POWER TO THE PEOPLE

The following morning UK domestic gas consumers were left reeling when they awoke to news that Scottish Power was set to increase gas and electricity prices by 19% and 10% respectively. Following steep price hikes in November, consumers could have been forgiven for imagining that the words of Tanaka were to be taken quite literally. That keeping the lights on and staying warm would in the future be the preserve of those fortunate enough to own a store of gold bullion.

Spanish-owned Scottish Power blamed the rises on a 34% increase in wholesale gas prices since November 2010. Gas is used in the production of electricity, so if gas prices rise so, too, does the price of electricity. Scottish Power’s move is likely to be mirrored by similar increases from other major domestic gas and electricity providers. Depressingly, industry analysts seem to be of one mind in predicting that prices will rise yet further.

“Our view of gas prices in the next few years is that they are on an upward trend,” said Noel Tomnay, head of global gas for Aberdeen-based oil and gas analyst Wood Mackenzie. “The gas price environment in Europe has been pretty good over the last few years. Benign.”

The end of this benign environment was heralded by a wave of popular uprisings against repressive regimes and dictators in the Middle East that spooked oil and gas markets. The dawn of the Arab Spring spelled an end to good times for energy consumers in the West.

Algeria, Jordan, Egypt, Bahrain, Syria and Yemen have all seen turmoil, while in Libya the crackdown against revolt by Colonel Gaddafi’s forces led to intervention from Nato, under a UN resolution.

Although Libya is not a significant gas producer its decision to cut off supplies to Italy in February raised prices for natural gas on world markets.

“Libya is not such a big exporter of gas. Its impact on prices has more to do with fears over wider instability in the Middle East which shows up in the price of oil and gets factored in to the price of gas,” explained Colin Welsh, chief executive of energy industry-focused investment bank, Simmons & Co.

The pressure on the price of gas was ratcheted up further when a magnitude 9.0 earthquake struck off the northeastern coast of Japan on March 11. The quake, and subsequent tsunami, shut down 11 nuclear reactors out of 54, while two refineries were set ablaze and severe damage to the infrastructure caused widespread power cuts. The ongoing level seven meltdowns at three reactors in the Fukushima I nuclear power plant have led to the loss of 11 gigawatts of Japan’s nuclear power capacity.

Japan has no fossil-fuel resources of its own, with the bulk of its heat and electricity coming from its nuclear reactors and imported oil and gas.

“Japan’s gas demand is nearly all met by liquefied natural gas (LNG). Since the earthquake approximately 1.5 billion cubic feet (bcf) a day of LNG has been diverted from Europe to Japan. For comparison the UK market is approximately nine bcf a day,” said Tomnay.

Investment analyst Goldman Sachs put out a report in late April saying that the combination of the missing supply from Libya and the increase in demand for LNG from Japan had “the potential to eliminate the supply overhang in the global LNG market, bringing it to balance”.

In plain English, Goldman Sachs was warning there was a danger of natural gas being in short supply and that prices could rise still further.

On the horizon is the impact on prices of the decision by the German government to close its fleet of nuclear reactors. In the immediate aftermath of the Fukushima disaster, Germany shut seven of its ageing nuclear power stations, thereby increasing its gas consumption by an extra 0.5bcms per day.

In the UK, Chancellor George Osborne announced in his March Budget that he was increasing levies on the North Sea oil and gas industry by £2 billion to pay for a 1p cut in fuel duty, in an attempt to quell growing anger over rising petrol prices.

“One of the principal drivers of the latest gas price hike in the UK is the tax grab made by George Osborne,” said Welsh. “Just last week Centrica [the largest supplier of gas to domestic customers in Britain] shut down one of the UK’s largest gas fields in response to the increased levy, and exploration and production companies are shelving operations.’’

Yet again, less gas equals higher prices. Those looking for hope point to the prospect of the UK and Continental Europe following the US lead in developing its shale gas reserves. This relatively new process sees rock deep underground laced with tiny bubbles of natural gas is blasted with high- pressure water and a cocktail of chemicals to release hydrocarbons which are collected and brought to the surface.

The practice, known as fracking, has been the subject of controversy both in the US, where it is blamed for polluting water courses, and in the UK, where drilling near Blackpool was suspended last month after it was suspected of causing earthquakes.

