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Countdown to 100$ oil (22) - gas shortages in the UK - 230$/boe

by Jerome a Paris Tue Mar 14th, 2006 at 11:57:46 AM EST

Well, it's been a while since the last "Countdown diary"

Promoted by Colman


These two graphs (from WTRG.com) explain it to some extent: oil prices have remained high, but flat, and gas prices has tumbled down from their December highs.

Crisis over?

Well, it seems the US dodged a bullet this winter. As I wrote in various episodes (including item 15 below), the natural gas situation was very tense and depended, to some extent, on the weather. Thankfully for you guys, the winter has been a lot milder than expected, in general, and consequently, heating and electricity needs have been lower than feared, and gas was available in sufficient volumes to avoid any shortages and the accompanying price spikes.

Before I turn to the UK, which was facing the same risks, and which is facing a much harsher winter, do note that today's apparently "low" prices for natural gas are still two-three times more expensive than only a couple of years ago, and, more to the point, twice as expensive as the high range of expectations for power producers when they built they gas-fired plants, as this graph for UK gas prices, from a 2004 analysis of electricity costs prepared by the Royal Academy of Engineers, shows:

(multiply by about 1.5 to have comparable prices in $/mbtu for gas)

That means that wholesale electricity prices (determined to a large extent by gas prices, as the marginal producer) are still much higher than they used to be, and these higher prices are now seeping through into utility bills, as a number of you have probably noticed.

So, what happens when winter is harsh?



Gas warning: not enough to meet demand (Guardian)

Cold weather provokes supply crisis

Gas supplies could be under threat

The National Grid, responsible for running Britain's gas and electricity pipes and wires, yesterday issued an unprecedented warning that the country was in danger of not having enough gas to meet demand.

It issued its first-ever "gas balancing alert" to the market, telling traders that gas demand might have to be reduced, initially for businesses. The move sent wholesale prices spiralling up fourfold.



UK gas prices hit record again (Financial Times, this morning)

UK gas prices hit record levels on Tuesday for the second successive day as cold weather and the temporary closure of the country's largest gas storage facility tightened supply, but prices later eased as the National Grid, the operator of the UK gas network, said it would not repeat Monday's warning about tight supplies.

Traders said wholesale prices for gas delivered within the day were quoted at 255p per therm, level with the previous day's peak. This represents the highest price since the UK gas market was deregulated in the early 1990s. The day within price later dropped to around 200p.

To convert that into $/MBTU as used in the US, that means that prices reached almost 40$/MBTU for the second day running - or close to 230$/boe (barrel of oil equivalent).

All it took was a snap of cold weather, in a context when a major storage facility has been damaged temporarily by a fire.



Traders said cold weather on the continent has slowed gas imports through the Interconnector gas pipeline connecting the UK and European gas networks. Although Interconnector gas flows increased marginally from 40 per cent to 52 per cent on Monday, this was seen as a minimal response to exceptionally high UK prices.

In comparison, Dutch gas prices were about 150p/th lower than the equivalent UK price.

This blatant attempt to blame the evil (continental) Europeans for the nasty price increases is already going on at full blast. It cannot be market liberalisation, because markets always bring prices down, right? So it must be the selfish protectionist Europeans.



Cold snap takes gas price to record high (Financial Times again, another article form this night)

The steep rise in UK wholesale gas prices over the past two years, reflecting higher oil prices and declining gas production from North Sea fields, is hitting consumers. All six of the UK's large energy suppliers, including British Gas and Powergen, have recently announced double-digit gas and electricity bill increases.

Whether yesterday's surge prompts further bill increases will depend on how long the rise in market prices lasts.

Because of higher demand for gas over the past few days, the amount of gas available in the UK has shrunk to just 10 days' worth of national requirements, according to traders.

Centrica, owner of British Gas and the Rough storage facility, blamed the inefficiency of the European gas market for the surge in prices. Gas in the Dutch market was trading at 116p a therm but was not being sold into the UK market despite the higher prices.

Stoopid foreigners who won't take advantage of higher prices (and would rather heat their own consumers than sell to the market friendly ones in the UK). Evil, evil evil.

No, the declining gas production, and the lack of anticipation by the markets of what has long been announced cannot be blamed, because markets are always right.

They built all the gas-fired plants in the US and the UK because thye were cheaper and easier to finance, and gas was plentiful. Right? Right?

Bleh.

Earlier "Countdown Diaries":

Countdown to 100$ oil (21bis) - long term vs short term worries

Countdown to 100$ oil (21) - 8-page extravaganza in the Independent: 'we're doomed'

Countdown to 100$ oil (20) - Meteor Blades is Da Man in 2005

Countdown to 100$ oil (19) - Your bets for 2006

Countdown to 100$ oil (18) - OPEC happy with oil above 50$

Countdown to 100$ oil (17) - Does it matter politically? A naked appeal for your support

Countdown to 100$ oil (16) - We'll know on Monday

Countdown to 100$ oil (15) - the impact on your electricity bill

Countdown to 100$ oil (14) - Greenspan acknoweldges peak oil

Countdown to 100$ oil (13) - Katrina strikes / refinery crisis

Countdown to 100$ oil (12) - Al-Qaeda, oil and Asian financial centers

Countdown to 100$ oil (11) - it's Greenspan's fault!

