- Forward gas and power markets shrug off weaker oil prices and renewed Russian gas exports to Germany, soaring to new record highs in early trading today.
- UK power prices hit new record highs at one point early morning trade. The 'bell-weather' October Year 2022 supply contract, which is generally used to set Industrial & Commercial (I&C) contract renewal prices, clocked £375/MWh in spite of a softening crude market (Dated Day Brent losing almost a fifth of its value at one point in the last six weeks) and shrugged off what should have been positive news on Wednesday last week when, contrary to market fears, Russia resumed gas exports to Germany through its Nordstream 1 pipeline, albeit at reduced 30 bcm/y volumes vs. 55 bcm/y capacity, but due to physical supply issues rather than a policy decision by Gazprom.
- This is still however 'panic on the trading floor' and this is related to perceptions of a physical shortages of energy. However justified or unjustified this latest market reaction might be. Frequently discussed in past editions of Energy Highlights, dating back over eight years now, has been the problem of weak liquidity in the back end (long-dated) of the forward curve - especially at times of market duress; now in other words. The consequence for consumer is one of 'artificially high' prices, or certainly prices higher than they would be in a deeper more competitive commodity trading arena. Weak liquidity also expresses itself in a widening of bid-offer spreads which is precisely what the OTC and electronic markets are also exhibiting at the moment in both the broker-traded Forward markets and exchange-traded Futures markets.
- Arguably a price is being paid by businesses for failures to address market liquidity problems, in essence general competition in the (officially unregulated) wholesale market in years gone by.
- The record Annual prices now and the dearth of liquidity along the back end of the curve could not possibly have come at a worse time for businesses with I&C supply contract renewal deadlines in view of the ongoing October Year '22 Buying Round gradually approaching.
- Despite otherwise more promising sounding news surrounding oil prices, resumed exports of Russian gas and (partially oil-indexed) imports of LNG - not to mention the fact that OTC prices have already risen to simply unsustainable levels for most businesses anyway at this point - gas and power prices have continued to rise.
- To illustrate, on this day last year the Oct' Year '21 power contract was trading below £75/MWh. Today equivalent Oct' Year '22 volumes are changing hands above £375/MWh. The same gas contract that traded at circa 50 p/th last year was trading closer to 350 p/th this morning.
The Challenges of Forecasting
On a lighter note… a First Year joke told to us by our First Year Econometrics tutor;
“Economic forecasting is always difficult ….particularly when it involves the future”
In energy trading I learnt another, even if the Bank of England is the rightful owner of this one…
“If you can’t forecast accurately, forecast often”…
With that in mind, I shan’t share or explain the direction I see the market moving next. Suffice to say that it’s a sporting bet that prices are unlikely to fall very significantly nor anywhere near last year’s levels in the weeks left between now and mid September.
What's the Outlook for Commercial Buyers?
Many commercial buyers of gas and electricity may now prefer to buy volumes on contracts which track market prices, rather than sign up for annual renewals fixed at today’s forward prices. Unfortunately (and as a sales agent for certain Big Six and independent suppliers myself I can vouch for this) no UK-based energy supplier will offer renewing I&C customers a ‘buy-on-index’ contract that simply tracks market prices over the contract term.
Smaller-sized commercial users needing to re-contract soon, not wishing to lock into current forward prices are therefore left with a more sophisticated and potentially more expensive contract: the so-called Flexible or ‘Flexi’ contract. A Flexi contact can however still be operated as if it were a ‘buy-on-index’ contract, without the user having to make actual trading decisions during the contract term or utilising the swap trading facility wrapped within it.
The Flexi option may initially look the more expensive way to go. However, if (and only if) buyers take the view that gas and power prices will not rise significantly further and be more likely to fall back, then a ‘DIY buy-on-index’ strategy using a Flexi contract, is one possibly to consider.
In the simplest example perhaps the buyer might simply sell-out a twelfth of its cyclically-adjusted volume each month. The contract will still bestow the buyer’s option to trade, perhaps midway through the contract, although exposure to the market will be rise sharply in such an event.
Today the path for commercial buyers looks difficult to navigate to say the least. With most government attention or support now focused on the domestic consumer at one end of the spectrum and on large employer, electro-intensive consumers on the other, there seems no obvious help from outside on its way. That said, there are still alternative strategies and contract options that exist. Energy conservation, bill checking & re-validation and demand-side-response remain important ‘easy win’ options which shouldn’t be forgotten either. So, I&C users who traditionally renew at prevailing fixed price shouldn’t feel obliged to accept current market prices if they don’t wish to and can avail themselves to the other options out there.
Monday 4 pm, 25th July, 2022
Dominic Whittome
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