EUROPEAN POWER AND GAS – Collision course

Siàƒ¢n Green

In 2000, oil major BP announced a number of new ventures to increase its presence in the European electricity market, including a large LNG power complex and a natural gas and power sales and marketing agreement. Similar moves have been made by TotalFinaElf and Repsol YPF, and signify the continued convergence of natural gas and power in Europe.

The gas and electricity sectors are coming closer together. Deregulation and the availability of natural gas have encouraged oil and gas companies to take up positions in electricity, and even some electricity companies to invest in the upstream gas sector.

This convergence is not a new phenomenon. It is a gradually-evolving trend which began with electricity deregulation, but in the past year has become more obvious, driven in part by the expectation of deregulation of Europe’s natural gas industry. Several major European players are making moves.

New positioning

In September 1999, BP announced its intention to set up a new business stream, BP Gas and Power. This is a business unit specifically designed to extend BP’s interests as the mix of world energy consumption shifts and becomes ‘lighter’ – i.e. towards natural gas. Its intentions are to increase BP’s focus on liberalizing and developing energy markets, and develop market opportunities for BP’s natural gas reserves.

Figure 1. Natural gas prices for the industrial sector, January 1999
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In June 2000, BP and ePower, one of Ireland’s newest energy companies, announced plans to form a power and gas marketing joint venture. The two companies will join together as the major shareholders in the proposed 400 MW Powerstown power project near Dublin, and will offer integrated products to customers in Ireland.

One of BP Gas and Power’s target markets is Spain, where the availability of natural gas and LNG is increasing together with a rising demand for electricity. In June 2000, BP announced a multi-million dollar investment in a fully integrated LNG-to-power project in the Basque region of northern Spain along with Repsol YPF, Iberdrola and the Basque Energy Authority.

The Bahia de Bizkaia project consists of an LNG import terminal, a 2.75 billion m3/annum regasification facility, a 300 000 m3 gas storage facility, and an 800 MW combined cycle gas turbine (CCGT) power plant.

Each of the partners has a 25 per cent stake in the project. In announcing the move, BP stated: “The project takes fuel from the wellhead to the transmission wire and with BP Amoco involved in nearly every part of the value chain it demonstrates our full range of skills in integrated energy development.”

One of BP’s partners in Bahia de Bizkaia, Repsol YPF, the Spanish oil and gas group, recently announced plans to develop gas-fired power plants in Spain. Together with its part-owned subsidiary, Gas Natural, the company will invest a4.3 billion ($4 billion) over the next five years to construct seven power stations with a combined capacity of 4400 MW, enough to supply around 15 per cent of Spain’s domestic needs.

Gas Natural intends to become a multi-utility, capable of delivering gas, electricity and telecommunications to households and industrial customers in Spain. In addition, it is likely to bid for Endesa’s and Iberdrola’s business units that will be spun off after their planned merger.

Dash for gas

The initial driving factor behind the convergence of natural gas and electricity was the liberalization of Europe’s electricity markets. As generation opened up to competition, new entrants were able to gain a piece of the action, constructing new gas-fired capacity. The ‘dash for gas’ was particularly prevalent in the UK.

The European Commission is now discussing the possibility of speeding up the liberalization process to overcome the disparities between countries that are fully liberalized and those that have met only the minimum requirements.

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An increased pace in liberalization could lead to further convergence of gas and electricity along the whole supply chain. The onset of liberalization in the EU’s natural gas industry is also likely to have an impact.

According to Simon Allen, European Utilities Leader of PricewaterhouseCooper’s Corporate Finance Group, one of the biggest drivers in the convergence of gas and electricity markets is the large natural gas reserves available. Oil and gas companies need to ‘monetize’ this gas, and are turning to power generation.

“Most of these oil companies are sitting on large reserves of gas where access to market has not yet been established, so one area that the oil companies have been looking at is getting into the construction of new power plants where they can use their own gas to generate electricity,” said Allen.

Another major driver is the increasing demand for natural gas in the power sector. In addition to gas being a relatively clean fossil fuel, combined cycle technology has emerged as a popular choice for new power generating capacity owing to its high efficiencies, short lead time and low investment requirements.

According to Datamonitor, the use of natural gas as a fuel by power generators in the European Union grew from just over 40 000 million m3 in 1995 to over 65 500 million m3 in 1999, a compound annual growth rate of 13 per cent. Datamonitor has also estimated that between 2000 and 2005, demand for natural gas in the power generation sector will increase by over 300 per cent in Spain, 45 per cent in Italy, and 27 per cent in the UK.

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An important factor in the uptake of natural gas by the power generation sector is the availability of piped natural gas. European countries such as the UK have a well-developed natural gas grid, which has driven demand for combined cycle technology.

However, rising natural gas prices in recent months have made some developers think twice about the construction of new gas-fired capacity. “The difficulty here at the moment is that the gas price has actually doubled in some markets over the past year,” said Allen. “This has put a dampener on the whole thing, because it is very difficult, particularly for the new entrants, to compete with established players when they have to go into the market and find some gas.”

Gas price uncertainty

According to National Utility Services (NUS), natural gas prices rose by almost 57 per cent in 2000 in some European countries. Germany saw the smallest rise, at 12.6 per cent, while Belgium saw the largest, with 56.6 per cent. In its International Natural Gas Report and Cost Survey for 2000, NUS attributes the rises mainly to recent rises in oil prices and an increased demand for natural gas.

NUS says that commercial and industrial customers across Europe are hoping that the deregulation of the gas industry will bring a more level and stable, and possibly lower, gas price. However, the linking of oil prices and natural gas prices, and the decline of the Euro against the US dollar, could lead to higher prices.

But according to Allen, one impact of liberalization of the gas industry in Europe will be the decoupling of oil and gas prices. “At present, [delinking of oil and gas prices] hasn’t yet occurred, partly because a number of the large gas companies are sitting on long-term gas supply contracts with Norwegian or Russian companies, and the prices within those contracts assume a linkage,” said Allen.

“If those contracts are not renegotiated, they will to some extent hold up liberalization, and because of the prices within the contracts, these companies are sitting on potentially large losses.”

The UK is one European country where oil prices and natural gas prices have decoupled. This happened in the mid-1990s when the UK deregulated its natural gas industry, allowing large industrial consumers to choose their own gas supplier. This decoupling is therefore likely to happen in Europe over the next few years as the gas industry deregulates.

“As we move forward,” says Allen, “We’ll see this delinking because once the large gas customers can choose their suppliers, they won’t want to get their supplies from a gas company that has a standard gas contract – they’ll want to find a competitive supply base.”

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