Countdown to 100$ oil (10) - Simmons says 300$ soon - and more

Countdown to 100$ oil (9) - I am taking bets

Countdown to 100$ oil (8) - just raw data

Countdown to 100$ oil (7) - a smart solution: the bike

Countdown to 100$ oil (6) - and the loser is ... Africa

Countdown to 100$ oil (5) - OPEC inexorably raises floor price

Countdown to 100$ oil (4) - WSJ wingnuts vs China

Countdown to 100$ oil (3) - industry is beginning to suffer

Countdown to 100$ oil (2) - the views of the elites on peak oil

Countdown to 100$ oil (1)

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$230/boe ? Wow ! Excellent. That will teach a good lesson to CCGT operators if they need to go on the spot market (vs. long term contracts).

The conclusion of the article in the Guardian is a fun read too.
The inability of traders to obtain new gas in Europe will infuriate British politicians and give further ammunition to the European commission which last week called for faster deregulation of continental markets. A lack of transparency means it has been hard to discover exactly where the bottlenecks are and why suppliers on the continent are not switching gas to Britain. Yesterday the spot price of gas in the Netherlands had reached 70p per therm [vs 250p/th in the UK ]. But the Interconnector pipeline to Britain was handling only 8m cubic metres, when it could handle 16m.

Mmmm. I wonder why? Mmmm. Like, because French and Dutch infrastructures and reserves are not for the British to use when they feel like it ? Like, because you gotta pay if you wanna play ? Like, because the UK made choices assuming others would pick up the tab for the back-end plumbing and the continuity of service ?

The UK invested in gas-fired power plants (40% of the production) because it was the politically easy and economically "cheap" choice. Well, now they gonna have to assume their choice and take it like a man.
by Francois in Paris on Tue Mar 14th, 2006 at 10:32:27 AM EST
The inescapable conclusion is that the Dutch gas infrastructure is not run entirely for profit at the expense of the Dutch population. Imagine that!

Now, if the UK really wanted to pay 250p/th directly to Russia, is there any way the UK and Russia could ensure that the gas gets to them and the Netherlands can't "siphon it off" (like Russia accused Ukraine of doing?). How does the continental gas grid work?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 14th, 2006 at 10:38:47 AM EST
[ Parent ]
Yeah, they may be able to do that, depending on the load along the pipes.

But what the Brits want is not 250p/th but rather the 70p/th like in the Netherlands. What they don't want to pay for is the very deliberate pricing policies the Dutch used for more than 40 years to manage their gas ressources (Nota de Pous).
by Francois in Paris on Tue Mar 14th, 2006 at 11:01:07 AM EST
[ Parent ]
Ah, but that's not how the market works. It will result in higher prices for everyone than the 70p/th. Maybe as high as 200p for everyone involved.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 14th, 2006 at 11:07:34 AM EST
[ Parent ]
There, you need to ping the resident specialist, Jerome.

Settling price depends on the elasticity of the demand, which tend to be very inelastic at short term, and spot prices can swing wildly on small variations. I don't think that gas markets are as volatile as electricity but it must not be a pretty sight.
by Francois in Paris on Tue Mar 14th, 2006 at 11:19:33 AM EST
[ Parent ]

I don't think that gas markets are as volatile as electricity but it must not be a pretty sight.

I think we're about to find out...

To be fair, it's probably easier to turn demand for gas off than it is for electricity, as industrial use is a higher fraction, and I suspect most of it is a lot more price sensitive than electricity users (except very specific cases like Aluminium producers who do not rely on the spot market anyway), so I expect gas demand to be cut ot lower prices, thus limiting volatility to some extent.

But if you have long term shortages, then it's another can of worms. A late cold snap might be vicious.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Mar 14th, 2006 at 11:23:43 AM EST
[ Parent ]
maybe, maybe not.

If the industrials have hedged, they don't suffer any short term pain.  Now you have to stimulate them to buy out of their sales contracts to free up the gas.  That sounds straightforward but people are lazy and would prefer not to upset well laid plans.

Energy markets have been running around for a decade selling these folks price hedges...

by HiD on Tue Mar 14th, 2006 at 06:39:50 PM EST
[ Parent ]
And, of course, in fully "deregulated" markets such as the California market in 2000 (the nirvana, if you wish), it can be a lot of fun:

In June [2000], the cost of a megawatt hour increased more than fivefold, going from the 1999 level of $30.53 to $170.60. In October [2000], prices doubled over the same period a year earlier, going from $53.47 to $111.04. And in December [2000] -- despite a 1.46 percent decline in electricity usage from the previous December [1999] -- peak wholesale electricity prices hit $425.59. They'd been $31.88 one year before.

