Energy News Flash: The UK Gov Energy Package and Fixing OTC gas prices – 7th & 8th September

News Flash – 8th September, 2022

A Downing Street announcement on its Energy Package was expected at circa 1pm today, rumoured to include measures to dismantle existing long-term electricity agreements based on contracts-for-differences (CFD).

The point Westminster is unlikely to mention – assuming it’s been thought through – is the immediate impact on OTC gas trading and – in particular – on the bi-lateral gas contracts market where long-term agreements include contract indexation to gas, power market indices or in most cases both. This will potentially open a Pandora’s Box in terms of disputes between importers, trading intermediaries and suppliers thereby undermining the long-term contracts signed between counter-parties, including those whose own commercial activities aren’t even influencing the target wholesale gas or electricity prices in any meaningful way.

The announcement will have short-term implications on wholesale electricity prices and forward gas prices, albeit to a lesser extent, as well as the structure of the bi-lateral OTC and exchange-traded markets and long-term contracts market. It will heighten uncertainties and produce an unexpected supply pool of ‘winners and losers’ in the process; the final winners will not necessarily be the consumer in all cases, even though the Energy Package is targeted at helping them with costs.

News Flash – 7th September, 2022

The current situation

Confusion reigns across UK and European gas markets now, amid the EU’s announcing a ‘total ban’ on Russian imports coupled with a ‘wholesale price cap’. Promoting (or certainly coinciding with) a Russian announcement that, for the first time, Gazprom will formally suspend gas supplies via Nordstream 1, the older and only recently operational pipeline of the two. For comparison, Nordstream 1 and 2 together could theoretically export 110 billion cubic meters of natural gas per year (bcm/y) or triple the annual gas volume from the UK Continental Shelf.

Perhaps the first paradox relating to the EU’s concept is exactly how a ‘price cap’ can apply to Russian gas whose imports are preclude in the first place.

The second perhaps is the somewhat bizarre situation we now have of Russia sanctioning gas exports to Europe via Nordstream 1 and the EU already sanctioning gas imports through Nordstream 2 which was commission-ready just days before the invasion of Ukraine. USA/EU/UK post-invasion sanctions against Russia included a ban on Russian imports of crude and refined products, principally heating oil, diesel and middle distillates. Hardly surprising then to see a self-fulfilling prophesy unfold and Europe short of gas of liquids’ heating fuel.

Energy Price Cap and Fixing OTC gas prices

It is possible that legal issues, amongst many other practical difficulties involved, have been pointed out to ministers. The anticipated 8th September announcement in Westminster may well concentrate on ‘taxpayer subsidies to gas shippers and suppliers but include little further detail on the salient question of fixing OTC gas prices which, from a consumers’ standpoint, might not be preferable anyway. Notwithstanding the mooted £150 billion cost of the overall programme, the final effect of establishing a ‘cap’ (at anywhere near current O.T.C. price levels) could be to ‘freeze’ wholesale prices to levels higher than they could have been otherwise, had the O.T.C. market been left to its own devises over the year ahead.

It is early days but there is silence on the same question from Brussels still. The whole idea of fixing OTC prices would yet be kicked into the long-grass were Russia to ever resume limited supplies via Nordstream 1. That might look unlikely just now and some degree of UK-EU intervention will come sooner but the prospect of limited Russian gas supply remains plausible.

Politically Divisive Moves

The Kremlin’s latest move is patently mischief-making, even if it is possibly temporary; a timed and politically-divisive measure which is already paying a dividend. Because the “sanctions’ paradox” (that of the EU and Russia sanctioning each other whilst complaining about supply) has already been seized upon by Italian opposition parties amid soaring domestic bills and a general election in three weeks time on 25th September.

Political splits pertaining to EU sanctions on Russian energy generally are also reported in Germany and other member states. Consequently Russia looks unlikely to change stance soon, preferring to watch events now set-in-motion to play out first. Meanwhile taxpayers will have to brace for substantially higher government borrowing to pay for subsidies while energy merchants will have to look out for sudden changes in the way they conduct business on the OTC forward, derivatives and exchange-traded futures markets.

Energy Prices – October Year gas for I&C users

As of now (2 pm, 7th September) October Year gas is trading at 540 p/th circa and base-load electricity just over £530/MWh. Down on my 22nd August News Flash but substantially over the 70 p/th and £75/MWh levels (comparatively stable ones at that) at this stage last September.

The current price level is clearly worrying for I&C users recently contracting or soon having to contract a new annual gas or electricity supply before the new Gas Year on 1st October. these users would effectively be forced into fixing a new contract price for 12 months forthwith (as no UK supplier currently offers businesses a ‘variable tariff’ (akin to such deals on offer to household buyers) unless they purchase on Flexi contracts, though such deals can only apply to a minority of UK businesses).