The real cause of the energy crunch lies in the east

Coal, gas and oil prices are rocketing. Electricity prices are soaring accordingly – especially in the UK, which has the highest electricity tariffs in Europe. Amid all the political recrimination, the root cause of these trends has been overlooked, says Victor Hill.

The outages begin

Lifts have stopped working and the streets have gone dark by night. Factory production has been disrupted. Energy-intensive industries such as aluminium smelting have suspended operations. Cars are gridlocked in traffic. Shopkeepers have lit candles to keep shops open. More than 13 million homes have endured power cuts – and thus have been unable to recharge their smartphones which carry their digital wallets, vaccine certificates and identity cards…

These were scenes from many Chinese cities, including Shenyang and Dalian earlier this month. China is confronting an energy crisis. Jilin is just one of at least 10 provinces in north-east China which have been forced to ration electricity as coal prices soar. In response, Beijing warned China’s state-owned energy producers that blackouts will not be tolerated. But already numerous companies which supply the likes of Apple and Tesla have curbed production in the face of a power squeeze. That was one reason why on 13 October Apple announced that the latest model of its iPhone will fall short of production targets.

Beijing wants to boost coal imports − principally from Russia, Mongolia and Indonesia. But the China Coal Industry Association warned that it was “not optimistic” about coal supplies in the run-up to peak winter demand. It admitted at the end of September that Chinese coal stocks were “critically low”. China’s purchasing managers’ index slumped to a 19-month low in response.

As a result of China’s insatiable demand for coal, the price of thermal coal has almost doubled over the last 12 months, to $210 per tonne. Shares in coal producers have risen accordingly. Shares in Thungela Resources, the South African coal producer, spun out of Anglo-American earlier this year, have risen by nearly 250 percent in the last six months. Shares in Glencore, which in June bought out its partners in the giant Cerrejon thermal coal mine in Columbia, have tripled in value since April. China is still expanding its coal-powered, electricity-generation sector even though President Xi announced to the UN on 21 September that it would not finance new coal-fired power stations outside its borders.

Meanwhile, the collapse of Chinese property developer Evergrande, with liabilities of about $305bn has set alarm bells ringing – not least because Beijing did nothing to alleviate the blow. The Communist Party of China is trying to deflate the country’s property bubble. This is a big deal – construction accounts for about a quarter of Chinese GDP. President Xi appears to have an animus against what he terms “speculation”.

There is a demographic backdrop to all this. China’s workforce is shrinking by about three million workers a year. The number of marriages last year was a third less than seven years ago. Household formation has slowed and rural migration – the once endless supply of unskilled labour from China’s rural provinces – has all but ended. That all suggests a downward trend in growth rates.

China’s energy crunch arises from the post-Covid spike in demand, plus numerous freak weather events, including a pronounced drought in the spring which restricted hydropower output and then a hot summer which stimulated demand for air conditioning. But a shortage of coal has resulted in a surge in demand for gas. China is now the world’s largest importer of liquefied natural gas.

The oil price has also been surging. Goldman Sachs is now forecasting a price of $90 a barrel by year end. It seems that the “commodities of the past” can still generate returns for those who extract and trade in them. We are likely to remain reliant on fossil fuels for decades to come.

Meanwhile in Moscow…

The consensus in the UK and across the EU (on one of the few matters that we agree on) is that Russia has deliberately restricted the flow of Siberian gas to Europe in an attempt to fast-track the approvals required to start operating the Nord Stream 2 gas pipeline. In so doing, Russia has precipitated a massive spike in wholesale gas prices – in fact, wholesale prices have risen eightfold since the beginning of this year. UK defence minister, Ben Wallace MP, has stated that Russia is using gas supplies as “a weapon”. Jake Sullivan, President Biden’s national security advisor, accused Russia of using energy as “a tool of coercion”.

The Russians, for their part, furiously deny these accusations. They claim that they have met all obligations to their contractual counterparts and that European countries are overly dependent on the spot market to buy in supplies at the last minute. The move this week by the EU – spearheaded, inevitably, by President Macron of France – to start buying gas from Russia as a bloc rather than as individual countries, suggests that the Russians may have a point. What is now called “joint procurement” would give the EU greater bargaining power and energy security.

