The Plain Facts - Why are Business Electricity Prices Going Sky High?

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With more than 38% of GB electricity generated by burning gas and with a link between wholesale oil prices and gas prices, it is the dramatic rise in the cost of gas and oil that is driving our electricity bills to record levels. As nuclear and other thermal generating capacity is retired and energy demand grows GB’s dependency on gas for electricity supply will increase to as much as 50 per cent by 2016. But do global changes in oil and gas prices really justify such huge rises in the cost of business electricity. electricity4business, the independent electricity supplier, investigates.

Crude oil prices have risen by more than 30% this year to levels which in real terms have not been seen since the early 1980’s. But what exactly is causing the oil price to rise and what impact is it likely to have in the short and long term?

What are the major causes ?

1)Rising Demand

Global economic expansion has resulted in the biggest increase in oil demand in the last 24 years. Whilst the Chinese economy has witnessed unprecedented growth with demand for oil up by 20% in the last year alone, the US economic recovery has simultaneously gathered pace.

Only Saudi-Arabia has significant spare capacity that can be made available and when resources are scarce prices rise.

2)Low Stocks

Oil companies, like many others, have recently been driving efficiency by adopting just-in-time practices. As a result they have depleted stocks and therefore the traditional cushion against supply interruptions.

Other contributors to the low stock levels are the events taking place in Middle East and the unstable economies of Nigeria and Venezuela.    

3)OPEC Strategy

OPEC, which accounts for about 50% of the world’s crude oil exports, has now become far more proactive in avoiding oil price dips. Previously the organisation would react to dipping oil prices by cutting output. Nowadays it wields its power by cutting production at the mere suggestion of a price fall thereby at the very least maintaining stable prices.

To add further to the pressure on prices producers have eroded the opportunity for oil companies to buy and build stocks of oil when it is cheap which in the past tended to stabilise prices over the long term.

4)Action of Speculators

One of the consequences of low stock levels is that they provide an opportunity for speculators to bet on the possibility of higher prices which itself can force prices up to levels well beyond those expected by market forces alone.

5)Violence in the Middle East

Uncertainty over security in Iraq and in Saudi Arabia casts a shadow over the stability of supply and despite there being little effect on the flow of oil from Iraq at present the possibility of mass interruption is real.

6)Other Political Tension

The unstable governments and the unrest in Venezuela and Nigeria add to the security of supply problems and when Russia’s biggest oil company Yukos faces bankruptcy due to government demands for unpaid taxes it’s easy to perceive a situation where the world could be on its knees.

7)Insufficient Refinery Capacity

The demand for varying qualities of oils has required heavy investment in all types of processing facilities. Clearly this is costly and even more costly when environmental issues are taken into account.

There is a greater demand for higher grade oils and these are not available from Saudi-Arabia’s spare capacity which is generally of the heavier grade variety.

Rising oil prices also have an impact on the prices of other fuels such as Gas – but how much of an impact?

The price of wholesale Gas in the UK has been driven by both soaring oil prices and declining North Sea Gas reserves. But is it all down to these two occurrences?

Global Insight who was commissioned to carry out an independent report thinks not.

They found that each ten dollar a barrel increase in the price of crude oil has given rise to a 7p per therm increase in wholesale gas price, or £50 extra on the average domestic gas bill.

However, they believe that this oil-gas linkage is a false one created by the non-liberalised markets in Europe and this could cost the UK an extra £10 billion in 2006.

Prior to de-regulation of the UK Gas industry there were direct linkages between the price of heating oil and gas. The aim of de-regulation was to open the market to competition and to let prices find their own level, irrespective of the heating oil price.

This works as long as companies are not obliged to purchase gas from European markets which have not gone through the same liberalisation process.

But as the rate of declining North Sea Gas reserves gathers pace and the UK becomes more dependent on supplies from Europe the potential for gas to find its own level is eroded.

British Gas has made representation that if European Union states don’t open their markets to competition U.K. customers will suffer even higher prices.

‘Most gas pipelines and storage facilities on the Continent are owned by monopolies or near monopolies’ they claim ‘and are in practice inaccessible to U.K. suppliers wishing to transport gas across Europe’.

In summary, Global Insight estimated that U.K. businesses would be poorer by £2.7billion a year, domestic customers by £3.9 billion and generation companies by £3.4 billion as a result of the non-liberalised European markets.

A simple analysis of the position is thus:

De-regulation in the U.K. Gas market brought much needed competition to the U.K. and a subsequent drop in prices for customers. The price of gas was able to move away from the linkage to heating oil and since the U.K. was pretty self-sufficient with supplies from the North Sea the price of gas was able to find its own level.

The large state monopolies remaining in Continental Europe then began to increase their strength by swallowing up companies based in the U.K. giving them eventual dominance of both markets.

As the North Sea reserves began to erode, some claiming much sooner than expected, U.K. suppliers were forced to source from the Continent where prices were kept high by the monopolistic non-liberalised market structure.

In conclusion, the price of gas – and to a degree the price of electricity given its dependence on gas fired generation – has been affected more by the European market structure than by rises in the price of crude oil and things are unlikely to change unless European markets are forced to reform, a challenge perhaps too far for a very slow moving EEC.

Contacts

For interviews, quotes, photos or comments contact:

Bernard Scally

electricity4business

Phone: 020 8847 2538    

Editors Notes

electricity4businiss is Britain's independent electricity retail company specialising in the supply of electricity to small and medium sized businesses. E4Bs aim is to cut the cost for British business by offering lower prices.

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Bernard Scally