Gas: who controls the tap?

Most of us take energy provision for granted, but Russia's threat last year to cut off Western Europ

The temperature in Kiev fell to five degrees below freezing on the day Gazprom turned off the natural gas taps, as it tried to force Ukraine to swallow a 360 per cent price hike. In a desperate bid to keep the heat on, Kiev siphoned supplies destined for Western Europe out of the main pipeline crossing its territory; Italy's imports dropped by a quarter as a result, France's by three tenths. The EU Energy Commissioner, Latvia's Andris Piebalgs, warned Russia not to make the EU "a hostage", yet hostage it was.

Some pundits argued that the Kremlin was just getting tough with the pro-Western government that had taken power in Ukraine after the Orange Revolution a year earlier. Others said that President Vladimir Putin was making a thinly-veiled threat to the West about the pivotal role Russia plays in Europe's energy economy. A few even believed the Moscow line that it merely wanted to get a market price for its main export.

Whatever the Kremlin's motive, the four-day Ukrainian gas crisis in January 2006 was not the end of the muscle flexing. Like a bear waking from hibernation, Moscow has been doing its wake-up exercises ever since, stretching this way and seeing how far it could push that way. In September, it pulled an environmental permit for Sakhalin II - a consortium created to produce oil and gas on Sakhalin Island - in a move that seemed calculated to put pressure on Shell, the leading Western partner in the $20bn (£10bn) project off its Pacific coast. Happily, Putin was in agreement by the time he attended the signing ceremony in December at which Shell handed over 50 per cent of the field - which contains 1.2 billion barrels of oil and 500 billion cubic metres of natural gas - to state-owned Gazprom for £3.7bn.

History shows that a change in the control, distribution or price of natural resources can have dramatic consequences. When the members of the Organisation of Arab Petroleum Exporting Countries raised the price of oil in October 1973, Western central banks cut interest rates to encourage growth. That caused widespread inflation. (There were benefits, too, one being that the high prices led to our cars becoming far more petrol-efficient.)

Britain's concerns today, however, stem not from Arabia but from Russia. The UK's other petro-giant, BP, is having problems with Moscow. Four years ago, Lord Browne, then its chief executive, signed a deal with several Russian companies to form TNK-BP, giving it a 50 per cent stake in the $20bn Kovykta gas field in Irkutsk, which has 2 trillion cubic metres of gas, enough to fuel the entire world for a year. This too is causing second thoughts in the Kremlin. In a speech before the G8 meeting in Germany in June, Mr Putin complained that TNK-BP had failed to meet its production target of 9 billion cubic metres a year. "How much longer do we have to tolerate this?" he asked impatiently. The company countered that the main obstacle to production was the lack of a pipeline to its Chinese market, a pipeline that would have to be built by, yes, Gazprom again, the company most likely to benefit should BP and its allies lose their licence.

Russia's new stridency comes at a bad time for Britain, and not just for the country's corporate interests. As rising well-head prices have re-invigorated the Eastern giant's economy, the decline of mature North Sea fields have turned the UK from a net exporter in 2003 into a net importer. Gas production peaked in 2000 at 297 million cubic metres per day, according to a report this year from Pöyry Energy Consulting, and is falling by around 2 or 3 per cent a year. This still leaves a substantial 1.5 trillion cubic metres of recoverable gas beneath the seabed, which will be withdrawn over many years to come. But Britain's dependence on foreign gas is expected to rise as demand inexorably rises. By one estimate, the UK will go from being 90 per cent self-sufficient now to 90 per cent dependent on imports by 2020.

The immediate fear is that Russia will use its dominance of the European gas market to leverage political and diplomatic issues as well as commercial ones. The point was driven home by commentators after the murder of former KGB agent Alexander Litvinenko by radioactive poisoning and the subsequent refusal of Russia to extradite the chief subject, Andrei Lugovoy, to London for trial. "The dangers of Gazprom's power could not be clearer," thundered the Daily Mail. "The company is perhaps the most important weapon in President Putin's armoury."

