The OFGEM Report - bad news which may be optimistic

As the year starts its move towards a close, there are an increasing reams of reports coming out that review aspects of the global energy supply. One of these came out in the UK last week. It is the report from the UK’s Office of Gas and Electricity Markets (OFGEM) on Project Discovery – which looks at four future energy scenarios for the UK.

The report recognizes that the UK has a growing problem. This is because there are two directives from the European Union, the Large Combustion Plant Directive and the Industrial Emissions Directive (pdf) that increasingly restrict the use of coal and oil-fired power plants, when, at the same time, some nuclear plants will also be closing which will lead to a reduced number of major power plants being available. New power plants take time to plan, permit and construct and the postponement of construction of the new power plant at Kingsnorth this past week merely underlines the coming problems.

And so OFGEM set out to see what the challenges and risks to the UK would be over the next twenty years. The report is the result of that investigation.

It looked at four scenarios based on two levels of economic recovery and two levels of investment in green technologies, which combine to the four scenarios examined.

The four scenarios OFGEM examined.

The scenarios had some underlying assumptions to allow dealing with the conditions that were imposed in the models. There is, for example, the assumption that investment for each scenario (which reaches 200 billion British Pounds (BP) for The Green Transition scenario) will be available and will allow the timely investment in power generating systems that meet the targets set. (As a source of reference the UK spent $8 billion BP in 2008 on utility capital investment for the green scenarios this will have to rise to 30 billion BP in 2019).

With an increased reliance on imported natural gas, where the domestic production falls short, there is also the assumption that this will be available – an area of concern in times of high demand in a severe winter. (And this winter may be one) This will, however, become more of an issue in the UK as it responds to the EU directives and loses a significant sector of its electricity generating power after 2015. The report notes that the market and the regulatory arrangements can well undergo severe testing as the nation moves out of the comfortable position it currently holds, with large gas reserve (by normal standards) and a robust gas infrastructure.

The investigation applied a number of stress tests, under the different scenarios, and evaluated their results. The results were summarized in the following figure:

OFGEM stress tests and their perceived results (Bacton is the UK gas import facility)

The designation 1 in 20 refers to the worst condition in the past 20-years with the peak day being the highest demand for energy on the coldest day; and the severe winter being a period of 60-days of exceptionally high natural gas (NG) demand.

While the rapid response and move to green energy both tighten the NG market, when there is not this initial high demand, then the evaluation is that the market will remain oversupplied, though tightening towards the end of the study period.

Perhaps the assumption that raises the greatest doubt is the one that crude oil prices rise to $130/bbl and then fall back, as upstream investments provide the additional supplies needed, to a price of $110/bbl. They cite the IEA and the EIA models as justification for these assumptions, which apply to the rapid growth scenarios. When there is a slower rebound of the economy, then oil prices are anticipated to stabilize at $90/bbl (and they point out that the EIA is predicting that it would actually fall to $50/bbl).

The peak price that they see for NG is 100p/therm under the rapid growth scenario, while carbon dioxide prices are set at 50 BP/ton by 2025 (assuming a global agreement at the meeting in Copenhagen this winter).

In assuming that adequate NG will be available it appears that they are assuming that all the gas pipelines projected will be funded and adequately supplied at full capacity (something that is currently quite questionable for Nabucco, as but one example – though Nabucco only becomes necessary under the rapid demand scenarios), though they also assume that LNG will be available to fill any shortfalls, and that NG will appear from the Yamal fields in the time and quantities predicted (either 2013 or 2014).

OFGEM assumed European supplies of natural gas

In all scenarios they recognize that there must be an increase in the amount of NG supplied from Russia, though, as noted, there is an assumption that there will be enough LNG to make up any shortfall. (Global demand is expected to double or treble by 2020 – to somewhere between 350 bcm and 700 bcm/year – and largely the USA takes care of itself).

As with many of the models of an energy future this one includes the caveat

provided the market participants respond adequately to market signals

but with those responses governed also by perceptions of future politics, and the potential limitations of future supply, that caveat may well cover a multitude of unpleasant outcomes. Yet this is recognized also realistically (but with no real current solution being available to provide an answer).

there are security of supply risks within each scenario, but as important is to consider the implications for security of supply resulting from the huge range of uncertainty that the scenarios cover. For example, by 2020 gas demand could be as low as 77 bcm/yr or as high as 113 bcm/yr depending on the scenario, low carbon generation could make up anywhere between 21% and 52% of the mix, the levels of investment required in the GB energy market (excluding upstream investment) could range between £96bn and £200bn depending on the extent of environmental actions. Together with more traditional risk factors such as commodity prices and project risks, this means that investors face difficult decisions before committing large sums of capital to new projects.

The way in which these events unfold in the UK is that report is now open to public comment with specific questions being identified that OFGEM is interested in getting answers to.

It will be interesting to see how this plays out, though I fear that some of the assumptions that have been made as the review progressed are a little optimistic about future supplies of oil and natural gas.

Although it has the highest investment cost, it appears that the Green Transition is perceived as giving the best outcome:

The Green Transition summary

While perhaps the dash for energy scenario projecting the worst outcome:

The Dash for Energy summary of outcomes

It will be interesting to follow the story, and see how Britain reacts, given that, as the report notes, while the time for decision is here, the conditions are still pleasant, and the urgency of the situation is not yet apparent.