14/01/15 – Prospects for the oil price and its impact upon UK investment and policy-making

Speaker: Peter Atherton, Liberum Capital

All Party Group on the Costs of Energy

Wednesday 14 January, 2015

The mid-term prospects for the oil price and its impact upon UK investment and policy-making

Chair: Lord Palmer

Lord Palmer welcomed the attendees and introduced the speaker, Peter Atherton.

Mr Atherton described current energy market prices:


  • Current price below $50bbl
  • Price for next year $62 -63/bbl
  • Price for 2023 $73/bbl


  • NBP 37p per therm
  • Henry Hub below $3/mmbtu

Coal: $49/te

Electricity one year baseload:

  • GB £48/MWh
  • Germany €31/MWh

Before the oil price started to fall the market thought that there would be a correction, but not as aggressively as it happened; for much of 2014 the forward price showed oil falling from over $100 to around $80 by 2016. Now the forward curves predict a strong recovery by 2016 / 17 from the current price, but only to around $70, which would be below market expectations prior to the recent price fall.


Those operating under the ROCs scheme are going to be experiencing material amount of pain. The system is that you have a ROC plus the market price for your output, and get a reasonable return on the two added together.

At a market price of £50MWh most renewables should meet the cost of capital. At a price of £60/MWh even the poor projects should meet the cost of capital, while at £45/MWh this would be true for only the best projects.

At current market prices, new projects (under the ROCs scheme) are difficult to finance. Offshore wind, in particular, would be very problematic. Prices in Germany suggest that GB prices could feasibly fall significantly from the current level.


The situation makes Hinkley Point, already bonkers (when the power price was £55-£60/MWh) staggeringly so now. The strike price of the contract is £92.50/MWh in 2012 prices. With inflation the price is likely to be £125/MWh or so by the time that the plant is operational. To be competitive relative to fossil fuel, oil would have to be around $230 a barrel compared to a market expectation of $75-80/bbl, or gas would have to be around $23-$25/mmbtu. UK gas prices today are $6-$7/mmbtu.

Hinkley is expected to cost £24 billion (including £6bn financing costs), with a ten years construction programme. Either one of these two facts should have killed the project, taken together they should have made the Hinkley deal unthinkable. The economics are now so off the scale (especially against a background of current and projected fossil fuel prices) that they are damaging to the economics of the entire country.

Levy Control framework

With the lower power price there will not be enough money in the pot to fund the amount of megawatts needed, although the fund could be increased.

The North Sea

Analysts estimate that the up-stream break-even oil price is $60-$80 and the outlook for a high cost region like the North Sea is not good.  There will be a much reduced tax take. Oil majors have largely left North Sea oil, only small and medium sized companies remain and they are less able to take price shocks.

Retail electricity and gas

Consumers will benefit from lower wholesale energy prices, and the fall in wholesale prices help off-set the cost of the government’s decarbonisation policies. There is an underlying non-energy cost pressure of 3%-5% a year This should help ease the political tension that surrounds the sector.. This winter that has been offset by the fall in commodity prices. A return to $100 oil and 65p gas would cause sharp price increases.

Investment in the UK power sector

In the Fourth Carbon Budget there were 4 scenarios for 2030: Ambitious Nuclear; Ambitious Renewables; Ambitious CCS; Ambitious Energy Efficiency. The Committee on Climate Change suggested that the capacity needed for each scenario is: 140GW for Ambitious Nuclear; roughly 180GW for Ambitious Renewables; 140GW for Ambitious CCS; and 140GW for Ambitious Energy Efficiency.

We have about 85GW of capacity today, requiring net build of 55GW – 100GW. There will be power plants shutting between now and 2030. The gross requirement for new capacity is 85GW – 125GW. The government thinks that the financial sector will deliver the investment for this capacity. Between 1990 and 2002 (the Dash for Gas period) 19GW was built. The total costs, depending on whether the capacity is nuclear or renewables, will be £130-£150 billion for the power plant alone.

There are other required investments in the sector, such as £17bn for smart meters and £50bn for transmission and distribution, and overall bill to meet the target could between £300 billion and £400 billion. The required spend is £25 billion a year (with a peak spend of £35 billion a year) compared to current spending of £8/£9 billion.

There will be a profit problem: that amount of new kit will generate big profits. The big 6 now make yearly profits of £2.3 billion from generation, this programme will produce profits of £24 billion a year.


Policy-makers did not anticipate the fall in fossil fuel prices. There is a dilemma in terms of EU/UK energy policy, which was sold to the public based on three points:

  1. The need to tackle climate change;
  2. A hedge against rising energy prices;
  3. The economic benefits of being in the industrial vanguard of de-carbonisation and selling the technology to others.

Unless there is a complete reverse in commodity prices, then Energy policy will now have to be sold on climate change alone. There will be a need to convince the public of the value of the policy based only on the environmental benefits. Will the public be content to pay for this?

There has been another big change: not a single megawatt can be built without the state underwriting the economics; that is in any technology. Big-ticket power stations will be built by the state, as companies in the public markets are divesting and shrinking their businesses. The listed utilities are selling-off assets (Centrica, E.ON, RWE), whilst those still investing in big ticket projects are overwhelmingly state backed corporations (Edf, Dong, Statkraft, Vattenfall). There is still private funding, for small scale solar and wind projects. There has been a backdoor renationalisation: EDF, 80% state owned, is building Hinkley.

