Natural gas. Chilling

Winter worries mean gas prices have gone haywire

ENERGY is fast becoming one of the biggest issues in British politics. Ambitious promises to develop renewable sources and the government's apparent determination (hinted at again on November 22nd) to build a new fleet of nuclear power plants have kept the subject in the public eye. Another simmering controversy erupted as natural gas prices - which had been rising for months, along with the oil price - shot to record levels this week (see chart on next page). Falling again as The Economist went to press, they were still far above their levels of just two weeks ago.

The sudden price hikes infuriated business users of gas, especially big industrial firms. Many have switched over the past year from annual, fixed-price contracts to spot-price ones, and some have had to cut back production as prices rose. Business groups gave dire warnings that expensive gas would lead to factory closures this winter and called on the government to rethink its energy policy. Malcolm Wicks, the minister responsible, was unimpressed: he said the price spike was "irrational" and pointed out that, in any case, there was little the government could do.

Several factors lie behind the volatility in gas prices. The immediate reason is that weathermen are predicting a colder-than-average winter, the first for many years. The market has been jittery for months. Frigid temperatures could severely strain the system, with big industrial users cut off in order to keep households warm. A recent cold snap seems to have spooked gas buyers, many of whom are now reckoning on future shortages. And sharp price spikes often generate their own momentum.

A broader explanation is the slow decline of the North Sea, and Britain's change from being a net exporter of energy to a net importer. That will require plenty of investment in new infrastructure to bring gas in from outside. Ministers and industry bosses have planned for this, approving an upgrade to the big Zeebrugge-Bacton pipeline that links Britain to the continent, and the construction of new lines from Norway and Holland. A new terminal designed to take shipments of gas in frozen form opened in Kent in July, and two more are due to open by the end of 2007. But until the new facilities are up and running, gas supplies will be tight.

And Britons are discovering that more capacity does not necessarily mean more gas. The Kent terminal has been quiet ever since it opened. Shipments have been diverted to take advantage of high prices in other countries such as Spain and the United States. Pipeline imports from Europe are running far short of what they could be. David Cox, the boss of ILEX, a consultancy, thinks that the French and Germans are wary of releasing stored gas on to the market so early in what could be a long, cold winter.

Britain's lack of storage capacity has amplified the market's fluctuations. Historically, the North Sea's bounty made stockpiling gas unnecessary. If demand rose, more gas could be pulled out of the sea to meet it. Falling production, and a shift away from natural gas fields to combined oil and gas deposits, means that this approach is no longer possible. Gas reserves can meet only 4% of annual demand, compared with around 20% in Germany, France and Italy.

Many commentators see price spikes in times of shortage as the flip-side of the same liberalised energy markets that provide cheap gas in times of plenty. Philip Wright, a professor at the University of Sheffield, points out that liberalised markets thrive on information that was hidden in the old, vertically-integrated monopolies. Even small shocks to supply can be amplified as other firms rush to take advantage of the information.

Nevertheless, the Conservatives - the architects of the original market liberalisation - jumped at the opportunity to stick it to the government. So far, ministers have stuck to the line that gas is a privately run business and that government interference is the last thing industry needs (although they have grumbled about the glacial pace of liberalisation in the European markets on which Britain will increasingly rely). Mr Wicks says that only the heaviest industrial users would be affected by an extremely cold winter, if one does occur. That's true, but only if the freeze is short-lived. Because gas generates around 40% of Britain's electricity, a prolonged chill would affect domestic energy prices as well. That would annoy voters, whose bills have already risen sharply over the past months. The last thing the government wants now is a white Christmas.

Worries about a severe winter mean gas prices in the UK have gone haywire.

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