Comment & analysis

Analysis

BONE-CHILLING: A DUAL WINTER THREAT
By Thomas Catan and Scheherazade Daneshkhu

Financial Times (UK)
November 23, 2005

http://news.ft.com/cms/s/4af6506e-5c5e-11da-af92-0000779e2340.html (subscribers only)

From London to Lyons, this week has given many people their first sharp taste of winter. Adding to the chill is the prospect of bigger bills as heat and power prices soar to vertiginous levels. In all the main economic regions of the globe, energy systems are heavily stretched in the attempt to meet ever-increasing demand.

Could an unusually cold winter be the trigger that tests one of those systems to the limit -- and perhaps beyond? And does the absence of slack in the system mean that even a relatively warm winter could cause serious disruption to supplies?

Signs are especially ominous in Britain, where such fears have pushed natural gas prices to record highs. Barclays Capital said on Wednesday that natural gas in the U.K. had become the most expensive traded fuel in the world. Electricity prices have also soared this week in Germany and France as the cold weather set in. In the U.S., the price of natural gas has been high ever since the autumn hurricanes brought havoc to its energy production hub. The storms also pushed up the price of heating oil, used heavily in the U.S. north-east to keep homes warm.

Record-breaking winter temperatures are often predicted but this time there is some reason to believe they may materialize. The U.K.'s Meteorological Office has declared a two-thirds chance of a colder than average winter, something not seen in a decade.

That would come at an especially sensitive time in the country's energy history. Britain is shifting from being a big producer of liquefied natural gas to a substantial importer of such products -- and traders fear it could get caught short in the transition. North Sea gas production is declining faster than expected but the pipelines and LNG terminals needed to import gas from abroad are not yet ready. The result is that Britain's gas supply this winter and next is likely to be among the tightest in living memory.

In a prolonged period of cold, traders fear that demand could outstrip supply. That fear is driving prices higher. The wholesale price of gas for delivery the next day has soared as high at £1.70 per therm this week, from 31p at the start of the month.

Not only are Britons heavily reliant on gas to heat their homes but they also use it to generate a third of the country's electricity. As a consequence, spot electricity prices have also risen sharply, from around £60 per megawatt hour at the end of last week to nearly £110 yesterday, according to Spectron, the energy marketplace.

In the U.S., natural gas production was hard hit by hurricanes Katrina and Rita and, even now, a third of the Gulf of Mexico's gas production remains out of action. The storms also disabled many refineries along the Gulf coast, hitting the production of heating oil.

The U.S. has so far enjoyed a mild autumn and the National Oceanic and Atmospheric Administration is forecasting a warmer than average winter. But worries persist. Weather Derivatives, a Missouri-based forecaster, on Wednesday predicted that home heating demand in the north-east states would be higher than average in the remainder of the month, pushing up oil prices.

In Germany, spot electricity prices peaked at 180 euros per megawatt hour this week after two of its nuclear plants were temporarily taken offline. In France, electricity prices traded as high as 129 euros per megawatt hour, according to Spectron, as the freezing weather settled across the region. Across Europe, gas and electricity markets face rising demand. A recent analysis by Capgemini, the consultancy, found "huge tension between supply and demand in the European energy markets" and said the spare generation capacity was "dangerously low".

"The situation in France is very tense," says Colette Lewiner, head of energy and utilities at Capgemini.

The events of last winter may prove instructive. The winter as a whole was warmer than average but a late cold snap caused serious disruption across the region. Electricity demand surged to an all-time high on February 28, forcing EDF, the then state-owned utility, to impose blackouts on Corsica and cut off some industrial consumers.

France, normally a big electricity exporter, had to import power from other European countries, many of which had their own problems. In Italy, gas stocks were all but emptied. In Britain, gas prices also doubled as supplies ran low. "The early spring cold snap we had in Europe this year nearly brought the continental European gas and electricity system to its knees," says Bob Skinner, director of the Oxford Institute for Energy Studies. "Nobody wants to talk about it."

This season there are also warning signals. Operators in Britain and elsewhere are already drawing gas from storage, an unusual practice so early in the winter. Mr. Skinner says that raiding gas stores now could leave the region vulnerable to another cold snap.

