The looming UK energy gap

Surging energy prices and meagre reserves mean that the UK might find it a challenge to keep the lights on this winter. Power outages are quite possible and that will hamper Britain’s fragile recovery, writes Victor Hill.

Expensive energy

Just as the British economy struggles to recover in the wake of the coronavirus pandemic, with all the bottlenecks and supply-chain disruption that I discussed last week, the country also stands on the brink of a major energy crisis. Many analysts think severe power outages over the winter season are quite possible.

Unusually light air in early September prompted National Grid (LON:NG) to power up a condemned, 55-year-old, coal-fired power station at West Burton, operated by EDF. There are 11,000 onshore and offshore wind turbines in the UK which should in principle supply 20 percent of national power demand; last week they averaged just three percent. Added to this, a severe squeeze on the supply of natural gas in Europe sent the cost of electricity in the UK to a record high of £2,300 per megawatt hour (MWh) last week, though by Wednesday this week (15 September) it was down to £475 MWh − still eye-watering.

On 7 September, wholesale gas prices climbed to 136.6 pence per therm, as compared to just 30p one year ago. This week the price reached 192p for October delivery. Wholesale gas prices in the UK have risen fivefold over the last two years. Goldman Sachs reckons that the futures market is pricing a winter risk premium.

Gas prices are rocketing because several major fields have been shut down for maintenance and because producers have slashed investment and exploration during the pandemic. Also, the Russians are restricting supplies to Europe. This is now having a material impact on production. On Wednesday, a major fertiliser manufacturer, CF Industries, said it was halting operations at its UK plants at Billingham and Ince “due to high natural-gas prices”.

Rising wholesale gas costs have forced ministers to raise the price cap on energy bills by £139 from October. Suppliers have already passed price rises on to consumers.

Two medium-sized energy suppliers, PfP Energy and Money Plus Energy, ceased trading last week, unable to cope with surging power prices. This affected about 89,000 domestic customers and 5,000 businesses. There are fears that several smaller suppliers may collapse imminently, 25 having collapsed in the last five years.

Some believe that would not necessarily be a bad thing. The UK energy supply and distribution market is highly fragmented. The power system in the UK, which following the Major government’s privatisation of the power industry in the early 1990s, provides a degree of competition in what would otherwise be a natural monopoly. But currently there are about 60 players in this market which buy electricity from the generators and resell it to domestic and commercial customers. Some analysts think that just a half dozen or so resellers would ensure sufficient price competition and customer service.

One of the problems is that there is insufficient backup capacity to cover the shortfall from renewables when the wind doesn’t blow, and the sun doesn’t shine (the latter eventuality being rather common in this archipelago). Most coal-powered plants have been decommissioned in line with the government’s goal of getting to zero net carbon by 2050, and nuclear-generation capacity has been in freefall – even Dungeness is set to close. Critics of renewable energy claim that the cost of keeping backup power on standby is not costed into renewable-energy projects, with the result that renewable energy appears cheaper than it really is.

Downside risks this winter include a major supply-side shock, for example a stoppage in shipments of liquified natural gas (LNG) from Qatar. The pandemic has played havoc with global LNG demand, which is surging in Asia. The LNG spot price has tripled since April. The UK might have to compete with China in future to purchase this vital source of energy which arrives at a specialised terminal on the Isle of Grain, Kent. Other risks include a protracted cold spell (‘Beast from the East’ 2?) or even another lockdown to forestall the spread of the delta variant of the virus. The latter seems much more probable this week than last: the government has even given it a name – Plan C.

The UK has slashed its gas-storage capacity over the years. For example, the government refused to refurbish the gas-storage cavern at Rough on the Yorkshire coast. Reportedly, the UK is currently storing just three percent of its annual demand in local gas terminals – that’s just a few days’ worth.

We buy plenty of Russian gas – from the Netherlands. That supply from Russia is now under threat. Russia is restricting flows of gas to Europe through the existing pipeline network that runs through Ukraine and Poland. This may be a ploy to force the European Commission to approve the Nord Stream 2 pipeline (which links Russia and Germany directly through the Baltic) on more favourable terms. Mr Putin has already gained much of what he wanted through a deal with Germany and the US, which some have dubbed a ‘modern-day Yalta’ – because it abandons Ukraine to its own devices.

