There are a number of market signals indicating that both the UK and European energy system will face significant risks this winter as Europe attempts to replace Russian gas that it has relied heavily upon in recent years. These signals include National Grid, the UK electricity and gas system operator, clearly stating the potential for rolling power disruption on very cold days this winter, energy company CEOs warning of rationing with no immediate quick fixes and the UK Government attempting to increase domestic gas production and delay decommissioning of coal fired electricity generation assets.
Looking at the UK specifically, about 50% of natural gas requirements are imported for domestic, industrial and power generation purposes which is where much of the near- term risk is concentrated. About two-thirds of these imports originate from Norway via pipeline with the remaining one-third imported as LNG via ship from LNG exporting nations such as USA and Qatar. Whilst the UK has the second largest LNG import capacity in Europe, it has minimal gas storage infrastructure. Gas fired power stations are the marginal source of electricity generation in the UK and so gas prices typically also set the wholesale price of electricity.
A key risk focus on a very cold winters day will be the UK interconnectors that can flow electricity and gas in both directions to and from the continent. Typically, on such days, the UK imports up to 5% of electricity supply from Europe via interconnector cables and up to 5% of gas from Europe via interconnector pipelines. Given the ongoing crisis in both, the gas and electricity interconnectors are currently exporting power and gas to Europe.
With Russian gas exports to Europe halted, much of Europe and particularly Germany is attempting to reduce demand by 15% to avoid rationing and is currently importing significant quantities of gas via the UK gas interconnectors. Similarly, France, which is normally an electricity exporter, is currently an importer given nearly half of its nuclear reactor fleet is shut down due to maintenance issues; it is importing significant quantities of electricity via the UK interconnectors.
The UK will be relying on these interconnectors to provide power and gas from the continent on a very cold day this winter to meet full demand, which clearly presents a significant risk. To mitigate this supply shortfall risk, the UK National Grid as system operator will aim to bring online up to three coal fired power stations whose decommissioning has been delayed. It will additionally introduce a demand flexibility service where companies and households will be paid to reduce demand if all other options have been exhausted. Only last week National Grid’s CEO has warned UK industrial and domestic consumers to prepare for rolling blackouts on extremely cold days.
So, ideally, companies should be assessing what risks will need to be mitigated as a response to this higher probability of interruption to both power and gas supplies this winter. These risk mitigations essentially fall into three main areas: (i) obtaining a deep understanding of your own energy system including security of energy supply and demand reduction options, (ii) improving system resilience such as stress testing critical supply chains under various interruption scenarios and, lastly, (iii) testing contingency plans for major supplier and customer disruption.
Energy supply chain resilience (KPMG, October 2022)
Boards have a key oversight and challenge role to play and need to ask the right questions. The chart above sets out ten areas board members should focus on, and puts forward questions they can ask their organisation to help assess and mitigate the potential risks arising from the high probability of energy supply chain resilience challenges this winter.
Nigel Hobson joined KPMG in 2022 following a significant period as Senior Vice President of the Global Trading and Supply Chain business at Shell. Nigel has held a unique blend of Senior Executive roles with accountability for both operational delivery and commercial growth with both Shell and ExxonMobil over the last 35 years. Nigel has held senior leadership positions across the broad energy spectrum including, Crude, LNG, Refined Products, Chemicals, Gas and Power and is an expert in energy value chains.