Demand Destruction & Oversupply: How Gas Prices Are Reshaping The World | Ep236: Seb Kennedy

Bryony Worthington

The elephant in the room, surely, is the gas market dependency that we have? 

Seb Kennedy

Absolutely, it's been interesting putting out this quite provocative op-ed in Energy Flux, and sharing it on social media and seeing the feedback coming back from people. There's like an army of folks who would just say, ‘it cannot be done. You're barking up the wrong tree, the market is liberalized, you can't do anything about it. There's no way.’ There is merit in all of those arguments, if you start from the basis of: governments have no power, the market is omnipotent and nothing will ever change. But the broader context, the geopolitical context in which we're having this conversation is well, everything's changing. Look at the way that the Trump administration is wielding its enormous institutional power to push US LNG into Southern and Eastern Europe. It wouldn't be happening without that political push. 

BW

I’m Bryony Worthington and this is Cleaning Up. My guest this week is Seb Kennedy, a journalist who takes a keen interest in energy, especially gas markets, and the founder of Energy Flux, his own media outlet. Seb and I, together with my colleague Harry Benham, recently collaborated on an article about the UK’s relationship with Norway, which is dominated by trade in natural gas. I was curious whether something could be done to reduce pressure on UK customers' bills. And, given we are living through some pretty extraordinary times, whether a new relationship could be forged that saw us paying closer to the actual supply costs rather than volatile market rates. Since the time of Margaret Thatcher, the UK’s mantra, when it comes to energy, has been to leave it to private markets. But as we have tried to balance affordability with energy security and environmental protections, successive Governments have introduced layer upon layer of regulations in our electricity markets. Gas markets however have remained relatively untouched. And despite the fact that dedicated pipelines deliver most of our gas, prices have been pegged to international markets, inflating costs to consumers. We’ve used taxes to try to reign in the massive windfalls, as market prices surged, but they can’t be applied to imported gas. Norway is our most significant supplier and their gas is cheap to produce and the market is largely state owned. They took the pipelines into national ownership recently and own a controlling stake in Equinor, the largest company. So the majority of the windfalls we’ve paid on imports have ended up in the Norwegian Treasury. In the article, which is published on Energy Flux, we discuss why, given market prices are set to reduce, it is now in both countries’ interests to sit down to negotiate a closer relationship. The new bilateral deal we described centres around more long term gas contracting between the two countries, at rates closer to the cost of production, coupled with more derisked investment opportunities for the Norwegian sovereign wealth fund in UK energy infrastructure, including gas storage and electrification. My conversation with Seb starts with an overview of the global gas market before we get into the details of the article and then ends by briefly discussing the level of speculative trading there is now in global energy commodity markets. Neither of us would describe ourselves as anti-market but there are some things like food and energy which are so essential to human wellbeing that all governments need to pay extremely close attention to prevent excessive rent taking. We hope you enjoy the conversation. 

BW

Seb, thank you so much for joining us on Cleaning Up. I wanted to kick off, as we always do, by asking you to introduce yourself in your own words, please.

SK  

Thanks for having me on the podcast, Bryony, and also thanks for taking the time to write such an interesting op ed in Energy Flux, which I'm looking forward to discussing with you. So I'm Seb Kennedy, I'm an energy journalist and analyst and a publisher of Energy Flux, which is an independent news and analysis platform focused on the natural gas and LNG markets.

BW  

Thank you. And that we should just explain your wonderful background, because you're based in Costa Rica, right?

SK  

Well, I kind of have one foot here and one foot back in the UK, so I spend as much time as possible running away from winter.

BW  

Very good, very good. And I'm here in California doing similarly. So this is a conversation we're going to have about gas. And just to put this in context, clearly, we're all about Cleaning Up, making sure that we make the clean energy transition. But by and large, if you look at how we've had big savings in Europe, in the UK, in emissions so far, it's been a switch from coal to gas, and we are still now pretty highly dependent on gas as a commodity globally, as well as in Europe and in the UK. So from your perspective, can you give us a bit of a snapshot as to what's going on in the gas market globally? How much of an important factor is it at the moment in our energy mix?

SK  

Yeah, so globally, the gas market is really quite fascinating. It's been through a real roller coaster in the last five years or so, obviously going back to COVID. Then we saw massive demand destruction, and prices crashed, and then we kind of whiplashed out of that into the kind of post COVID recovery. There was a lot of demand, supply couldn't keep up. Prices went really high. And then to top it all off, Russia invaded Ukraine, and we saw this absolutely stratospheric pricing of natural gas unlike anything anybody had ever seen before for natural gas in Europe and, by extension, the UK. And that stratospheric pricing triggered a huge amount of demand destruction. So demand was created because people were literally just turning down their thermostats. And industrial facilities in Europe and elsewhere were shuttering because the cost of running on gas was just too expensive. Since then, we've had a significant correction, as is always the way with these extreme situations. The prices have eased off over the subsequent years, and then they rebounded. Last year we had this kind of incongruous rally again, where prices sort of increased nearly 50, 60, 70% in a few months, and then another big sell off at the start of this year. Because what we've got coming, and what the market is struggling to price in, is the next big structural change, as if all what's happened isn't enough, we've now got this unprecedented new wave of supply of liquefied natural gas (LNG), which obviously is those big cryogenic vessels that sail across the Atlantic carrying liquefied shale gas from the US and from other producers. And the amount of new supply and production that's going to enter the market between now and sort of 2029, 2030 is like a kind of 50% increase in LNG supply. And there are big questions everyone's asking: where's all the gas going to go? And in order to absorb all that gas, then prices need to come down to stimulate new demand. So there's this question about how low will prices go between now and the end of the decade? That's the big question. And that's at the heart of the question we've been asking about, well, what about the UK? How reliant is it on imports? And how is it positioned to kind of benefit or not from these structural changes.

BW  

So there's two things going on, or there have been two things going on at the same time. There's been this destabilization caused by Russia, who were one of the largest suppliers of gas, certainly to Europe. So that's caused price spikes.And that's led to demand destruction, where people are looking for alternatives. But then also we've got a kind of structural desire to move away from fossil fuels which, as you know, Europe has set itself some quite challenging targets. Lots of countries and self-targets to transition away from fossil fuels. And so that's also contributing to demand destruction. So how much of this coming glut is an increase in supply versus this sort of more structural, we want to get away from this dependency, this kind of addiction to a fuel that we have to keep purchasing repeatedly, and the price volatility being a vulnerability for countries. Is it just both coming together at the same time?

