Operation To The Moon

What Iran means for British energy policy

Via Trading Economics

The above chart shows prices for natural gas futures for delivery to the National Balancing Point, the virtual trading point associated with our gas transmission system. You will note that it’s nearly doubled over the course of the day, rising from about 75p/therm to over 120p/therm. Given that most people are billed in kilowatt-hours, this is equivalent to a rise from 2.5p/kwh to 4.1p/kwh. The current gas price cap is about 5.93p/kwh. If this rise is sustained and passed through directly to the customer, our bills will go up by at least 25%.

I feel considerably for KC Green, having this as their enduring contribution to the Discourse

Fans of history will remember that when this happened in ye olde times of 2022 the UK incurred enormous additional expenditure to hold down bills and prevent widespread economic collapse. We are now carrying the debt from this event, plus the debt from Covid, and much of the debt from the financial crisis. We are not in a great place to manage a further crisis.

So it’s important to ask whether this rise will indeed be sustained. There are two broad scenarios:

Scenario 1: Air Defence is Doing

In this scenario, Iran’s efforts to close the Straits and degrade LNG production by destroying both extraction and liquefaction infrastructure are stymied by a combination of the air defences of the Gulf States and the rapid degradation of launch sites by the Western allies plus Israel. Following a short period of heightened uncertainty, the focus of the conflict turns to whatever happens to a newly destabilised Iran. In this scenario, we assume the Americans rush in to secure what remains of Iran’s fossil fuel infrastructure, either directly or via proxies as in Venezuela. Normal service is resumed, potentially within a fortnight.

Scenario 2: Too Many Missiles

In this scenario, the Iranian regime proves to be resilient and is able to maintain the flow of Shaheds and other munitions and continues a programme of infrastructure bombardment sufficient to severely impair both the production of natural gas and the freedom of the Straits of Hormuz. While production does continue, the need for destroyer escort of cargoes means that Qatar and other states are essentially cut off from the global market. Price rises are sustained, likely for at least six months.

Chaos with Ed Miliband

Naturally, we could fall between either of these two stools, but what’s relevant for our purposes is less the precise breakdown of outcomes and more how it cashes out for UK supply. In all worlds we see a short-term tightening of supply and higher costs overall. These manifest for industry, for power production, and for households. Regardless of how long the disruption lasts, it is likely that the price cap in September will be higher than currently planned for April.

However, although the economic impact will be significant, politically this is good news for the Government’s energy policy. Ministers have repeatedly emphasised that their target to decarbonise power by 2030 is fully intended to ensure that a gas price crisis can never happen again. Any price rises can be reasonably blamed on the US’s actions, and based on the public response to Russia’s invasion of Ukraine, this seems plausible. This means that some of the price rises locked in by the Government’s infrastructure decisions, including for renewables and grid upgrades, can be bundled into a narrative of the cost of Trump’s wars.

The knock-on effects might be considerable. Energy is a key contributor to inflation, and people building renewables are not immune to inflation. Buying renewables and other infrastructure through long-term contracts right now risks locking us into higher prices for many years. Avoiding gas price risk only works if gas price volatility means on average it’s higher than the cost of renewables; the time during which renewables are cheaper than gas shrinks with every pound of additional cost.

This implies that Government may be best off reducing its expected infrastructure buy, especially given that demand will be suppressed through higher prices. It may still be within shouting distance of its 2030 target if it does so. Its big problem, however, will be the North Sea, where the public is not likely to want to be told that we can’t do absolutely everything to hold down prices because Labour has committed to halting exploration for new gas reserves. Any reserves are likely to take many years to come online, but holding the line against exploration under these circumstances looks politically challenging.

This is true in all of our scenarios, but is particularly true in our secret third scenario:

Scenario 3: Trump Turns Off The Taps

Henry Hub prices - the US equivalent of our National Balancing Point - have been up through the day, albeit much less than UK volatility. As we grow closer to November - and especially if we are in a world that more resembles Scenario 2 - Trump may be tempted to ban LNG exports to hold down American consumer prices. If this happens, and if Hormuz is still largely closed, then all bets are off and prices go to the moon.