Thursday 30 September 2021

Self Sufficiency Revisited

For it's Tommy this, an' Tommy that, an` Chuck him out, the brute! 
But it's " Saviour of 'is country " when the guns begin to shoot

[In response to a BTL question last week]

Yes, paying for an insurance policy is always annoying when there's not a cloud in the sky: but there's always regrets when the rain sets in.  So now the cry goes up: why do we have so little gas storage?  Why did the government allow the Rough storage facility to close?  Why are we so much worse off than the Europeans?

The answer, ladies and gentlemen, is the usual convoluted story.  Rough (a partly-depleted gas reservoir in the southern North Sea) was cannily sold by its American owners to the old British Gas (when still a monopoly / monopsony) for conversion to a storage facility.  They spent an epic amount of money on it, and were very proud of it when it came on stream.  But there's a very strong case that they never actually needed in those days (1980s), such was the strength and diversity and flexibility and reliability of North Sea gas production straight from the fields.  However, monopolies of that kind are run by engineers, whose solution to every question is "build more stuff", especially when they can just dump the cost on captive customers.  And so they did, gold-plating and all.  How we all laughed.

Two changes of hands later and it's back with Centrica, one of the several linear descendents of the old BG.  Rough is huge, & what we call "seasonal storage", i.e. 180 days to fill it, 180 days to blow it down (rather than smaller fast-cycle: perhaps 30 days to fill and 10 days to blow down).  It found its place in the early years of this century as a perfectly commercial asset, making its way in the very liquid, dynamic gas market that developed in the last half of the 1990s and hasn't (yet) looked back - indeed, it's spread to the whole of Europe.

Where they still, however, do some things a bit differently, most notably in Italy.  Some history: with the exception of the Dutch, they've all been uncomfortably dependent on Russian gas for many decades - enough to make anyone invest in a good bit of storage.  In most countries it is operated more-or-less commercially, with the glaring exception of Italy (also a big importer from, errr, North Africa) where the government mandates in detail the maintenance of extremely costly, and most would say excessive, gas storage inventories, and won't allow the storage facilities to be operated commercially at all.  As insurance policies go, this one is very costly indeed.  The French used to be similar, but not for quite a while now. 

Because ... we now have a thriving and very efficient integrated European gas market, embedded in an increasingly efficient global gas market mediated by shipborne LNG - so folks can choose their supply-security measures from a range of alternatives:  physical storage; virtual storage; call options; flex contracts etc etc.  They all have their pros and cons: I could draw you a nice table in powerpoint®.  So when Rough suffered a couple of explosions and became "too costly to repair" (and after Centrica's pleading for a special subsidy fell on deaf ears) it was allowed to fall idle.  (Though not abandoned, because Centrica dreams of getting a big subsidy to restore it / convert it to CO2 storage / convert it to hydrogen storage / convert it to a theme park / anything, really  ... except shell out for actual, final abandonment.) 

Behind this lay an important factor: the price spreads (seasonal, and general volatility) that drive the value of a storage-option were in the doldrums, and remained that way for the best part of a decade.  Centrica wasn't the only European operator closing storage facilities during that period, by any means.

The decision was perfectly fair, commercially; and not particularly negligent of the government of the day, either.  Because, even now there's little concern we will run out of physical molecules of gas, from a variety of sources: it's just the price that folk don't like.  But hey, markets are like that when there's an Actual Shortage; and more storage in the North Sea would barely be noticed against the global price-spike we are now suffering.

HOWEVER: it's fair to say that at times like these, the whole "efficiency / rely on an effective market" vs "self-sufficiency / don't trust the market" debate gets revisited with a vengeance, and rightly so.  Because There's No Right Answer!  There are some well-tried quant methodologies to deploy, and they illuminate the issue:  but as ever it all hinges on the assumptions.  People who are anyway self-sufficient tend to lord it over the rest and claim their position is the moral high ground.  People who could never remotely be self sufficient (e.g in Belgium, where there is no indigenous gas whatsoever) are, faute de mieux, rather keen believers in open markets.  I once had a very interesting discussion with a Chinese person (a commissar with a commercial delegation) who, on receiving a presentation about cross-border gas and electricity interconnectors in Europe, commented sniffily that it was a very bad thing for a country to be reliant on imports for gas and electricity.  I politely remarked that yes, it was a debating point for several nations, not least those who import almost all of, *ahem*, their oil ....   I digress.

