Select Committee on Trade and Industry Appendices to the Minutes of Evidence


APPENDIX 7

Memorandum by Jonathan Stern, Royal Institute of International Affairs and Imperial College

SECURITY OF UK NATURAL GAS SUPPLY AND IMPORT DEPENDENCE[11]

SUMMARY AND CONCLUSIONS

  Security of natural gas supplies is not an urgent problem for Britain at present and there is no reason to believe it will necessarily become a problem even if the more extreme projections of future import dependence prove to be correct. The most immediate and substantial gas security issue is the risk of an incident as a result of which, a large proportion of capacity at a major gas receiving terminal—in particular St Fergus or Bacton—became unavailable for a prolonged period of time. To address this problem, government and regulatory authorities need to develop criteria for determining:

    —  appropriate contingency plans for market players in the event of a major supply emergency;

    —  how a major supply emergency might affect Ofgem's ability to appoint a "supplier of last resort";

    —  acceptable levels of supply and facility concentration.

  Government and regulatory criteria would need to include judgments on how additional costs arising from imposing greater security obligations on market players would be met.

  A British gas supply emergency would have significant consequences for northern and southern Irish supply, but particularly for Northern Ireland which will be entirely dependent on a single pipeline from Britain until a pipeline link with the south is established.

  UK gas security must increasingly be viewed in a European context where substantial import dependence has been an accepted feature of the market for many years. Imports, and particularly access to gas stored in northwest Europe, could be an important part of contingency plans for responding to a British gas security emergency. Despite the probability of increased import dependence over the next several years, this should not be seen as necessarily increasing security of supply. For at least the next five years it is unlikely that import dependence will approach the level of the mid-1980s when imports from Norway accounted for up to 25 per cent of British gas demand.


INTRODUCTION

  This note addresses the Committee's request for views in respect of UK energy supplies particularly in relation to:

    —  Maintaining secure gas supplies in the event of imports;

    —  Possible policy and regulatory changes, which may be necessary in order to achieve greater security and diversity of gas supplies.

DEFINING NATURAL GAS SECURITY

  The International Energy Agency (IEA), in its study of natural gas security, attempted to define security in terms of risks: [12]

    "(i)  technical risk, eg that, as a result of an accident, terrorist incident or natural catastrophe, a major supply facility is put out of action. For some countries this could be a significant short-term problem;

    (ii)  failure to mobilise long-term supply or ensure deliverability of supply;

    (iii)  political events which can be short-and long-term in their impacts".

  The IEA suggested a number of measures which could be taken to promote security of supply: [13]

    "Diversity . . . the key concepts is whether it is conceivable that supply from different sources could be interrupted by a single event or related events . . .

    Flexibility . . . substitution of one source of gas by another..substitution of gas by another fuel . . .

  With the publication of this study in 1995, the IEA changed the emphasis of its security commentary, away from dependence on imported gas: [14]

    "Domestic self-reliance is not now regarded by the IEA as of itself a security measure. In some cases . . . domestic production does fulfil many of the criteria set out above eg diversity, efficiency and flexibility. But there have been cases in the energy sector . . . where domestic production has not satisfied these criteria and has therefore increased rather than decreased security risks. It is true that underlying much of the debate on gas security there has been a concern about growing dependence on imports. But the level of imports should not of itself be taken as an indication of a security problem: it is more a question of the market structures within which these imports take place, the inflexibility of the delivery systems, the lack of diversity, etc . . . Indigenous supplies may equally be subject to disruption, eg by industrial action, if the necessary flexibility, diversity, etc are not present."

  Thus import dependence should not necessarily be regarded as a threat to security of supply. Risks arising from natural gas supply—domestic or imported—can be divided into: source dependence, transit dependence and facility dependence; but in the case of Britain which does not depend on the transit of gas through third countries, only source and facility dependence are relevant.

UK GAS SUPPLIES: SOURCE AND FACILITY DEPENDENCE

Source Dependence

  (i)  Domestic Supply

  Gas is supplied from around 150 offshore (and a few onshore) fields. In 2000, the largest production from any single field was South Morecambe which accounted for just over 7 per cent of total UK production. In terms of supply therefore, Britain is well diversified but the same cannot be said for Northern Ireland which has no indigenous supply and is entirely dependent upon supplies from Britain.