What the western mainstream media has missed, however, is that Russia may be diverting gas production to its huge neighbour and security partner, China. Typically, Russia pumps large volumes of gas into Europe over the summer months, not because it is needed for immediate use but in order to replenish gas-storage facilities. (The Europeans typically hold at least two months’ gas supply in storage – unlike we ‘seat-of-the-pants’ British who run everything on a just-in-time basis). This summer those top-up gas supplies were much attenuated, possibly because they were redirected towards China. Also, Gazprom’s Amur gas-processing plant, which supplies China, was severely damaged by fire last week. Significantly, Russian gas production is already at record levels, the experts reckon, and may well begin to decline soon.

Winter worries

Ministers and officials right across Europe are praying for a mild winter. A severe winter could result in shortages, especially in the cold countries of Eastern Europe such as Poland and Ukraine. The gas crunch has exposed an inconvenient truth – that Europe has become overly dependent on Russia, which supplies about 43 percent of its total needs. The next- largest supplier is Norway, which supplies about 16 percent of European gas consumption. Spain, Greece and Italy are particularly dependent on gas supplies from Russia, having no hydrocarbons of their own. Germany, the largest economy in Europe, is the biggest consumer of gas on the Continent and is about two- thirds dependent on Russia.

Fortunately, Britain is less exposed since only about three percent of our gas consumption is supplied from Russia, sourced mainly via the Netherlands. The North Sea still produces about 40 percent of the gas we consume, and 85 percent of British homes are still heated by gas. That said, we are still exposed to the surge in global wholesale prices. Furthermore, British consumers have been protected thus far by a price cap on energy bills imposed by Theresa May’s government (based on a Labour Party manifesto commitment in the 2015 election). This has entailed that energy-distribution companies have been forced to sell energy at less than cost – hence a number of smaller players have gone out of business. Analysts now expect that the more than 50 energy suppliers extant in the summer will reduce to around 10 by next year.

The boss of Britain’s energy regulator (Ofgem), Jonathan Brearley, signalled this week that the way in which the price cap is calculated will have to be modified in future. This implies that energy companies will be able to pass on a larger proportion of wholesale price increases to consumers. The UK energy cap was raised by £139 on 1 October, taking the average annual household bill to £1,277. The cap will next be revised on 1 April next year. Cornwall Insight, the energy consultancy, has warned that average household bills could rise by £400 next year. Marcus Rashford, the footballer and anti-poverty campaigner warned that many families will have to choose between “eating and heating” this winter.

The increase in domestic gas prices will be inflationary – indeed, it already is. Capital Economics expects higher energy bills in Spain to add 0.5 to the rate of inflation by the end of this year. The Spanish government has decreed emergency measures that will cap energy bills for households by effectively taking €2.6 bn out of power-company profits. France has offered a one-off €100 energy grant to about six million low-income households.

The UK: untapped reserves

The irony is that Britain still has untapped reserves of natural gas which it is loath to exploit because of the “legally binding” pledge to attain net-carbon neutrality. The Offshore Petroleum Regulator for Environment and Decommissioning has just refused permission for Shell to explore the Jackdaw Field, 150 miles off Aberdeen in the North Sea, which is estimated to hold reserves equivalent to 120-250 million barrels of oil. Jackdaw, if developed, could cannibalise existing pipe networks so would not require extensive new infrastructure. If we don’t produce our own gas, we just have to import it from somewhere else – like Russia.

Then there is hydraulic fracturing – fracking, which unlocks shale gas. It was the future, once. This activity has made the US self-sufficient in energy but has effectively been outlawed here.

And there is an absence of direction on nuclear energy. This week President Macron announced an initiative to build small, modular nuclear reactors (MNRs) in France. Rolls Royce has the technology to do this here – but has still not gained government backing. Rolls Royce proposes to generate up to 440 megawatts of power from each MNR with a carbon footprint one tenth that of Sizewell B. They could be rolled out over a five-year timescale and would create thousands of jobs. There is also some promising research on thorium-powered nuclear reactors, which do not produce the waste associated with the uranium fission cycle. A thorium plant is currently being trialled in China.

The Johnson government is committed to a major expansion of wind power – which is all very well until the doldrums arrive, as happened in early September with a spell of windless, halcyon weather. For 100 percent renewable energy, wind power would have to increase fivefold in the UK from its current level. In the meantime, we are unduly dependent on the kindness of others to keep the lights on. France, under an increasingly hostile President Macron, has already threatened to shut down the interconnectors between France and England and between France and Jersey, in a dispute about fisheries.