SK  

It is. But what's interesting is that the gas industry itself is always quite slow to acknowledge these big changes. And the mantra has always been, ‘oh, there's not going to be a glut.’ You know, demand always rises, the market fixes itself. The best solution for low prices are low prices. More and more we’re just seeing oil and gas executives acknowledging that, ‘yes, okay, like there is this kind of structural oversupply problem, but we think the glut won't be too big.’ And then you've got voices coming and saying, ‘actually, it could be quite big, and it could extend into the 2030s.’ We don't really know. And then the next thing, which they'll have to acknowledge is the demand destruction side that you've just mentioned. So they've taken some time to acknowledge the oversupply structural issue which they themselves have created, the market has created. And then in the background you have things like electrification driving down critical end use applications of gas. I'll give you a couple of examples. One is in China, where actually a huge amount of the liquefied natural gas that China imports is used in heavy duty trucking. They have enormous fleets of LNG powered trucks, but the sales on electric trucks is just going absolutely parabolic. They're electrifying their trucking fleet much quicker than anybody anticipated. So the idea that that will provide a kind of demand growth segment in China is potentially open to question, even if prices become very low, if they can electrify, then they will and look at Pakistan. Pakistan has had a solar revolution. In Pakistan, people just put solar PV on their roofs because the grid is so unreliable. And I think I saw a statistic that said that around the entire capacity of natural gas fired power stations Pakistan has just been installed in solar PV capacity in the last year or so. So you can imagine what that's doing to base-load demand for power, much of which comes from gas. They've got a kind of backup of gas in the system, they've got too much. They've got nowhere to burn it, because the power generation systems aren't running as much because of all this PV on the system. And they're actually having to turn away cargo. There is liquefied natural gas that they've contracted to buy from Qatar, and that's very expensive, because they're on the hook to pay for these cargoes, whether they take them or not. So there's a financial cost to being exposed, to being long on LNG when you have demand destruction eroding your LNG demand base.

BW

This shift is driven by the sort of economics of the alternative. That it is now just quicker and cheaper to put in solar plus batteries if you want to diversify away. And it sort of strikes me that that's kind of unstoppable now. And weirdly, if you look at the way the US has come in hard against climate measures, it may have a really counterproductive effect. Because climate measures have actually driven demand for gas, quite a lot of it. And if you think about Indonesia, China, large parts of India, they've got a lot of coal. And the only reason they would shift off coal is if they cared about the environment, right? And so, if you halt all climate activity because you don't believe it, you think it's a hoax, you might be killing off the demand for your product. Is anyone talking about that paradox? That the US is maybe killing off its own markets by being such a skeptic on climate?

SK  

It's an interesting theory. I think it depends on the energy system of each country. So the reason that countries like Indonesia don't want to turn away from coal very quickly is because of energy security. They have coal in the ground. If you rely on a commodity that is traded globally and in liquid in vessels that can be redirected depending on where they can get the most profit, then it's not the most energy secure option to base your economy on. It's a bit of a luxury and you don't have the security that you might otherwise have from things like homegrown sources: coal, or, for that matter, wind or solar. So in markets where gas is abundant, then it's a different question, right? In the US, they're very much leaning on the gas sector to power the next stage of their economic development, and much of that being the energization of huge data centers to power these big AI machines and LLM systems, which are incredibly power hungry. They want the natural gas sector to do the heavy lifting on that, and that raises all sorts of problems, because at the same time, they want to export “cheap” US LNG around the world. But at the same time, they're putting a huge amount of demand onto their domestic supply base, which is inevitably going to increase the domestic cost, and that cost gets passed through into the buyers of LNG on the other side of the world. So again, you're into this place where, well, how competitive can LNG really be if you have demand destruction in importing nations, combined with rising costs for the gas that gets put into these liquefied natural gas liquefaction plants to turn it into LNG to sell to places like Asia and Europe?

BW  

And I'm fascinated by this kind of unintended consequences of the US current approach to everything really: diplomacy, energy… It all seems quite chaotic. And because we're talking here about LNG, most of our listeners are very aware of this, but to take LNG to market is a lot more expensive than to push gas through an existing pipeline. So why did the market think LNG is the future? Because we had this big disruption of Russian pipeline gas no longer being acceptable. But then what happens is China says, ‘Oh, well, hang on, we've got a neighboring border with Russia. We'll start taking Russian gas from you.’ So again, that reduces the demand that could have been met by US supplies because of this kind of US first, US against the world position. Other alliances being formed are really unhelpful to the US. So I think it's perhaps not been very well thought through, or at least it seems to be playing out that this move to use gas as diplomacy isn't really panning out as I expected. Or maybe I'm just reading the tea leaves wrongly here? And perhaps they just will prevail, but it feels like for most countries, it's going to be quite a difficult thing to think: ‘Oh yeah, sure, of course, we want more reliance on the US.’ Just at the point where the US is indicating that it's America first and America only.

