Why are energy costs rising? And what’s in store in the next 5 to 10 years?

May 2nd, 2013 by

The current consensus is that energy costs are going to rise significantly over the next 5 years and further still in the following five years. This is going to be a major issue for businesses, and households alike.
But why are prices rising? Here is a quick review of the factors which are pushing energy costs up rather than down.

There is a fall in the UK’s capacity to generate electricity.

Power generation capacity in the UK is falling. Much of this has been planned, but the lowest point in the UK’s capacity is expected to be in 2015/16, about a year earlier than anticipated.

The two main reasons capacity is falling are:

  • Older and dirtier (more polluting) power stations are being phased out in response to EU legislation and UK commitments on reducing pollution from fossil fuels.
  • Replacement plant namely renewable energy, nuclear and coal with carbon capture and storage has been slow to come on line. Investment in these new technologies has been hit by the financial crisis. The programme to replace existing nuclear power stations is running well behind schedule.

To meet this shortfall in capacity the government is looking to gas to generate electricity and bridge the gap until these new technologies come on-line.

Burning gas in power stations to generate electricity was to have fallen from 40% to 20 – 30% by 2020. In fact the use of gas is expected to increase to 60 – 70%.

Why are energy costs rising? And what is in store for the next 5 to 10 years?

Chimney & Smoke by njaj courtesy freedigitalphotosnet

But why will a shift to gas push up energy prices?

The UK’s own supply of North Sea gas is insufficient to meet demand so we will need to buy gas on the open market from Eastern Europe and other parts of the world. In the winter of 2012 there was a sharp fall in expected supplies of gas from Russia and Eastern Europe for combination of technical and political reasons.

At the same time other European countries such as Germany, and Belgium are also on the hunt for new supplies of gas. In Germany this is due to the closure of nuclear power stations following the Fukushima disaster in Japan.

But what about shale gas?

The UK has reserves of shale gas which could be extracted using the process of hydraulic fracturing (also known as “fracking”). But getting the gas out is going to be expensive and time consuming and there are significant environmental hurdles which have to be overcome not to mention the issue of public opinion. Shale gas is very unlikely to lead to a fall in gas prices over the next 10 years.

So is there enough gas to meet the UK’s demand to 2020?

Alistair Buchanan, the departing head of Ofgem has stated (see sources below) that by 2020 there will a shortfall in gas supplies in the order of 27 billion cubic meters. In other words demand will exceed supply by this much. The shortfall will, he believes, have to be met by supplies of Shale (from outside the UK), gas from Norway and Liquid Natural Gas (LNG) from other parts of the world.

By how much will energy prices rise?

When demand comes close to or outstrips supply prices go up, of that we can be sure. The demand for gas to generate electricity also means there is less available for the production of heat, so energy prices across the board will rise. What no-one can say for sure is by how much. What we can do is look at trends over the last decade and use these as the starting point for scenarios of what might happen in the next five to 10 years. Looking back over the last 5 to 6 years the cost of energy in the UK has roughly doubled.

So how should businesses respond?

What do you do if you know one of your core costs is going to go up but you don’t know by how much or over what period of time. A useful way of tacking this is to use a risk based approach with the existing rate of increase (doubling every 5 to 6 years) as the mid-point scenario. This can then be used to develop strategies for how to respond if prices rise faster or more slowly.

You will find further information on how to do this on the blog.

Links and resources

Will GB’s lights stay on and will the gas keep flowing: a look at the next decade? Alistair Buchanan CBE, 19th February 2013.

Written by

Environmental consultant, facilitator, founder & Director of Climate Works Ltd.