As I write, the France-England interconnector, which was recently compromised by fire, is supplying 2.6 percent of UK demand. That could almost certainly be made up by alternative domestic capacity, though that would result in another increase in the wholesale electricity price. By the way, such a move by the French would adversely affect Ireland, which has been dependent on British-generated electricity to make up its own shortfall this year. But, regrettably, our compatriots in Jersey could not sustain demand without French power.

Will we have to import green hydrogen when the hydrogen economy takes off? This is imminent – as I shall explain in a future article. But the Johnson government’s stance on this critical question is also unclear.

The government’s strategy to date has been to charge all environmental levies to energy bills rather than by general taxation (some form of carbon tax). These have added around 25 percent to domestic and commercial energy bills, or around £10bn a year, which is roughly equal to the revenue to be generated by the increase in national-insurance contributions due next April. Electricity in Britain was already more expensive than in competitor countries even before this energy crunch. The risk is that this surge in prices will force high-energy manufacturing to move overseas, to countries which have cheaper electricity and less onerous restrictions on CO2 emissions. This week British Glass warned that all British glass manufacturers may have to shift production overseas.

National Grid estimates that demand will peak in the UK around 60 gigawatts in the coming winter. The average winter peak demand for gas is 385 million cubic metres per day. If we get a mild but windy winter, we’ll probably get away with it. But a cold and still winter could plunge us into chilly darkness.

Consequences

The energy crunch or price-hike (whatever you want to call it) has divided opinion within the commentariat.

Some are saying that we have sacrificed energy security on account of a headlong rush towards net-zero carbon. Business secretary, Kwasi Kwarteng MP, pledged that the national grid would be “entirely green” by 2035 at the Conservative Party conference last week. But renewables are intermittent and there is insufficient back-up generation capacity. It is still not clear what the Johnson government’s policy is on that, though we do know that the PM is a fan of Kermit the frog.

Others say that the crisis reminds us that we are overly dependent on fossil fuels and that we should accelerate our trajectory towards net-zero carbon accordingly. They are right that decarbonisation is now a fact of life. But they are shy to admit that zero-carbon energy will cost more and will disproportionately disadvantage the least well off. The Royal Navy was founded on wind power; but Britain only began to industrialise thanks to abundant cheap coal. China is prioritising keeping the lights on over hitting ultimately arbitrary emissions targets. But not Britain.

Part of the equation is the need to look busy so that COP26 – beginning on 31 October – doesn’t degenerate into what Greta Thunberg calls “blah, blah, blah”. Apparently, the Prince of Wales agrees with her, but he should be cautious. Greta and her champions believe that the climate crisis is not just about the environment but about the “colonial, racist and patriarchal systems” which have fuelled climate change.

Humankind has generated carbons emission since the Stone Age. And we know that the climate has fluctuated wildly throughout geological history. The great warming that melted the glaciers of northern Europe about 12-15,000 years ago, flooding what is now the North Sea, was not caused by anthropogenic carbon emissions. In past articles, I have questioned whether going carbon-neutral is possible in practice. Rather, it’s a kind of Holy Grail. Increasingly, I also wonder whether it is desirable. I suspect the Chinese would agree with me.

PS

My TalkTalk internet connection in rural Norfolk, on the blink for more than a month, died altogether last weekend. I spent an hour or two on the phone to TalkTalk’s polite and cheerful operatives at their South African call centre on Monday, only to receive a text that they could not detect a problem.

I called again. This time (as I found out by visiting a local hotspot – the church) they did admit by email that there was a hardware problem. By Tuesday afternoon, after much aggravation, I got through to a supervisor who was able to sanction a site visit by an engineer from Openreach, scheduled for Wednesday morning. The said engineer failed to materialise.

I called again on Wednesday afternoon, this time speaking to Nelson (not his real name), who sounded businesslike. He advised that regrettably, due to a technical error, my request for an engineer’s visit had not been actioned. He could assure me, however, that he would instigate an Openreach visit – but it would take 48 hours to sanction it, and he could not advise precisely when it might take place.

Then, on Thursday morning – miracle of miracles – I woke up to Farming Today, as I usually do, to find that the internet was working. No explanation, of course. So, I don’t have to write an irritable letter to my MP, Liz Truss. Until the next time.

Listed companies cited in this article which merit further investigation:

• Thungela Resources (JSE:TGA)
• Glencore (LON:GLEN)
• Royal Dutch Shell (LON:RDSA)
• Rolls Royce (LON:RR)
• National Grid (LON:NG)