If the diplomatic consequences of Moscow turning energy into mass and then chucking it around seem worrying, just imagine how much worse it would be if Russia ever followed through on its implied threats. Readers who are old enough may remember the three-day week forced on the country by prime minister Ted Heath during the first two months of 1974 when the coal miners' work-to-rule campaign drove stocks dangerously low. Today, Britain produces as much electricity from natural gas as it did from coal in the mid-seventies, according to the International Energy Agency. But disruption of electricity supplies now would be far more severe. Computerisation is so pervasive that only a handful of workplaces can function without it. Even essential services such as the police and the NHS would be severely hampered in the event of a blackout.

And in Britain's deregulated market, an enforced shortage would have a dramatic effect on prices, with the hardest blow being taken by those who can least afford it: the poor, the elderly and the disabled. This was demonstrated during the winter of 2004, when wholesale electricity prices soared by 62 per cent according to an Ofgem inquiry. Part of the problem then was that, although British prices are influenced by what happens on the Continent, the reverse is not necessarily true. Most European countries have regulated markets, fixed prices, long-term contracts and mandatory reserve requirements, which means that when supplies are limited, they do not always go to the highest bidder. Britain, however, faced the bizarre situation that despite prices higher than the rest of Europe, flows in the Interconnector pipeline from Zeebruge in Belgium to Bacton in the UK remained below capacity.

The Government's Energy White Paper, published in May, was seen by many people as a response to one pressing issue - climate change. For a full news cycle, debate raged over the role of renewable sources, such as wind farms and tidal power, versus an expansion of Britain's nuclear generating capacity, currently producing 20 per cent of the country's power but set to fall dramatically as ageing power stations are decommissioned; by 2025, only one nuclear power plant is set to remain. Critics warned that the nuclear power option could turn out to be a "dirty white elephant", complained that a new consultation on the issue was a "farce", and raged at new rules that would make getting planning permission for nuclear plants much easier. The outgoing prime minister Tony Blair responded by telling MPs bluntly: "We are not going to be able to make up through windfarms all the deficit on nuclear power."

The role of natural gas was barely mentioned. Yet this fuel has done more to change Britain's carbon footprint over the past two decades than any other. Since prime minister Margaret Thatcher launched the "dash for gas" in the 1980s, it has become central both to the country's energy security and the reduction of greenhouse gas emissions. Since 1992, gas consumption has grown by 66 per cent; it is now 100 billion cubic metres a year and the National Grid forecasts an increase of 11 per cent by 2011. And it is by far the cleanest major fuel, producing 30 per cent less carbon dioxide per unit of energy than petrol and 45 per cent less than coal.

Natural gas is not the only source of energy in the UK, of course. Britain still relies heavily on coal and nuclear generation for its electricity, while oil serves for all forms of transportation except electrified trains and the odd hybrid car. But uranium, coal and oil can all be supplied by stable, or at least friendly countries, with relative ease. You just load them on to ships and point them in the right direction. There is only one global market place, and for oil and coal, after a supplier has sold into it, anyone can buy from it.

The ease with which markets for other fuels adjust to interruptions in supply was dramatically demonstrated when the Buncefield storage depot went up in flames on 11 December 2005. The explosions at the petrol storage facility near Hemel Hempstead could be heard as far away as France and were recorded by the Geological Survey at 2.4 on the Richter scale.

The terminal, with a capacity of 273 million litres, was a hub for 5 per cent of Britain's transportation fuel, including 30 per cent of the aviation fuel for Heathrow. Although shortages continued for months, they were dealt with behind the scenes, with tankers being diverted to make deliveries to petrol stations and planes being directed to Stanstead for pitstops. Yet by the time the plume of smoke, initially visible from space, had dissipated and media attention had turned elsewhere, few members of the public would have noticed the loss.

Gas is different. It either has to be shipped by pipeline, the preferred method, or to be expensively liquified at -163C. But pipelines can take decades to build, and have an effective range of just 5,000km or so. This means that the European market is, for example, isolated from the North American market. So the identities of major suppliers do matter, and in Europe, Russia is the dominant player, with a quarter of the market. If Moscow decided to divert its gas to Asia, say, it could take years before replacement capacity came on line.

