Is there a light that never goes out? – Stuart Paton
The surprising thing about energy is that it is so cheap. This may seem a strange thing to say given the recent high profile cost increases but look at this in context. Oil is currently about $90/barrel (the strange unit of volume used for oil), which is actually down about 20% in the last 3 months. This is equal to 55p/litre (yes, 55p per litre). Petrol at the pumps increased dramatically but has now reduced somewhat to about £1.60/litre (with about 55p of that being UK fuel duty). If you compare this against about £1/litre for milk, Coca Cola (other brands of fizzy drinks are available), or £20.00 (or much more) for whisky, it is remarkable you can drive 15 miles for this amount of money. And remember, this product has involved multi-billion pound investments, over many years in some of the most inhospitable places on the planet. And the exploitation of the resources has involved huge geopolitical ramifications from Iran to Saudi Arabia to Aberdeen. But the economic development of the last 100 years would not have happened without this cheap power (or indeed expensive fizzy drinks and quite a lot of whisky).
The issue we are now struggling with is that energy is not as cheap as we have been used to, and at a price required to maintain our standard of living. The wholesale electricity price has increased by about 50% in the last year. The UK day ahead wholesale gas price has more than tripled in the last year and is 10-times the average price in 2020. On this measure, gas is now selling for $260/barrel of oil equivalent compared to an oil price of about $90/barrel. For reasons ranging from economic growth post COVID in 2021 when the gas and oil price had already increased significantly, to the impacts of the Russian invasion of Ukraine and in particular the leverage the Russians have over western European gas supply, we are now having to deal with a very large price shock. And large energy price shocks, be it the oil shock of the early 70’s or the low oil price of the late 80s, have significant political impact. However, we live in a very different world where, at least for developed economies, there is much less of a link between energy price and GDP growth and where the cheapest form of electricity is not now coal or gas.
What does this mean for the proposed UK government support through the ‘Energy Price Guarantee’. Putting aside the fact that the government really seem to have no idea how much this may cost (‘the biggest single fiscal intervention in my lifetime” according to Paul Johnson of the IFS) and that it is essentially a regressive policy as the largest houses use the most energy, what is the basis of the cap?
Firstly, the Energy Price Guarantee initially applied to domestic electricity and gas users for two years but has now been extended, in a somewhat different structure, to businesses for 6 months. However, although the mechanism is reasonably clear for households using gas and electricity (including clarity on pre-payment meters), there is still a lot of uncertainty for businesses and for households who use other sources of energy including oil on the detail. Announcements to date suggest that off grid consumers £100 for off grid support. 14.4% of Scottish households, about 361,000 homes, are not connected to the gas grid and are classed as “off grid”. This figure includes all of Shetland and Orkney, the vast majority of the Western Isles, as well as 58% of households in the Highlands and 49% of those in Argyll & Bute. These homes will already have seen very dramatic increases in oil (although prices have somewhat reduced in the last few months) or LPG and other sources of ‘off grid’ gas. To date, the government is only offering all these homes £100 of support which is likely to be substantially less than the actual increases and much less support than that given to ‘on grid’ households. This issue is presumably much bigger in Scotland than England and should be a focus of the Scottish Government in the coming months.
Secondly, the cap actually applies to units of gas (10.3p/kWhr from 1st October up from 7p/kWhr)) and units of electricity (34p/kWhr up from 28p). The figure usually quoted of £2,500 is for an average household although this is often conflated, even by the Prime Minister, to the maximum amount a household will pay. Surprisingly, OFGEM and the government don’t provide a variety of scenarios, as for example the papers provide at a (normal!) budget (if you are a married smoker with 2 children living in a 3-bedroom house with a dog the impact of the budget will be £15/week). I therefore have sympathy with the pensioner interviewed on Radio 4 a couple of weeks ago who was expecting half her pension going on heating bill. For this individual, this was highly unlikely to be the case but as the figure of £5,000 per household (prior to the Energy Price Guarantee) was the only figure being mentioned what are people meant to think?
Thirdly, this is a cap on the energy price, and unlike the claims of most commentary, this should have an impact on usage as the price is a lot higher than last year. The cap could have been set higher which presumably would have a larger impact on usage but then would have required additional targeted support. However, as the price cap is double what it was one year ago at which time many people presumably had contracts below the price cap, this will still be a huge increase in the cost of domestic energy. Therefore, the government should be clearer that while it is introducing the price cap to ease the fiscal burden, we still need to individually reduce our consumption where possible to save money and as, reducing demand is also necessary if we are to meet our NetZero commitments.
This is of course a difficult message going into winter, which is why it also needs to be linked into help and advice around insulation and ways to improve energy efficiency. However, a recent poll for the Economist by Ipsos suggest a large proportion of people (approx. 60%) would support measures that would require households to reduce their energy consumption this year, provided there are exceptions for the most vulnerable, compared with one fifth opposing the rules. Of course, whether people would actually support these measures in practice is a different matter but it does show at last notional support.