SK  

Well, you mentioned China in that context and let's not forget, there's a trade war between the US and China, and one of the reciprocal measures that Beijing has implemented is a tariff on US liquefied natural gas. So China hasn't imported a single cargo of American LNG for a year or so now. But yeah, it's like this idea of using LNG for diplomacy measures and then also trying to start a trade war. When you're exposed as a seller, you're reliant on them as one of the biggest buyers of LNG, it's not particularly well thought through. The market is kind of able to hide the worst effects of this. But next year, you have some some very big supply contracts between us, LNG plants and Chinese off takers that will come into effect, and if they can't literally import them into their home market, then you're going to see the that kind of oversupply in the Atlantic basin being just that little bit bigger than it might otherwise have been because China could have absorbed those cargoes but it won't. Now in Europe, it's different because there's been this almighty lobbying push by the Trump administration to sell US LNG into parts of Europe that were and still are, to an extent, reliant on Russian gas. And we've seen this absolutely phenomenal display of diplomats and ministers and high level CEOs from US LNG and gas companies going over to, like Southern Europe, Eastern Europe, and trying to open up new import routes for liquefied natural gas towards Ukraine. So through Greece, there's a pipeline network. They're trying to feed the gas up from Greece into Bulgaria and then onwards through Romania and Moldova and Ukraine. And also from the north, so from Lithuania and Poland, down through those countries towards Ukraine. Because Ukraine is obviously extremely short of gas, having suffered so much bombardment of its energy infrastructure, they urgently need to get that gas into Ukraine. I'd say that they're actually kind of being more successful on that front because Ukraine just imported its first cargo of US LNG. Just last week, a private company called DTEK imported a cargo from Louisiana, and I think it docked in a terminal in Lithuania, and it offloaded that gas. It's going to wind its way through the network into Ukraine. And I think they're knocking on an open door there, because the proposal to ban all Russian oil and gas from Europe by 2027 and the losses that we've already had from the end of transits through Ukraine already are creating this kind of big demand hole in central, eastern and parts of southern Europe. And so, you know, having an abundant supply of liquefied natural gas from the US, which is nominally an ally of this region, makes more sense. And so you've seen energy ministers and the transmission system operators all queuing up to to enable that to happen, by lowering tariffs for the import of LNG, and through those routes, and facilitating logistically, the ability to kind of get the liquefied natural gas from places like Alexandropolis in Greece into the the pipeline system and pump it north towards towards those countries. And I think you'll see that trend increasing over time.

BW

But also geographically, surely it's much easier to bring in gas from the Middle East to that region? Are they not competing against much cheaper per unit production from, say, Qatar or other nearer vendors?

SK  

Yeah, I'm glad you mentioned Qatar, because that's really the elephant in the room for the whole LNG outlook. Not many people talk about Qatar, but you're right, they have the lowest cost of production of any LNG supplier. No matter how high prices go, they will be profitable. So if market prices in Europe and Asia fall to a point where liquefied natural gas plants in the United States have to shut down because they're not profitable, Qatar will still be making money. So there's a big question there, and they're massively increasing their production capacity over the same period between now and 2029-30. So there's this question about how Qatar manages this advantageous position it finds itself in? Is it going for market share? Is it going to flood the market and essentially try to price the US shale LNG supply out of the market? Or are they going to just maximize revenue and withhold production and try to maximize the margins on the molecules they are putting into the markets. It'll be very interesting to watch. Qatar is a big factor in this, but the problem they have in terms of getting to Europe is that they can't get their cargoes up through the Suez Canal because there have been a lot of hijackings, and there's a little insecurity in the Red Sea. So liquefied natural gas vessels have been going the long way around. They've been going down around the southern tip of Africa, around the Cape of Good Hope, and all the way up the other side, along the west coast of Africa in order to get to Europe. And that adds a lot of expense and time and logistical constraints to do that long trip. So increasingly what we're seeing, as a result of that issue, we're seeing LNG slightly fragmenting the markets. Where Qatar is facing east and focusing on China. And, you know, China is turning its back on America, and America is kind of focusing on transatlantic trade and just supplying into Europe. So you're seeing this kind of, not really a fragmentation, but certainly like a bifurcation of the liquefied natural gas markets. And I think you'll see that manifest in different pricing regimes for LNG on the water in the Atlantic compared to in parts of Asia.

BW  

Returning back to the US, I mean, one thing that strikes me is that Qatar has an advantage over the US, is that Qatar's domestic market and its population is tiny, so they can keep exporting. I'm sure their actual physical demands for their own country is a fraction of what they export. Whereas in the US, you've got a very large domestic market, so every increment of more exports that you add to the system, you're pushing up prices for your domestic market. And I just think it wasn't so long ago where there was a ban on exporting gas from from the US, but precisely to keep prices low at home, and to keep a handle on inflationary pressures, on cost of living. And here we have that kind of completely ripped up it seems. And it's just: export as much as you can. But that's going to have an effect domestically, isn't it? And that's going to cause some political problems, I'd have thought.

SK  

Yeah, and I've flagged this in Energy Flux on numerous occasions. There are political repercussions that come when domestic energy prices go really, really high. And the US electorate is nothing if not accustomed to having cheap energy. They've had this shale bonanza, it's kept gasoline — petrol — prices cheap at the pump. Whenever gasoline goes above $5, stickers start appearing on the refilling tanks saying, ‘Biden did this.’ They're trying to pin the blame politically on Biden for making gasoline expensive. And I think you're going to see something similar happen in natural gas. Because gas is, I think it's about 30% of electricity generation, depending on which part of the United States you're in. But it's a humongous supply portion of power generation. And so if that marginal cost generator goes up from… The traded price on the Henry Hub is like $3 or $4. If it pushes up towards like five or six, then that gets translated through to power prices. And people are really going to feel it, and that won't go unnoticed. There will be a response. If it goes structurally higher for significantly longer than anyone's anticipating, then I think you could see some repercussions. And it could happen in the next couple of years, and it could coincide with the next presidential election in 2028. It's not beyond the realm of possibility that we see domestic natural gas pricing in the US get really expensive at exactly the time that it gets much cheaper in importing regions such as Europe and the UK. And of course, the UK is going to have a general election in probably 2028-29 as well. So there's an interesting political dynamic around this kind of equalization of prices, or the kinds of narrowing of the spread between cheap US and expensive EU gas and electricity prices, coinciding with elections on both sides of the Atlantic. You know, when people feel worse or better off, it can influence how they vote. So there is this enormous political dimension to the price of energy and it all. It's all predicated on the cost of gas, which is influenced by all the things I've explained.