Even if supplies remain adequate, there is another level of vulnerability: the effect of higher energy prices on the economy. Global demand has proved surprisingly resilient so far to increases in energy prices. Despite a sharp rise in U.S. petrol prices, consumer spending has been relatively robust. But an increase in home fuel bills could hurt more.

Motorists are able to limit their petrol use by driving less or switching to more fuel-efficient vehicles. Without making large investments, however, most homeowners would not be able significantly to cut their use of domestic fuel. "A brutally cold winter would be a significant threat to the consumer, in my opinion, because it would promote a surge in natural gas prices in a market still limping from the double whammy to supply of Katrina and Rita," says Richard Berner, an economist at Morgan Stanley. He estimates that, even if prices were to remain at current levels, a very cold winter would force U.S. consumers to spend up to $60bn more to heat their homes. Increased heating bills in the winter of 2000-01 helped weaken the economy in early 2001, he says.

European consumers also face increased costs as utility companies raise tariffs to compensate for this year's increase in oil prices. Italy, for example, is due to raise electricity prices by 4.4 per cent in the fourth quarter, according to Natalie Dempster of Royal Bank of Scotland. Gas prices will go up 3.8 per cent in Italy and France and an average 9 per cent higher in Spain, RBS says.

As bills go up, belts will probably be be tightened. According to a report by Deloitte this week, consumers across Europe are likely to spend less on Christmas gifts than last year as the effects of rising oil prices -- as well as factors including concern over unemployment -- dampen confidence.

Governments say they have little control over global commodity prices. But the prospect that Europeans will be spending less on presents this Christmas and more in merely keeping the house warm will be a worry. The U.K. government, which is committed to lifting people out of fuel poverty, is clearly irritated by suggestions of soaring energy bills this winter. In parliament on Wednesday, Malcolm Wicks, energy minister, said U.K. natural gas spot prices were "irrational," adding that the system was "awash with gas."

Behind the scenes, however, it is taking the possibility of winter shortages seriously. The government held a meeting this month to discuss the issue with oil industry officials and Ofgem, the energy regulator. The government also commissioned two separate reports into possible fuel scarcity. "The obvious political danger is that we get a three-week cold snap and tabloid papers run stories of grannies frozen in their flats," says John Curtice, politics professor at Strathclyde University.

At least as alarming is the effect of soaring fuel bills on national businesses. EEF, the UK manufacturers' organisation, yesterday accused the government of being "in denial" over the impact of high energy prices on companies and risks to the security of winter supplies. Already, British chemical manufacturers such as Ineos Chlor and Terra Nitrogen have been forced to leave plants idle in recent weeks as gas prices soared. Gas-fired power stations, which provide around a third of Britain's electricity, have also cut back.

Many of the companies blame the government for their woes, saying they have done little to prevent it. PVC Group, a family-owned plastics manufacturer based in the north of England, says the cost of electricity it uses has shot up by 50 per cent in a year and profits are suffering. "What is our government going to do to help us?" Richard Loynes, senior manager at the company, asks with rhetorical resignation.

With the first snow of the season due to fall in London on Friday and temperatures across Europe set to plunge, the cries of anguish from business may soon be resounding more loudly.

DISAGREEMENT BUFFETS FORECASTERS

At the end of September the U.K. Meteorological Office put its reputation on the line, warning the government and industry to prepare for the first "cold" winter in a decade, writes Clive Cookson. Two months later, it is sticking to its prediction, which applies to the whole of northern Europe – and is based on a controversial technique said by forecasters in the US not to be reliable enough for public use.

The Met Office forecast leans heavily on predicting the North Atlantic Oscillation (NAO), a fluctuation in atmospheric pressure across the northern hemisphere, on the basis of sea surface temperatures during the previous summer and autumn. This method, incorporating data for the past 50 years, gives a 67 per cent probability that the NAO will be "negative" this winter. If so, high pressure to the north of the British Isles will allow more cold air than usual to flow in from Siberia.

But the U.S. government's Climate Prediction Center maintains that there is no satisfactory way to predict the NAO more than a couple of weeks ahead. According to its winter forecast, which uses a variety of other methods, eastern America is equally likely to have temperatures below or above normal -- and, fortunately for energy supplies, most of the central and western states will be warmer than average.

Relying on the NAO would have led to a forecast of unusually cold weather for the U.S. east coast, says Mike Halpert, the center's head of forecast operations. "We view the NAO as a research issue but not an operational tool," he adds.