  (ii)  Traded Supply

Table 1

UK NATURAL GAS IMPORT DEPENDENCE (IMPORTS AS A PERCENTAGE OF DEMAND)
YearPercentage Import Dependence*
1970    5.6  
1975    2.5  
1980  22.9  
1985  25.3  
1990  13.4  
1991  11.2  
1992    9.4  
1993    5.8  
1994    3.1  
1995    1.0  
1996    0.05
1997  -0.08
1998  -2.1  
1999  -6.7  
2000-10.9  


  *minus figures denote net exports as a percentage of demand

  Source: Digest of UK Energy Statistics, 2001, Table 4.4, p 126, London: Department of Trade and Industry, 2001.

  The UK is one of only four European countries which, in 2000, were net exporters of gas. The UK is the largest gas market in Europe, and has moved from being an importer to a net export position in 1997 (Table 1); but is expected, within a few years, to return to a net import position.

  The current net export position is relatively recent with substantial exports being made possible only since the opening of the Interconnector pipelines between Britain and Ireland in 1994, and Britain and Belgium in late 1998. The development of these pipelines has brought Britain into the European gas trading arena to an extent which had not been anticipated. British gas exports now reach—on a contractual basis—France, Germany and Italy; and it cannot be excluded that Britain has already imported (although not on any long-term contractual basis) its first molecules of Russian gas.

Gas Trade Policy

  In the mid 1960s Britain imported its first gas in the form of liquefied natural gas (LNG) from Algeria, a move which was influential in accelerating conversion from town gas to natural gas. In the late 1970s this was substantially increased with the import of pipeline gas from the Norwegian share of the Frigg gas field. The rationale for large-scale imports was two-fold:

    —  it was not clear how long Britain's reserves of North Sea gas would last;

    —  imports from a "secure" European source would prolong the natural gas era in Britain which had required a considerable investment in appliance conversion and pipeline construction.

  From a purely practical point of view, the fact that the Frigg field straddles the median line between Britain and Norway meant that either the Norwegian share would need to be delivered to Britain, or the British share would need to be exported to Continental European markets.

  As shown in Table 1, Norwegian imports rose to the point where, in 1985, they were providing 25 per cent of British gas demand. This was the cause of some resentment not least from UKCS producers, many of which were being paid considerably less for their gas than British Gas was paying for Norwegian imports, and were unable to market gas because of the large volumes of imports which British Gas had contracted. There was also concern from the Treasury which in the mid-1980s was seeing an adverse balance of payments from gas importers in excess of £1 billion/year.

  These two factors were the root cause of the rejection, in early 1985, of gas imports from the Norwegian Sleipner field which British Gas (in its pre-privatisation incarnation) had intended to replace Frigg supplies in the early 1990s. [15]At the time, many UK producers claimed that Britain could obtain self-sufficiency in gas by 2000 by producing its own gas supplies more quickly, a view which was enthusiastically embraced by the government. Successive governments in the late 1980s and early 1990s took this position further. They refused to allow new import contracts to be signed, and strongly promoted a pipeline link to Continental Europe (which initially was not supported by any of the commercial parties), in an attempt to both promote gas production and revenues, and "export" the British model of gas liberalisation and competition to Continental European countries some which had been (and continue to be) slow to embrace such policies. [16]When approval was given for the pipeline in late 1994, the impression was that UK gas would flow to Continental Europe for 10-15 years, after which the flow would then reverse. [17]Only after the opening of the Interconnector did the government allow new import contracts to be signed.

  During the period 1985-98, imports of Norwegian gas were not rejected by government for security reasons, despite an incident in April 1986 when a strike among Norwegian offshore workers spread to the British part of the Frigg field and the country lost around one-quarter of total supplies for a period of several days. [18]Neither the fact of UK gas import dependence nor this potentially serious security event, attracted any significant publicity.

Facility Dependence

  The technical section of the IEA's natural gas study contains a judgment that is universally relevant: [19]

    "Perhaps the greatest risk of prolonged interruption comes from the destruction of a major production or processing facility or a deep water pipeline whose replacement might take many months to build."