BW  

I think those political prices are already coming to bear. There was just a gubernatorial election in November where a candidate won on the basis of basically saying, this is the New Jersey Governor, ‘I'm going to cap utility prices.’ Because the cost of living and affordability now is the big battleground. We've got the midterms coming up, where I think energy prices are going to be a big feature. So let's just talk though the plus side, the upside of gas prices softening, because this theory is right, that this big over capacity has been unwittingly unleashed by private actors seeking to gain as much market share as possible, leading to this perhaps oversupply. And now that could mean prices softening. That's kind of problematic for the electricity transition. Just thinking about the spark spread that we have to — if you want to see electrification as your answer to climate change, which a lot of people are realizing that it’s let's get off the molecules that stop burning stuff and let's electrify. But for electrification to make sense, you've got to have relatively cheap electricity and expensive gas. That spark spread has to be within reach. And at the moment, certainly in the UK, you know, the spark spread is so high. I mean, it's over four times per unit, right? So for your heat pump to make sense, you've got to really see gas prices higher and electricity prices lower. But it looks like the opposite is going to happen, right? We're probably going to have electricity prices and now lower gas prices. So that really challenges this electrification narrative, doesn't it?

SK  

It does. It's a real double edged sword, cheap gas in a decarbonising economy, for the reasons you say. And one of the problems is that, yeah, while gas is the marginal generator in it, when it gets cheaper, it literally becomes cheaper. The reality is that for a whole host of reasons, power prices are not going to come down massively, and it won't be like one for one proportionate to the reduction in the gas price that you see on wholesale traded markets. And that's a problem. So I'm not really an expert in that field, but I've always thought that it's just madness to put all of the levies onto the electricity portion of the retail bill and to give gas a free ride. Like if you're trying to incentivize electrification, put as many of those social and environmental levies onto gas or onto taxation or anywhere else, and keep the electricity as cheap as possible. And then you're going to see more people using heat pumps, you're going to see more people using electric vehicles. And then you're kind of reducing the demand base on your gas. And for a country that's exposed to import dependency, that improves your energy security. So I just see it as a bit of a no brainer. There must be a reason why it hasn't happened until now, and it's probably because the departments can't agree. Nobody can agree when, ‘Oh, you want to heap some more cost onto my department.’ Or just the kind of institutional inertia around getting things done could be a reason why this hasn't happened. But I think there's a bit more movement in that space, if I'm not wrong, like people thinking about it anyway.

BW

Certainly people are thinking about it. And I think the problem is, in our very immediate memory, we've got that massive spike that we had as a result of the illegal invasion of Russia into Ukraine, which saw gas prices triple pretty much overnight. The wholesale prices just spiked extraordinarily. And so the idea of making gas, this is gas for heating now, gas for keeping us warm in winter. And the idea of loading more costs onto that, it's just socially and politically sensitive. Because this is how people keep their warm, keep themselves warm in winter. And so there's been this kind of desire to not put any more prices on. But if we’re entering into an era of softer prices, maybe then we do have the courage to say, actually, now our focus has got to be making electricity affordable. And so that could see a rebalancing of the levies in the tax base to internalize the cost of gas. And the other factor is, if you look at what Europe's up to, they're about to extend their carbon pricing regime beyond power into gas and transport. So Emissions Trading System 2 is about to come into force, which will see carbon prices being added to those bits of the economy that have not currently been paying any real internalization of climate costs. That's about to start. So again, that changes the dynamic of electrification, hopefully in favor of more of it. But a lot depends on how that's implemented.

SK  

If ever there was a time to do it, it's now because, yeah, we're going to have structurally cheaper gas for the next five years or so. So you have a little bit of leeway to do things like carbon pricing, to do things like building levees on the gas portion of bills because there will be a little bit more headroom for it.

ML

Cleaning Up is supported by its Leadership Circle. The members are Actis, Alcazar Energy, Arup, Cygnum Capital, Davidson Kempner, EcoPragma Capital, EDP of Portugal, Eurelectric, the Gilardini Foundation, KKR, National Grid, Octopus Energy, Quadrature Climate Foundation, SDCL and Wärtsilä. For more information on the Leadership Circle, please visit cleaningup.live. If you've enjoyed this episode, please hit like, leave a comment, and also recommend it to friends, family, colleagues and absolutely everyone. To browse the archive of over 200 past episodes, and also to subscribe to our free newsletter, visit cleaningup.live.

BW  

So we should have said at the beginning how we met, which was I'd been sort of musing about this relationship that we have with Norway — and we can come into why Norway matters so much — and I'd said to my friend Laurent Segalen, from the Redefining Energy Podcast: Who can I talk to about gas pricing and gas markets? And he said, ‘Well, you need to talk to Seb Kennedy.’ So that's how the introduction came about. So we just published an op-ed on your site, and it was a collaboration between myself, my colleague, Harry Benham, and you. And we did a deep dive on Norway. But just tell us why Norway matters so much?

SK  

Yeah, so Norway provides about half of the natural gas that's consumed in the UK. It's produced in the Norwegian North Sea and other parts of the continental shelf of Norway, and it's gathered up through a network of pipelines and exported to the UK. They also have pipelines going to other countries, such as Germany and most recently, Poland. But they are a major, probably the single largest source of natural gas for the UK. Of course, it never used to be that way. We had our own North Sea bonanza, but most of the resource has been used up, and production is on this kind of secular decline trajectory now. And no matter how much investment you put in, it's never quite going to get back anywhere near to the glory days of the 1990s when we were self-sufficient in gas and could even export to the rest of Europe. So yeah, the UK has huge import dependency. A lot of that falls onto Norway. And of course, they didn't do what the UK did, which is they didn't completely privatize their upstream sector. They kept state involvement in their state oil company, Equinor, whereas the UK didn't. It was all privatized, and a lot of the benefits of the North Sea bonanza were essentially frittered off in shareholder returns, and there was nothing really left for the state. Whereas you look at Norway, they have this sovereign wealth fund, and I probably should have checked the figures for how big it is, but I think it is in the trillions? 

BW

Yeah, it's over a trillion.