Normally in September, European gas reserves would be at 80-90 percent of capacity; this year they are at 58 percent in Germany and 48 percent in the Netherlands, according to Gas Infrastructure Europe. In the short term, sky-high gas prices risk forcing a return to the widespread use of coal and diesel power plants.

Interconnectors

Last week Ireland froze power exports to the UK, fearing outages as energy prices continued to surge across Europe. Power transmission was halted on the Moyle interconnector which transmits electricity from Northern Ireland to Scotland (and vice versa). Northern Ireland and the Republic of Ireland participate in an all-Ireland single electricity market. The Irish Single Electricity Market Operator issued an amber warning on 9 September, referring to a “general shortfall” of electricity which could result in power cuts. It seems that the proliferation of power-hungry data centres is putting a strain on the Irish grid.

Ironically, last month the UK government asked the French to send less power across the English Channel via the interconnector there after technical problems with a trading platform threatened a power surge. French electricity is cheaper than British because it is overwhelmingly generated by a network of nuclear plants. Then, on Wednesday night, a fire broke out at one of the France-England interconnector maintenance points in Ashford, Kent. The cable is likely to be entirely out of service until at least 25 September and will not be fully operational until next spring.

As British power prices peaked last week, a new 720-kilometre interconnector came onstream linking Blyth in Northumberland with Kvilldal in southeastern Norway. Once fully operational in October, Britain should be able to benefit from Norway’s extensive network of hydropower electricity plants. An interconnector linking England with Germany – known as NeuConnect − is planned to be operational by the mid-2020s. This is backed by a consortium of investors including Meridiam, Allianz Group and Kansai Electric Power of Japan. Another consortium, Xlinks, led by entrepreneur Simon Morrish, is seeking to build a cable to connect Britain with solar arrays in Morocco.

There are already cables linking England with the Netherlands and with Belgium, as well as with France and Ireland. As I write this, according to the National Grid’s Gridwatch website, 2.81 percent of the UK’s power consumption is coming from France, 2.57 percent is coming from the Netherlands via the BritNed interconnector, 2.84 percent is coming from Belgium via the NEMO interconnector and 1.98 percent is coming from the new interconnector with Norway. That’s a total of 10.2 percent coming from our European neighbours right now. But given Britain’s planned fourfold increase in offshore wind-generation capacity, we are expected to become a net exporter of electricity by 2040. Or that is the hope, anyway.

Interconnector projects are eminently investible. Humza Malik, chief executive of Frontier Power which is active in the NeuConnect project, told the Daily Telegraph that the cap and floor regime operated by Britain’s regulator, Ofgem, has provided a level playing field for investors. That said, at a critical point in the Brexit negotiations last year, President Macron appeared to suggest that the France-England interconnector might be used as a bargaining chip – so there is a degree of political risk. Both fishing rights and energy-market access will come up for renegotiation between the UK and the EU in 2026.

Tony Lodge, a research fellow at the Centre for Policy Studies, argues that EU directives since 2006 required the closure of one third of the UK’s power-generation capacity. Coal, oil and nuclear-generated capacity have not been replaced with equivalent capacity, so the UK has increasingly relied on imported electricity. Further, he says, our concentration on renewables has made our electricity more expensive: UK manufacturers pay one third more for power than their EU competitors. The UK steel industry pays 80 percent more than steel plants in France and 60 percent more than those in Germany.

Twenty years ago, the UK enjoyed a high level of energy security. Now we are overly dependent on imported power. That will only get worse with the electrification of vehicular transport and if all homes are required to install electric-powered heat pumps.

Nuclear

The Nuclear Industry Association recently published an analysis which argued – unsurprisingly – that the solution for Britain is more nuclear power. Thus far, attempts to roll out a modern, nuclear-power network have fallen foul of spiralling costs, opposition by green campaigners and the intractable problems of financing construction with Chinese money and technology. Until such point as the government grasps this nettle and commits to adopt the small modular reactor (SMR) technology developed by Rolls Royce (LON:RR), the ‘elephant’ will remain in the room.

