Falling wholesale gas prices are finally being passed on to consumers by big energy companies – and there may be further cuts to come. But with wholesale prices remaining well above pre energy crisis levels, bills will not return to levels we had all become used to. And a recent UK report from its budget watchdog – the Office of Budget responsibility – points to the longer term risks to its economy if it falls short on its renewable energy targets and its reliance on gas does not fall as expected. While Ireland’s energy mix is a little different, we rely on the UK for 70 per cent – and rising – of our gas and in turn this generates close to half of our electricity. So these warnings are highly relevant to Ireland, too, with big implications for households, businesses and the State.
How does gas fit in with the transition to green energy?
For Ireland, the longer-term goal is to reduce reliance on fossil fuels, including gas. Use of the fuel is due to fall by 40 per cent by 2030 under Government plans. However, as the “less-polluting” of the main fossil fuels, gas is also seen as a key fuel during the “transition” to cleaner energy and will remain required thereafter given the unpredictability of renewable sources, notably wind, and the time it will take to build capacity in this area and in other renewables. Gas is also important in the energy mix as it is the key fuel in terms of setting electricity prices, in a market mechanism which has proved contentious over the past year, but is not easily changed. For now, the Government is taxing the windfall profits earned by companies selling cheaper, renewable fuels who are benefiting from higher priced based on this gas reliant mechanism.
So gas remains a vital part of the Irish energy mix, second only to oil. It heats about 700,000 Irish homes, as well as being responsible for close to half of Irish electricity. About 70 per cent is imported from the UK, with the remainder coming from the Corrib field, which is gradually running down. So Ireland remains heavily reliant on the UK market and this will only increase in the short term. A new electricity connector with France, due to be completed by 2026, is set to cut reliance in this area. In turn the UK’s own North Sea production is running down, making it largely reliant on Norwegian gas, as well as imported LNG. From being a significant net gas exporter, the UK is now an importer.
What is the trend in gas prices?
Given our reliance on the UK market, Irish wholesale gas prices generally track UK trends. In turn, given the interconnections between the UK and Europe, the market there broadly follows European trends. The energy crisis intensified by the war in Ukraine led to UK wholesale prices rising to a peak of 640p per therm in August 2022, almost 13 times the pre-pandemic average of 50p a therm. This fed through to higher prices for households and businesses in the UK and Ireland – the UK chose to protect households via a price cap, while in Ireland this was done via cash payments. In the UK 80 per cent of households depend on gas for home heating, while here oil remains the most popular fuel.
The OBR report calculates given the UK energy mix, the latest crisis took prices to an inflation-adjusted peak higher than any of the previous crises, including 1979. The overall economic impact is less than previous peaks, it says, as economies are now less energy reliant, though household energy spending remains relatively high and the main impact of the current crisis has been on the disposable income of consumers.
Wholesale gas prices have fallen sharply from their peak. But the UK wholesale market is still quoting a price of 115p a therm – and looking at gas for delivery in summer or Autumn 2024 this rises to between 120p to 125p per therm, well over twice the pre-pandemic level. The OBR says it is reasonably to assume that wholesale gas prices will average around 2.5 times the pre-Covid average. In turn this would keep gas prices to households well above pre-pandemic averages and also keep the price of electricity at a higher level, leading to an ongoing economic cost to oil importing countries like Ireland.
There are real risks to future supply and pricing
In the wake of the outbreak of the war in Ukraine, the immediate focus was on the security of energy supply and whether shortages might emerge at peak times. In other words, would the lights stay on and would supplies of gas remain readily available to households and businesses? This remains an important debate, with discussions on whether Ireland should develop an LNG storage facility – An Bord Pleanála recently ruled against a proposed private facility in the Shannon Estuary. This is a controversial issue, with Green Party opposition to the use of LNG derived from fracking in the US. A long-awaited Department of Energy support on Ireland’s energy security may have something to say about this, with Green Party leader Eamon Ryan hinting that he might support some kind of State-owned operation.
However the OBR report puts the focus on another aspect of energy security – the risk of ongoing gas price volatility and the implications of this for households, businesses and the UK exchequer. The OBR points out that the uncertain outlook in energy markets mean future spikes in gas prices are quite likely. On one side the expansion of renewables could lower this risk, but on the flipside the transition of coal- dependent economies like China and India towards gas could have the opposite impact. Also LNG prices could be affected by geopolitical issues.
The report looks at one key scenario that would see the UK not reducing its reliance on gas – in other words it fails to meet its targets of converting to renewable energy. Gas price spikes similar to those seen over the past two years could push UK inflation back over 5 per cent, it warns, as direct energy prices increase as well as follow through rises as costs increase across the economy. In turn this hits spending and growth, just as it has done over the past year. Crucially, the OBR assumes that the UK government steps in, as it did over the past couple of years, to support households and businesses, at a significant fiscal cost, pushing up the long-term level of the national debt.
What does this mean for Government policy?
There are two major policy implications here – applying to the Irish Government as well as the UK one. The first is that the ongoing high cost of gas and the risk of volatility increases the economic incentive to successfully transition to clean energy. For the UK and Irish governments, it makes it more worthwhile to push ahead and invest in green energy and encourage others to do likewise, to reduce reliance on gas and lower the risk from price spikes. Given the cost of compensating households for gas spikes, the OBR says that for the UK “continued dependence on gas could be as expensive fiscally as completing the transition to net zero, were periodic upward spikes to global gas prices to continue to occur.” And of course completing the transition also carries vital other benefits.
Reflecting a point made by the Irish Fiscal Advisory Council, the OBR also warns that leaving the transition late and having to do it in a rush would also be likely to carry significant additional costs. For Ireland, in particular, as well as the price risk of not transitioning away from imported fossil fuels, the security of supply risk is another argument.
The second policy question is how to support households and businesses over the next few years if, as expected, gas prices remain above historic norms and possibly spike higher from time to time. This risk provides yet another reason to leave leeway in the public finances in these uncertain times.