SK

So they're swimming in cash. But I guess the other element is, it's not always a fair comparison, because obviously Norway has a tiny fraction of the gas demand that the UK does, because they have such a small population, plus they're endowed with enormous hydro resources, so they don't really need to burn gas. So their gas demand is just a tiny, tiny fraction of their overall resource base. So they have to export it. They are as reliant on the importing markets as the UK is on the exporting market. So there's this energy interdependency, and it’s very closely intertwined, going back decades now, of this codependence between the UK and Norway. But the issue which you flagged to me, which I hadn't given much thought to, which has really got me thinking over the last week or so, is that there's this codependency, but the vast majority of the gas which the UK imports from Norway is sold at market rates. And so Norway has just enjoyed the most phenomenal windfall rents on the back of market pricing for gas, which they produce right next to a friendly neighbor. And it should be added, they have some of the cheapest gas in the world, too. We talked about Qatar earlier. They've got a cost of production, which is depending on the field, perhaps even lower than Qatar. Difference being they don't really export it as LNG, they export nearly all their gas through pipelines. So they're constrained to where they can send it, but they have expanded their destinations to all across Northwest Europe and as far as Poland now. But still they need people to buy their gas, as much as the UK needs to buy it from them. And so you came to me from the political perspective, saying, ‘Well, shouldn't there be a conversation about, is this a sustainable situation, as much for Norway as the UK?’ Because if they keep selling their gas at market rates, then they're going to see an enormous revenue hit when the LNG wave depresses hub pricing for wholesale gas that they sell. And we ran some numbers, didn't we? And a very rough calculation, the estimate is that Norway, Equinor I should say… Equinor specifically, they earn about €10-ish billion a year on their gas exports just to the UK. And like right now, the futures markets are pricing in a 30% decline in hub pricing. So that means a €3 billion euro hit. I think it could go much lower than that. Many other people think it could as well. Goldman Sachs, this week said that TTF, that's the main trade price of gas in Europe, could go down to $4 per MMBtu, which is 60% lower than it is now. So Equinor, €10 billion minus 60%, you do the math. That's the amount of revenue they could be losing every single year. So is there an incentive, maybe, for them to strike a new deal with one of their biggest partners, who could do with long-term visibility over their supply sources. And Norway, in return, would get long-term demand certainty for their core export product.

BW  

You covered a lot there, and so for me, the thing that really struck me was this point you made that Norway's gas is amongst the cheapest to produce in the world, right? And it's kind of tethered to us via pipelines, which is also the cheapest way to deliver gas. So you would expect, then, that geographic arrangement to pass through to us having a reasonably priced gas wholesale price. But it's not how it works. How it works is that Norway prices their gas according to market value, which is highly volatile, which we saw with the Ukraine invasion, massive spiking. And so, because we're geographically tethered, it's kind of a monopolistic arrangement, but they can just set the price according to the market, and it's not regulated. There's no form of price regulation that says, ‘Oh, hang on, that's a bit too high a profit. You're in excess of 40% 50% profit here at the expense of the UK consumer.’ There's no way of stopping that from happening, except for signing contracts, long-term contracts that try and give you a price corridor. And I was just really surprised by it. But that's not how it works. The majority of the market is still being priced on the spot, paying merchant prices for a big portion of that, which, when prices are low, is fine. But when prices are high, you're really suffering. So there's been an enormous amount of rent-taking by Norway from the UK over the last, let's say, five years, and that's now sitting in their sovereign wealth fund. And we are, as a country, desperate for inward investment to get our economy kick-started, still exposed to high cost of living because of gas prices being still relatively high at the moment. Is now not the moment to be having a big conversation with Norway about what can be done differently that benefits us both? And from the politics perspective, both are left leaning centrist governments, both are facing attacks from the far right on a cost of living basis. And politically, it would seem to me, a deal with Oslo that kind of dampens this down, gets us onto a more even footing, and acknowledges that interdependency. You said Norway needs us just as much as we need Norway, and we basically geographically share the same basin. It's just an accident of where the line was drawn and timing. We exploited our fields a lot faster and earlier than they did, so they've still got a lot left, whereas ours is more or less done. This feels like a conversation we should be having, and I was trying to find evidence of high level conversations between the UK and Norway on energy. And the things they talk about are, it seems, I'm not in the room so I don't know, but what's reported out is, ‘oh, we had a conversation about CCS, or we had a conversation about offshore wind, or had a conversation about hydrogen.’ All of which are important, but that's the elephant in the room, surely is the gas market dependency that we have?

SK  

absolutely and it's been interesting putting out this quite provocative op-ed in Energy Flux and sharing it on social media and seeing the feedback coming back from people. I mean, there's an army of folks who would just say, ‘It cannot be done. You're barking up the wrong tree. The market is liberalized. You can't do anything about it. There's no way.’ And there's an element of truth in that. Gas deals are struck by companies, not governments. Why should Norway give up its windfall rents? It's a free market, blah, blah, blah. And there is merit in all of those arguments, if you start from the basis of ‘governments have no power.’ The market is omnipotent, and nothing will ever change. But it's the broader context, the geopolitical context in which we're having this conversation is well, everything's changing. Look at the way that the Trump administration is wielding its enormous institutional power to push US LNG into Southern and Eastern Europe. It wouldn't be happening without that political push. So this idea that governments are powerless, I question that. I think that we need to have a bit more imagination around what's possible. And this idea that the ministers stand back and say, ‘Oh, we can't do anything. It's just the market. ‘It's like, well, that's not necessarily the case. You've seen the way the government's influence markets in the last few years, now, more than ever.

BW  

A couple of things on that one as well that I found quite shocking was the degree to which the Norwegian system is not open to the market. Because Equinor is the biggest provider. I think it is something like 67% owned by the Norwegian government. So it's not the market. It's sort of a state-sponsored market in Norway's case. Plus they just re-nationalized the pipelines, so that's now totally in government control. And then they take a 78% rent, you know, tax on the revenues from these. So it's wrong to say the market is driving things in Norway. It's very much a state driven question and intertwined. Now we, on the other hand, have just gone, ‘yeah, sure, let everything be liberal.’ And we try to do price controls downstream, like we try to put price caps on the utilities and this to protect end consumers. But we've done nothing to try and control the upstream side and to think again about how you could regulate this differently? Or how could you sign bilateral or have negotiated arrangements that focus on the real issues here that are driving affordability problems. And it comes back to gas prices, really. They drive the electricity prices up, and they keep our heating bills up and make our industries more expensive. If there's nothing more important than that… certainly it’s more important than messing around with miniature hydrogen discussions or promises of some CCS at some point, which haven't materialized and will only ever add costs. They won't save costs. So I feel like it’s time for a reset.

