How the UK can meet energy needs by going back to the future
Contracts for Difference, as deployed in the wind power sector, could help guarantee the supply of North Sea gas too, writes Chris Sawyer
As events unfold in the Middle East, the hot topic of UK energy security and cost has prompted two opposing narratives.
The first narrative holds that the best way to derisk energy security is to remove oil and gas from the mix entirely. If electricity generation is no longer dependent on hydrocarbons, the UK’s carbon emissions will be minimised and the country will be insulated from geopolitical disruptions that tighten supply and inflate prices.
The UK Climate Change Committee’s Supplementary Analysis of the Seventh Carbon Budget (published 11 March) supports this, noting it represents an economic opportunity that could cost less to deliver than a single fossil fuel crisis.
The second narrative highlights that under all net zero scenarios – including those put forward by the Climate Change Committee – the UK will continue to consume oil and gas, potentially as much as 13 to 15 billion barrels of oil equivalent by 2050.
Not all of this can be produced domestically, but at least half could be, and relatively quickly given several material North Sea projects could be producing within the next 12 months. Given the fragility of global energy supply chains, increasing domestic production to reduce reliance on imports – over which we have no control – seems prudent. According to a poll commissioned by Offshore Energies UK and published this week, 76 per cent of the UK population agree.
A further point is that increasing domestic gas production will not reduce UK energy prices for businesses or consumers. This is because electricity prices are determined by “marginal pricing”, which is almost always the market price of gas – a price set internationally, not domestically.
Whether the gas is produced here or imported, the market price remains high when supply is limited and demand is elevated. So, can electricity prices be decoupled from the gas price?
The 1970s transition from coal to gas offers a useful precedent. Long-term gas purchase agreements between the State (through British Gas) and North Sea field operators guaranteed supplies to power stations at contract prices independent of market fluctuations.
These arrangements derisked purchasers’ exposure to volatile gas prices whilst providing investment certainty for producers. The oil from those fields was still traded on the open market – giving producers upside – but the nation received affordable gas to keep industry running and the lights on.
A similar contractual model could work today. GB Energy, for example, could act as the purchasing entity, buying gas at agreed contract prices and selling it on to generators. This would mirror the way Contracts for Difference have successfully underpinned the growth of offshore wind – guaranteeing supply by derisking the investment case and guaranteeing a minimum return for producers. Were such a model adopted, the rationale for the Energy Profits Levy (the “windfall tax”) would largely fall away.
With electricity demand set to grow significantly over coming decades – driven by electric vehicles, heat pumps, and the energy-intensive requirements of data centres – it may well be time to go back to the future.
Chris Sawyer, Partner and oil and gas specialist at Pinsent Masons
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