Crude Oil
Oil prices continued to rise amid concern that Russia and Saudi Arabia, who share a de facto duopoly in marginal OPEC+ export supply, have a tacit agreement to increase production only modestly as global energy demand recovers. The market was underpinned further by the continuing production problems afflicting OPEC producers, notably those in North and West Africa where political tensions have been intensifying.
Meanwhile the election of the hard-line Iranian President, Ebrahim Rasi, has ended any prospect of a relaxing of US sanctions. This embargo has forced the Iranians to shut-in production and to export the bulk of remaining oil to China for blending, re-export or supply to refineries which are not equipped to process all of the crude efficiently.
Markets are increasingly factoring-in the spectre of rising global inflation to levels higher than those publically anticipated by many governments and central banks. This is already reflected in sharp rises in raw materials’ prices across the board, with the crude market caught in this slipstream. Another factor driving oil prices higher has been the steady depreciation of the dollar. This will have reinforced the conviction of all OPEC+ producers to defend export revenues through higher prices, as the petro-dollar falls amid new US Treasury spending and Federal Reserve asset purchase programmes now totalling an extra $7.8 trillion over 18 months.
Oil prices rose 19% over the quarter and have risen 45% so far this year. The bell-weather Brent Futures contract closed the quarter at $75.85, breaking through $75/bbl for the first time since October 2018.
Natural Gas
Wholesale prices for natural gas rose substantially over the last quarter, with the Forward Year October 2021 contract rising by 57%. This is in part due to the 3 to 6 month oil-indexation lag effect in long-term contracts, which still predominate in the market today, as well as a general tightening in supply and low storage levels reported across Continental Europe. Market sentiment was buoyed further as senior Gazprom executives reaffirmed that long-term contracts are to indefinitely remain the company’s principal mode of business, adding that Russia will prioritise delivery for customers bound by oil-indexed contracts. This stance is consistent with the current OPEC + position and the objective is to optimise export earnings.
The gas market was also driven higher by rising global LNG prices, as Asian and other international buyers competed for spot cargoes as their economies picked up. Gas demand in Canada and the USA was boosted in particular by strong air-conditioning demand, as record temperatures hit North America, together with a strong start to the US gasoline season which spilled into other energy markets.
Since first going to press in 2015, Energy Highlights has stressed the importance of supply & demand fundamentals, the incremental cost of replacement gas when assessing the direction of gas prices. There are geo-political considerations too and today’s market faces a wider question concerning the incentives of Russia, China and other influential players who may like to see oil and gas prices staying higher for longer; a riposte perhaps to trade sanctions or threats, petro-dollar devaluation and other matters. However, if Western governments do allow their indigenous gas producing industries to wind down, ostensibly to stimulate green investments, there would seem to be little they can do in future to counter any concerted drive to keep energy prices high if/once demand fully rebounds in the aftermath of Covid 19. Gas prices have had a tremendous run although it is far from clear when or how any price correction will come about.
Electricity
Last quarter UK power prices saw their sharpest quarterly increase since the advent of NETA, the New Electricity Trading Arrangements, which opened up the UK electricity market to OTC counter-party trading in 2001. At one point the October 2021 Year Contract was up over 100%, whilst the Winter 2021 Contract traded over £100/MWh at one point.
Base-load electricity prices were pulled up along with rising oil, gas and raw materials’ prices generally. The power market also rose amid rising expectations of inflation. For many bi-lateral power purchase agreements (PPAs) are indexed by general energy and producer prices, which are currently rising faster than retail inflation itself. Another inflationary impact will be PPAs involving CFDs: Contracts for Difference clauses entailing a guaranteed & inflation-escalating strike price payable to the solar, wind or nuclear producer concerned over the project life, which can vary between 15 and 35 years. The market was also spooked by the announcements that the Dungeness nuclear power station will cease output immediately and by news that up to four more reactors will shut in four years’ time. This isn’t so much a ‘supply shock’ given that all UK reactors except Sellafield are already operating beyond their initial design lives. However, last month’s news did serve as a pertinent reminder that all bar one nuclear reactors will cease production, if anything sooner than expected previously. The Annual Contract rose an unprecedented 82%, which is the sharpest quarterly price increase since the NETA market was first launched over 20 years ago.
In other times perhaps, a headline spark spread of £29.12/MWh (which rose another 20%) would be expected to encourage further gas-fired power stations to be commissioned, theoretically still in time to address potential mismatches in peak-day supply & demand. However in the current political climate and with carbon prices just shy of €60.00/tonne CO2, we can discount the chances of any renaissance in gas-fired generation. Consequently, balancing the system on peak days will increasingly rely on new-build nuclear reactors, renewables and imported power via interconnectors to Iceland, Norway and the Continent, though such seabed wires entail specific reliability issues of their own. Power prices have certainly soared but the market could always turn on a sixpence at today’s unchartered, dizzy price levels. That said, there remain sound factors behind the market’s current strength, as explained above and previously. A return anywhere close to the early pandemic lows witnessed last year therefore seems far fetched and the forward curve is still rising as we go to press.
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.
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