first year of production, which will account for 4% of gas consumed in the UK.

The other major supplier to the UK comes from the Norwegian Vesterled pipe that terminates at St Fergus in Scotland. This source currently has capacity to satisfy about 13% of UK’s current gas demand. The remainder of gas supply is provided by Quatar and Algeria.


One major alternative gas supply option under consideration is via Israel. This has come about as a result of Israel demarcating its maritime borders with Cyprus in 2010 and drilling an off shore field 130km west of Haifa where Noble Energy estimate there is up to 16trillion cubic feet of natural gas available. This will probably initially help the situation in southern Europe but it will be some time before it has any impact on UK supplies.

 

As coal is more polluting than gas per unit of energy generated, mass campaigns against new coal power have stimulated a second "dash for gas". According to The Ends Report, the specialist environment news service, about 24 new gas-powered stations – adding up to 29 gigawatts of power – are under construction or in the planning process, compared with only a handful of planning applications for new coal generators. (see below)

 

So, as we may be transferring more of our energy production to gas fired power stations and our own natural gas reserves are drying up, we are fortunate to have a range of alternative potential suppliers of gas to the UK. However, it looks like Russia’s monolith Gazprom will be playing a major role in keeping British industry working and British homes warm in the future. Not something any one might have predicted pre Glasnost  25 years ago and an interesting conundrum to factor into future gas pricing predictions.

 

 

Coal

 

Coal production in the UK was at the heart of the industrial revolution and was the staple fuel for power generation for over a hundred years.  The sector also played a significant role in the labour movement and political history of the UK. The position of coal in our future energy requirements is therefore complicated with several leading bodies and experts taking polarised views.

 

Besides price variations and security of supply the position of coal is also heavily influenced by environmental concerns.

 

“Industrial coal prices decreased in 2009 (from 2008) by 7% in real terms, and were 45% higher than ten years earlier…” (UK Energy Brief DECC 2010). However, even coal prices are not immune to rapid price fluctuations; as a result of the Japanese earthquake researchers are forecasting up to 30 million extra tonnes of demand coming from that region. The amounts are so large as Japan has no indigenous supply of coal. The net result has been that coal derivatives in Europe recently rose to a two-year high.

 

As with oil, demand for coal on a global stage is dominated by the situation in China. In 2000 China used about the same amount of coal as the USA, just over ten years later it consumes three times as much. It has increased local production by just under 100% during that time to 5 billion tons per annum but has now moved from a net exporter to an importer.

 

The UK consumes about 58 million tonnes of coal per year, 80% of which is used by power generators. Coal fired power stations account for just under half electricity generated.  Latest figures show that over 70% of coal consumed in the UK was imported with the bulk of imports coming from Russia and South Africa.

 

One of the issues with coal is that it is considered a “dirty fuel” as it emits substantial amounts of sulphur dioxide as well as other harmful pollutants associated with global warming. This resulted in new legislation based on the Large Combustion Plant Directive (LPCD) in 2001. Plants built before 1987 can either follow the directive and participate in the National Emissions Reduction Plan (NERP) of 2007 or operate for a limited time. While the legislation also covers emissions from gas powered stations it is the coal fired power plants that are most seriously affected.  Coal can be graded on its sulphur content and much of the coal mined in the UK has particularly high levels of sulphur which drives power stations to look even more for imported lower polluting coal alternatives.

 

As a result of the above, some experts have predicted that coal will reduce in importance for energy production in the UK. In 1990 coal usage in UK power stations peaked at 84 million tonnes but over the last ten years it has been fairly consistent at about 40-50 million tonnes per annum.

 

However, with the uncertainty over pricing and supply of alternative fuels and the political challenges, compounded by the recent problems in Japan, for renewing older nuclear power stations, the position of coal in electricity production is far from clear.

 

Some suppliers have committed to building new coal fired power stations that comply with NERP legislation. The investment is significant and the rationale for taking this decision is around spreading your supply risk and to some extent a gamble on the future pricing of coal compared to gas. As an example, Npower recently opened one of three new coal fired power stations in Aberthaw in December 2009. This is a state of the art plant that has been built using Flue Gas Dessulphurisation (FGD) technology to significantly reduce sulphur dioxide emissions from coal burning, using seawater discharge to convert the harmful chemicals to sodium and calcium sulphates which occur naturally in the sea.

 

On the other hand, the situation is further complicated by news that the new government coalition is watering down commitments to environmental emissions standards and therefore raising the possibility of giving the go ahead to the building of new “dirty coal-fired power stations” such as Kingsnorth.

 

The energy company Peel Power has already come forward with a proposal in Scotland to build a largely unabated coal plant.

 

If the Emission Performance Standard (EPS) is abandoned it would almost certainly encourage power utilities to push forward with their original plans for a whole new fleet of dirty coal stations in the UK (the first to be built here for 30 years).

 

So a very complicated and conflicting picture, but like the story with gas it looks inevitable that coal will play a significant role in power generation in the immediate future, the UK will become more reliant on imports and global demand will continue the upward trend in prices.

 

 

Summary

 

It is clear that the future for power generation and ultimately electricity prices is a complicated area but on balance it seems safe to assume that while gas and coal are the dominant fuels then prices are more likely to increase in real terms over a 5-7 year energy efficiency investment program.

 

We have not gone in to any detail on nuclear power’s (or alternatives such as wind, biomas, solar or tidal) position in the UK power generation landscape as this is the subject of a future blog. But as a taster; at a presentation at the Oxford Energy Futures conference on June 11th 2010, Andy Duff, non-executive chair of RWE npower, made some controversial statements about the future of electricity in the UK. He asserted that “the UK will be unable to meet it’s carbon targets without a significant investment in nuclear power generation.  In addition, the UK will not have sufficient electricity capacity by the latter part of this decade unless we are willing to accept a doubling of wholesale electricity prices, which is the minimum required to free the capital required for such large investments.”

 

While we focussed on the investment required to update coal fired stations with FGD technology, with the growth of gas fired stations (the dash for gas) there is a growing demand from environmental lobbyists that both gas and coal generators should implement Carbon Capture Systems (CSS) in their generating plants. According to analysis by the climate change committee, the cost of fitting CCS to coal and gas plants would be considerably higher than current generation, but lower than future unabated power stations because of rising carbon trading costs to energy producers. For gas, the cost per megawatt hour is currently just under £70, in future with CCS it would be a bit less than £105 while without CCS it would be £115, calculates the committee. For coal the unit cost is currently about £60, rising to £115 with CCS and £160 without CCS, it says.

 

I’ll leave the last word to the Foreign Office Minister, David Howell, who was reported as saying the following when asked about the government’s strategy for UK power generation.

 

"The main features (of low carbon power supply)are introduction of facilities for carbon dioxide (CO2) capture and storage (CCS) into thermal power plants fired with coal and natural gas, and the widespread diffusion of wind power and other forms of renewable energy. Energy utilization must also become more efficient in the residential and industrial divisions. Our nuclear power stations have aged, and we must decommission them in succession while also building new ones. The current plans call for nine new units, and there is a possibility of a tenth. Construction will probably begin in 2018 or 2019. There is a need for cooperation in all sorts of areas in both the supply and demand aspects. Our aim of low-carbon systems is shared by Japan, and I hope to bolster interchange in the areas of knowledge and experience, research and development, and production.”

 

Pretty straightforward then!

Back to main page
Some Of Our Clients: