The Energy Challenge

The Global Energy Market

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To maintain a secure supply of energy, the UK must compete in the international energy market.

Diversity of sources is the best way to ensure secure supplies of energy – that’s why Centrica signs long term gas supply deals on top of gas sourced from the UK’s own fields.

Centrica has commitments to long-term supply agreements to secure gas and electricity, through a range of suppliers, worth over £50 billion.

Does the price of oil have an impact on UK gas prices?

Historically, wholesale gas prices in Europe had been linked to the relatively higher price of oil, however this has changed over the last decade. According to the International Gas Union in 2013 only 43% of Europe’s gas supplies were still indexed this way.

Today very little of the gas consumed in the UK is price linked to oil as in recent years the UK has led the way in creating an openly traded gas ‘market’ called The National Balancing Point (NBP) contributing to a shift towards market (‘spot’) pricing based on supply and demand.

The UK’s gas marketplace: the National Balancing Point

The ‘National Balancing Point’ (NBP) hub is the largest and most developed gas market in Europe. NBP is a physical market, with the gas being delivered into the National Grid pipeline network. Gas can be traded for delivery the next working day (the ‘day-ahead’ market), or for future periods and dates up to 4 or 5 years in advance. The NBP is a relatively liquid, highly traded market, with an overall churn rate of traded volumes ten times that of physical volumes.

There are about 130 buyers and sellers in the NBP market, with around 100 of those trading on a typical day . The participants include all the major gas and oil producers, energy suppliers, trading houses and banks, from the UK and overseas. They trade to balance their supply/demand positions, to optimise the value of their assets and production, to manage risk (through hedging), and for trading on their own accounts.

Forward buying (aka ‘hedging’)

British Gas customers have said that they don’t want their energy prices jumping up and down - that they value knowing in advance how much their energy will cost.  In addition, regulation in the UK market requires that energy suppliers set prices and let customers know of any changes to prices well in advance.

For these reasons, British Gas buys its gas and power needs gradually and well ahead of delivery which smoothes out the effect of wholesale price movements both up and down.

This means that when prices spike, customer bills don’t increase as quickly or by as much either. Just as a fixed rate mortgage avoids fluctuations in interest rates, forward buying makes sure that suppliers don’t have to constantly change the price customers pay for their energy, helping limit the effects of volatile price movements – shielding customers from the need to increase prices suddenly.

Forward markets enable suppliers to guarantee a price for delivery up to four years before that energy is needed.  Every month a small proportion of the total energy British Gas estimates it needs for the year ahead is purchased.  For example, if buying energy over 10 months, 10% of that need would be bought each month. This reduces the need to buy during extreme price spikes, and means what households pay closely tracks the price paid for the energy

 

Key drivers of supply and demand in the global energy market

The world energy market is highly unpredictable. Everything from global weather, to the financial markets and geopolitical pressures impacts on prices.

Global Gas Prices

Prices per MMBtu in 2014 were around $9 in Europe, lower at $4 in North America and highest at $15 in Asia. MMBtu means 1,000,000 British thermal units (Btu). One Btu is the heat required to raise the temperature of one pound of water by one degree Fahrenheit.

 

SHALE PRODUCTION IN NORTH AMERICA

The growth in production of oil and natural gas from shale in the US has had a significant impact on the global energy market, and has been one of the main drivers of the recent fall in commodity prices.

The International Energy Agency (IEA) has predicted that the U.S. will remain the number one source of global oil supply growth up to 2020.

STRONG PRODUCTION IN the Middle East

The price of crude oil halved in the second half of 2014, as the Organization of Petroleum Exporting Countries (OPEC) maintain a strategy to boost market share by oversupplying the market. This has the effect of forcing higher cost producers in other countries to cut production, and lowered global oil prices.

Recently, growth in global demand and a slowing in US production has led to a partial recovery in the oil price, and there is much speculation and debate about where the oil price will go in the next few years.

Global demand for LNG

LNG imports are fueling the fast growing economies of developing markets such as Asia and Latin America, where strong demand has led to higher prices.

Long-term LNG supply deals such as Centrica’s contract with Qatargas to purchase up to 3 million tonnes per year to December 2018 are essential whilst preparations are made to begin exporting LNG from the US.

Centrica has signed a £10bn deal with Cheniere to begin exporting LNG from the US by the end of 2018, with supplies indexed to the lower Henry Hub price.

Global events

In March 2011, global gas prices rose sharply on world markets following the Japanese tsunami and damage to the Fukushima nuclear plant.

With most of its nuclear power industry out of action, Japan’s sudden demand for LNG imports to fill the gap effectively increased worldwide demand by some 4 to 6% and absorbed the spare export capacity of the major LNG producers.

Geopolitical instability

The period of political unrest that started in December 2010 in North Africa and spread across the Middle East caused widespread concerns about supply disruptions, which added a risk premium to supplies from affected regions sending prices upwards.

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