The pact with the US on supply of natural gas isn't all it seems
Following the UN’s COP27 climate summit, UK Prime Minister Rishi Sunak is set to announce a deal for the UK to purchase 10bcm [billion cubic metres] of liquefied natural gas, or LNG, from the United States. This would represent roughly half of the UK’s LNG import requirements. It’s been pitched as an ingenious political trade move, but whether the deal will actually improve Britain’s energy security is another matter.
Cutting a supply deal is all very well, but guaranteed supply volumes are meaningless without guaranteed prices. To date, we’ve heard barely anything about how much this supply guarantee will cost us or on what terms the contracts have been struck.
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Then there’s the fact that the government doesn’t control the companies it has to rely on to execute these deals. In a liberal free market, all the sellers and buyers involved will continue to be non-government entities. That means they should, barring some major financial repression, be free to make their own commercial choices. What we should really be asking Sunak is what happens if the likes of Centrica, a private company, are not willing or able to purchase certain volumes at certain times, perhaps because of oversupply?
Additionally, long term contracted deals don’t just work one way. Today’s first dibs on scarce supply at a discount price risks becoming a forced purchase of highly expensive gas should the market be better supplied than expected.
To guarantee the deal, therefore, all the respective governments involved would have to use legal means to force publicly listed companies to abide by prices that aren’t always favourable to them. This involves repressing sellers when supplies are tight and penalising buyers when supplies are plentiful.
Since commodity markets move too quickly for courts to intervene in such a scenario, in an unexpected glut UK companies would have no choice but to set heavy price discounts that incentivise storage at sea, at a cost to themselves.
Nor is such an imbalance a far-fetched scenario. Earlier this year the National Grid announced an import restriction for technical reasons. This caused LNG vessels to be diverted to alternative destinations, mainly continental Europe. The UK’s highly limited storage capacity, which runs at 5% of Germany’s, has also forced British players to redirect cargoes over the summer months, a time when storage is usually being filled.
The acute lack of storage throughout the European continent can be explained by the substitution of dependable pipelined Russian gas for that shipped as LNG. This is now resulting in LNG ships sitting offshore waiting to discharge in countries like Spain, and incurring further costs in the process. Storage costs on a vessel are a multiple of land based storage and that has to be paid by either the taxpayer subsidising the cost or the seller discounting the price.
Needless hoarding at sea of supply that could otherwise be used by other nations will, ironically, likely force China to burn more coal to compensate. This would be a total contradiction of the objectives of COP27 in the first place. Do we shun Qatari imports in times of distress? What are the consequences to our previously reliable suppliers?
If our prime minister really wanted to help improve energy security, he would be better off committing to increasing our storage capacity and creating a strategic natural gas reserve akin to the US SPR. Unfortunately, the time for that was in 2020, when commodity prices were low and financing costs negligible. Restarting the Rough storage site, which was decommissioned in 2017, on a marginal basis will certainly help, but its capacity is ultimately non-material. Much more expansion is needed. That’s why news that Qatar is planning to invest millions to expand the UK’s Milford Haven facilities is far more important.
Which brings us to 2023. While the start of the winter heating season has been mild, it will inevitably get colder. People will turn the heating on, even if the thermostat is down and jumpers are employed. This will cause Europe’s inventory to decline to near-empty levels like it does every year even with ongoing LNG resupply because we will be consuming more quickly than resupplying. That’s when we will have to think about other ways to keep the lights on. With or without Sunak’s prospective deal, the risk of consumer rationing has not gone away.
Izabella Kaminska is the former editor of FT Alphaville and founder of The Blind Spot.