  In 1998, this was most graphically demonstrated when an explosion at a processing plant in the Australian state of Victoria caused the disruption of gas supplies to all customers throughout the entire state for a period of nearly two weeks. [20]Despite the fact that gas supplies originated from domestic offshore fields through different pipelines, all gas production was dependent upon the availability of a single onshore processing plant.

  Britain's natural gas infrastructure is growing old, having been built in the 1970s and 1980s. [21]The state-owned gas company was accused of "gold plating" the network at the expense of customers. In the privatised era, the regulatory framework is intended to monitor and limit Transco's network investment costs to necessary and efficient levels. In general, the growing competitiveness of the gas market and pressure on profit margins will bias companies towards prolonging the life of existing facilities. At the same time, ageing increases the likelihood of facility failure.

  Table 2 shows national dependence on individual gas facilities. This shows a healthy diversification, with the Bacton and St Fergus terminals—and their associated processing plants—being the only obvious points of vulnerability. Clearly any incident which affected the availability of a substantial proportion of the capacity at Bacton or St Fergus for any significant period of time, particularly during the winter months, could have serious security consequences. [22]

Table 2

BRITISH DEPENDENCE ON GAS FACILITIES, 2000

Offshore Gas Pipelines% of total production
Receiving Terminals
% of total gas received Approx number of fields
FLAGS9Bacton 20>40
CATS12Barrow 124
MORECAMBE11St Fergus 3750
SAGE15including:
  —Flags/Fulmar 10
27
  —Frigg 10
11
  —SAGE 16
11
  —Miller 1
1
Teesside 1314
Theddlethorpe 1324
Others 513


  Sources: Development of UK Oil and Gas Resources, 2001, Department of Trade and Industry, Appendices 10 and 11.

  Table 2 does not include the British-Belgian (Bacton to Zeebrugge) Interconnector pipeline (IUK) which is currently capable of importing annual volumes of 8.5 Bcm/year compared with its annual export capacity of 20 Bcm. Future investment is planned in order to expand import capacity. The landfall of IUK is Bacton which further concentrates facility dependence. The reutilization of the Frigg import pipeline, following the completion of the Vesterled pipeline connection (in the Norwegian sector) in October 2001 will further concentrate supply at the St Fergus terminal.

Northern Ireland

  Table 2 also does not include the Interconnector pipeline (SNIP) between Scotland and Northern Ireland which carries Northern Ireland's entire gas supply. Disruption of this facility could cause a serious security situation, particularly in respect of residential gas customers, given the total dependence on a single facility and a single source of supply. [23]Plans for the pipeline connection between Northern Ireland and Eire would provide the province with an additional supply source and this is envisaged at both a government to government—the "all-island" initiative—and commercial level. Eire is also substantially dependent on the Ireland-UK Interconnector and that the capacity of this link may be increased in the future. Despite the fact that additional Irish offshore gas supplies at the Corrib field are under development, the impact on northern and southern Irish gas supply of any British supply emergency would be significant.

Security of Supply and Import Dependence: contrasting policy approaches

  The traditional British approach of gas security was to use import to "stretch out" domestic reserves for as long as possible. This led British Gas to import a proportion of supply and impose a "depletion policy" on the UK resource base in order to prolong high levels of UKCS production. Such a policy followed a "traditional" line of reasoning applied to virtually all energy commodities, and followed by the majority of policy makers, prior to the 1990s which assumed that:

    —  domestically produced resources were secure and cheap but would "run out" within 20 years;

    —  imported resources were insecure and expensive and, if given the opportunity, external suppliers—particularly those beyond the borders of Europe—would not hesitate to exert maximum commercial and political leverage to secure their goals.

  This can be contrasted with a "market approach", which relies on privatisation, market liberalisation and the promotion of free trade for maximising efficiency, minimising costs and producing the lowest possible prices for customers. The reasoning in this approach is to allow market players and market (particularly price) signals to dictate decisions. An important guiding principle is to ensure that no single market player can exercise monopoly power in respect of commodity or service. Where natural monopoly is involved—such as in the ownership of networks—this must be regulated. Despite considerable dirigisme by both government and regulatory authorities in its establishment, Britain has achieved one of the most highly liberalised and contestable gas markets in the world. [24]Sophisticated short- and longer-term markets and trading arrangements in gas and capacity have been established and continue to unfold. But the liberalised market has left some uncertainty as to the importance of security of supply and the role and responsibility of government and regulatory authorities in determining a framework for judging how security obligations should be defined, responsibilities apportioned and measures implemented.

