Future Trends in the Energy Market

The country's officially in a recession, possibly facing a period of economic depression.  Surely the inexorable rise in energy prices is over and so offers some good news amongst all the doom and gloom?

Well, yes...and no...

Mike Lee from Watt-Knots Ltd, an independent energy & water consultancy specialising in sustainable technologies, takes a look at the some of the current issues in the energy industry.

However, there are many reasons to believe that this period of softer pricing will not last very long, partly because of the economic downturn and the "credit crunch" that has contributed to it, and partly despite the recession.

We would not be so foolish as to predict the precise level of energy prices over the next few months or years, particularly given the volatility of energy markets.  There are specialist economists, academics and industry analysts that spend their time doing little else - and with only limited success!  It is a very complex and difficult task, influenced by so many diverse yet interrelated factors.

You and your colleagues will inevitably reach your own conclusions on the future cost of energy and how it will affect your organisation.  You will make decisions based on these conclusions. 

Here are some of the most relevant factors that will influence the conclusions you reach.

Energy is an international commodity delivered locally.   So there are global, European and UK specific factors - and the interplay between them - that ulimately determine how much any business or domestic customer pays for their energy at any one time.  We've tried here to help you by briefly setting out some of the key factors that are involved in this process.

Let's start with the price of oil and gas:

In the summer of 2008, oil reached a peak price of over $140 a barrel. 

Some eight months later this has fallen to around $40

However, the cost of producing oil is more than $50 a barrel and around $26 trillion needs to be invested in additional production for supply to able to meet even the most pessimistic forecasts of demand over the next 20 years. 

In the meantime, there is every prospect that Opec will use cuts in production to support the price, as they have often done in the past.  A steep rebound in the oil price is expected during 2010 to well over $100 a barrel and then beyond $150.

For no reason other than producer "convenience", the whoesale price of gas in Europe is linked to the price of oil.

As the medium to long term oil price rises, so will gas, and over 40% of the UK's electricity is generated by gas fired power stations.  The fact that we're increasingly dependant on imported gas, with up to 90% imported by 2020 (vs 10% imported in 2006) adds considerably to the price risk. 

56% of the world's known gas reserves are owned by Russia, Iran and Qatar, and the prospect of "gas Opec" does nothing to allay price concerns.

On top of these wholesale supply issues, the UK desperately needs more gas storage, having only two weeks worth.  This compares to the 18 weeks storage held by France, for example, where only 4% of electricity is gas generated.

Shut Down of Electricity Generation Capacity

Over 30% of the UK's electricity generating capacity is due to be decommissioned by 2020.

This has huge implications for the security of supply - and the prospect of power cuts - if new generating capacity (whether nuclear, coal, gas or renewables...) and badly needed upgrades to the electricity transmission network are not in place in time - something that is anything but certain.

The cost of maintaining supply and the investment needed for new and upgraded capacity is an eye-watering £28 billion over the next ten years.  It is energy customers that will have to foot the bill!

The Cost of Carbon

Governments around the world are committed to reducing carbon emissions and for all the benefits to future generations there is a cost in achieving this which will also fall on energy users, particularly those using energy sourced from fossil fuels.

At today's prices, the UK government estimates that the costs will be in the region of £5 to £6 billion a year by 2020.  These will arise in the form of a step by step increase in the "tax" on carbon and used to fund financial incentives for investment in zero, low and carbon neutral technologies and energy efficiency programmes.  There is no fundament difference between the main UK political parties on this issue, so a change in governing party - or a hung parliament - at the next election will not lessen the impact of this.

The Energy Distributors

The suppliers of energy argue that their "retail" margins are not sufficient to fund the

huge investments they need to make in improvements to their own infrastructure.

As the price of energy for domestic users attracts such media and political attention, we expect energy suppliers will seek to widen their margins primarily from industrial and commercial users.

The "Credit Crunch"

The banking crisis and the "credit crunch" are already having two serious adverse effects on energy prices; one short term, the other medium to long term.

In the short term, some suppliers are simply not bidding for new business where they believe there to be a risk of customers going bust.  In other cases customers are only being offered short term contracts because suppliers want to limit their exposure. 

SMEs are particularly badly hit, but larger companies, especially those in sectors such as retail construction and automotive, that are most vulnerable to the effects of the recession.

The longer term impact will be felt due to the reduced availability of investment finance for everything from oil and gas exploration to the building of new power stations, the funding of large scale renewables projects and upgrading of the national grid.  The delays that arise will mean higher costs (and risks to energy security) in the future.

Watt-Knots are a Spiral partner and offer advice to clients on how to reduce their energy & water costs, whether through lower usage or improved pricing, or both, as well as evaluating opportunities for alternative technologies.  If you would like to speak to a Watt-Knots consultant to find out more about how you could reduce your energy costs or carbon emissions, contact us here at Spiral.