UK energy, how it works and why we have a problem.

Vital to understanding all of below is that there is no shortage of oil, or gas and nobody is going without. Wholesale prices are mostly driving high retail prices and they are very high because traders are betting that the Ukraine war will continue and that Europe in particular will be starved of supplies, thus they have raised their prices and are enjoying a boomtime. The technical term is price gouging.

It’s important however, to understand 3 things:

1. These rises only impact the 20% or so of UK consumption that is bought on these markets.

2. There never was a threat to cut off supplies and only further action by the US can cause this to happen.

3. Many countries other than UK have already taken steps to increase their share of the windfall caused by these prices and are using it to protect householders and business users.

The windfall.

A barrel of oil today costs around 87dollars. That’s actually quite a modest cost despite all the predictions of doom. The issues are mostly around gas and especially European supplies.

In comparison to oil, “European benchmark Dutch wholesale natural-gas” prices hit a record high of nearly 335 euros, or $341, per megawatt hour in the spring this year, according to Reuters. They have fallen back to about 226 euros per megawatt hour, but are still about five times higher than a year ago.

This accounts for the huge profits from exporting North-sea Gas to places like The Netherlands. Profits which the British people are not sharing in despite their predicament.
Europe’s problems arise from the closing of Nord Stream 2 as a result of the US interventions and the beginning of Ukraine war and because of EU sanctions against Russia made in line with US requests.
The problem as it stands, is that the pipeline is running at 20% of capacity which is enough for now but may not be enough in mid-winter. The cause is maintenance work delayed due to sanctions.

This will massively affect European consumers, but should have only minor impact on British users unless the government decides to expose us to it. I say this because as stated elsewhere we don’t rely on gas from Nord Stream 1 apart from occasional shortages and would not rely at all if we had adequate storage facilities. Various figures are pushed around for how much of our needs the North Sea produces ranging form 50% to 80%. The variance is caused by including, or not the gas produced and exported in low season and the lack of storage space in UK causing shortages in the high season to occur. Any shortages are because of bad management on behalf of UK government.

The reason UK prices are expected to go through the roof is that UK suppliers (North Sea end) are matching their prices to the wholesale markets, our suppliers (Billers) are therefore forced to bill us based on this high rate and the profit goes mostly to the gas producers, but suppliers with a trading desk that got it right this time may also be buying it via cheap futures and making a killing, others will go into receivership. That’s the mess we have in UK.

Since Scotland is part of UK and UK is a democracy, the resources under North Sea are owned by the British people, but the right to extract (pump) that gas has been sold to private interests at rates based on the value at the time. Other countries like France use levies or windfall taxes to ensure that these interests don’t reap vast fortunes at the cost of households and the local economy, but not the UK. Bear in mind also the propensity to cause wars and high prices if we reward it.

The electricity generating part uses gas to drive 80% of its generation and that comes from North-sea supplies. The remainder includes sun, wind, water and some purchases of other fuels or gas on spot markets.
This leaves the electricity suppliers with a very small dependency on global markets for less than 20% of its product and thus a certain need for price elasticity. In reality though, if storage existed, there could potentially be no need to import any gas, suffer shortfalls, or pay exorbitant prices.

Electricity and gas are fed for transmission over long distances into the National Grid, a leftover from when it was a national industry and transported to people’s homes. Maintaining this grid involves a small cost added to the total price. This grid has allowed it’s storage capacity to be dramatically reduced, thus leaving UK more exposed to supply issues such as fear caused by Ukraine war.

Finally there’s a myriad of “suppliers”. Since privatisation there’s no longer just one local supplier like British Gas, or Midlands Electricity Board, but now they all compete with each other. Some bright spark thought this was competition and must be good and would thus reduce prices. Those were the days.
In reality, theses companies provide no part of the service as you will notice from the chart above. They add no value to that value-chain and hence they have no leeway to introduce price cuts for example other than via tomfoolery as we have seen recently that saw them go bankrupt.
My personal experiences of privatisations reminds intensely of a piece of analysis at old BT, the conclusion of which was that BT does have one great strength, it’s good at billing. The re-structuring afterwards was based largely on that conclusion I’m told. The same conclusion was used to drive the privatisation of the likes of YE and MEB which I also played a part in and was passed around the privatisations industry as is so often the case.

Some will argue with that analogy above because the system is complicated. Well yes it is.
Here’s the thing; although as I stated, they sell you and I fuel created in Britain almost entirely from the North Sea and entirely through the National grid, there’s a make-believe free market where they can if they wish buy fuel elsewhere as long as it’s placed in the national grid and if they can buy it cheaper they can afford to sell it cheaper. This however is mostly make-believe with occasional short advantages or losses and naturally they sell fuel from the North Sea except when there’s a shortage.

Without getting too buried in this subject, lets just say that all the time, North Sea producers are also exporting gas, currently vast amounts are exported to Netherlands. The issue arises when Netherlands or another buyer offers to pay more for the gas, in which case it’s natural that the North Sea supplier asks our supplier for more and hence we get overcharged.

The reason for all that complexity is of course the privatisation and the lack of workable controls. It is still perfectly feasible to insist on supplying UK at a fixed price. Its perfectly feasible to achieve the same thing via windfall taxes, but that doesn’t deal with shortages.

The biggest thing that this privatisation did was to introduce the cost of marketing and advertising which is inherent in all private markets. Although the gas or electricity was already provided at their house or business by other actors and even a meter issue is resolved by someone else, homeowners had to choose which company they would pay their bills to. In touting for this free profit, the suppliers spend vast sums on advertising. I know because I’ve managed those budgets and this of course added a huge cost, as much as 20% on to the supply cost of gas or electricity. In return for that cost we the consumers receive nothing because these companies do nothing other than collect payments and try to compete with other suppliers for customers, us. Politicians playing with economics books all over again you may say.

The privatisation affect also had other impacts such as driving the desire to cut corners and minimise investment in things like storage.
Actually the suppliers do slightly more, in order to try and gain a few pence advantage on price, they trade futures in the spot market hoping that thus, they will be able to buy gas cheaper on the day they need it, but often this works backwards and its not adding any value long term. It’s trying hopelessly to replace a good storage facility.

That is the UK privatised gas and electricity market in a nutshell. Ive been away from it a while and never was an expert, but this is more than most people understand based on my conversations.

My point is that there’s ample room for government to fix the problems and no excuse for allowing a catastrophe to unfold.

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Ed has enjoyed a dual career moving backwards and forwards between leadership roles in software engineering and transforming marketing functions.

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Edward Taaffe

Ed has enjoyed a dual career moving backwards and forwards between leadership roles in software engineering and transforming marketing functions.