Thank God for the Glory of Gas

Natural gas gets little mention in discussions of British energy policy. That is surprising, because natural gas accounted for 39 per cent of primary energy supply in 2009, slightly higher than oil and more than twice as much as coal. In the power generation sector, gas produced 46 per cent of the electricity generated in Britain. And on any reckoning, gas will continue to be a large and vital component of Britain’s energy supply for many decades to come.

But why is gas politically invisible? Perhaps the most important reason is that the energy debate, such as it is, has been dictated for 20 years by green activists bent on ending our reliance on fossil fuels. The fact that natural gas is more efficient and produces less than half the CO2 of coal and oil just makes them angry. For green ideologues, gas is just another vile product of the evil global hydrocarbons industry, and as such its relative benefits should be ignored.

Recent British governments have failed to acknowledge the economic importance of gas. Energy policy has been calibrated to appease the environmentalists, their powerful allies in the media and a sentimental electorate. Yet the headlong dash for wind power — underwritten by taxes and subsidies that will force up consumer prices to uncomfortable levels as the total amount of wind capacity rises — will itself increase the need for gas-fired generation. Gas is the only fuel that has the scale and the flexibility to generate at very short notice to back up highly intermittent wind turbines.

Gas-fired power is also the only possible replacement for the coal-fired stations that will be retired in 2015 under an EU directive. And gas is going to fill the gap between the withdrawal of old nuclear power plants in the years up to 2020 and the still-doubtful replacements which are unlikely to come online in any numbers before 2025.

National Grid, whose job it is to transport power from generators to customers, forecasts that by 2017 gas-fired power stations will represent nearly half of Britain’s installed generation capacity.

Some of the generation capacity forecast for 2017 may not be built, but it is clear that gas will be the dominant source of electricity in Britain towards the end of this decade, as well as continuing to provide about two-thirds of central heating and cooking needs. At the same time Britain’s own gas production from the North Sea continues to decline and imports to rise. Should we be worried?

The alarm has been sounded by politicians of all stripes. Tony Blair used security of gas supply as the hook to hang his decision to back nuclear new-build. Charles Hendry and Greg Barker, the Conservative energy spokesmen, tried to sound at once green and patriotic, while demonstrating their ignorance of one of the Tories’ economic triumphs of the ’80s and ’90s, namely the competitive gas and electricity markets that efficiently guarantee Britain’s energy supply.

Rather than being ignored, the British energy market should be celebrated as a national economic triumph. Successive Tory governments privatised the old monopolies, but it was left to the gas and electricity industries, together with clear-sighted regulators, to work out how to deliver real competition. Gas and electricity are both network industries that require systems of pipes or wires to connect suppliers to consumers. Due to the compact size of the country, the British networks were regarded as natural monopolies that would transport gas and electricity owned by competing suppliers on a non-discriminatory basis. This enabled a wide range of interests to begin supplying and trading gas and power to the British consumer.

One of the features of British energy is the degree to which it relies on open market mechanisms to price everything from the commodity itself to the cost of transport and storage. Although overseen by the regulator Ofgem, this system has evolved between the parties themselves. The process is both competitive and cooperative, and immensely adaptive. The results have been spectacular.

Unlike much of the rest of the world, where monopoly and market manipulation still rule, British wholesale gas and power prices respond efficiently to supply and demand. Competition keeps them keen. During the initial decade of competition, from 1995 onwards, gas prices to British industry were 50 per cent lower than those paid by their competitors elsewhere in the EU. There was a brief period in 2005/6 when, during the shift from gas independence to increasing reliance on gas imports, prices rose. But they have since fallen to about 20 per cent below comparable prices in the EU. Much of the downward pressure on prices in Britain is exerted by competition between our new suppliers in Norway, Holland, Qatar and elsewhere.

The EU has taken notice, even if our own government seems to have forgotten. Against entrenched opposition from vested interests, the EU Commission has painfully pushed through liberalisation measures that are now beginning to bear fruit — though it will be years before continental markets achieve British levels of efficiency and freedom. The commission understands that an open and competitive energy market delivers economic benefit and energy security.

The open energy market not only provides short-term benefits to Britain, it has also massively expanded vital gas infrastructure at no cost to the taxpayer. Since 2000, private companies have invested around £10 billion in import pipelines and new reception terminals for liquefied natural gas. That figure does not include the much higher costs involved in developing the new supplies of gas that are shipped via those pipelines and terminals. None of these costs are passed on directly to the consumer, because the commodity price of gas is generated in the short-term market. Instead the new infrastructure costs are largely swallowed by the suppliers who use them.

The picture is different in electricity, where there is less need for imports. Within Britain, investment decisions focus on the huge expansion required to transport intermittent wind-generated electricity from remote windier spots to consumers in England. These investments are handled by National Grid, a regulated private monopoly, and will inevitably be passed on to the consumer — another reason to re-examine the government’s obsession with wind.

At the heart of the free British energy market is a sophisticated trading system used by hundreds of competitors that continually prices gas and electricity, both spot (short term) and forwards (long term). This trading system — actually multiple interlocking platforms, all in different ownership — encourages arbitrage between the gas market and power generation: when gas is relatively cheap, the generators buy it, and vice versa. And, with the development of free markets in Europe, Britain has become the hub of competition for the continent as a whole. When gas is cheap here, the Europeans buy it from us (to the extent that they are allowed to), and when it is expensive here, they sell to us.

Which leads us to security. Big gas producers, specifically Russia, are more interested in security of demand than the faintest Westminster heart is in security of supply. They are terrified that the West will stop buying the stuff from them. And though they would rather that their European customers would continue buying gas at high non-market prices under restrictive contracts, they will have no choice but to accept the consequences of the British-style liberalisation that is fast bearing down on them. 

The existence of the competitive market for gas is the ultimate guarantee of security. Britain is now the hub of a highly flexible competitive network that attracts gas supply, short- and long-term, from across Europe by pipeline, and across the world as Liquid Natural Gas.

Aside from this extraordinary commercial innovation, there are many other reasons to celebrate the role of natural gas in British life. The arrival of North Sea gas in 1965 brought with it central heating and hot water on demand. The British people are cleaner and more comfortable than they have ever been. The offshore gas industry — still thriving, albeit at a lower level-has earned hundreds of billions of pounds for the Exchequer and many more for British firms. The rapid growth of gas-fired power generation in the ’90s had the unacknowledged benefit of keeping Britain’s carbon-dioxide emissions to the level agreed at Kyoto, the only nation to meet its target.

In the gas trade, the contract year runs from the beginning of October, which gives a good excuse for a round of “gas new year” parties. I suggest a grateful nation should adopt this date and make October 1 Natural Gas Day.

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