Energy is like health care. It's not a market. Short-term choice is always marginal and cannot support serious market mechanisms.
by Francois in Paris on Tue Mar 14th, 2006 at 11:27:04 AM EST
[ Parent ]
You heretic!

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 14th, 2006 at 11:31:40 AM EST
[ Parent ]
I was there and I can tell you the heretics came pretty close to burning the orthodoxes alive on a pyre.
by Francois in Paris on Tue Mar 14th, 2006 at 11:34:48 AM EST
[ Parent ]
So was I, then someone shouted "look, they're going to tar and feather Martha Stewart!" and the heretic mob let the orthodoxes escape.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 14th, 2006 at 11:36:46 AM EST
[ Parent ]
And then the heretics elected Hanuld Governator ...
by Francois in Paris on Tue Mar 14th, 2006 at 11:51:39 AM EST
[ Parent ]
Actually, there is nothing wrong in theory with price spikes like these:

  • they don't apply to large volumes, so the absolute amounts of money involved are not so big even if the headlines are spectacular;

  • they are required in a market setting to make peakers - i.e. power plants that function only when there is a lot of demand - profitable. As they produce a lot fewer kWh than base load plants, they need higher prices per unit to make it worthwhile. It's a pretty risky business, but it is possible to build a business plan on it.

What goes wrong is the following:

  • "liberalisers" that do not have the courage to apply their ideology to the end, and liberalise the wholesale market while keeping caps on retail prices (final users are thus artificially protected form higher prices - one wonders why if the goal is efficiency and good allocation of resources; surely high prices would be a signale to end users to consume less, right). That's what happened in California, and the utilities got squeezed between higher wholesale prices and fixed retail prices, and lost tons of money;

  • market transparency and liquidity becomes essential, and anti-competitive behavior by traders or others must be fought. But that's pretty hard to do against determined cheaters;

  • as a side note to the above, the requirement to have enough spare capacity, a vital need of the system, should be imposed on all players. The UK electricity market is much better in that respect in that it imposes fair balancing and spinning reserves costs to all, thus making it an even playing field and a well regulated system. Traders are penalised in such a system, but that's how it should be because otherwise they'll just free-ride on the spare capacity provided by others.

  • on a long term view, the way new entrants are allowed in is an essential part of the regulatory framework (can they get permits easily, is there a NIMBY syndrome that protects existing players, are they allwoed to sign long term supply and sale contracts to secure financings...

All of this shows that deregulated markets are possible, but are much harder to design than most people say, and politicians have rarely gotten it right, ans sometimes spectacularly wrong.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Mar 14th, 2006 at 11:59:00 AM EST
[ Parent ]
market transparency and liquidity becomes essential, and anti-competitive behavior by traders or others must be fought. But that's pretty hard to do against determined cheaters;

Meaning you have to be very, very heavy handed with people who have a lot of money and influence, which is a recipe for corruption and influence disasters in a liberal democracy.

If heavy handed need be, rather be heavy handed with the real task at hand, producing and managing energy.

I'm not a socialist by any mean and I believe than markets work ... most of the time. But for certain things, it doesn't - exhibit A is health care insurance (as opposed to supplying health care itself, where a large private sector can be accomodated as proven by France). IMHO, energy is exhibit B.
by Francois in Paris on Tue Mar 14th, 2006 at 12:26:18 PM EST
[ Parent ]
based on a number of years in the energy markets, I'd say they mostly work to satisfy the needs of the strongest players.  Consumers are disorganized and therefore terribly weak.
by HiD on Tue Mar 14th, 2006 at 06:43:58 PM EST
[ Parent ]
on all points.

PUC regulation is like democracy...  The worst possible system except for all the rest.

by HiD on Tue Mar 14th, 2006 at 06:41:21 PM EST
[ Parent ]
I wrote this over at the Guardian blog (http://commentisfree.guardian.co.uk/larry_elliott/2006/03/gas_crisis.html)

I note already the trend to blame higher prices not on market liberalisation (which, somehow, in the energy sector, is deemed not to produce more transparent prices, but only lower prices) but on the nasty continental ('nationalist', 'protectionist', 'rigid') Europeans who refuse to share their cheap gas.

  • how come they have cheap gas? Maybe it has to do with the fact that markets are not liberalised, that they have long term supply contracts, and States that cared enough to build strategic storage facilities

  • how come they are not selling their gas to the UK to make a quick profit? Maybe because the notion of service to the public has not been devalued so much that it has to pass behind the profit motive.


In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Mar 14th, 2006 at 11:20:39 AM EST
[ Parent ]


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