Security of Supply: expanding the policy and regulatory framework

  The loss of any single field or facility would not necessarily cause chaos or widespread curtailment of supplies (although if this occurred during severe winter conditions, such consequences could not be excluded). But it would give rise to a period of extreme price volatility with adverse and unpredictable consequences for suppliers and customers. In the event of such an emergency, the Network Code provides for the suspension of the gas trading arrangements, with Transco sharing out the available supply among shippers and suppliers under conditions of non-discrimination.

  In a traditional (monopoly) market, the monopoly or dominant player—a national or regional company—makes all the necessary physical and contractual arrangements to meet both statutory security standards and obligations, and decides on the different security contingencies it deems necessary to meet. Such measures and their associated costs are generally not transparent, and the way in which these are passed on to customers is also not transparent.

  Moving from a traditional (monopoly) market to a liberalised market, the monopoly/dominant player is replaced by a larger number of actors each of which operate under licence conditions which set out their obligations. The pipeline company Transco has a licence obligation to provide sufficient capacity to meet demand on a 1:20 winter day. It is also required to publish an annual projection of system requirements for the next decade—the 10-year statement. Ensuring that Transco carries out its obligations, and has the necessary financial resources to develop the network in order to meet anticipated systems requirements, is an important part of the regulatory framework set by Ofgem. Other market players—shipper and suppliers—aside from co-operation with Transco in the event of a major supply emergency, have no specific security obligations other than those of the contracts with their customers. [25]

  Missing in this framework are any explicit contingency plans against security incidents of low probability but high impact, which may disable specific liabilities producing or transporting substantial quantities of gas. Also missing is any specific policy or regulatory instrument which might prevent concentration of transportation or processing infrastructure at a particular location. It may therefore be worth considering an expansion of the policy and regulatory framework to include the creation of security standards in the form of obligations on market players to have in place contingency plans in the event of a major supply emergency. Obligations would be expressed in terms of physical or contractual arrangements which each of the market players would be required to put into operation for a given period of days.

  The starting point for developing such arrangements would be annual simulations by Transco of the supply consequences of major supply or facility failures—particularly by Bacton and St Fergus—of varying duration in different seasons of the year and the likely regional and sectoral impact on shippers, suppliers and customers. Depending on how government and regulators viewed the gravity of the outcome of these simulations, shippers and suppliers would be required, for each simulation, to set out how they would allocate available gas and capacity between their customer groups and geographical locations. Examination of shipper and supplier plans would allow government and regulators to determine the adequacy of contingency plans for a range of supply emergencies. For example if it was found that the majority of suppliers were intending to depend largely on availability of short-term gas during a supply emergency, then volatility and huge price spikes could be anticipated. In addition, the contingency plans of shippers and suppliers would also certainly require additional capacity to be built by Transco in other parts of the network. The purpose of such an exercise should therefore be to develop a transparent regulatory and policy consensus as to the security standards which market players need to meet.

  Assuming the government and regulators judged the existing contingency plans of suppliers to be inadequate, suppliers could be required to meet higher security standards, in terms of emergency preparedness. Any such standards should leave suppliers free to make such contingency plans, for both emergency gas supplies and capacity, based on the best combination of option available to them including:

    —  contracts for additional supplies either from production or storage from domestic or imported sources;

    —  contractual interruption of customers by region and customer class.

  Annual evaluations of security standards and contingency plans would allow for obligations to be changed over time as appropriate, for example factoring in the security aspects of imported supplies as and when they began to increase.

  However, imposition of security obligations would impose additional costs on market players—Transco, shippers and suppliers. Government and regulators would need to decide how those costs should be apportioned between the players themselves, and between players and customers for whose benefit they would be implemented. Given the nature of security as a "public good" it might be appropriate for these costs to be shared among all parties.

