Wholesale Energy Prices: March – June 2019

Crude Oil

Having eclipsed the $70/bbl mark at one stage, the Brent contract fell back to finish the second quarter 8% down, as fears of an US-Iran war eased for at least for the time being. Nevertheless, the Persian Gulf remains a tinderbox, one which could cause crude oil prices, and petroleum product prices in particular, to snap upwards at some point. If recent history can tell us anything, perhaps it is that military campaigns in the Middle East can last longer and have far further-reaching consequences than initially imagined. So this latest stand-off with OPEC’s second highest oil producer in terms of proven reserves, could equally affect the forward markets for gas and electricity, not just prompt prices.

Natural Gas

In this context, Gazprom of Russia and NIOC (NationalIranian Oil Company) together hold some 80% of global gas reserves which are economically-recoverable at currentprices. Although no Iranian gas to speak of is exported to Europe insignificant volumes, certainly not yet, conflict with the US could have all sorts of impactsacross energy commodities markets.

Leaving geo-political issues to one side, it may beworth looking at the supply & demand fundamentals. In particular, consensusindustry estimates of the break-even (long-term marginal cost (LRMC)) ofbringing new gas supplies to the European border over the next decade, asexisting 25 year gas and LNG contracts (many signed in the late 1990s) expire.

One of many expressions bandied in trading circles isthe one that “the market is well supplied”. By itself, this statementis perfectly true. The day-ahead market always clears after all. But it is notso much prompt market availability which affects wholesale or industrial gasprices. It is the ‘break-even cost’ (LMRC) of mobilising new gas supplies andbringing them to market.

The consensus industry estimates now put the LRMC fornew gas supplies, those destined for North West Europe over 2020-2030, atbetween $8.00/MMBTU (for West African, Siberian and low-case North Americanshale) and $10.00/MMBTU (including Frontier LNG and high-case North Americanshale). Even were we to assume the lower-case eight dollar MMBTU figure andassume gas is delivered at or close to the break-even price (so no risk-premiumand low supply margin), then at current exchange rates the UK wholesale gasprice could still rise past 70 p/th, i.e. a third higher than today with theAnnual Contract just closing the second quarter up 6% at 49 p/th.

So, notwithstanding Climate Change Emergencies andZero Net Carbon 2050 targets set in Westminster,no demand side reduction or perceived ‘abundance’ will altar what thefinancials are suggesting: that gas prices may not fall far from here and evenif they do it will not be for very long. Nomajor producer will export at a loss. So, if our ‘cost plus’ valuation isaccepted, then gas prices could start to rise as more legacy long-termcontracts expire, replaced by higher-cost/ LMRC supplies.

For all its merits, renewable electricity does notoffer reliable base-load supply. And it actually increases relative demand forpeak-load generation. Given that all 14 operating reactors in the UK bartwo at Sizewell will be decommissioned over the next ten years, today’s ca. 80TWh demand call from gas-fired power stations looks very unlikely to fall.Indeed the share of gas in the UK’sgeneration mix may need to rise at some point. The combined domestic heating& industrial quotient for gas is much higher, at circa 250 TWh and thereare measures to phase out use of gas in homes past 2025. However, this demandtail-off will be gradual. As the economics stand (and are unlikely to change)an impending deficit in flexible/peak-load electricity looks very plausible.Perhaps it can only be properly addressed by new forms of fossil generation, beit domestic gas-fired generation or brown- coal generation, imported from Poland or Germany through interconnectors.Either way, the consensus LMRC figures suggest in future, Forward Market gasprices will be higher.


Base-load power prices followed natural gas, rising 5% over this last period April to July. There wasalso the announcement that, for the first time in the UK’s industrial history, ‘cleanelectricity’ had exceeded fossil generation.

Amid the fanfare, it needs repeating that the Whitehall’s definition ofclean electricity includes nuclear power. And while last month may have been atrailblazing one for renewables, the tail end of June saw day-ahead powerprices spiking up to £375/MWh or 38 p/kWh. This was partly attributable tocloudy skies and low-wind speeds which severely cut renewable generation. Moreominous perhaps (since such imports are being relied on more to fill any supplygap) was the wanting performance of Nordic and Northern Europe inter-connectors. The general reliability of such cableswas discussed in recent editions of EH. In the event, it was domestic gas-firedgeneration that the system ultimately had to fall back upon on, come the dayitself Monday 24th June.

This tale relates as much to nuclear power as it doesto gas. The mainstream political parties remain opposed to any new-build gasprogramme and with no new-build nuclear reactors bar Hinckley on the horizon,the UKpower market does appear to have a forward supply & demand picture thatdoesn’t stack up – or certainly the consensus in the Energy Highlight bunkerjust now. What this could mean is two fold. First, perhaps we should braceourselves or hope for some change in government policy. Even it no change isannounced any time soon and this can has been kicked many times before.Inter-connectors alone, even if/when the power supply is firm, will notcompensate for GW output lost by retiring UK reactors. Second, it we assumethere is no government money left for significant new subsidies and limitedstomach either for new levies on households, then our energy authorities maywell feel inclined to sit back, watch the market mechanism do its work and seewholesale power prices rise and so quell the energy demand to help the UK reachthe new and somewhatfiercer ‘Zero Net Carbon’ emissions target announcedlast month.

Looking short term, power prices couldrise if French, Benelux or German reactorsshut due to lack of cooling water from reservoirs amid the European heat-wave.On the downside, renewables output is currently strong and across energymarkets generally there are concerns over the global economy which may dampenboth gas and electricity demand.

About the Author

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.

Prospect Law is a multi-disciplinary practice with specialist expertise in the energy and environmental sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, surveyors and finance experts.

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