Gas prices will keep going up, but there are ways to keep the costs down

Despite optimism over a shale ‘glut’, gas prices will remain high. Yet the UK is well placed to ensure the lights stay on.

With tensions rising in Egypt and throughout the Middle East, the price of oil this week broke through $100 a barrel, its highest level for nearly two years. It’s a development that has already raised concerns about the impact on global economic recovery.

But beyond these regional geopolitical influences, commodity prices are rising across the globe. Everything, from food to raw materials, appears to be on an inflationary path. Gas is no exception. Wholesale prices on the UK spot market doubled from 30p a therm in March 2010 to 60p by December. Forward prices for 2011 rose by nearly 50% over the same period. This dramatic shift triggered the recent increase in domestic UK energy prices.

To some observers, this upward move is perplexing, as they read about the prolific discoveries of shale gas in the US. It has been hailed as a long-term “game changer”, which could trigger a global gas glut. Shale has certainly revolutionised the US market, releasing vast, and hitherto uneconomic reserves. It now accounts for 20% of production there, up from just 5% in 2006. As a result, the price of natural gas in the US has fallen by 40% over the last three years. At times this month it has traded at half the cost of gas in the UK.

But there are strong reasons for seeing the shale gas phenomenon as largely confined to the US, at least for some time. Although the existence of gas-bearing shales in the States has been known about for decades, its potential has only recently been unlocked through a combination of access to acreage, incentives for owners and exploration companies, and the existence of a well-developed supply chain.

These conditions are unlikely to be replicated elsewhere. Even in the US, while technology is lowering the cost of shale gas extraction in some basins, other wells are rapidly depleting and the cost structure and environmental charges are rising. The impact of shale on world markets will be very limited in the short to medium term.

With a well-supplied North American market and low natural gas prices there, US imports of LNG (liquefied natural gas) have dried to a trickle. Ninety per cent of the country’s import capacity is lying idle. So the obvious question arises: if the US no longer needs large volumes of LNG imports, will this gas flood on to world markets, leading to oversupply and falling prices elsewhere?

The answer is that, while the supply overhang may exert some short-term downward pressure, the long-term trend remains inexorably upwards. Among the consuming countries, Asian gas demand grew at more than 10% last year, supporting the rise in wholesale prices. Barring a significant recession in the region, Asia’s demand for LNG will continue to increase.

In developed economies, switching from coal to gas power generation is a cost-effective method of achieving emission reduction targets. Coal-fired power stations need replacing as soon as possible; old nuclear plants will start to shut down in five years’ time. This too will increase demand for gas, causing wholesale prices to rise, and further upward pressure on household bills.

Of course, there’s always a degree of uncertainty in predicting the direction of wholesale gas prices. A mere 1% change in global demand can shift the market from oversupply to shortage. But there’s no uncertainty about the range of other costs which together make up about half the average domestic energy bill in the UK. So-called “non-commodity” charges rose by nearly 9% last year and will continue to increase well into the future, largely as a result of sensible government policies to make sure we have a sustainable energy market in the decades to come.

These costs include charges for the transmission of gas and electricity, the installation of smart meters in every UK home, huge investment in low-carbon power generation, and big energy efficiency programmes. The government estimates that the UK needs to invest a total of £200bn by 2020 to decarbonise its power industry and ensure that the lights stay on.

But it’s not all gloom. Britain has an opportunity – unrivalled in the developed world – to revolutionise the energy efficiency of its aged and inefficient housing stock, ensuring that higher prices do not necessarily result in higher bills.

We are fortunate in having North Sea gas – declining but still important – to meet some of our needs, as well as a range of import options through various pipelines and cargoes of LNG. Already, Qatar has invested heavily in building import facilities at Milford Haven and, during another very cold winter, LNG imports have met one fifth of total UK demand.

New long-term supply contracts would underpin that investment. But that in itself is not enough. Gas is only part of the energy security solution. We also need prompt action on the pricing of carbon and reform of the electricity market currently being undertaken by the government, so that new nuclear power stations and low-carbon sources of energy can be developed as soon as possible. Otherwise we could find ourselves facing a very different future, one that would threaten our long-term energy security.

Source: The Guardian