This is indeed a debate we return to periodically here, not least with our good friend Sackerson.   And we've discussed Rough specifically, too.   There have always been fair points on both sides.  Personally, I'm way up the open-market end of the spectrum.  But it's a continuum, and if you can ever identify clearly enough that the risks are increasing (volatility is generally a good metric) then you can justify a higher insurance premium - be that in the form of storage, call options etc etc.  Since it's been going that way since Jan of this year (I first wrote about it here in Feb), you may be sure all the capable players have been doing just that.  And, by the way, there's no obvious reason why volatility should be going away any time soon, and plenty of reasons why it should stay high.



dearieme said...

Tangentially relevant: I've just checked the local rag's website. No mention whatever of a problem with supplies of motor fuels. No list of filling stations open or closed. Not a sausage.

Yesterday we drove past a closed filling station. When we passed that way again forty minutes later it was open but with hardly a vehicle in it.

Is the panic over already?

Are there conspiracy theorists saying it was all a beat-up to distract attention from the Labour Conference?

Timbo614 said...

A stoopid question re your volatility Nick:

Why would you not fill your storage when the price is low and empty it when the price is high especially if it is enormous?
You could say keep it say half full at a minimum to satisfy the requirement for backup supply, again if it is enormous!

Nick Drew said...

Oh yes, Timbo, that's broadly how storage is utilised commercially! It can be even better than that: you could buy low today (on the spot market - and immediately store the physical gas) and SELL HIGH TODAY AS WELL - in the forward market. (If those forward prices are high enough to cover costs.) Arbitrage!

Things are made a bit more complicated if

(a) it isn't so easy to be sure what's a 'low' price and what's a 'high' price. That may be quite obvious in extreme conditions like today, but through the long period of very low volatility it wasn't always
(b) you can only act on 1/180th of the inventory on any one day
(c) the price might be high today, but maybe it'll be even higher tomorrow ...

etc etc - many moving parts if you want to optimise your opportunities. The greater the volatility, the greater the potential for profits - but the more difficult the assessments, too. Still, if life was easy ...

Anonymous said...

Great stuff. Looking forward to reading more as the situation eats companies and careers this winter.

jim said...

Known unknowns and unknown unknowns. As you say, no shortage of gas molecules but a superstorm could send a few tankers to the bottom or a decent fire at a gas terminal cause disruption. One can hedge and play integration games all day but when there is no physical a big storage hole looks a nice idea.

Back in the day an IT manager got a generator installed on the roof of his office and a load of modems plus some mylar film. His office was on Bishopsgate. WFH was very profitable in the following months. No one moaned about the cost after that.

Sobers said...

Its ever the same, no-one wants to pay the insurance premium for self sufficiency when times are good, but screams 'Why didn't they do something???' when the balloon goes up. And of course there's no commercial incentive to provide it free in the hope of profiting during the shortages, as sure as eggs is eggs the State would step in and commandeer supplies and set prices etc, and prevent you from making any profits to offset against the years of costs. Taxes on 'super-profits' have already been waved around in this crisis, so why would any commercial entity bother?

So as Paul Weller sang, the public gets what the public wants, and so thats what we have, a system thats pared to the bone all the time and can't cope when the SHTF.

Anonymous said...

and its not like its only gas. thats Newcastle in Australia.
energy just got very expensive everywhere. anyone have a decent theory why ?

dearieme said...

"anyone have a decent theory why ?"

Supply and demand, innit?

Nick Drew said...

dearieme has the truth of it, anon, in the most succinct way possible

Demand (for most commodities) - surging, esp in the far east, due to post-covid bounce plus big emphasis on infrastructure projects

(which, though in many cases nominally 'green', are steel-&-concrete intensive. And these days, as often noted here, even road repairs have been classified 'green' ...)

Supply - impacted adversely, at least for the near-term, by several factors, e.g.:

- covid-induced production hiatus (notably US shale oil & shale gas: very price-sensitive and hence wound down during the covid price collapse)

- Putin holding Europe to ransom so as to get approval for Nord Stream 2 (he's doubled down just this week, though it's fair to say gas storage levels in Russia itself are low. But in earlier times he'd have sacrificed Russian consumers' demand in favour of hard currency exports)

- regional short-term factors like, no wind in Europe for 3 weeks

- Germany having decided an ultra-rapid phase-out of coal & lignite (again, they've doubled down on this in the last couple of weeks)

HOWEVER the phrase P*****t S***m is banned around here

Nick Drew said...


(you don't need to read it, the embedded headline speaks for itself)