UK: UK Gas Storage - So What if the Government Doesn’t Build Strategic?

Last Updated: 24 May 2010
Article by Humphrey Douglas

With declining indigenous swing gas production available, the UK is argued to be lagging in terms of gas storage capacity and hence security of supply. Query whether the proposed "demand management approach" to gas storage is the right solution for the UK and its aspirations for a liberalised European gas market

Although Russian gas molecules aren't delivered to the UK, they do back-fill the European gas grid and have a knock-on effect on UK supply. As last winter's colder weather again increased the strain on the Ukraine-Russia gas supply situation, so Western Europe's security of supply concerns heightened.

European states have interpreted the EU Security of Supply Directive (Directive 2004/67/EC) (the "Directive") differently. Many, including certain Eastern European states, have acted upon the Directive's requirement to ensure an adequate level for the security of gas supply by building (or requiring generally national energy companies to maintain) gas storage facilities. The UK, however, has not done so because it has historically relied upon its North and Irish Sea gas swing production and the ability to request producers to pump harder in times of need.

The UK, with the most liberalised energy market in Europe, has relied upon the assumption that the market will fill any shortfall in gas storage and other supply solutions, and with just 16 days' or so gas storage, it does not have the security of supply from gas storage that other EU states, for example France (122 days) and Germany (100 days), have. That being said, the small amount of gas storage that the UK does have is used in a particularly dynamic way and some commentators query why the UK appears so concerned with security of supply when Russia currently appears equally concerned about security of gas demand. Clearly, timing is key.

One major issue the UK faces is that with now swiftly declining swing production, gradually increasing long term demand, and reliance on gas (and intermittent electricity supply like wind) for power generation, new piped supplies (for example, via the Langeled pipeline from Norway), LNG re-gas facilities and supply contracts, may not technically be able to plug the shortfall to satisfy the Directive's admittedly broad requirements or, arguably, to keep all the lights on in a prolonged supply crisis, at least until new nuclear comes on-line around or before 2020.

UK gas price volatility has not, on its own, been sufficient economic incentive for entrepreneurs to overcome planning, tax and other obstacles to building commercially viable gas storage facilities although, to be fair, the Government is starting to do its bit. The recent Planning Act 2008 is designed to With declining indigenous swing gas production available, the UK is argued to be lagging in terms of gas storage capacity and hence security of supply. Query whether the proposed "demand management approach" to gas storage is the right solution for the UK and its aspirations for a liberalised European gas market. May 2010 prioritise Nationally Significant Infrastructure Projects (such as gas storage); and, following concerted industry lobbying, HMRC (the tax authority) even announced its intention to treat cushion gas (being the gas necessary to pressurise a storage facility so gas will flow out properly once injected) as amortisable plant and machinery. Further, the recent Energy Act 2008 is intended to codify and aggregate regulations which apply to gas storage (although the industry has accused the newly empowered Crown Estate (a "statutory corporation") of taking the opportunity to charge disproportionately high lease fees).

Yet, despite all this, security of supply concerns and lack of gas storage remain. Last year's review of energy security (by former energy minister Malcolm Wicks) suggested that strategic gas storage (that is, state-owned gas storage capacity and even strategic reserves of gas owned by the state) may be a solution, although all political parties have so far publically ruled out strategic storage, largely due to the unsettling impact it could have upon UK gas price volatility - the main driver for building commercial gas storage. Whilst the full effect of that impact could perhaps be mitigated by only allowing the use of strategic reserves in an emergency, it arguably wouldn't solve the short-term need for storage (until new nuclear and so on comes on-line) as Ian Marchant, CEO of Scottish and Southern Energy, is reported to have commented:

"...to build storage...available for use, can take four to ten years....It is a great idea on paper, but it is very difficult to make it work."

Conservative (and then Labour and now, most likely, Liberal Democrats also) instead favour a "demand management approach" to gas storage which would likely require the gas and power generation industries to ensure sufficient gas supply by, for example, commissioning their own gas storage facilities, leasing storage capacity or by putting in place long-term gas supply contracts or interruptible industrial end-user contracts (similar in some respects to the approach adopted in Eastern Europe). The Conservative manifesto hints at such safeguarding of supply security being executed by Ofgem.

Such regulation is still likely to push up gas prices as consumers ultimately bear the cost of new storage infrastructure which, whilst being neutral to good news for integrated storage companies which own gas inventories and storage facilities, may not precipitate the volatility of prices and arbitrage opportunities which pure storage entrepreneurs may require to develop further storage capacity and may, therefore, favour fewer, more integrated storage players.

Increased top-down regulation (versus perhaps making the UK a more attractive energy infrastructure investment climate in general through, for example, increased tax breaks) may offer short-term gains in terms of reduced market failure of storage capacity but perhaps threatens the UK's pioneering role in European gas market liberalisation just as other states (like Germany) are beginning to open up and offer freer access to European storage and hence security of supply. It may also have a knock-on effect on Ofgem's routinely exempted third party access rule application together with planning and other regimes. What does seem certain is that security of energy supply in general will remain a priority as, without that, the UK can't choose what it will burn to generate power and that may also be bad news for the environment, which was in every party's manifesto.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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