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UK needs more gas for power


In a valedictory speech before he stands down from Ofgem, the UK regulator for the electricity and gas markets, its CEO, Alistair Buchanan, gave a speech this week dramatically entitled ‘Will GB’s lights stay on and will the gas keep flowing’. This is an important contribution to the discussion about developments in European energy markets, more so as it comes from the energy regulator of Europe’s single largest gas consumer.

Ofgem’s current analysis is that UK power capacity levels could sink to dangerously low levels by the winter of 2015/16 and much lower than previously anticipated. It now forecasts a capacity margin that could drop to less than 3%. This outcome is seen as the result of forceful environmental legislation and the financial crisis which has significantly reduced the amount of new power generating capacity that has been added in the UK and is rapidly forcing installed capacity which does not meet environmental regulations out of the market.

Ofgem’s main conclusion is that gas is needed at least as a transition fuel to 2020 and that gas in power stations will not fall from 40% to 20-30% but will have to increase to 60-70%. One of the many ironies of this view is that the current market structure continues to incentivise coal burning at the expense of gas, as shown by the strongly positive dark spread relative to the spark spread.

Buchanan went on to consider a number of possible sources of gas for the UK, concluding that although there is plenty of gas worldwide all sources have their issues and neither European shale nor LNG, whether from existing or new supply sources, such as the US, is an easy or necessarily feasible solution and none is likely to prove cheap.

With respect to Russian gas, Buchanan noted the loss of potential developments such as Shtokman and transit security issues over Ukraine as potentially limiting the availability of Russian gas. When considering the European gas market there are many large moving parts which make precision impossible, but this presentation aligns with our views in many respects while adding a deeper insight into developments in power markets as they are likely to affect gas demand in the UK and hence at the European level. It continues to confirm that forward gas demand for Russian supplies is actually likely to grow significantly, despite current difficulties. 

Colin Smith, Marc Jacouris (CFA)
VTB Capital analyst

UK, gas

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