Oil
- Crude was driven higher over the first quarter amid rebounding global demand for petroleum fuels, geo-political worries over the technical ability of Middle Eastern producers to ramp up supply and new restrictions on Russian exports of oil, gas and refined products.
- Whilst new upstream investment by G7 multi-nationals was halted last month, the headline ban hasn't applied uniformly to existing production activities in Russia. Some principal US and EU energy majors are continuing to produce significant volumes of Russian oil and gas which, one way or another will seep onto world markets, possibly sold at higher final prices if the volumes are now sold through more convoluted supply channels and oligopolistic trading intermediaries.
- In order to counteract rising oil prices, the USA on 30th March announced the unprecedented release of a million barrels of crude a day from its Strategic Petroleum Reserve, the most significant stock release since the SPR came about in 1975, in the aftermath of the first oil crisis.
- Reassuring though this move may sound, the track record of 'buffer stocks' in reversing the tide of price is historically poor across commodities markets and if oil should be no exception then the 1 mb/d release could make little or no difference even if it will ease supply in the short run. Conceivably the move could finally make the situation worse by inducing a sense of panic or even suggesting that authorities or 'those in the know' are themselves worried and for reasons undisclosed.
- Going to press, crude prices have since recovered and made up all ground lost in the immediate aftermath of the announcement. Perhaps a further difficulty arises once the 60 day release period is up; not so far off and just at the start of the US gasoline season.
- In recent years key OPEC+ producers have acted as the world's 'production buffer' and with a fair amount of success at that. Suffice to say that Russian co-operation will be less forthcoming this time around.
- The crude market looks set to remain choppy, certainly for the immediate foreseeable future. Dated Brent closed the review period up nearly a third, closing just above $105/bbl.
Natural Gas
- First up it is important to acknowledge that, one month into the crisis, there has been no clear default or physical disruption to date in relation to Russian gas exports transported to Europe via Ukraine; not by either of the two sides.
- Above all else is fear of a suspension of supply that has spooked the market, coupled perhaps with many continental utilities going into winter armed with unusually low storage inventories, recovering gas demand across Europe, sharply rising coal prices and Russian petroleum restrictions themselves rendering all the alternatives more expensive.
- Up until now at least, no news had reached the Energy Highlights bunker of any breach in export gas supply terms with swing, take-or-pay and other, counterparty-specific flexibility terms all provided for by Gazprom Neft and Ukrtransgaz alike.
- Having soared in the immediate aftermath of Russia's invasion, Forward Year gas prices went on to collapse during much of last month.
- The bell-weather October Year gas contract more than halved at one point in one three week period, only to recover ground again last week after Russia threatened for the first time to physically halt deliveries of natural gas to west European utilities, unless they now make payments in Roubles. No supply was halted, but that is not to say it won't. The Russians are simply offering utilities more time as behind-the-scenes negotiations continue. If so, then all or some such talks may fail, in which case European buyers may soon face physical restrictions extended to Russian gas in addition to oil & petroleum products.
Russia’s Gold
- However, there is a second gas market development. One which may have more significance to the Forward Market in the long run than the threatened restrictions themselves, which hasn't perhaps been as widely reported as it should have been, which is Russia's neo-conversion to a Gold Standard such that the rouble is pegged to the dollar-denominated price of gold bullion.
- This would provide a de facto 'gold-related ‘floor price’ for the rouble and enable Russia to use its gold reserves (built up extensively over the last few years) to support its currency. It could even serve to increase the cross-correlation between the gold and natural gas markets, especially if European utilities fold and they now agree to pay for their Russian gas supplies in roubles, fixed against gold, in future.
- If just to defend the petro-dollar's Trade Currency status in respect of gas, the Federal Reserve and Washington Administration are likely to be putting behind-the-scenes pressure on European utilities and governments to resist this move. This could be part of a wider picture, conceivably with China which has been building up a substantial position in gold.
Gas UK
- Gas is fast becoming a pure geo-political power play with consumers caught in the middle.
- Completely missing from the Chancellor’s Spring Statement was any mention of extending the price cap to the industrial & commercial sector, leaving energy purchasing managers with the headache of having to decide very soon whether to hedge positions any further or wait in case the market drops down further; mindful that over the counter prices possibly stand now at commercially unsustainable levels for their businesses to survive. Things may unravel over the months ahead barring a new market developments or intervention of some kind.
Electricity
- Base-load electricity prices initially followed gas prices down last month, its peak price fall some three weeks into March being closer to 45% compared to 55% in the case of wholesale gas.
- The decline also fell during the period and - along with gas - quite sharply by over 38% over the last month alone even though the price finished slightly up over the last quarter. However prices recovered as soaring carbon, coal and gas prices dragged the UK electricity market back up again, closing 5% higher since the start of the year at circa £200/MWh.
- UK electricity is already among the world’s most expensive but I&C users will also be facing rising non-commodity costs, which are indexed to inflation and will also be rising with green subsidies.
- Consequently, forward year contracts that will have been signed in the weeks leading customers to the close of the April Year buying round will be exceptionally expensive for commercial end users, especially those who may have had to renew contracts roughly 2 to 3 weeks before cut-off, thereby missing out on the sharp retreat in over the counter prices.
Renewables and Nuclear Power
The only positive on offer has been talk of a further renewed push towards renewable electricity and encouragement for mini-nuclear reactors even though no working prototype or final design exists yet.
In the event that new renewables and small modular reactors combined do work together to provide the extra peak and base-load volumes needed to offset the fact that the UK will lose the final four of its five operating nuclear reactors five years from now, there is the demand impact of the transition to EV transport, commercial and residential heating electrification to consider.
There seems to be no concrete medium-term solution on the table therefore.
Market Talk
Perhaps unsurprisingly, some quite interesting debates and contrasting views are now doing the rounds in energy trading circles.
The market fundamentals look precarious for both fuels. However, barring a change in UK energy policy soon, perhaps the power market is the tighter one.
The Russia-Ukraine war and global gas supply problems may be partially resolved in a year’s time. The power market though faces a seemingly intractable problem of mobilising enough extra carbon-neutral and reliable electricity on time.
Consequently, the forward market in electricity looks set to command the higher risk-premium of the two in future and it is already far less liquid than the gas market.
With that in mind, the spark spread could make up much of its lost ground, possibly moving back above £50/MWh and staying there for some while yet.
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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