Winter energy buyers need to be aware of the challenges of the season
Colder weather drives up heating demand
Demand changes are perhaps the most evident price driver for the winter. The winter season is the period of highest demand for both the UK’s gas and electricity systems. Running from October to March inclusive, the season encompasses the most extreme of the country’s weather. The darker, colder weather conditions provide a platform for increased winter energy consumption as households stay inside more, switch on central heating and turn lights on earlier.
The UK’s domestic heating system is mostly gas-fired. As such, cold temperatures have a far stronger impact on gas demand levels than they do on power. Daily average domestic (Local Distribution Zone) demand for the summer season this year (April to September 2016) was 84 million cubic meters (mcm). However, the average demand for the previous winter season was 175mcm per day – more than double that of the summer.
Domestic gas demand has already doubled this October, compared to September. The gas system has experienced tightness which has supported a steady rise in gas prices. However, the UK is yet to experience a prolonged cold snap. When a spell of below seasonal normal temperatures hits the UK, how well the system copes with the spike in demand will tell the market a lot about the UK’s supply situation for the rest of the season.
Winter weather conditions also affect peak power demand. However, it is daylight hours that have the bigger impact when it comes to electricity rather than temperatures, given the relatively low use of electrical heating in the UK. The end of the British Summer Time put clocks back one hour at the end of October. This traditionally provides an increase in peak demand of 6-7% (around 3GW) as the number of evening daylight hours shorten.
UK reliant on outside help for supply
The increased demand levels inherently place additional strain on the gas and power systems as they seek additional supply to meet the higher consumption.
The UK has developed its own gas reserves in the North Sea and UK Continental Shelf. However, as domestic production has matured and gas extraction becomes more complex and expensive, the UK is increasingly looking to imports via pipelines and Liquefied Natural Gas (LNG) tankers to provide sufficient supply. In fact, the UK has been a net importer of gas since 2004.
Norwegian production levels operate on seasonal profiles, switching between winter energy and summer energy levels in line with demand. From 1 October, the switch to the winter profile led to an increase in overall production and subsequently stronger exports to the UK. Norway’s oil and gas company, Statoil, also agreed to increase annual production limits at its largest gas field, Troll, from 1 October, increasing available supply further. The UK can also utilise gas imports from Europe via the BBL pipeline with the Netherlands and the Interconnector with Belgium. However, as with any imports, price differentials come into force.
The cost of winter energy imports
The Pound Sterling has dropped around 15% against the Euro since the UK’s vote to leave the European Union on 23 June. This has increased the cost of imports for the UK when buying supply from Europe. Day-ahead gas prices have risen 50% so far this winter as the UK tries to maintain a premium over Continental prices to attract supply to Britain ahead of Europe.
The UK can also import LNG, predominantly shipped from Qatar, into its terminals at South Hook, Isle of Grain and Dragon. There are annual contracts for deliveries, but the UK still competes in the global market for spot cargoes, meaning frequency of delivery is dependent on global demand levels and market prices. During the winter, demand can be high across Europe, particularly if there is a widespread cold snap, which can increase competition for available LNG supply, and subsequently push up prices. So far this winter, the UK has struggled with low LNG deliveries. Just two tankers arrived in October and the first November arrival is not due until the seventh. This has left available LNG in storage low, increasing the pressure on other supply sources to make up the shortfall.
Gas saved for a cold day
Gas storage sites play a significant role in the fundamental make up of supply during the winter season. Producers build up storage stocks during the summer season, when demand is relatively low, in preparation for withdrawing that supply during the higher demand winter period. The level of storage supply available at the start of the winter is often an indication as to how well the UK will be able to cope with the higher demand levels.
This year, the UK is facing significant problems with its sole long-range storage site at Rough. Representing more than 70% of the UK’s storage capacity and able to meet 10% of peak day winter energy demand, the Rough storage site is critical to the UK’s ability to navigate the winter. However, routine safety checks back in March 2015 revealed problems with the integrity of the wells at the site. Injection capability was limited and a storage cap was put in place at around 75% of capacity, which is still in operation today. In June 2016 an additional issue was discovered which prompted Centrica to cease all injections and withdrawal operations at the site. Injections at the site will not be available until at least April 2017.
Shortfall of reserves
With suppliers unable to inject gas into the site, stock levels at Rough have been stuck at 40% of capacity, with around 1.5 billion cubic meters of gas less than 2015. Some withdrawals will be possible from November but the significant shortfall of reserves has limited the UK’s supply flexibility for the winter and increased the pressure on pipeline imports, LNG and withdrawals from medium-range storage sites to meet demand.
European gas storage levels, conversely, are significantly higher than last year. While this offers an avenue for potential imports to the UK during the winter, the availability of imports is dependent on winter energy demand levels in Europe as well as pricing, with the current weak value of the pound raising costs for UK buyers.
Keeping the lights on
In terms of the electricity system, this winter has generated significant concerns over the availability of power supply during times of system stress. National Grid manages and balances the electricity network between supply and demand. It has a toolkit of measures it can put in place to help balance the system. However, the grid operator has still forecast tight and negative margins several times already this winter. Tight surplus margins should remain very narrow through much of November, December and January.
While the margins do not include possible Interconnector flows, transferring supply from overseas, the upcoming winter is expected to be the most challenging in decades.
A sharp reduction in the number of coal-fired plant has reduced the UK’s baseload capacity. Baseload plant are able to generate electricity consistently. They ensure a minimum level of supply is provided to the grid at all times. However, a challenging economic environment and increased taxes for carbon consumption have triggered the closure of several plant. Nearly 6GW of coal plant capacity has closed since the beginning of the year with a further 4GW only available as emergency reserve plant during the winter season. This leaves just 9GW of coal left which can operate freely. The reduction in baseload plant has made the country more susceptible to fluctuations in renewable generation – with wind and solar supply entirely weather dependent.
Solar generation is minimal during the darker winter seasons and while wind levels are generally stronger during the winter, there are still strong fluctuations in available supply. Most of the main sources of renewable generation – wind and solar – are unable to provide baseload electricity as their output is intermittent. As a result, it cannot be relied on to meet demand during times of stress. This already led to significant price spikes during September as the UK power system struggled to guarantee sufficient supply to meet demand. Day-ahead power prices spiked to record highs at over £150/MWh and there remains a strong potential for further price spikes through the coming winter.
The UK is able to import power supply via Interconnectors from France, Netherlands and Ireland. However, the availability of interconnection has seen major problems so far this year. The East-West Interconnector with Ireland developed a fault in late September and will be shut down until the end of February 2017, reducing the available imports from Ireland by 50% for the bulk of the winter. In France, safety concerns over its nuclear power plant have resulted in the shutdown of 12 reactors, with maintenance work expected to run until the new year. This has halted the expected flow of supply from France to the UK as the country struggles with tight supplies and becomes dependent on neighbouring countries – including the UK – for imports itself.
Balancing the system
National Grid has a range of balancing tools and reserve power that it can call upon if faced with the prospect of tight supplies or worse. The operator has secured more than 3.5GW of back-up gas and coal-fired capacity as part of the Supplemental Balancing Reserve (SBR) to help support winter energy demand. Schemes such as the SBR can avoid the risk of blackouts. However, the cost of paying plant to come online when required places an additional strain on customer’s bills as the costs are ultimately recovered in increased non-commodity charges.
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