Believe it or not global oil and gas prices are falling. But this isn’t likely to feed through to significant cost reductions in the UK. EN reports on a bleak midwinter to come.

Are you one winter away from bankruptcy? Research by energy supplier Electricity4Business suggests that one UK small business in five already spends more than ten per cent of its turnover on energy. If they were households they would be classed as being in “fuel poverty”. And more gas and electricity price rises are expected.

A further 22 per cent of the 1,000 companies with fewer than 20 employees sampled said they spent between five and ten per cent of turnover on energy.

Energy costs, the poll suggests, have become the second biggest item of expenditure for respondents, after wages and recruitment but ahead of premises/rent, equipment and insurance. This “energy” figure does not include transport costs and motor fuel.

There are two big numbers to look at – the price of oil and that of gas. These are the fuels that, along with coal, are used in the lion’s share of UK electricity generation, so their impact goes way beyond heavy users of diesel or companies that use gas to heat their offices.

Interestingly, both have been falling in price lately, though the hefty tax component that has to some extent meant the UK hasn’t felt the shock from recent oil price rises as badly as, say, the USA, means we haven’t immediately felt the benefit of a market that is softening slightly. And the operative word is “slightly”.

At the time of going to print crude oil cost $124 a barrel. This was down from its peak of around $145 at the beginning of July, but still a massive increase on the $70 or-so at which it was trading only a year ago. Before the Iraq war, just five years ago, a barrel of oil cost just $25. Nobody seriously expects it ever to return to anything like that level.

UK gas prices used to be based on supply and demand. Then, in 2002, North Sea production peaked and began to decline rapidly, meaning we had to import increasing amounts from continental Europe and the Caucasus.

European gas prices are linked to the global oil price, and supply is controlled by a small number of big companies whose pricing practices are currently being addressed by the European Commission. The net effect was that gas prices paid by industry more than doubled between 2000 and 2006, although they have since fallen back a little.

Interestingly, the real cost of gas in the UK today is still lower than it was before privatisation (the price plummeted in the late 1980s and throughout the 1990s) but that’s cold comfort to businesses whose model was based on cheap fuel.

Meanwhile there are several schools of thought in relation to current oil prices. Two of the more optimistic ones include it all being the fault of the Iraq war and – particularly popular in the US – that it’s mostly down to speculative investors playing the futures market.

A variant on this theme is the idea that producer nations are actually speculating on future price rises by keeping oil in the ground rather than extracting it, in anticipation of higher returns to come. This further restricts supply, becoming a self-fulfilling price prophecy.

Others (and Gordon Brown is seemingly one of them) argue that it’s just a simple matter of supply and demand, with rampant growth in developing countries led by China, India, Russia and Brazil driving prices ever-upward and producers not pumping fast enough. This is fair enough, but can it really explain a five or six-fold price increase since 2003?

There are those who predict that prices will actually fall in the autumn because demand from China will drop. Since being awarded the Olympics, they argue, the Chinese government has rushed headlong for development in order to buy off its population with rising wealth and ensure that, with their bellies full and iPods set to shuffle, they don’t embarrass it with pro-democracy demonstrations in front of the world’s media.

Once the Olympics is over, they argue, the Chinese Government will take a much more relaxed approach to development, factories will close, its demand for oil will drop, and so will the global price.

But what are the chances of the oil price (and therefore that of gas) falling back even to the level of a year or two ago based on reduced demand? Slim to non-existent, if we consider another factor: global supplies of conventionally accessible oil may have already peaked.

In the best-case scenario experts believe “peak oil” will be reached at some point between now and 2020. In a presentation to the All Party Parliamentary Group on Peak Oil earlier this year, however, Dr Mamdouh Salameh, an international oil economist and World Bank Consultant, argued that OPEC has grossly overstated its “proven oil reserves” by some 300 billion barrels. Peak oil could actually have been reached, he said, as early as 2004.

Several major oilfields are at risk of coming offline at any time, he continued. Even if he was being unduly pessimistic, it’s obvious we have to get used to oil being scarcer and harder to access. And that clearly means that, even if we’re seeing the deflation of a speculative bubble in the short term, in the medium to long term we have to get used to paying more.

In the UK there is only one way petrol products are going to get much cheaper – and that’s lower taxation. Can there be anyone left who thinks that any of the major political parties would do this?

With the exception of BP, there can hardly be a British company for whom this isn’t all bleak news. Hauliers, couriers and other heavy petroleum users are already feeling the pinch, and Damian Waters, North West regional director of the CBI, tells EN he knows of companies that are negotiating their 2009 gas supply contracts at almost £1 a therm. The current price is around 70p.

One business that has borne the brunt of recent rises in petrol prices is Knutsford-based courier Same Day Plc. Its managing director Tracey Hoather, who speaks for the Forum of Private Business on fuel prices, says, “Transport companies have been the worst hit as they cannot always pass on the increases to their clients, dependent on the wording of contracts put into place several months or years ago. These rises have been steep and unexpected.

“Manufacturers have also been hit, as many operate just-in-time production techniques which necessitate frequent delivery runs for inbound parts for their production lines.

“And distribution companies that use regional or national distribution centres will have had huge increases in costs to get product lines picked and into shops with the same speed as before.”

Hoather seems to accept that high fuel prices are a fact of life. She continues, “As managers and owners of small businesses we have to accept that change is going to occur more rapidly than in the past. We must set more fluid price regimes and not be afraid of adjusting the prices we charge to reflect the costs we have to absorb.”

While she might be sanguine, though, it would be a mistake to think she is happy about the situation or thinks that no-one is to blame. “The RAC foundation claims that the Chancellor intends to take £2bn from motorists in the next two years,” she points out.

It isn’t only heavy fuel users who stand to suffer though. As both businesses and consumers continue to nurse their hangovers from the borrowing binge of the last decade, a double whammy of scarce credit and high fuel prices is stripping money out of the economy. And that’s bad news for everyone.

As Waters says, “One reason for the current slowdown is that the consumer is spending less. The domestic consumer will have less discretionary spend going forward.”

This is anecdotally already affecting spending on the high street. What will be particularly interesting will be to see the effect on the local tourism industry. Will cash-strapped holidaymakers forego their fortnight in the sun now that cheap flights aren’t so, well, cheap, and the euro is at an all-time high, and instead enjoy day trips and short breaks in the region’s beauty spots?

Or will the fact that Joe Public can still fly to Spain for not much more than the cost of filling up the Mondeo mean the narrow lanes of the Lake District enjoy their least clogged summer in living memory? The tourism figures for this year will be awaited with keener interest than most.

Another imponderable is what will happen if oil stops being priced in dollars. The US currency’s slump since the beginning of the Iraq war has led producer countries to consider pricing oil in a basket of three currencies: the dollar, the yen and the euro. Sterling is currently strong(ish) against the dollar but weak against the euro – so a repricing in the latter currency might increase the UK’s energy costs further.

Waters says that, over time, “It will become part of our DNA to treat energy as an expensive resource.” That won’t, however, stop the price of oil and gas combining with tight credit to tip us headlong into recession if the coming winter is anything like as long and cold as the last one.

---