Does Domestic Oil and Gas Production Improve UK Energy Security?

The potential impact on energy security of further oil and gas exploration in the UK Continental Shelf (UKCS) is very much in the eye of the beholder, as can be seen in recent press coverage of the opposition Labour Party’s plans to stop granting new licences for oil and gas exploration. The plan is part of an ambitious energy agenda that will form a core part of the party’s economic and industrial strategy should it win the next general election, which must take place by 28 January 2025.

Despite scaling down plans for public green investments as interest rate rises have eroded the government’s borrowing capacity, Labour’s commitment to the strategy is likely to remain strong. Shadow Secretary of State for Climate Change and Net Zero Ed Miliband, a former party leader, is a longstanding advocate of action to reduce greenhouse gas emissions and, more importantly, so is Shadow Chancellor Rachel Reeves.

The party intends to invest heavily in decarbonisation, scaling up to £28 billion by the end of the parliament. Plans to end licences for new oil and gas exploration are a complementary aspect of the strategy, and both elements must be considered together: investment to reduce demand for fossil fuels while limiting supply, with the goal of reducing the UK contribution to climate change. If the plan is successful, it could result in an energy system which is more secure and less vulnerable to price shocks than an alternative scenario with higher – albeit still diminished – gas production but also higher demand.

Intervening in the market to prevent developments that might be commercially viable is a break from the energy security policy of recent decades encouraging companies to maximise economic returns, in the process taking an independent view on how gas demand in the UK and Europe might develop. In that sense, the policy goes against the rationale for having an open market in the first place. Many in the oil and gas industry are also sceptical of the feasibility of a fast and deep reduction in fossil fuel demand, citing the increasing costs of renewables as fossil fuel prices have declined. However, in this case, the risk to energy and national security is likely to be limited, as UKCS is a mature basin which is in any case in decline.

Domestic Gas Production and UK Energy Security

There is no doubt that domestic gas production currently plays an important role in the UK market, meeting around 53% of UK gas demand in 2022. It is equally clear that the role of domestic supply in mitigating the energy price crisis that followed Russia’s invasion of Ukraine was minimal, with the UK shown to be just as heavily exposed to price shocks as neighbours without domestic gas production, if not more so – a problem exacerbated by the UK’s comparatively high reliance on gas.

This should not be surprising for several reasons. Domestic producers are not the marginal suppliers to the UK market, with supply steady throughout the year. When supply is tight and the price rises, liquified natural gas (LNG) generally makes up the difference as the oil and gas majors and large-scale traders shuffle their portfolios to take advantage of arbitrage opportunities between markets, diverting shipments from markets such as Pakistan and Bangladesh which cannot compete in either scale or purchasing power.

This has two implications. Because the same price – known as the National Balancing Point (NBP) – is paid for all gas supplied to the UK market and that price is set by marginal volumes, the NBP is largely set by the global LNG market. This is clear from research showing that global gas price benchmarks are increasingly correlated and that the NBP is no longer the dominant benchmark in Europe, ceding that position to the Dutch Title Transfer Facility (TTF). The latter point is significant; it was a liquidity crisis affecting TTF that exacerbated price spikes in 2022. This also means that to attract gas to the UK market (which includes Ireland) from continental Europe, the NBP price must be higher than the TTF. As a result, UK production has little role in setting the NBP, and lower production in the future is unlikely to influence the price.

Preventing additional exploration will reduce the amount of gas available in the future. Production is projected to fall to 10–25% of demand by 2035, resulting in a relative increase in imports. However, Labour intends to land in the 25% world envisaged by the Climate Change Committee’s (CCC) Balanced Net Zero Pathway, where its energy policies will have reduced gas demand significantly (so domestic production will account for more of it) and gas will be less relevant to overall energy security. The CCC pathway could see the absolute volume of imports decrease by 2 bcm by 2035.

The 10% world of the Department for Energy Security and Net Zero’s reference scenario shows the risk if demand reduction policies fail, but also the limits of that risk. In this case, imports would increase from 32.7 bcm in 2022 to 48.9 bcm in 2035 – a significant increase. But the reference scenario also assumes that gas demand reductions over the next 13 years will amount to less than half of the reductions over the previous 13, which is unlikely.

More significant than the increased proportion of imports is that the 30 bcm drop in overall demand by 2035 envisaged by the CCC balanced pathway could not be replaced by increases in domestic gas production, which stood at only 37.8 bcm in 2022.

