How do movements in international oil and gas prices affect our prices?

Movements in European wholesale gas prices impact on UK wholesale gas prices and in turn affect the Irish market price for both gas and electricity (Fig. 2).

The UK wholesale price of gas is closely linked to other North West Europe traded market prices (i.e. those of the Netherlands, Germany, Belgium and Northern France) ¹. Gas prices are mostly driven by the laws of supply and demand. Historic oil-product price indexed contracts for pipeline gas imports from Russia exert some influence (through arbitrage) on these market prices ². Thus, there is a degree of oil price influence on European gas wholesale prices, but it is indirect and it is likely to wane further once significant volumes of new LNG supply from the US and Australia augment import capacity in the 2016 – 2020 period ³.

A striking feature of figure 2 above is the gap between US and UK prices (represented by prices at Henry Hub and the UK National Balancing Point). The gap developed as large quantities of shale gas came on stream in the US from about 2010 onwards. As a result, European consumers now pay substantially more for natural gas than those in the US.

As gas is the largest fuel input to electricity generation in Ireland, the price of gas directly affects the price of electricity ⁴. Movements in the wholesale price of electricity (SMP) in Ireland closely track the price of gas (NBP) reaffirming the price-setting role of gas in power generation, as illustrated below (Fig. 3) ⁵,⁶.

Retail electricity prices do not rise and fall to the same degree as gas prices  because gas supplies a little less than half (46% in 2015 ⁷) of our electricity. However, its price-setting role increases the price impact above its weight in the energy mix for power generation.

The impact of changes in gas commodity prices is slower to appear in retail prices because gas is usually bought forward on short and medium term contracts. Suppliers buy ahead at a fixed price and hedge to ensure a measure of stability ⁸. As a result, any drop in prices on international markets can take up to six months to feed into a reduction in consumers bills ⁹

Irish prices for gas also include local transmission charges and levies such as a carbon tax ¹⁰ that do not alter with international prices. Therefore the percentage change in Irish prices is seldom as large as the percentage change in the UK wholesale market price.

Likewise, infrastructure costs for importing, transmitting and distributing gas  do not  change in response to changes in the commodity price of gas in European and UK markets. That means there is a part of our price that stays the same no matter what happens with international commodity prices; thus the full volatility of commodity gas prices is not reflected in domestic prices.

However, should the forecast demand for gas fall, the unit cost of the transmission and distribution infrastructure will increase to recover the fixed costs of the gas infrastructure ¹¹. Prices to final customers will rise as a result.

Currency exchange rates also affect the prices of oil products and gas on the Irish market ¹². Many of our suppliers’ oil contracts are priced in dollars, so when the euro weakens against the dollar, it makes oil products more expensive for us. Wholesale gas in Europe is priced in euros but the indirect influence of oil product pricing (dollar denominated) in Russian contracts can set a ceiling on such prices.

As the European price of gas is not directly linked to oil price, we should not expect a direct linkage between the two.  The price at which we buy gas is set in sterling at the national balancing Point in the UK (NBP) and, unlike the Eurozone, we are exposed to this sterling currency risk.