GIF INSIDE STORY: UK industries squeezed by surging gas prices, tight energy supply

By Kaja Sillett, Jake Stones, Richard Ewing, Ruth Liao and Ben Samuel

LONDON (ICIS)–Surging European gas prices continue to struggle to attract LNG from resolute Asian buyers, coal-to-gas power switching has been near exhausted and traditional pipeline suppliers are pushing every molecule they can.

With conventional flexibility sources pushed to their limit the market is having to turn to less conventional forms of demand side response to prevent a worst-case scenario in peak winter.

A range of European fertilizer production has been taken offline amid record high Dutch TTF and British NBP gas prices, although the British government has stepped in with short-term financial support which led to the resumption of one of CF Industries’ two UK fertiizer plants.

This followed a lack of UK carbon dioxide production, a by-product of ammonia production which is critical for a range of products and services, such as the UK food industry.

High gas and electricity prices are not confined to Europe, with tight energy markets a major global issue. Governments from Brazil to China are try to mitigate concerns over supply and the impact on downstream industries ahead of the peak winter demand period in the northern hemisphere.

Industrial slump

British gas demand from the industrial users linked to the National Transmission System (NTS) has dropped with some companies reducing offtake due to high NBP prices, although low renewable generation is having a larger impact on the wholesale market.

On 15 September, CF Industries announced that it would halt fertilizer production at two UK facilities due to the high cost of gas.

A day after the announcement, gas demand in Britain from the industrial sector dropped to just over 4 million cubic metres (mcm), down from 6mcm the day before.

Gas offtake from industrial users was already below average with consumption of about 6mcm/day during the month to date, compared with 10mcm/day over the same period between 2016-2020.

Demand from the sector only represents around 5% of the UK total, meaning even if other offtakers cut nominations, the impact on the NBP is likely to be limited. However smaller industrial users, also feeling the pinch of high prices, often connected to local distributions, come on top of that 5%.

Petrochemicals companies that rely on natural gas as feedstock have felt the brunt of higher wholesale prices. European gas and LNG analyst at Wood Mackenzie, Graham Freedman, said much will depend on the nature of each buyer’s gas supply contract and the level of exposure to wholesale prices that they have, anticipating that a number of European governments may step in to support essential industries over the coming weeks.

Limited power response

Overall UK gas use during September has been above average for the month despite the lower industrial usage, as power sector offtake has increased to compensate for low wind generation.

Strength in gas prices has led to more UK coal-fired capacity coming back into the mix with these plants accounting for about 2.5% of the UK generation stack this month, compared to less than 1% during September 2020.

The UK has retired the majority of its coal fleet in the past few years with the Carbon Price Support (CPS) tax putting an additional cost that made many units unprofitable to run. In mainland Europe the least efficient hard coal and lignite plants are now out competing gas plants for baseload generation.

In September to date, offtake from UK gas plants has averaged just under 60mcm/day, compared to 46mcm/day on average over the period between 2016-2020.

Over the same days, wind farms have produced about 2.4GW on average, accounting for less than 9% of the generation stack, down from more than 21% during September last year.

Days of particularly low wind output have corresponded with surging gas demand from the power sector, for instance on 15 September when wind farms produced just 1.7GW while off-take from gas plants was up to 70mcm.

This lifted the ICIS NBP Day-ahead index by around 15p/th that session to almost 180p/th.

One LNG trading source said that these historic price levels, it was inevitable that LNG cargoes would be diverted toward Europe away from Asia, particularly given the cost of shipping rates.

The source said that portfolio companies and sellers that decide to divert would then have to backfill their commitments to Asia.

“Not sure how Asia keeps the lights on in peak winter,” a source said.

Continental impact

Norwegian fertilizer manufacturer Yara said it was curtailing European ammonia production due to the record rise in natural gas prices.

The Norwegian major said by the week starting 20 September around 40% of its European ammonia production capacity will be offline, through a combination of capacity cuts and scheduled maintenance.

The company will continue to monitor the situation, with the objective to keep supplying customers but curtailing production where necessary.

ICIS understands more ammonia production may also be brought offline by other companies in the coming weeks, especially at less efficient plants.

Yara has seven ammonia plants across Europe which together can produce 4.9m tonnes of ammonia annually, according to Yara data from 2020.

Assuming around 33MMBtu is needed to produce one tonne of ammonia, this would indicate Yara’s European operations consume around 4.4 billion cubic metres (bcm)/year of gas.

According to the International Fertilizer Association in 2019, the EU along with the UK, Norway and Ukraine produced around 18.7m tonnes of ammonia.

Using a 33-37MMBtu range of ratios, ICIS estimates total European gas demand for ammonia production could be as much as 17bcm/year.

Similar reductions in output have also been seen at other major producers in western Europe, including OCI’s Geleen ammonia plant in the Netherlands, with many of the older and less efficient plants in Ukraine expected to fall offline in the next few days.

In Lithuania, the Achema ammonia plant is currently running at half capacity due to annual maintenance scheduled to finish at the end of the month.

One trader did not expect the downturn in industrial demand to have much price impact itself.

“The market is so worried about a shortage that anything remotely bullish is treated as a certainty, and anything bearish is treated with scepticism,” the trader added.

Wood Mackenzie’s Freedman also thought reduced industrial demand was unlikely to impact NBP prices significantly, with large global supply and demand imbalances exerting greater influence currently.

Other companies with NTS-linked industiral sites – INEOS, Prax and Philipps 66 – did not reply when asked whether price spikes had reduced offtake.

Another trader said that they expected prices to remain high but with strong volatility over the approaching gas winter. They also said that the impact to industrial demand may not last beyond the gas winter either.

Macro effects

The government-backed rescue deals, as they look to solve issues in other industries negating any impact of the closures might have had on overall gas demand.

A number of other energy intensive users have started to make noises about the potential consequences from the unprecedented prices.

CEO of British Glass Dave Dalton said “The [glass] sector has seen a substantial increase in the cost of energy, which has already impacted profitability and could also lead to consequences in the day-to-day production of the sector if these costs continue. Not only will current manufacturing be affected because of the price increases, but it also puts at risk the sectors long term plans to electrify the glass production process.”

The British Ceremaic Confederation released a statement saying “Energy is normally a third of production costs for many of our members. Many ceramic companies have already purchased much of their energy for the upcoming winter and so will not have to fully pay the higher prices immediately. However, some members are already facing higher gas, electricity and carbon prices, which is leading them to scale back production.

“We are deeply concerned the prices reflect the market’s views about the physical availability of gas over the winter. In the event of national supply shortfall our members are near the front of the queue to be forced off the gas network, while households are last.”

UK Steel Director General, Gareth Stace said: “extortionate prices are forcing some UK steelmakers to suspend their operations during periods when the cost of energy is quoted in the thousands per megawatt hour; last year, prices were roughly £50 per megawatt hour. Even with the global steel market as buoyant as it is, these eye-watering prices are making it impossible to profitably make steel at certain times of the day and night.”

Inelastic supply and demand mean that, in order to safeguard household heating this winter, industries and governments may end up having to make difficult choices as to what parts of the economy can continue to consume gas and power.