SK  

It's interesting, because the gas market used to be all about bilateral trades, point-to-point, long-term contracts. There never used to be deep, liquid, traded hub market pricing for gas. This is all a relatively new phenomenon from the last decade and a half or so. And it's been thoroughly embraced by every single UK Government. It's been embraced by the European Commission, by regulators across the continent, and of course, in the States as well, where they've financialized a lot of their commodities too. And the experience of liberalization has been an increase in market efficiency and lots of cost savings for consumers. So until Russia's invasion of Ukraine, the cumulative cost savings to consumers of buying gas on a liberalized market basis was in the billions of euros. But all of those savings were wiped out the day that Russia invaded Ukraine, and prices went parabolic, and all of that pricing was passed straight down to the retail bill of all the consumers. And that's the reality of market pricing. You are exposed to the roller coaster of the market. And I'm not advocating for a complete abolishment of the market, that's completely unrealistic, but I think just having the conversation, now is a really interesting time to have it. Just because there is so much uncertainty out there and can we do things differently? Now, one of the arguments that came back to me. that really stuck from sharing this op-ed, was: ‘we've been through the pain of Russia's invasion of Ukraine. We swallowed these high energy prices that we've had to subsidize bills. We have to shut our industry. We have to turn our thermostats down. Why don't we just sit back and enjoy the lower market pricing that is about to wash over the market and just be happy?’ Why should we turn our back on the cheap energy when it's just around the corner? And it's a really good point, right? And the only thing I can really think about that is: isn't that a good moment to negotiate and get a long term deal? If we can lock those prices in for longer, then the next time the market goes crazy, we’ve got a little bit of insulation around the edges. At least we've got this long-term contract that has a cap and a floor price, and we're not totally exposed to the next parabolic geopolitical event.

BW  

That is the argument, isn't it? Oh, but the sunny uplands are about to arrive, we should just sit back and allow this volatility to dip. But the nature of volatility is it won't be long before it spikes again. There'll be a boom and bust, and another cycle. And there's two other elements that I think we touched on in the article, which I found fascinating. One is: what about our storage capabilities? Because one of the reasons the UK is so exposed to the volatility is because we have to buy spot, and we don't have very much in the way of storage capacity. And famously, when we left it to the market, Centrica shut down Rough, which was our biggest gas storage facility, on the pretext that it just didn't make any money. Now you have to question and wonder, was it because you were making so much money on the trading side of the business with the volatility that the storage was actually the arbitrage? The storage actually would have undercut that income. We just don't know, because this is all now in private hands. And we do know that commodity markets make a lot of money from trading, right? There's a reason why there are so many people involved in these markets now who are not buyers or sellers, they're just intermediaries, and they are trading on a daily basis on this volatility. So why did we not keep strategic storage on it so that we could protect ourselves? And you came up with some amazing numbers about how exposed we are, say, compared to Germany. They've got, I don't know how many days worth of gas storage and we've got, what? How many days do we have? Less than a week, isn't it? So it's just mad how exposed we are to not having storage. 

SK  

The UK has about 3.2 billion cubic meters, or 19 days of supply of storage capacity. And you compare that to Germany, which has 25.6 billion cubic meters, or 119 days of supply. So obviously they're far more insulated from price shocks to the extent they can use the storage for that purpose. Now, the question we didn't attack in this article, because it was already very long, but one thing I've covered a lot in Energy Flux is the way that storage is used. And so you can either use it as a strategic facility, for the benefit of the consumers. Or you can let the private sector manage it and essentially, kind of arbitrage away the time spreads. And so the idea of building more storage capacity, it's like, well, what's it going to be used for? And if it's just for the private sector, if the private sector is going to be the one that finances it, they're going to want to be able to play the market and arbitrage away all the time spreads. But they've already told us that the margins aren't good enough to be able to justify the capital investment in storage. That's why we don't have much storage in the UK, because it was just not very profitable or even loss making, because the spreads weren't big enough, and the margins you made from putting gas into storage and pulling it out later just weren't high enough to cover the cost of operation, the cost of finance, cost of construction, all that stuff. So, essentially it goes: ‘well, we better put up money somewhere where it gets used, put to better put to better use.’ So, again, you've got this question of: Is there a role for the state to get involved, de-risk the investment and manage the facility for the public good? Why not have a strategic gas store, seeing as we're so exposed to the market and we're so exposed to imports, and no matter how much money you pour into the North Sea, we're not going to get back to a place where we have this kind of abundance of gas. So that being the case, maybe we should have a strategic gas store and a bit of resilience in the system to tide us over these moments when the markets go crazy and consumers are kind of on the hook.

BW  

That also led us down into realizing that, instead of bringing Rough back online to store gas, what Centrica are currently doing is exploring whether they should convert it to a hydrogen store, which kind of beggars belief. And in fact, we are already converting one of our smaller stores in the UK to hydrogen in the hope that somehow that's going to be filled up with some cheap commodity. How that's going to happen, I have no idea. So at times it seems as if we sort of skipped over the bit in the middle of the transition where we're still relying on gas and we've got to make sure it's affordable for consumers, and we've gone straight to this kind of hydrogen economy Nirvana, which is a bit of a figment of a of a gas lobbyists wet dream. I don't see this as the strategic priority for today, right? If it turns out that there's tons of green hydrogen floating around, it's really cheap and we need storage, then let's think about it when that happens, not now, where we're potentially reducing our gas storage in favor of this commodity. It just felt like we're strangely focused on the very, very near term and the very, very long term and missing the middle bit.