Consequently, with prices set by global markets (in the absence of infrastructure bottlenecks) and UKCS production in decline, two main pathways remain to improve price security: the UK must either use less and decouple gas and electricity prices, or intervene in the gas market to sign long-term contracts above average costs. Measures to ensure market liquidity would help in extreme situations. With a huge expansion of global LNG capacity coming online in 2026–27, long-term contracts signed in the current environment could look like very bad business in five years’ time. This is why the policy of demand reduction coupled with market reform to reduce the impact of gas prices on electricity and to equalise policy costs between them is an attractive route for reducing vulnerability to price volatility resulting from future unexpected supply shocks – particularly where this reduces system costs – with the additional benefit of reducing greenhouse gas emissions.

Domestic production does play a role in infrastructure resilience, but less than might be assumed. The latest statutory security of gas supply assessment found that if the Felindre pipeline in southwest Wales – the single most important piece of gas infrastructure in the UK – was unavailable on a day when demand was at its highest for 20 years, the UK would still have excess capacity equivalent to 122 million cubic metres (mcm)/day. As the maximum infrastructural capacity for domestic gas production in 2022 was 117 mcm/day, the UK could lose its entire domestic production and its single largest piece of import infrastructure and still have the infrastructure to just about meet demand.

Similarly, while having infrastructure located in UK territory may improve security in some situations, the most damaging infrastructure disruption in recent years in a high-income country was the 2021 ransomware attack on the Colonial Pipeline in the US, a domestic pipeline.

In sum, Labour’s plan to end new licences will increase energy security risk if the party fails to reduce gas demand. Should gas reduction efforts disappoint, the risk still appears to be manageable because of the UK’s strong gas import infrastructure and the medium-term trajectory of the LNG market.

One Big Oil Pool

While gas was the focal point of the 2022 energy crisis and resulting economic crisis, oil is traditionally regarded as the more critical fossil fuel for national security. This is not because of its potential impact on the UK economy or society, but because effective national defence simply cannot happen without it. Day-to-day, UKCS oil production has almost no energy security benefits for the UK, as 80% of oil, condensates and petroleum gases were exported in 2021, and 75% in 2022. UK-produced oil consumed within the territory met only 16.7–16.8% of domestic demand in both years.

In an importing country like the UK with an open market, the oil price is set globally, and no marginal increase in domestic production would have any impact. This is because the oil market is widely considered to be ‘one big pool’ – a hugely liquid market dominated by shipping and with highly substitutable products sold almost exclusively on a short-term basis. This also tends to make infrastructure less of a concern in oil importing countries, where strikes by oil tanker drivers are frequently the biggest concern for government officials.

Hypothetically, UK oil production could meet a significant proportion of demand in a crisis – 84% in 2021 and 70% in 2022 after demand increased. But in what situation is this relevant? Only one in which the UK is cut off from the global market, or there is a global supply crisis so severe that direct government control of both the industry and prices is exerted. Being cut off from the global market would require a military blockade which the UK and its allies are unable to circumvent, a total war eventuality which is not being seriously planned for in any sphere of government. Should the UK lose control of its territorial waters in such a way, it would almost certainly not be able to access its offshore fields in any case.

It is for these reasons that a strong oil market, strategic reserves and control of the seas – currently one of the foundational roles the US plays in global security – are generally considered the critical issues for oil supply security.

The energy transition makes the energy security case for UKCS oil production even more underwhelming. Already, oil consumption in the UK has reduced from around 100 million tonnes/year in the 1990s and mid-2000s to a little over 60 million tonnes/year in 2019, before the Covid-19 pandemic hit. With road transport accounting for more than half of oil demand, most analysts expect oil demand will drop further in the future. Assurance and risk management giant DNV forecasts that oil demand in the UK will halve from current levels by 2040.

Conclusion

While preventing market actors from taking a view on how much supply is required – and from what source – to meet demand is not advisable, the Labour Party policy of ending new licences for oil and gas exploration in the UKCS is unlikely to have a significantly negative impact on energy security. With effective implementation of its policies for reducing fossil fuel demand, the strategy could result in a system which is more secure and resilient to price shocks. The scaling back of ambition announced earlier this month – with the promised £28 billion/year for the energy transition pushed back from the first year of office to within the parliamentary term – could result in marginally higher reliance on imports. But the limited impact of domestic production on prices and the planned expansion of global LNG supply mean that – from an energy security perspective – the downside risk is very limited, while the potential upside from reduced demand is high.

The views expressed in this Commentary are the author’s, and do not represent those of RUSI or any other institution.

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