Author: Kent Moors, Ph.D.
Brexit, the UK’s divorce from the EU, remains a contentious affair. Despite having officially taken place almost two years ago (January 31, 2020), essential trading arrangements between the two parties are still at an impasse.
COVID has transformed the environment in which an agreement can be struck. With major changes in customs regulations taking effect on December 31, new fears in the UK are surfacing about shortages in several products, including food.
Despite what proponents spun in various PR campaigns to sell Brexit, it has inflicted a significant cost on the British economy. It is for this reason that the current government has been desperate to negotiate a codicil trade agreement whereby much of the exchange would continue after the UK departure. But London cannot take comfort in what has happened thus far. Prime Minister Boris Johnson and his ruling Conservative Party have come under increasing criticism with their approval ratings declining in consequence.
There is a major energy component to all of this. It hardly bodes well for UK citizens and belies an underlying (and persistent) forex problem in the process. It had been telegraphed previously as the Brexit drama played out in excruciating slow motion over some four and a half years.
In the current climate, this problem is even more acute as historically high natural gas prices combined with accelerating delivery problems are threatening to inflict widening losses on the British economic landscape.
Prospects for improving UK expectations are buckling under the weight of crippling energy costs, knock-on power blackouts/brownouts, and an increasing European-Russian crisis over Moscow’s policy against Ukraine creating further uncertainty about reliable gas deliveries.
Of course, Brexit cannot be blamed for all of this. But there remains an undercurrent directly resulting from the political rupture. And its rise in the present worsening natural gas situation will accentuate the internal UK problems.
Unusually warm temperatures have blunted an even worse pricing and availability imbroglio. That will not last because, while ongoing energy costs remain the primary concern, this also addressees a decline in electricity distribution. Brexit has already created shortfalls for the UK in transmissions from France, made more acute by unanticipated accidents causing a withdrawal of generation from the gird.
The situation is now worse than when I first commented upon it in a private investment briefing issued on July 26, 2016 (a month after the June 23, 2016 Brexit vote shocker). Then and now a significant spike in UK domestic natural gas prices beyond the levels occasioned by the current European market crisis will be a direct result of the forex problems ushered in by Brexit.
That July 2016 briefing said the following:
History tells us that the winter of 1946-1947 was one of the worst experienced by the British Isles in a century. Coming so soon after the end of World War II a crippled economy felt the full impact. At one point, Winston Churchill observed he could not even obtain his favorite cigars.
Of primary concern, was the provision of power. Not a single electricity generating station in all of England had escaped wartime destruction and a return to “normalcy” in the power sector would take years. The historically crushing winter of 1946-1947 would require that an entire population hunker down.
The current situation is hardly as dire. But ever since the UK voted to separate from the EU (the co-called Brexit referendum), I have been waiting for the initial signals that the divorce will have consequences in the energy sector.
Over the past week that sign has emerged. What it signals is a double whammy for British domestic natural gas users, with both parts a result of the multi-decade level decline in the value of the British Pound Sterling post Brexit. The currency has collapsed to more than thirty-year lows against the dollar. And the decline has prompted two energy moves in very different directions, neither good if you are intending on living in the UK as temperatures decline.
First, the descent of the pound sterling has prompted UK retail natural gas distributors to forego discounts moving forward. This is, of course, based on the same reasoning that will certainly result in another round of appreciable electricity price hikes by the major national utilities later in the year.
Maintaining profit margins will be impossible at current levels, given the forex pressure on the bottom line. Most observers also believe that increased taxes are now inevitable in an environment in which all revenue considerations will have to factor in a quite unexpected effective currency devaluation.
Even before Brexit, this was shaping up to be a hard fall and winter in any event, placing additional pressure yet again on an already strained power sector. The new government [at the time of this writing] headed by Prime Minister Theresa May is still Conservative. And while she will delay the substantive Brexit negotiations with the EU in Brussels, the party’s policies of cutting subsidies will remain intact.
That means some difficult times lie ahead, both for end users and domestic power distributors. Problems, some Brexit some not, are hitting all energy sources – resurging North Sea production profitability concerns, a decimation of renewable alternatives (for example, over a third of all employment positions in UK solar have vanished), and rising indications that French EDF may be having second thoughts about a major nuclear energy plant at Hinkley Point (way over budget and certain to be hit hard by currency fluctuations moving forward).
The British end user, however, is going to feel the pinch in an additional way (once again hitting the pocketbook).
Utility giant Centrica announced it would not inject any additional gas into the offshore Rough field [a move continued in 2017]. Rough accounts for about 70 percent of all British natural gas storage capacity. Immediately, that caused a spike of over 10 percent in winter month natural gas futures contract prices.
Even then the capacity issue at Rough does not illustrate the seriousness for British consumers. The field has a capacity put at 150 billion cubic feet. But the present volume stored there is only 50 billion. Unless there is a subsequent revision to Centrica storage plans – and there are no indications that a change is likely to take place – that 50 billion cubic feet is now the maximum that will be available from Rough this winter.
There is a knock-on effect shaping up. U.K. summer gas demand usually results primarily from the storage for winter heating. But Centrica’s has decided to shut Rough “for tests” at least into November.
And that has introduced the second factor. The dramatic change in cross currency valuations has resulted in the UK exporting more natural gas to Belgium (and onward to a broader Continental market) than at any point in more than two years.
The “spare fuel” is actually coming primarily from volume that would have gone to Rough and is being sent along the North Sea Interconnector east-west pipeline to the terminal center at Zeebrugge on the Belgian coast.
Trevor Sikorski – the head of natural gas, coal, and carbon at Energy Aspects Ltd. in London – told Reuters that the spike in exports comprised gas “that would otherwise be going to Rough, now being incentivized to go and get injected into European storage.”
However, just about all analysts agree that the rising exports from Britain to Europe are more a result of the collapse in currency value that with any outage at Rough. A Brexit-induced “pounding of the pound” has provided some nice profits for European importers and Centrica has obliged.
But what of the average citizens back home? Given the decision to close injections of gas into Rough, the short-term future will require a traditional British stiff upper lip.
Thanks to a much weaker currency, those imports in lieu of the normal domestic draw off of storage out of Rough will be far more expensive. A nasty cycle has formed.
Current rising exports of British gas will go to European storage with some of that returning as higher-priced imports when matters get colder. This may attend to profit considerations along the Interconnector.
But it is hardly welcome news for people living in Britain.
It is this last point that is once again surfacing in Continental natural gas forward contracts. It is a phenomenon I have labeled in other writings as the “Brexit Loop.” UK natural gas is exported to Belgium for foreign exchange profit reasons and is then replaced with higher-priced imports. For UK gas companies the volume commands a higher return on the Continent, with the British consumer taking it on the chin (once again) as the temperatures fall.
There will be an as yet unknown commercial price to pay from the loop as well, one which will have an additional effect on domestic employment. In what is perhaps the cruelest impact, that gas price-employment dynamic will have its most pronounced adverse impact in those UK regions where the economy is most vulnerable and in which Brexit generated its largest referendum majorities.
Almost eight decades ago, the UK energy sector reeled from the aftermath of Luftwaffe bombers. This time, it will be entirely a result of the domestic ballot box.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
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