Questions and comments

Lord Palmer raised the point about the effect of the dramatic drop in oil price, on the duty and VAT for paid to the Treasury?

Peter Atherton:  It will affect payments to the Treasury. The question is; will there be a general boost to the economy to offset this decrease in duty and VAT?

What are the speaker’s views on nuclear?

Peter Atherton: nuclear is safe and carbon free. However, the £24 billion bill for Hinkley Point (the most expensive single man-made structure built on earth) should make it unthinkable. The Hinkley should be stopped. Instead the UK should set up a competitive procurement process getting the major nuclear construction companies (such as Japan/US/Korea/Canada) to bid to build a major new build program (up to 16GW although this might be split into a number of contracts) This would represent the biggest nuclear contract in the world and it can be expected that the bidders would compete fiercely for the work. The cost would probably be around £65-£75 /MWh in 2015 money. However, Hinkley will continue because government made promises on jobs, and Whitehall has to deliver. Politicians have no understanding of the maths. To illustrate, at the start of negotiations on Hinckley the price was £50/MWh and EDF would take the power price risk and the construction risk. By the end of negotiations it was £92.50/MWh in 2012 prices indexed for 35 years, with the government taking the power price and construction risks. According to Edf the project has should earn a 10% IRR unlevered and 15% return on equity. This programme needs more parliamentary scrutiny.

Lord Palmer: One of the problems is that energy costs have to go through several government departments DEFRA, BIS, Treasury, none of them can agree with each other.

Would the Chancellor be wise to announce and energy review after the election?

Peter Atherton: Current policy is built on principles set in 2003. Energy policy is driven by climate change goals. Changing direction would need re-negotiating EU directives and repeal of the Climate Change Act. If the Conservatives win a majority they could leave legislation alone and simply not make huge efforts to achieve the goals. Labour will apply emissions standards to existing coal-fired plant to force its closure. Governing combinations such as Lib/Lab would strongly favour current policy. These combinations would view failures in the policy as one of implementation rather than the fundamentals of the policy.

Is gas policy absent?

Peter Atherton: There was a gas strategy, published in 2012. At face value, the Fourth Carbon Budget requires an expansion of gas capacity to 42GW but with a load factor of 10 – 15%. Unless CCS is successful gas plant will operate at peak only. The demand for gas from the power sector will be down significantly. Domestic heating would by 2030 have mainly moved to electrified. The plan is to decarbonise electricity, move away from gas and other fossil fuels in order to hit the 60% greenhouse gas reduction target by 2030.

Wholesale gas prices are down 30%. Should the utilities reduce prices further and faster?

Peter Atherton:  Wholesale gas prices had fallen by 23-25% by Christmas. Gas makes up around 50% of the average bill, so that suggests a potential cut of up to 12%. However, other costs are rising, so the maximum reduction is around 8%. Price cuts so far have been around 3%. It must be remembered that utilities will have hedged the price; that prices could go back up; and that utilities may be reluctant to reduce prices because of the threat of a price freeze after the election.

If the effect of UK/EU policy has driven utilities out of business, who will take over investment? Is this a case for renationalisation?

Peter Atherton: To an extent there has been renationalisation – certainly of the investment making process. Central government has more control than it had over the (old arms -length) CEGB. The effects of this can be seen in the share price of Drax. Their policies were perfectly aligned with government policy; supporting large-scale biomass. Now the underpinning for biomass has been removed by government, the share price is £2.40 (from £8.00 a year ago). This is a degree of centralisation unprecedented since the 1950s. The funding of big-ticket items (£500m plus) is now entirely dependent on the state (Green Investment Bank etc). It might be more sensible for the state to build the assets directly and then sell them once operational.

With the Saudi policy aimed at shale, Russia and Iran, how long can this go on for and to what extent can shale come back after this?

Peter Atherton: The pain point for US shale is around $40. Production is unlikely to reduce much in 2015. But even if / when production is cut, the costs of re-starting production are relatively low (especially in comparison to the North Sea, Alaska or the Gulf of Mexico).  A contraction may happen, but once the oil price is back at $60-$70 shale will be back.

Lord Palmer pointed out that the royalties system for land-owners in the US was different to the UK, with US landowners receiving larger portion than UK local communities received royalties. An audience member, from the UK shale industry, clarified that local communities received 1% of the pre-tax production revenue.

Is it too pessimistic to summarise that the power companies have no confidence to invest?

Peter Atherton: Confidence of management and share-holders in the UK power market is shattered. It is currently inconceivable that a company could issue equity to fund a big-ticket item like off-shore wind; maybe another 5 years before public market investors return? The state will have to finance the build of what needs building which is what is happening now.

What are the expected prices of oil-linked gas and coal?

Peter Atherton: Cannot think of TTF off the top of my head, the price will come down: to $6-$10/mmbtu.

For oil/gas switching, the prices have improved; one of the benefits of the oil price decrease, gas-fired generators have been haemorrhaging profits for the last four years, this gives them a bit back.

The Chair thanked the speaker and the attendees, and closed the meeting.