To support this finding, a recent study by the think tank Breuegel, which compared a whole range of measures across Europe, clearly showed that countries that implemented more price support had less impact on natural gas demand and vice versa.
Despite all these comments, in the short term, the UK government really had no other option than to provide support to households and businesses. However, to leave the household support in place for 2 years seems a huge misjudgement and a potential huge liability.
The other key statement made by the new prime minister in relation to energy was regarding security and self-reliance. The mechanisms presented were greater exploration licencing and fast-tracking developments in the North Sea and encouraging onshore hydraulic fracturing of gas reservoirs (‘fraccing’). Both of these solutions seem wrong-headed.
UK oil and gas production has been declining for much of the last 20 years (although there has been an uptick in oil production this year probably due to post COVID effects). Average total production of oil and gas in 2021 was about 1.3 million barrels of oil equivalent. The key reason that companies are not increasing production from the North Sea is that this is a very mature basin with very few large discoveries still to be made rather than a lack of exploration activity.
Even the high-profile discoveries such as Jackdaw (75 Million barrels) and Cambo (170 Million barrels) are tiny on a global scale when you consider oil production and consumption is about 90 million barrels PER DAY. In comparison, ExxonMobil has discovered 11 billion barrels- 11 thousand million barrels- in Guyana since 2015- and will imminently be producing 1.2 million barrels per day. Recent UK discoveries are small even in a long term UK context- the last very large discovery in the UK was Buzzard- 1.5 billion barrels discovered in 2001, onstream 2007, currently producing 60,000 barrels/day. Recent UK discoveries are challenging- Jackdaw is very high pressure and high temperature, Cambo is in the relatively remote West of Shetland. Glengorm discovered in 2019 was originally thought to contain approximately 250 million barrels but following further drilling the current estimate is 60 million barrels.
Each of these discoveries could be an important part of the energy mix but it is overly optimistic to think they will have a major impact on the amount of gas or oil we need to import. This is not to say we can or should shut down the UK oil and gas industry overnight- far from it. However, we need to be realistic about the impact North Sea production will have on our energy supplies and also have a debate on the impact on our progress to net zero if we keep bringing new fields on stream.
The impact that developing gas fields using hydraulic fracturing (‘fraccing’) will have on the UK gas market is likewise hugely overoptimistic. As a previous advocate of fraccing, I now think the world has moved on in the last few years largely due to the increasing urgency, underpinned by legislation, to achieve net zero and the large reductions in cost of renewable electricity generation. The US (and to a lesser extent Australia) is the only place that has really made fraccing work. The US has a wide range of geology to explore and test ideas, a huge onshore oil and gas industry with each stage of the supply chain honed and hugely innovative and wide-open spaces with mineral ownership rights which incentivise production. The UK has none of these. Further, is the government really going to go head-to-head with local objectors to fraccing- many from key Conservative seats? At best, this will be a small, incremental benefit.
Instead of pursuing the fruitless goal of energy security from the North Sea and fraccing, the government should instead focus on developing the cheapest forms of energy- wind and solar- supported by nuclear for base load, storage of all forms and massive improvements to the electricity infrastructure. They should be ensuring companies are progressing with offshore wind development and that the UK supply chain is capable of taking a major part in this development. In parallel, with more renewable capacity, the government should be supporting companies delivering storage, green hydrogen and grid balancing, all vital for maximising the increased renewable capacity. Apart from their desire to start a publicly owned Green Energy Company, these aims are much more aligned with those of the Labour Party than the Conservative government. As an aside, it is interesting to see the UK Labour party enthusiastically advocating nuclear power which is at odds with some within the Scottish party and the SNP.
Secondly, the government with OFGEM must redesign the electricity market so that the price is decoupled from the gas price. As stated above, the electricity price is currently set by the ‘marginal therm’- the last therm generated. Until a few years ago, this made sense as the cost of renewables was driving the price of electricity too low to incentivise anyone to generate electricity on the windless, cloudy winter days. The logic is, therefore, to pay the highest cost producer to ensure they can deliver when required. However, this means consumers are not seeing the benefit of lower cost generation- from renewables and, at the current gas price, nuclear. The benefits of this flow to the lower cost generators, specifically those who sell short term, and to upstream gas producers who are directly benefiting from the high gas price. The regulators, in Britain and across Europe, now need to modify the system to allow consumers to benefit from the lower cost renewable electricity but allow mechanisms for some type of option when we need gas generation or to pay for storage. The solution is complex but should be tractable in a timely manner as it does not require building lots of new power stations but focussing on running the system.
Thirdly, developing a support scheme for the most needy households and businesses rather than blanket support for everyone which cannot be sustainable. The government’s approach to supporting households and businesses in the coming months is necessary and likely the least worst choice. However, the government needs to quickly decide on a sustainable method of support for the most vulnerable. The government should also be clear that, even with this support, energy prices have doubled in the last year and people will need to consider how they mitigate this impact likely looking at reducing consumption, improving insulation and installing solar panels.
Stuart Paton is an energy industry advisor and former Chief Executive of Dana Petroleum. He is also an associate of Reform Scotland