Supply and Facility Concentration

  Britain is currently well placed in terms of gas supply and facility diversity. However, from a security perspective it is questionable whether any further supply concentration at either St Fergus or Bacton is desirable because of the consequences of any incident which might affect a large proportion of transmission or processing capacity for a period of time. Simulations of the supply consequences of a major facility failure, suggested above, should allow government and regulators to form a view as to whether facility concentration is approaching maximum advisable limits. If that is believed to be the case, a possible conclusion is that new pipeline supplies—particularly imported supplies—should be directed to alternative landfalls. Such a conclusion may not be popular with market players, which naturally wish to minimise costs in a competitive market.

The Position of Different Groups of Customers

  In liberalised markets, some classes of customer—especially large customers—are able to take considerable responsibility for determining their own level of supply security. Those customers concerned about physical delivery can make contractual decisions about the level of additional security—price or physical delivery—which they require, and contract with suppliers for such services. Those concerned about sudden price volatility can use the forward market to hedge their positions several years ahead.

  There is a larger potential problem in respect of residential and small commercial customers. It is highly unlikely that these customers would suffer physical disconnection unless the security incident was extremely severe. Disconnecting large numbers of residential and commercial customers from the network is an act of last resort. The security risk of these customers is therefore primarily from price shocks, such as spikes or volatility. These customer are not equipped to make their own arrangements in terms of contractual protection against price volatility. But the nature of the contract which they have with their suppliers protects them from the immediate consequences of price volatility. Within a few months prices may increase, but the ability to switch to competing suppliers should guarantee residential customers that they are still paying something close to a market price.

  The security consequences for residential customers of a supplier which make unwise commercial decisions—eg fails to hedge its position during a period of price spikes and volatility—is that the supplier may become insolvent. In such a case, Ofgem has powers to appoint a "supplier of last resort" (SoLR). [26]Whilst under normal "market conditions" it is unlikely that Ofgem will have a problem in finding a supplier willing to take over the customer base of an insolvent company, should this happen during a supply emergency, the situation might be more complex. [27]If substantial market turmoil should cause a number of suppliers to become insolvent simultaneously, it could be difficult for Ofgem to make a SoLR direction. The regulatory authority has recognised this possibility but has not yet suggested how it might be resolved. [28]

Integration with Continental Europe: an important change in the security context

  Continued development of gas trading infrastructure—the British-Belgian Interconnector (IUK) and the Frigg pipeline connection with the Norwegian continental shelf—will provide Britain with imported gas options in the event of a gas security crisis. In the period up to 1998, Britain was a "gas island" with no connection to Continental Europe. [29]The future will increasingly see Britain as part of the European gas market, both in terms of supplies and prices.

  In 2001, oil-linked Continental European price movements had a major influence on British prices. In future, price signals on either side of the IUK mean that a British supply crisis which increases prices in Britain will cause supplies to flow from the Continent. Thus imports, far from being a security problem, will become a part of a security framework and British security issues should be viewed in the context of the European gas market. But this also means that a supply crisis in Continental Europe would increase prices on the Continental side of IUK and cause British supplies to flow to the Continent. [30]It is therefore equally important that any security criteria created by government and regulators takes into account the possible impact of a supply crisis in northwest Europe.

  Contingency plans for any supply crisis should feature market-based solutions to the maximum possible extent, with additional gas imports being an increasingly likely option. Comparing volumes of gas storage with annual demand and imports, it is clear that the heavily import-dependent countries in both North West and Central Europe have much greater protection against supply crises than Britain (see Annex). Contingency contracts with Continental European countries in the event of a security crisis could be an attractive option for British suppliers.

  Such criteria could also address the issue of whether a maximum limit—stated in terms of a percentage of national or regional gas demand—should be placed on supplies from any single imported source. However, this is not an urgent issue as it will be some years—perhaps as long as a decade—before Britain returns to a 25 per cent level of import dependence experienced in the mid 1980s.

