Energy crisis – it’s complicated

October 13, 2021

12:30 am

Lower wind speeds are taking much of the blame for the current energy crisis in the UK, digging a little deeper it gets complicated. Wind did account for close to a quarter of electricity generation for the UK in 2020, but that record generation was driven by unusually high wind speeds. This has reversed in 2021, with 16% and 10% decrease in renewable generation in the first and second quarters respectively. The third quarter also witnessed lower generation. This outturn shouldn’t be a problem, intermittency is hardly a surprise, the wind sometimes blows and sometimes doesn’t. It should also be noted that wind only accounted for 3% and 4% of overall UK energy needs in 2019 and 2020 respectively. This low level, versus what it accounts for within electricity, is a function of transport and heating relying almost entirely on fossil fuels, outside the electricity grid. How can a drop in wind generation, back to 2019 levels, cause such a crisis? It didn’t.


A global crisis


Oil, gas and coal prices are rising sharply across the globe. Brent oil has gone above $80 per barrel, a rise of 60% from December 2020. Benchmark Asian LNG (S&P Global Platts JKM) for delivery in May was trading at $5.57 in March. This month delivery for November is trading at $56, witnessing a one day jump of $16.65 on October 5th. In the US Central Appalachia coal jumped 35% since December. While in Europe, the German power market is headed for the highest winter prices in 20 years.


Underlying causes


It is impossible to quantify the impact of various factors, the main driver likely to be economies awakening from the COVID induced lockdown sharply increasing energy demand. China has rebounded rapidly; GDP in Q1 and Q2 was 18% and 8% respectively above the same quarters last year. This has led “to power-rationing for industrial customers and blackouts in some residential areas”. It is reported that the Chinese government has ordered LNG to be bought at whatever the cost.


Beyond demand, there are several other factors at play: oil supply remains tight with OPEC+ looking to keep supply and demand in balance, rather than risking over supply. The gas market is also very tight, cold weather across Europe and Asia earlier in the year meant strong demand, with storage inventories subsequently not fully replenished. Maintenance work, some delayed from last year due to COVID, hindered that storage build. Russia, a key supplier of gas to Europe, has not responded to the increased demand. They also cite a tight domestic gas market driven by a winter draw on supplies and maintenance on both production facilities and pipelines.


There is of course a geopolitical angle, President Putin encouraging Germany to approve Nord Stream 2, hinting strongly that were it to do so Russia might find additional gas supplies for Europe. The US intervened telling the Russians not to politicise the energy market.


Back in Blighty


How much blame can be put on domestic energy policy for the current crisis?

First, to give the government some credit, it has had much success in promoting renewable energy, as mentioned nearly a quarter of electricity is generated from wind, while fossil fuel electricity generation has fallen nearly 60% since 2010. This transition away from fossil fuels, to renewables is sorely needed to halt climate change.


However, a comprehensible and robust energy policy has been lacking. The main criticism that may be levied not just at this government, but countless governments, is a lack of long-term planning and a failure to create a resilient energy system. It could be argued that such resilience wouldn’t have avoided this crisis; it would have eased it.


Finding oil and gas in the North Sea meant energy policy was less complicated, the country was a net exporter of energy for two decades. It resulted in a dash for gas, the cheapest route and a very flexible option to deliver the energy needs of the country. But when the oil and gas fields started to run dry the government needed to do more on energy security. For example, the Rough gas storage facility was closed in 2017, the government defended its decision not to keep it open against strong pressure from the utility companies. Rough was one of nine storage facilities but accounted for an outsized 70% of total storage. When the UK gas fields now run a surplus, it is exported to the Netherlands. This year the tightness in domestic production was compounded by maintenance on the Forties Pipeline System Keep in mind gas accounts for c. 40% of overall energy needs.


Meanwhile, as the Prime Minster and Business Secretary speak about the need for nuclear power to balance renewables, it is a sector that has been neglected for many decades. Whereas in France over 70% of electricity is generated by nuclear power, in the UK it is 17%. When Hinkley Point C opens in 2026 it will be more than 30 years since the last power plant opened, Sizewell B in 1995. Meanwhile, the existing fleet is beset with problems. Nuclear generation fell 14% in 2019 and a further 10% in 2020 due to outages. The problems have persisted into 2021 with the announcement in June that due to continued problems Dungeness B power plant will be closed. In fact, the remaining fleet of seven nuclear plants are due to all close by 2030. With long lead times in planning and construction and low public support for nuclear, it is a big challenge for the government to deliver on their ambition.


Politically, the focus has been on ensuring low energy bills for the consumers (price caps) and competition in distribution (breaking the dominance of the big 6 suppliers). Resilience was also missing in this policy as demonstrated by the failure of many new entrants during the current gas price spike.


Portfolio impact


The oil and gas companies are obvious beneficiaries of the price increase. The additional cash flows should support the energy transition, strengthening balance sheets and allowing for more capital expenditure in transitioning businesses. The crisis also illustrates that the transition must be carefully managed, securing energy supply as we move away from fossil fuels.


Another beneficiary may be Centrica. For long suffering shareholders in the stock, it might finally turn the corner. Consolidation of suppliers, regulatory relief reflecting the failure of current policy, more valuable upstream assets and more support for nuclear gives it relief and a brighter future. The 30%+ share price rise from summer lows potentially signals other investors think likewise. 


The information shown above is for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.


No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.


Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.

Unless otherwise stated, all opinions within this document are those of the RWC UK Value & Income team, as at 13th October 2021. 

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