Our Energy Economist, Dominic Whittome shares his Energy Highlights Report on oil, natural gas and electricity prices at the start of 2023.
Oil
- Brent closed the year generally flat. There was little change in January, but the seemingly placid market was punctured by two strong rallies on 28th March and 23rd September 2022, spot prices eclipsing $125/bl intra-day. The oil market could yet turn bullish in months ahead, especially once China reopens fully and pent-up demand across South East Asian economies ramp up to compete with scare extra supply from OPEC+ producers.
- Troubles relating to Russia and Iran have been worsening. The two oil producers may be supported by fellow 'hawks' within the cartel and resist future measures aimed at moderating oil prices if need be. Either way, the continuing lack of investment in producing for countries worldwide may itself limit the scope for responsive oil supply increases necessary, heaping pressure on Saudi Arabia to offer flexibility - which it might not have - to step in to stabilise the market. Even if the kingdom were to increase output unilaterally, alienating itself politically in the process, this might not affect market prices much. And the consequence of failing to do so, after attempting it, might only spook the market further and so have the opposite effect. The kingdom remains reliant on seven principal fields, now nearly 90 years old, one of which is known to be faltering. Principal OPEC oil ministers might face a delicate balancing act if global oil demand takes off again.
- Market rumours the Biden Administration may soon trigger a release from the US Strategic Petroleum Reserve once oil moves past $100/bl can be discounted. The SPA was triggered only early last year, in spite of which the market continued to climb sharply. It is doubtful this gambit will be played out again soon, or not until viewed as absolutely necessary.
- The calm in the crude market may be deceptive, however. In many respects, the adage “oil is the poor man's gold' (as pointed out in the very first, 2014 edition of Energy Highlights) still holds true today. Any renewed 'surge' in commodities, the next phase of the so-called “commodities super-cycle” and/or a fundamental reset of the petro-dollar, as some monetary economists predict will eventually happen, will drive oil prices up along with this.
Natural Gas
- Forward gas prices have fallen by some 300% since late summer 2022. But the wholesale market still faces an unsettling period ahead. Going to the wire, the situation in Eastern Europe has deteriorated also, with recent troubles surfacing again in the Balkans region, including reports of roadblocks. Although such intelligence reports aren’t being re-conveyed in mainstream news, any reports relating to unrest in this region could be significant. It was, after all, an innocuous-sounding roadblock that triggered the Yugoslavian war of May 1991. It is a theoretical or unspoken risk, but it is not far-fetched to envisage a Serbian, Belarusian and Russian axis emerging. Any early signs of the war in Ukraine spreading or involving new countries could be interpreted as a threat to remaining gas supply routes and influence forward prices accordingly.
- US, Qatari and Norwegian LNG supplies certainly helped European consuming countries restock their gas storage facilities last year. But LNG can only go so far. The reliance on Russian gas supplies to balance the market will remain, for the medium term at least. France recently became Russia's largest gas customer and is believed to have imported as much as 7 million tonnes of LNG in 11 months, roughly 10 billion cubic metres.
- EU countries and the UK signed medium-term (1 to 3 year) LNG supply contracts with US producers. But such imports have come at a price. In the main, the substituted Russian gas had been supplied under long-term Gas Sales Agreements, 15 to 25-year deals chiefly indexed to petroleum products, general prices and commodities indices. At current prices, much of this forfeited Russian gas would have been delivered below £2.00/th. Compared to the Treasury-backed strike, prices to pay for the extra LNG were reported at circa $90/MMBTU. At the prevailing $1.10/Sterling exchange rate, that price works out at [90/1.10] ÷ 10 or £8.00/th. The UK appears to have taken the fourfold price increase in its stride. This is not so much the case in France or Germany, with a proper diplomatic scrap breaking out last month. Energy ministers of both EU states condemning the USA of "profiteering" and repeating the charge in both their national assemblies, unlikely though it is to make a difference now.
- But significant new LNG exports from North America are anyway unlikely on account of soaring domestic demand, gas reservoir constraints and maxed-out LNG terminal capacity. The complete re-opening of the Chinese economy, possibly matched with rising gas demand across South East Asia, could tighten the global LNG market further.
- New gas price gyrations remain possible, therefore, with much of the "good news" (from a buyer's perspective) already built into the wholesale price, which has returned below pre-invasion levels. With three or four high-demand months to go, April traditionally being the most difficult for a gas trader to cater for, this market could yet turn on a sixpence, especially if events relating to Ukraine or the Balkans take a further turn for the worse.
Electricity
- Power prices remained volatile throughout 2022 amid concerns over ageing nuclear power plants on both sides of the English Channel. At one point, half of France's 56 reactors were out of commission, causing EEX auction prices to spike above €1,000/MWh on successive occasions.
- The UK, with its more diversified power plant portfolio, saw its 'workhorse' Advanced Gas-cooled Reactors perform comparatively well. But the chapter will draw to a close soon. All operating AGRs are set to shut completely within five years. Now new threats by operators to close the Heysham II and Hartlepool units early, unless the government agrees to rescind its 45% Energy Profits Levy in respect of nuclear assets. Whether it is Whitehall or EDF & Centrica (with a 20% stake in each plant) who blinks first remains to be seen. However, if things pan out, both reactors will shut anyway by the end of 2027 given they’d be operating far past their original design lives, and followed two years later by Heysham II and Torness. At which point the UK will have no AGRs left - just the one pressurised-water-reactor at Sizewell and possibly the new European pressurised reactor at Hinkley Point C which could be operating before 2018 is through. So the UK system could see a shortage of base load and shape, which is mainly provided by gas-fired stations.
- A policy to refocus on thermal plants may be needed, but that is not to say or predict it will happen. Gyrating market prices of gas, coal, and carbon (now trading back above €90/tonne CO2e) beside windfall taxes, unfavourable fiscal and legislative measures that target fossil fuels' generation have all but halted their redevelopment. Gas was fleetingly mooted as a "Transition Fuel" during the Truss administration. But there are few signs now of any imminent government encouragement for new thermal power stations, mining, North Sea or other UK projects required to support them.
- Looking at a five-year time horizon, the power market does look set to stay tight amid growing electrification nationwide spurred on by expanding data centres, space heating and electric vehicle demand. So new peak-load generation will be needed to keep the system balanced and spare end-users from incurring unsustainably high power prices.
- Installed UK renewable capacity is still increasing at a rate of less than 1½ per year, which will not be enough to offset the impending void left by decommissioned nuclear plants. Import interconnectors will have an important role to play. Although installed capacity and (firm) supply contracts are very different things. Additionally, interconnectors and faraway power projects can be inherently unreliable in practice, even with the state-of-the-art cables and high-voltage transmission technology now available.
- The short-term picture is also uncertain for the reasons outlined above. There was better news for buyers in that Forward Year prices have now fallen some 250% since the late summer peak, as reported in the August News Flash, even if much of this news has already been discounted in wholesale prices by now.
Dominic Whittome
Dominic Whittome is an economist with 25 years of commercial experience in oil & gas exploration, power generation, business development and supply & trading. Dominic has served as an analyst, contract negotiator and Head of Trading with four energy majors (Statoil, Mobil, ENI and EDF). As a consultant, Dominic has also advised government clients (including the UK Treasury, Met Office and Consumer Focus) and private entities on a range of energy origination, strategy and trading issues.
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