Impact of Rough Storage on Gas Price Volatility

Abstract

This paper explores the impact of supply shocks on the UK natural gas market following the closure of the UK’s largest gas storage facility, Rough. It provides statistical analysis of the impacts of the closure on both the changes and volatility of gas prices. Natural gas has become a dominant energy source in many countries worldwide. Its unique advantage over other competitive sources such as coal and oil is that it is flexible in supply and produces less carbon emissions. In the UK, particularly, the Government has announced its plan to phase out the use of coal by 2025. Despite growing capacity in the renewable sectors, a reliable energy source to provide consistent energy to the transmission and distribution lines is highly important. Hence, demand for gas has become a growing trend. These continuous changes in energy policies and infrastructures have gradually altered market fundamentals as well as price levels and their volatility. Since the 2008 financial crisis, NBP (the National Balancing Point) price levels have been low and the market less volatile.On the supply side, the UK still produces natural gas from the UK Continental Shelf (UKCS) though at a decreasing volume year on year. At the same time, the market relies on pipelines and interconnectors which transport gas from continental Europe to the UK. Furthermore, LNG imports have challenged the regional supply for natural gas and enhanced its role in international trade. For example, the recent increase in US LNG supply, as a result of its aggressive shale production, has increased LNG supply to Europe. The tranquil NBP market, however, finally changed this year. In 2017, Centrica announced their decision to close Rough Storage due to its low economic viability. While some industry experts argue some of the multiple and flexible gas supply sources make Rough redundant, others argue that Rough played a crucial role in the market in relation to security of supply. Thus, the market would become more volatile when there are demand shocks. These concerns on the impact of Rough closure on gas price volatility seemed to be justified when, from late February until 1 March 2018, gas prices spiked to their highest levels for almost 20 years due to a cold spell in the UK. However, no robust analysis to back up these have yet been conducted.To evaluate these changes in the gas market, this paper uses statistical analysis, namely the Two Stage Least Squares (TSLS) method, to estimate the impact of Rough’s closure on the NBP spot price. Subsequently, I use the generalized autoregressive conditional heteroskedastic (GARCH) model to estimate how changes in market fundamentals affect the spot volatility before and after the closure. My econometrics studies identify the inverse relationship between the available inventory, the spot price volatility and the spot price returns which are consistent with the Theory of Storage. The results suggest that percentage changes in prices have increased significantly since Rough’s closure, by approximately 9%, indicating a positive change in sensitivity of supply to prices. If we take the average day-ahead NBP price from my data sample, my results indicate that, after Rough’s closure, prices were on average 3.78 p/therm higher than if Rough would have been available. At an average household annual consumption in the medium level of 12,5000 kWh per annum 1 (426.5 therms), assuming all other factors remain the same, the wholesale price component of an annual bill would increase by £17 or around £400m nationwide.