“It has taken 40 years for shale gas to get to where it is today in the US,” said Professor Jonathan Stern, director of gas research for the Oxford Institute for Energy. “It’s not going to take off in Europe for a long time and it’s not just because of stricter environmental regulation. Conditions in Europe are difficult and development is a long process.”

Stern points out that the US is a large landmass with a lot of open space. Exploratory drilling has been going on for decades and a lot of knowledge about sub-surface conditions has been built up. Landowners are also given incentives to develop reserves on their property.

“In Continental Europe, as well as nimbyism, you have issues of water availability. It is a crowded continent with less open space and there is little knowledge of the sub-surface conditions.”

Stern also points to the lack of equipment, technology and infrastructure to develop shale gas wells. Europe currently has around 30 rigs carrying out exploratory drilling for shale gas; the US has over 1000 rigs.

“In the US a landowner can pick up a phone and call a shale gas developer and within two weeks the developer could be producing gas. That entire service industry has to be developed for Europe,” said Stern.

The huge growth in US shale gas production has taken the market by surprise in recent years. Prior to its emergence, the US was dependent on importing natural gas from the Middle East where it had positioned itself to become a key customer of Qatar.

“The development of the Qatar LNG industry has boosted the global supply by over 30% in three years. A lot of that was destined for the US but the development of shale gas there has meant Europe getting a lot more of this. Around 40% of UK gas demand being imported was LNG within the last month,” Tomnay said.

“We’ve benefited but it’s changing. The LNG available for Europe is set to decline. A lot will move to the Pacific as Asian demand is growing,” he added.

THIS is a far cry from the early 1970s when natural gas was seen as a by-product of the lucrative oil industry. Indeed, the North Sea industry of that time is characterised by images of rigs flaring off excess gas and the price of gas was closely linked to the price of oil.

However, the development of large sources of natural gas from countries such as Qatar with little by way of oil reserves and the development of US shale gas reserves has led to the link between oil prices and gas prices being weakened.

As more of the global LNG heads east, the UK will become increasingly dependent on gas from Russia, piped across Europe.

Here the price of gas still has a strong link to the price of oil as a result of long-term contracts struck between Russia and its European customers.

“We in Britain are importing high gas prices from Continental Europe. The truth is that the price of gas is much higher than the normal rules of supply and demand say it should be,” said Stern.

“The problem is that the gas we import from Continental Europe is pegged to the price of oil. That’s because the long-term contracts struck with suppliers such as Russia had this built into them and the Russians do not want to change that.

“The Continentals have been trying to negotiate a change to these contracts for some time without success. Some have decided to go to the international court of arbitration but the outcome of these tribunals is not expected until next year.”

This link between oil and gas prices should give us cause for concern as oil prices are thought to be on an even steeper upward trajectory than prices for LNG.

For Welsh at Simmons and Co there is little surprise in the current rise in the price of oil.

His former boss and company founder was Matt Simmons, who died last year. A one-time energy adviser to President George W Bush, he broke ranks from the industry to speak out about the looming threat to the global economy posed by dwindling oil reserves as world demand was increasing remorselessly.

“A lot of what Matt said is coming to pass. Saudi reserves are declining and it’s clear that it’s harder for independent oil companies to maintain production. The declines in production are quite aggressive,” said Welsh.

There are now signs that governments around the world are taking the threat of Peak Oil – the terminal decline of global oil supplies – seriously. Peak oil means peak prices.

In the UK, the Secretary of State for Energy and Climate Change, Chris Huhne, met with representatives from the UK Industry Taskforce on Peak Oil and Energy Security (ITPOES) . The group, which includes Scottish and Southern Energy’s Ian Marchant and Richard Branson, has been arguing for three years for proactive, rapid mobilisation against the threat of Peak Oil.

With oil prices having risen 35% in the last five months, Huhne agreed to work on plans to protect the UK and its economy from rising oil prices. What comes out of this will not only be eagerly awaited by business, but by the millions of Britons struggling to pay fuel bills.

Fuel poverty charity, National Energy Action, has estimated that around 5.5 million UK households spend more than 10% of their budgets on energy – and the latest price rises are expected to add three million more to that number.

Together with relentless increases in the cost of petrol at the pumps in recent years, it would seem that we are at the end of an era, and must adjust to the seismic shift in the cost of our energy.