31 October 2001

Annex

UNDERGROUND GAS STORAGE FACILITIES IN EUROPE (END OF 1999)
Working Capacity as a % of:
Depleted
Field
AquifersSalt Cavities Total Working Capacity (Bcm)Annual Demand 2000 Imports 2000***
Northern Europe
Finland
Sweden
Denmark1 10.8216
Estonia
Latvia 12.5  184 184
Lithuania
North West Europe
Belgium1 1 **0.654 15
Luxembourg
France12 310.8  32 44
Germany139 16+118.3720 54
Netherlands3 5  11
UK1 13.2  3  
Ireland
Central Europe
Switzerland
Slovakia1 2.3829 30
Czech Republic31 1 *1.8  19 24
Austria5 3  38 59
Hungary5 3.6  29 51
Poland4 1.1  10 16
South East Europe
Bulgaria1 0.5  16 16
Albania
FYRoM
Slovenia
Bosnia/Herzogovina
Romania4 1.257 40
Yugoslavia
Croatia1 0.5  18 45
Southern Europe
Greece
Spain2 1.2779
Italy9 15.1  21 25
Turkey
Portugal
*mined cavity **disued mine ***non-European imports


  Source: adapted from: Cedigaz, Natural Gas in the World, 2000 Survey, Rueil Malmaison, December 2000, Table 37.


11   This note is part of the ongoing work by the author on European natural gas security issues, which will be published by the Energy and Environmental Programme of the Royal Institute of International Affairs in the coming year. Back

12   International Energy Agency, The IEA Natural Gas Security Study, Paris: OECD, 1995, pp 26-27. Back

13   Here we quote only three, others are: energy efficiency, research and development, free markets and cooperation among market participants. International Energy Agency, The IEA Natural Gas Security Study, Paris; OECD, 1995, pp 28-29. Back

14   Ibid, p 29. Back

15   Jonathan Stern, "After Sleipner: a policy for UK gas supplies", Energy Policy, February 1986, pp 9-14. Back

16   Hansard, 1071-77, 30 January 1992. Back

17   Robert Corzine, "Eggar gives approval for gas pipeline", Financial Times, December 10-11, 1994. Back

18   "Norwegian gas customers unruffled by production shutdown", World Gas Report, April 21, 1986, p 3. Back

19   The IEA Natural Gas Security Study, Paris: OECD, 1995, p 147. Back

20   The Esso Longford Gas Plant Accident, Report of the Longford Royal Commission, Government Printer for the State of Victoria, No 61, Session 1998-99, June 99. Back

21   This refers to the offshore and high pressure onshore infrastructure. Much of the distribution network dates back to the 19th century but has subsequently been upgraded. Back

22   These terminals are large physical sites containing a number of installations over a substantial land area. It is therefore not certain that any incident short of terrorist attack would result in a complete loss of terminal capacity. Back

23   In 2000, only 9 per cent of Northern Ireland's gas was used in distribution, the majority is burned at the Ballylumford power station which can also use heavy fuel oil. Back

24   Jonathan P. Stern, "The British gas market 10 years after privatisation: a model or a warning for the rest of Europe?" Energy Policy, March 1997, Vol 25, No 4, pp 387-392. Back

25   Aside from "Supplier of Last Resort" obligations-see below. Back

26   Ofgem has powers under the Utilities Act 2000 to direct one or more other suppliers to be a SoLR for a failed suppliers' gas (and electricity) customers. Ofgem, Supplier of Last Resort-Guidance on Current Arrangements, March 2001; and Supplier of Last Resort-Security Cover and Levies, A Consultation Document, June 2001. Back

27   Ofgem has expressed the view that the commercial benefits of obtaining a customer base at no cost are such that it would expect suppliers to volunteer for SoLR status. But it has also warned that it cannot guarantee that the failed supplier's customers will not have to pay more for their gas to a SoLR. Ofgem, op cit, June 2001, para 2.5-2.6, p 8. Back

28   Ofgem, op cit, March 2001, para 3.15, p 18. Back

29   1998 was the year that IUK was commissioned and therefore the start of large-scale trade with Continental Europe. Small-scale exports to Germany via the Netherlands had begun in 1992 with the connection from the Markham field. Back

30   As shown in the Appendix, storage volumes in north west Europe are of a magnitude that makes it possible for market players to respond adequately to a very severe and protracted supply crisis. Nevertheless the possibility should form part of the framework. Back


 
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