SK  

Absolutely. I mean, let's just get real. UK gas demand is not going to fall anywhere near as fast as UK gas production. There is this kind of yawning gap between supply and demand, and that's only going to be filled in by the amount of gas we can convince the market to send our way. And that means by paying market prices, paying above… So we have the UK traded price, which is called the NBP, the National Balancing Point, that frequently trades above the TTF, which is the Title Transfer Facility in Europe. So if the prices are higher in the UK than they are in continental Europe, the gas flows towards the UK to draw gas out of continental Europe, to meet British demand. Or conversely, to attract LNG cargoes that are free to go wherever they want. They follow the market, they follow the money. If the UK is offering the most profits, that's where the gas goes. We're going to be reliant on this dynamic for a long time. No matter how quickly we manage to decarbonize and electrify and all this business, there's still going to be this massive import dependency. So I just think there needs to be a little bit more thought given to this. It’s always ‘There's loads of LNG, we'll be fine.’ That was the answer of successive energy ministers in the UK whenever there was a question in Parliament about ‘should we not have a conversation about gas storage?’ They're very relaxed, just leaning on this LNG argument, saying we have these just in time supply chains, LNG will always be there. We've got loads of unused capacity to regasify the LNG, to dock the ships and regasify the LNG and get it into the UK grid. But look what happens when the market tightens, when the market goes crazy, everyone's in the same boat. They're all bidding up the price to try to pull the gas towards them. That's what we saw in 2022-2023. I don't think it's a very healthy place for an industrialized economy to be that reliant on imports, on market pricing. There needs to be some sort of resilience built into the system. And I think the idea we flagged in the article is just kind of opening the conversation about, ‘what are we going to do about this?’

BW  

And I mean, just to return to Norway again, it's also the case that, as you mentioned, we did not build up a sovereign wealth fund. We did not put our tax revenues into a special capital accruing facility. We spent it on schools and hospitals and goodness knows what to keep the country running. But Norway didn't do that. As we talked about, like Qatar, it has a very small population. All of this geographic accident of gas is an export potential for them, and that through this period, they've accrued a huge amount of money into their sovereign wealth fund. And that sovereign wealth fund is getting to the size where, I mean, it owns 1% of everything, I think. We had a brilliant episode on this with the lady who runs the Norwegian investment strategy. And it seems to me that they've had a bit of a failure of imagination. They just buy 1% of equities of everything. They've now sort of said, ‘Oh, we're going to invest in some strategic project-led financing and debt.’ But what if we said to them, ‘Look, the UK, we're a very good customer, a very investable economy. We need to make a transition. That transition is going to be electrification, and we want strategic gas reserves. Put some of your capital to work in our country, and not fiddle around with little bits of gas, little bits of CCS infrastructure, but do the electrification investments with us.’ That's the long term vision for us. And then do this gas storage in the medium term, so that we're sort of tying ourselves into a bit of a medium term plan and addressing the real issues that we need to get to grips with so that the consumer ultimately benefits. Because Norway's gas is going to run out, right? That's the other thing. Our gas is already on a declining pathway. No matter how much money you put in. It won't be long before Norway is there, maybe 20 years behind us, perhaps. But it's not going to go on forever, so let's put in place these different terms of mutual investment, but on the longer term, which is through this electrification strategy. I feel like there needs to be a serious conversation about energy between these two countries. As we said, politically, they're very similar. They've got mutual interests. They're trying to fight back against populist right wing attacks. It seems like the right time because of the softening gas prices. Let's do it.

SK  

Yeah, well, hopefully we've sowed some seeds in the minds of people who are placed to do something about it, we'll see. Just a final word on the storage thing, like on the sovereign wealth fund is that we've seen essentially sovereign capital put into UK energy infrastructure, in things like UK new build nuclear, like Sizewell LC. A lot of that is sovereign capital when you trace it back. So the only way to leverage that is to massively de-risk the project. We have a model, there's the regulated asset based model, which can be applied to big infrastructure projects. And that could make UK storage facilities like an investable asset for something like the Norwegian sovereign wealth fund.

BW

We spent a lot of our time on that transition away from fossil fuels. But the reality is, at the moment, we are still highly dependent on them. We're about to enter into the winter, Britain is a  famously cold and wet island that needs this to keep everyone safe and to keep the economy running. And gas is a fascinating topic. Perhaps we've been guilty of skipping over it, and if we do focus on it and look at it, it is the biggest driver of our prices. Now we could do other things, including, as we talked about just today, rebalancing the tax base away from electricity, to keep that more affordable. We can change the way we price electricity as well. That's the other big elephant in the room. Is that gas is the price setter for everybody in the market, therefore, renewables are actually, on occasion, getting big windfalls. Those of them that are outside the CFD mechanism, they're getting a lot of money in rents because of the gas setting the price. So there's lots that needs to be done. I feel like that's where our attention should be in the short to medium term, because the cost of living crisis may be softened by the market, but I'm skeptical that just hoping that happens is all that we can do. I'm sure there's more that can be done. 

SK

Yeah, hope is not a strategy, 

BW

Exactly. But listen, Seb, it's been a delight getting to know you and to work together on this article. Where can people find this article if they want to, if they want to read it?

SK  

Yeah, and go to energyflux.news. It's on the homepage at the moment. You'll see ‘UK-Norway gas trade. Time for a new deal?’ It's free to view. And yeah, I'm on the regular social channels at Energy Flux, or Energy Flux Mews. 

BW  

And as we said this is an intervention that's designed to provoke responses. And we've already had a few. There's also going to be questions raised about, ‘Well, if you're asking Norway to start doing this, what's the UK's approach to its own supplies?’ That's a whole other subject about the fact that at least when it's our own North Sea production, we are taxing it, you know, we tax it for windfall profits. We can't do that to the Norwegian supply, but maybe there's a better way even there. Why allow prices to be set at market rates and then claw back the tax? It seems a bit inefficient. Perhaps just get the pricing better. Could we not regulate that? So hopefully, a good stimulus for lots of people to come in and say, why we're wrong, why it can never be done. But then for some people, maybe we could reimagine it, not that we want to mimic Trump and his way of working, but in a period where norms are being challenged all over the place, perhaps we should be challenging norms in favor of citizens and consumers getting a better deal. Slightly less rent-taking on this commodity market that is at least volatile. That seems to be its defining feature at the moment. 

SK  

And the structural changes I've described coming down the pipe of the gas market, I follow them with granular detail in Energy Flux. I've put out regular chart decks and deep dives looking at how the economics of gas are changing. And as an independent publisher, I'm in a privileged position to say things that other gas analysts are perhaps encouraged not to say in such a loud voice.

