In thisarticle, Dominic Whittome covers recent changes to wholesale energy prices.
Oil
Crude prices climbed amid deepening geo-politicalconcern in the Middle East. As well as heightened Iran-US tensions in the Gulf,political instability in Iraq and Libya has risen sharply amid the splinteringof militia groups and rise in terrorism in both producing countries. After athree year wait, Q4 witnessed the successful initial float of 2% of SaudiAramco, the world’s principal oil producer. It is anyone’s guess whether thisIPO will affect the willingness of Saudi Arabia itself to cut production tosupport oil prices in future.
Meanwhile, the financial world seems split on theoutlook for oil prices. One major Wall Street refiner is doubting NorthAmerican shale exports are sustainable and adequate to cover coasting orfaltering output from OPEC countries and elsewhere, with world oil demandholding firm. Other investment banks have declared more bearish views, withprices falling below $50 as global petroleum demand declines. Whichever view isright, the opening oil price at the start of the New Year is perhaps the leastreliable indicator to bank on, certainly on recent form. Brent opened the yearin 2016 at circa $30, in 2018 at $115 and now $65, and with no significantsupply shocks or unforeseen change in demand trend to explain it. We expectprices to roller-coaster this year, especially if recent tensions kick off inthe New Year.
Natural Gas
Gas lost a quarter of its value in three months, withNBP prices weakening along the forward curve, partly due to high gas storageinventories on the Continent and a warmer-than-expected European winter so far.
Strong LNG exports from the Americas and Qatar addedto the downwards pressure on the Spot and Forward Markets. On 1stJanuary, Russia and Ukraine agreed to a new five year transit deal,safeguarding 50 billion cubic metres per annum of exports to Europe. Meanwhile,the Trump administration announced sanctions to halt a new major pipelineproject, Nordstream 2, which could export up to 60 bcm/y should it become fullyoperational.
This move is reminiscent of earlier moves by theReagan Administration to block Russia’s very first such project in the 1980s. However,this latest threat may not have the legs that it needs, with Germany, Franceand almost all other EU member states firmly supporting the project. After all,Nordstream 2 will still leave the Russians with a market share (circa 20%)below its peak level under the post-Brezhnev era at 24%.
The LNG terminal building programme has successfullytransformed Europe into a global gas market which is well supplied just now.However, the trading of gas via pipeline or LNG can lead to significantgyrations in price. Wholesale prices almost halved since early 2018 and themarket could easily snap back, especially if oil and energy commodity prices ingeneral do make sustained price gains this year.
Electricity
Annual contract prices fell 15%, closing below£45/MWh.
Whilst welcome news for industrial and commercialusers, with the April Year 20 buying round now in full swing. on the domesticfront December saw the ‘unlucky 13th’supplier go out ofbusiness inside 12 months. The trading liquidity window, which aimed toencourage ‘new suppliers’ has not proved a success, partly due to certainsuppliers themselves who did not budget for and spent green taxes, such as theRenewable Obligation (RO), which were in fact payable to Ofgem.
The insolvencies have left all domestic users sharingthe outstanding liability in our future bills. With over 20 new supplierseither insolvent already (or on our own watch list), we do not see the storyending immediately. Especially since the Capacity Market (CM) mechanism wasreintroduced, to general surprise, last year, which will mean a fresh trancheof pass-through CM payments payable to Ofgem which some such companies simplywill not have. For if there was no provision for initial RO payments, thenfurther Commodity Market payments may well prove the straw which breaks thecamel’s back in some cases.
Hopefully this will clear up soon and thankfully thisone market experiment was confined to the domestic market only, with no supplydisruption to any household or I&C business. However, the episode will dolittle to encourage investors to the UK I&C gas and electricity markets,where competition has been waning amid perennially weak margins for suppliersto business customers.
As we have explained in earlier updates on wholesaleenergy prices, business users will be seeing significant increases inpass-through costs including network capacity and eco taxes over the next fiveyears, even if the commodity price for the electricity itself looks relativelyfavourable for now.
Last year there was much fanfare around the cost ofrenewables, particularly offshore wind, which was not so much due totechnological breakthroughs but chiefly economies of scale. However, there arelimits and it is important to appreciate that many renewable energy optionsthemselves are ‘resource constrained’ due to the availability of remainingsites, planning issues and practical network constraints.
Whilst there is greater scope for up-scaling offshore,larger turbines also mean less reliable turbines and shorter commercial life,with increased torsion and load on bearings, a higher risk of bladedamage from environmental factors as well as early wave-line corrosion issuesbeing reported as of late.
Renewable energy efforts must certainly be encouraged,although their limits must be recognised. Given that coal generation is out ofthe equation and we will see a sharp net reduction in the nuclear fleet beforelong, reversing the decline in gas-fired generation may be one practical way toaddress the impending shortfall and also provide peak volumes and responsegeneration to actually foster renewable projects. However, last year’s repriseof the Capacity Market could spur the economics of large/peaking andsmall/responsive gas units over the coming years.
In future we could see more embedded gas unitsinterfacing with users’ energy portfolios and storage assets, with larger unitsselling electricity volumes direct to the exchange, private wire or OTCcontracts as well as making use of the Capacity Market mechanism itself. Eitherway, certain I&C customers may see new cost-saving options or commercialopportunities over the next five years as energy regulation evolves. In therising energy price environment, it is worth keeping tabs on regulatory eventsover the year ahead.
About the Author
Dominic Whittome is an economist with 25 years ofcommercial experience in oil & gas exploration, power generation, businessdevelopment 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 governmentclients (including the UK Treasury, Met Office and Consumer Focus) and privateentities on a range of energy origination, strategy and trading issues.
Prospect Law is a multi-disciplinary practice withspecialist expertise in the energy and environmental sectors with particular experience in the lowcarbon energy sector. The firm is made up of lawyers, engineers, surveyors andfinance experts.
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