This month, the nuclear-power plant in Hartlepool has been struggling with technical issues while the Heysham 1 plant is out of service pending maintenance. The capacity of Britain’s nuclear sector is down by about one third right now (5.2 gigawatts versus a theoretical eight gigawatts). At its peak in 1995, the UK nuclear sector had a capacity of 12.7 gigawatts. The only nuclear-power plant currently under construction in the UK is Hinkley Point C in Somerset, developed by EDF (EPA:EDF) and China General Nuclear (SHE: 003816). This will not now become operational until 2026.

Britain used to lead the world in nuclear power – indeed the world’s first commercial nuclear reactor was opened by the Queen at Calder Hall 1 in 1956. Our loss of pre-eminence in this domain is entirely due to poor political leadership.

COP26 and all that

When John Kerry, President Biden’s climate envoy, visited Beijing recently to persuade China to burn less coal, he was rebuffed. The western idea that climate policy is somehow beyond politics is alien to the Chinese who are now using carbon-emissions targets as bargaining chips. China loosely aspires to attain net carbon zero by 2060; but the 14^th five-year plan, published in May this year, commits only to reduce carbon emissions per unit of GDP. This means that China wants to improve energy efficiency but is not prepared to sacrifice economic growth to reduce carbon emissions.

If the objective of COP26 is to shame China into committing to new, legally binding carbon limits, then it is likely to be a failure. In the meantime, many will say that the UK – which emits less than one percent of all greenhouse gases – has risked its continued prosperity by making what is essentially a moral gesture.

Let’s hope the lights don’t go out as the climate potentates arrive in Glasgow.

The perfect storm

This week the Office of National Statistics (ONS) revealed that inflation was running at 3.2 percent last month. That was the largest month-on-month annualised rate since the metric was first introduced 25 years ago. The main factors were increases in food and petrol prices. Once increased energy prices make themselves felt over the winter and tax rises bite as of next April, there is likely to be a perceptible squeeze on living standards in the UK – especially if the avowed reversal of the £20 increase in Universal Credit goes through (although the government has already pledged to extend the Warm Home Discount which cuts bills for low-income households). There could be widespread strike action in response, as was the case in the 1970s. That would have political consequences.

All this is happening at a moment when the bill for the government’s green agenda – a commitment to the net carbon-neutral economy – is becoming apparent.

And it could get worse. There were national blackouts in the UK in August 2019 when a wind farm and a gas-powered plant tripped, triggering a plunge in frequency. That affected more than one million people, as well as hospitals, airports and railways from the southeast to Yorkshire. The UK grid frequency is controlled to maintain at exactly 50 hertz on average, but does vary narrowly. A frequency of less than 50 suggests that potential demand is higher than available generating capacity. As I write, the frequency across the UK grid is 49.943. Generators are designed to trip if the frequency falls too fast, to avoid equipment damage. It would be a strategic mistake to become overly dependent on interconnectors to correct frequency changes.

Matching power supply with demand becomes more difficult with intermittent renewables. The government wants to run the grid without gas-fired generation except for short periods, by 2025. At the time of writing (16 September), combined cycle gas turbines account for 45.83 percent of UK power supplies. That is very far from what the government wanted. One solution might be run combined cycle gas turbines with carbon capture and storage – but there seems to be no political will to do that by a government which is obsessed by wind power.

PS

Michel Barnier, Britain’s nemesis in the Brexit negotiations, is now front-runner for the nomination as France’s Republican-party candidate in the presidential election of May next year. At a moment when both President Macron’s and Madame Le Pen’s popularity are sliding, Monsieur Barnier, a European champion, has issued a remarkably eurosceptic manifesto. In a video released by Le Point newspaper on Wednesday he argues that France should seek souveraineté juridique – legal sovereignty. That means, amongst other things, that France would not be subject to the European Court of Human Rights. Further, each EU member state should have complete control of its own immigration policy. If elected next spring, he will hold a referendum on these issues in the second half of 2022.

This is momentous. If France had gone down this route five years ago, Britain would probably not have voted to leave the EU. It would change the dynamic of the European project forever. It is a supreme paradox that Monsieur Barnier is now our best hope for any longstanding modus vivendi with our closest, most important and once best-loved neighbour.

Listed companies cited in this article which merit further investigation:

• National Grid (NG)
• EDF (EPA:EDF)