BW

Which reminds me, actually, Seb, I wanted to mention the work you've done looking at the supplier-demand interdependency. There is this middle tier of commodity traders who are in the market. And you've done some really interesting analysis. Because of the European transparency rules, we can now see how many trades are happening on these commodities, and it's an extraordinary number of actors that have come into this market, right? And hedge funds and the different trading desks. And you've uncovered some of that, but that transparency isn't quite what you want it to be, is it? It's still in favor of this market mantra that all trading is good trading. And there comes a point where I think some trading is entirely parasitic, and we're just seeing another source of rents being taken out, which is just straight into the city and into financial markets.

SK  

So this is another heretical view that I like to give a little bit of oxygen to in Energy Flux, is just to ask the question about the amount of speculation that happens in these financialized commodity markets. So yeah, just last week, the commitment of traders report — that's where the exchanges publish the overall net positions of all the different actors, it's all anonymized and aggregated into trader type — but basically there are now 450 hedge funds actively holding TTF futures. That's risen, you know, I don't know five or six times since Russia's invasion of Ukraine, because there was such a massive money making opportunity. When prices went really high for anybody that was holding a long-paper position in gas futures, they made just immeasurable fortunes. Also physical volumes, obviously the rents on those were enormous. And so since then, you've seen this humongous wave of investment funds, hedge funds, piling into TTF futures. They see it as a kind of very easily accessible, deeply liquid trading hub where they can come in, take positions, exit and kind of repatriate profits back to the original source of their funds, which often tends to be in the US or in Asia. You have investment funds, hedge funds, high net worth individuals who are basically playing the markets. Now, the argument I always get, always get criticized for is ‘well, you can never have too much liquidity on a traded hub’. Everyone always says there's no such thing as too much speculation — when you want to get in and out of a contract, you need a liquid hub to do it. And the traders, they're all there, the hedge funds, are all there as your willing counterparty to allow you to exit or enter a position quickly. I just think that nothing in extreme is healthy, and I don't think that that argument holds up. What if we have 1,000 or 2,000 hedge funds, or 50,000. Is that still healthy? I don't know the answer. I just asked the question because what we saw on the traded price of gas last year was this almighty bull run in the price. Even after Ukraine and the prices had come down again, we saw a 50% increase in the traded price of gas on the basis of nothing very much apart from the hedge funds having built up an absolutely humongous net long bullish position on the future price of gas. So I did some correlation analysis looking at this and the relationship between the price of gas on the market hub and the change in the position of the traders is upwards of 60 or 70%. So what I'm saying is that when the hedge funds move their positions in TTF futures, it moves the price of gas. And TTF is the benchmark that moves the price of gas all over Europe, including the UK. And it doesn't seem to me that they are all improving liquidity for the good of the consumer. They're all in it because they're extracting value from the system and I just don't really buy the argument that if we were to lose 50 or 80% of the hedge funds, that somehow the traded depth of the market would dry up, and prices would go all volatile again. I think there are a lot of people who are just trend following. You buy low, sell high, exit, take the money back to Texas, and everybody's happy. That seems to be the way that the prices are set on the TTF at the moment. But what's really interesting is, I don't want to go on too much, but the hedge funds are all sold out of their positions. They're almost net-short TTF because they can see the LNG wave coming. So they've all been flushed out at the moment. So it will be really interesting to see how that dynamic evolves as well, because they aren't holding long positions, but there are more of them involved in trading futures than ever before. So big question mark, what are the hedge funds going to do to the price over the next five years? We don't know.

BW  

You don't need to be a trading expert to realize that the presence of speculation in a market is going to be extracting value out of a market and therefore adding cost to the end consumer, right? Because even if a lot of the losses, if a hedge fund is making money, it's presumably because a physical contractor is losing money. And that price cost to them, if they're losing, will be handed on in the commodity prices that they charge. So I feel like it's parasitic, in the sense that these are people in the market, in buying and taking long and short positions, which if they're making money, then that money's coming out of the system, and that's going to pass through into wholesale prices. Now I'm sure we'll get people commenting saying, ‘well, you’ve fundamentally misunderstood this.’ But I remember meeting a very old bank, actually, interestingly, whose stated sustainability policy was they would not trade in food commodities, and it was just there, and it’s kind of been there for hundreds of years. And I asked them why. And they said it’s because it pushes up the price of food, and that's kind of immoral, really. Because we need people to have more food, not less, and they want prices low. And so 500 years ago, they knew that speculation on commodities has a real world impact, in a way that speculation on equities doesn't, or bond markets, because these are commodities that people need, and if you're pushing up those prices, it's morally questionable if that is actually okay. So I think there's just a very fundamental question about how we regulate trade in commodities, and I suspect one of the post-Brexit dividends we've got is that it's completely unregulated now, and that Europe is itself still struggling with this, because capital can always put pressure on policy makers. Anyway, big philosophical discussion to end there, not doing it justice. But I think hopefully our listeners have, many of them are gas experts already, but those who aren't, I hope we've kindled some interest in this market and how many fun dimensions are at play at the moment, and how interesting it is. I encourage everyone to follow your work on Energy Flux, where you can get the very interesting, heretical view sometimes, and a detailed understanding of this market. So thank you.

SK

My pleasure. Thanks so much for inviting me. It's been a pleasure getting to know you and working together.

BW  

So that was Seb Kennedy, journalist and founder of Energy Flux. As always, we put links in the show notes to relevant information, including the article we discussed, and to Episode 138 with Carine Smith Ihenacho from the Norwegian sovereign wealth fund. My thanks, as always, to Oscar Boyd, our producer, to Jamie Oliver, our video editor, and to the rest of the Cleaning Up team and the wonderful leadership circle who make these podcasts possible. And thanks to you for listening. Please join us at the same time next week for another episode of Cleaning Up.

ML

Cleaning Up is supported by its Leadership Circle. The members are Actis, Alcazar Energy, Arup, Cygnum Capital, Davidson Kempner, EcoPragma Capital, EDP of Portugal, Eurelectric, the Gilardini Foundation, KKR, National Grid, Octopus Energy, Quadrature Climate Foundation, SDCL and Wärtsilä. For more information on the Leadership Circle, please visit cleaningup.live. If you've enjoyed this episode, please hit like, leave a comment, and also recommend it to friends, family, colleagues and absolutely everyone. To browse the archive of over 200 past episodes, and also to subscribe to our free newsletter, visit cleaningup.live.