Green Leader

I was watching the Russia Ukraine spat over gas deliveries to Europe and kept promising (myself) to put pen to paper on the subject. Finally I carved out sometime on a train to start. As everyone in the (European) gas industry knows Europe is heavily dependent upon imported gas, particularly Russian gas, especially if you reside in Central and Eastern Europe. The UK has been lucky to have indigenous supplies close at hand in the North Sea. This local supply is declining, and the recent collapse in exploration wells in the North Sea will exacerbate that decline (although the latest I read is that UKCS production will hold up well this winter, the lagged response to historically higher prices). A recent FT Article (not so recent now) on the subject in part pushed me over the edge to put down my thoughts, the last push was the email the text of which I set out below on investment in storage.

As usual I apologise for the Anglo centric views, after all I live on an island. Also before I go any further if you would like to be removed from this circulation list please let me know.

So as Russia and Ukraine manned the barricades (valves) Europe looked on shocked at our own omnipotent inability to make the gas flow. Europe was subject to the “real politick” of the post Soviet Union and post several other things leverage by way of control of energy supplies. So what did the dispute demonstrate:

1. It demonstrated that the Russians can turn off the gas. Does this mean Russia is an unreliable supplier? It depends upon your definition I suppose. In Western Europe it is normal practice to shut off supply when someone doesn’t pay. Leaving aside the niceties of the source of the dispute at one level the Russians did no more that what any other commercial institution would do.
2. It also demonstrated that the Ukraine can also turn off the gas. The complicating factor was that the Ukraine also acts as a transit country and could retaliate by cutting off supplies to Russia’s other customers, again to many in the west a normal commercial response. If only the arrangements being curtailed weren’t so large and critical for many countries.
3. Leaving aside the niceties of “normal” commercial interactions. Energy is politics by other means (I paraphrase von Claustwitz – my wargaming hobby comes to the fore). Many observers in the West don’t see the Russian Ukrainian standoff as a purely commercial spat. This is more worrying because it is but a small step to cut off supplies to get something else you need. Would a future as yet undetermined Russian government turn the screw to get its own way with Western Europe? It is this perceived political motive (real or otherwise) that perhaps worries the West most. We are not imaginative enough to envisage a time when the West can’t pay for its gas so logically we only have to fear politically motivated supply curtailment. However stepping aside the scenario where oil prices hit new record highs driving up gas prices linked to oil prices, while renewables and nuclear displace fossil fuels in generation, just how flexible are those thirty year take or pay contracts?

1 and 2 above lead to the conclusion that strategic gas storage has its uses, something we Anglo Saxons have always been sceptical of, the North Sea was our store. The UK lacks such strategic gas storage and yet became an exporter of gas during the period of Russian curtailment, albeit most was probably Norwegian in origin. So one solution to further threats is to build more storage, something the UK Government wants to happen (subject to planning, another story). However most of the projects being pursued in the UK are not large seasonal stores but rapid response salt cavities favoured by traders – a drop in the ocean. So where is the commercial incentive to invest in strategic storage (above and beyond normal seasonal need such as Rough). At the moment with large volumes of LNG regasification capacity coming on line it is hard to see the need for expensive seasonal storage, after all if you pay enough doesn’t the LNG flow to you? Surely, the argument runs, it is more economic to buy a few high priced cargoes than invest millions (billions) on facilities you may never need.

Surely you say if the Russians do cut of supplies won’t you get payback then? Well yes assuming the grid doesn’t call an emergency and “nationalise” you capacity, or some helpful politician doesn’t decide you are profiteering and cap gas prices. Take note the drug companies are lining up for a decent profit on the back of swine flu but are becoming easy targets for politicians wanting to make a point, we have had retrospective windfall taxes in the energy sector before!

One question is does the UK need strategic storage? I’m sure those oil companies with depleted Southern North Sea gas fields think so, provided someone else pays. After all they can’t all be switched to carbon storage! But do we really need it, how much of the UK’s gas realistically comes from Russia? Surely with access to world markets (LNG) we can manage? How reliable are world markets? Just some of the long list of issues you have to start grappling with when considering the issue. One thing is clear lots of uncertainty!

So strategic storage will only really happen if someone mandates it, thereby putting up the price of energy. Strategic stores of fuel (oil) exist and the market keeps working, so perhaps they are appropriate for the gas industry. However any such storage would need to be mandated by Parliament, perhaps those supplying households could be required to have X days of supply in store. But what about gas for power generation, there again if gas supplies were shutoff gas would be priced out of the market, assuming adequate alternative generation (and a windy day).

In many ways not sure where I ended up with this ramble and as we are approaching Heathrow (now a couple of days later on the train to Reading) so I need to draw a conclusion. Perhaps it is that market forces will never support strategic storage in the UK, they hardly support seasonal storage. So strategic storage will only come about if required by politicians. Politicians have short memories and even shorter time horizons so don’t hold your breath. The status quo will be maintained and we will rely on paying high marginal prices in the event of a crisis, nothing new there then. Offset, hopefully, in the good times with lower prices giving a reliable supply at lower overall costs, there I do believe in markets.

Also feel free to comment on the email below, which makes a slightly different point, that not only are storage expensive and capital intensive the existing UK tax structure isn’t helping.

“Richard,

Like you my responses are as twice as slow as your missives.

But it’s all very well looking at Carbon reduction and the like but what about security of gas supply?
Like all things carbon management is the way to save the planet and the right thing to do but we need to also assure ourselves that we’ll have hydrocarbons to trade and “keep the lights on” in winter.

So I would like to start another discussion going about true GAS STORAGE.
Many of us have tried to put these schemes into operation and spent good money trying to do it. Unfortunately we failed because we just couldn’t get the economics to work. Those who have tried know just how difficult it is to try and get a really serious large scale storage facility of the ground. The only real growth is in the gradually expanding peak shaving salt cavern business.

The major reason for this failure to use existing depleted gas producing reservoirs is the Tax regime. It is geared and designed to take from revenue produced and is intransigent in regard to the use of reservoirs for anything else. Any attempt at trying to get decent tax allowances against capital investment for storage is a nightmare as you have no production to offset it – only the service charge for redelivery! Similarly the biggest cost of trying to set up the facilities – besides making the compressors go in reverse and other such minor issues – is the cost of cushion gas and the complete lack of tax break on getting it, buying it or retaining it in the reservoir.

The UK is quickly going to go into being a purchasing rather than a producing nation. Storage has to be the long term need of UK Co Ltd and lots of it. Surely it’s time once again to start this debate about what any government – Labour or Conservative – is going to do to help this massive deficit in our infrastructure. Let’s move forward on carbon taxes but let’s also be sure we can keep the lights on in UK to be able to pay the carbon tax. The industry needs clear tax breaks for this effort soonest.

I’m sure the debate would be more wide spread if you were to have a tilt at it.”

Richard Harper
Managing Director
Harper Energy
(o) +441189545726
(m) +447738159962
(e) richard@harperenergy.co.uk

Tags: Energy Security, Gas Storage

This entry was posted on Wednesday, August 19th, 2009 at 8:16 pm and is filed under Energy Security. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.