Although the Climate Prediction Center does not issue seasonal forecasts for Europe, a leading U.S. academic center, the International Research Institute for Climate and Society (IRI) at Columbia University, does. In marked contrast to the U.K. Met Office, it predicts that winter temperatures in north-west Europe are likely to be above the average of the past 30 years.

Tony Barnston, IRI forecast operations director, says: "Our forecast is based mainly on the fact that the planet as a whole is slowly warming." Like Mr. Halpert, he dismisses the NAO as a predictive tool, describing its correlation with data such as sea surface temperatures as "too weak."

The Met Office is not deterred. Richard Graham, its long-range forecasting manager, says that as winter approaches -- it starts officially on December 1 -- new evidence is coming in to support the negative NAO prediction. This includes the latest sea-surface observations and multiple runs of the computer model of the atmosphere used for shorter-range forecasts.

"Of course there are uncertainties but we thought the two-thirds probability of a negative NAO was enough to put people on 'amber alert' for a cold winter," Mr. Graham says.

The Met Office has professional critics in the U.K. too. The Benfield Hazard Research Center at University College London agrees that the NAO can be predicted, though it uses a technique based on snow cover and air temperature gradients rather than sea temperatures. Its forecast is for the NAO to be only slightly below normal this winter -- not enough to justify the Met Office's warning.

"I would not base economic decisions on NAO forecasts because they are not reliable enough," says Mark Saunders, head of long-range forecasting. "There is a divergence of opinion between forecasters and I think the Met Office should have been a little more cautious."

Prof. Saunders points out that cold weather in late November, such as the British Isles will experience over the next few days, does not portend an Arctic winter. In fact, the Met Office's four-week forecast suggests that it will become mild during early December. Then, if the winter prediction is right, the cold will return in late December and dominate the weather in January and February.

So forecasters will be following the next three months' weather with particular attention. If mild spells predominate, the Met Office will regret its bold decision to draw attention to its prediction so far in advance. A cold winter would be a triumph for it -- and an important contribution to the emerging science of seasonal forecasting.

INVESTING IN RENEWABLES STARTS TO PAY

Winds blow most strongly during the autumn and winter months in many areas, making wind power -- regarded as the most advanced form of renewable electricity generation -- a promising candidate to supplement fossil fuels, writes Fiona Harvey. But only a few countries will this season be able to use wind to top up electricity supplies.

Although wind-power generating capacity has grown at nearly 30 per cent a year for almost a decade, it still provides less than 1 per cent of world electricity. That capacity is concentrated in a small number of nations such as Denmark, where wind provides more than 20 per cent of electricity.

While the U.S. accounts for 14 per cent of wind generation capacity, that remains small relative to its consumption. In the U.K., the government has pledged to generate 10 per cent of energy from wind by 2010, requiring heavy investment.

Steve Howard, chief executive of Climate Group, an international advisory organisation, says fuel shortages or high fuel prices this winter "will stimulate people to think more about renewables."

Some wind turbines are compact enough to be installed on individual houses, while factories and offices are being equipped with turbines to generate their own power rather than relying on the grid. Mr. Howard says: "Companies that have invested in renewables are seeing their strategy validated by high energy prices."

Detractors point to the unreliability of wind: when it fails to blow, the turbines do not generate power. As electricity cannot be stored, a back-up power source -- usually a conventional fossil-fuel power station -- must meet peaks in demand. Many say wind and other renewable sources can therefore only ever make up a minor proportion of electricity supply.

Some see a solution in changing the infrastructure to microgeneration. Instead of large centers of generation distributing energy to myriad points of consumption, there would be many smaller points of generation including not only wind farms and turbines but also smaller fossil-fuel power stations that supply heat -- normally a wasted by-product -- as well as power.

If governments balk at this change to the grid, there remains the nuclear option. Nuclear power stations fit into the existing infrastructure, avoid the oil and gas supply crunch, and bring no greenhouse gas burden. Yet with China alone set to build 40 N-power stations to supply about 5 per cent of its electricity demand, the high-grade uranium those require could itself become a scarce resource.

The first snow of the year is due to fall in London Friday and temperatures across Europe are due to fall. In the U.S., the mild weather has now come to an end. Governments will be crossing their fingers it isn't a sign of things to come.