What's more, Britain's imports come through just three major pipelines. The Interconnector, built initially to export surplus gas to the Continent during the 1990s, has recently been expanded from 16.5 billion cubic metres to 23.5 billion cubic metres. The second, the BBL Interconnector from Balgzand in the Netherlands, began shipping up to 15 billion cubic metres to Bacton in December, and the Langeled pipeline from Norway's Ormen Lange field is to start shipping up to 25 billion cubic metres to Easington from this autumn. This will be a huge improvement over just a year ago, when the Belgian Interconnector was the only link. But the shortage of alternatives still has many within the industry worried.

The two new pipelines are part of £10bn worth of private-sector investment aimed at diversifying Britain's natural gas supplies. The main projects include four new terminals for importing liquified natural gas. One owned by the National Grid, on the Isle of Grain in the Thames Estuary, is already open, with a capacity of 4.5 billion cubic metres and the potential to expand to 20 billion cubic metres by 2011, though it is currently used primarily to meet peak demand. Two more - under construction at South Hook (Exxon/Qatar Petroleum) and Dragon (Petroplus) in Wales, with a combined capacity of 16.5 billion cubic metres and planning permission for double that by 2010 - are to be used to meet baseline demand. The fourth, at Teeside, is unusual. Instead of piping the liquified gas ashore and then warming it up in the terminal, Excellerate Energy plans to regassify the cargo onboard ship, making the link to shore much simpler. It will have a capacity of 4 billion cubic metres. Proposals have also been put forward for terminals at Teeside and Canvey Island.

The good news, according to Ofgem, is that these developments mean that Britain will remain fairly well protected from Russian energy belligerence. Most of the decline in UK production of natural gas is to be covered by importing more, not from Siberia but from Norway.

In May, the Government began lobbying Oslo for another new pipeline, this one from the Troll field to St Fergus in Scotland, to bring another 20 billion cubic metres to the mainland by 2012. If nothing else, this should give British politicians and diplomats room to manoeuvre the next time the Russian bear roars.The Russian President, Vladimir Putin, is accused of using fuel to threaten the West*percentage of total electricity consumptionNuclear producer

1. US 510mboe

2. France 281mboe

3. Japan 177mboe

4. Germany 105mboe

5. Russia 91mboe

20%*

78%

26%

28%

16%*percentage of total electricity consumptionHydro producer

1. China 222mboe

2. Canada 214mboe

3. Brazil 202mboe

4. US 170mboe

5. Russia 110mboe

16%*

57%

83%

7%

19%Natural gas exporter

1. Russia 1,273mboe*

2. Canada 661mboe

3. Norway 518mboe

4. Algeria 431mboe

5. Netherlands 324mboe

*mboe=million barrels of oil equivalent paCoal exporter

1. Australia 1,105mboe

2. Indonesia 517mboe

3. Russia 364mboe

4. South Africa 349mboe

5. China 345mboe

Oil exporter

1. Saudi Arabia 2,733mboe

2. Russia 2,038mboe

3. Norway 1,043mboe

4. Nigeria 972mboe

5. Iran 967mboe

Source: Latest figures from International Energy

Agency (2004)Natural Gas importer

1. US 755mboe

2. Germany 568mboe

3. Japan 505mboe

4. Italy 462mboe

5. Ukraine 387mboe

6. France 293mboe

7. Spain 206mboe

8. South Korea 181mboe

9. Turkey 168mboe

10. Netherlands 144mboeCoal importer

1. Japan 852mboe

2. South Korea 369mboe

3. Taiwan 292mboe

4. UK 211mboe

5. Germany 182mboe

6. India 177mboe

7. US 134mboe

8. China 120mboe

9. Spain 120mboe

10. Italy 115mboeOil importer

1. US 4,558mboe

2. Japan 1,627mboe

3. China 972mboe

4. South Korea 901mboe

5. Germany 869mboe

6. India 758mboe

7. Italy 735mboe

8. France 672mboe

9. UK 498mboe

10. Netherlands 474mboeA gas platfom in Norway, which could become the main supplier to the UK