Summer is coming, but energy consumers shouldn’t count on an easy ride in the energy markets…
End-of-April Met Office forecasts are showing a higher probability of above average UK temperatures for May through July, primarily as a result of warmer than average sea surface temperatures and an increase in anticyclonic influences across the UK.
Currency movements lately have been primarily sentiment-driven as the almost constant stream of political commentary in the UK, Continental Europe and the US plays out. The pound has benefited somewhat against the euro, as the focus has partly shifted away from Britain’s future relationship with the EU to Europe’s future relationship with itself. As a result the pound is in a much stronger position at 1.18 euros than in the depths of its fall last year (cf Oct 16 1.11 euros), but with some marginal retracement likely now that the issue of the French Presidency has been resolved. As most energy flows tend to be from Europe to the UK, a stronger pound and weaker euro is generally bullish for UK energy prices (continental sellers increasing prices to make up for lower euro value of the underlying commodity).
The pound has rallied to an even stronger position against the US dollar over a similar horizon and coinciding with Trump's transition and first 100 days in power. The main driver here would appear to be the Trump administration’s trade stance and a desire to weaken the dollar relative to other currencies . Despite the relative strength of the pound, a weaker dollar is also bullish for energy prices by virtue of its strengthening impact on dollar-denominated oil prices.
The above effects are not necessarily strong enough to outweigh more significant supply/demand fundamental effects outlined below and indeed other macroeconomic data. Notwithstanding UK manufacturing and services PMI and US non-farm payrolls continuing to show impressive gains, there has been a more general economic slowdown suggested by poor Q1 GDP growth data in the US (0.7%) and UK (0.3%) and the European Central Bank sticking with its program of Quantitative Easing until the end of the year. Higher inflation worldwide is also likely at some point this summer to have a bearish impact on demand and therefore energy prices as we go forward in time.
End-of-April Met Office forecasts are showing a higher probability of above average UK temperatures for May through July, primarily as a result of warmer than average sea surface temperatures and an increase in anticyclonic influences across the UK. Whether this has a knock-on bearish effect on demand is less certain than previous years, as air-cooling demand may well yet become a factor in the UK as installations increase. This said, the UK transmission network operator, NGT is expecting lower demand again this summer (with minimum demand as low as 17.3 GW weather-corrected), which in contrast to the winter delivery period, presents challenges in balancing during periods of oversupply. As a result NGT have tendered a Demand Turn-Up service to incentivise large energy users to help meet supply and balance the grid during these periods.
Throughout last summer domestic combined cycle gas turbines (CCGT's) provided on average 46% of overall electricity demand. The lower UK power demand this summer means gas demand is also likely to be lower, particularly as there will be no injection demand into Centrica’s Rough gas storage until May 2018. Supply from the now 28 GW of CCGT capacity in the UK could conceivably meet up to 79% of peak demand this summer. We have already seen again this year no coal running at all over a sustained period, and almost all coal plant if required to run at all this summer, would be running at a loss.
While the coking coal sector has witnessed a cyclone induced rollercoaster ride recently, thermal coal prices (coal used for power generation) continues to follow a more moderate incline driven by mining operation restrictions in China. With North Korean coal now banned, China has replaced its lost imports with increased deliveries from Australia, Mongolia and Indonesia and notably Russia where imports gained 19.5% to 2.3 million tonnes.
As long as there is no U-turn in Chinese policy, domestic supplies should incrementally increase this year but with resilient industrial Chinese power demand, prices may well continue to rise and impact the at-risk European winter heating season.
Meanwhile the carbon market continues to struggle with EUAs now well below the 5 €/tonne psychological level as auction volumes increased up to the deadline date for 2016 EU ETS compliance. The weaker energy complex and poor German dark spreads have also contributed.
Dec-17 prices are now at €4.51/tonne. With the fourth ETS phase beginning in 2021 the key question at the moment is whether the UK will remain part of the Emissions Trading Scheme (ETS) post BREXIT, as it seeks to implement its own, possibly pro-fossil fuel, emission controls / pollution and/or climate change policy.
This March has already seen the start of huge levels of European LNG sendout – in fact the highest levels since Sep 2012 and a long overdue materialisation after volumes expected in the previous 12 months failed to appear. More than 50 LNG cargoes arrived into European terminals in April creating something of a “dumping ground” as the normal demand fall-off in Asia and the Middle East during the shoulder season has combined with a hitherto delayed ramp up in LNG production in Australia and the US.
More Qatari cargoes into Europe are expected going forward this summer – some of which have been diverted from Egypt and US export production continues to rise – though most cargoes are into Mexico and South America. There have been some arbitrage relays from European terminals such as Fos in France with the current glut of LNG supporting strong storage injections in continental Europe. Some of these storage “plays” are likely to have been a result of Rough withdrawals in the UK - Centrica Storage informed shippers in April to withdraw from storage now as shippers will not be able to withdraw in winter.
While LNG is dominating the currently bearish outlook for UK NBP prices, range-bound crude oil prices mean that oil-indexed (principally Gazprom or Middle East supplier) contracts are still competitive. The lack of direction in crude prices has arisen from the price-response of US shale oil projects as non-US crude volumes are cut. Despite OPEC adherence to agreed oil production cuts and the prospect of an extended agreement beyond end June 2017, non-OPEC production is expected to grow by 485,000 bpd this year, primarily from US shale projects returning to profitability above $50/bbl. Global rebalancing is for all intents and purposes here already and the most likely trend for the rest of the year is for Brent crude to drift towards $55/bbl, with a corresponding marginally bullish influence on UK gas prices.
Looking ahead into winter, the situation is not at all as rosy as the picture might appear through the summer, with Rough almost completely drained (now down to 4% full ) and it can be expected there will be a further significant hike in power price volatility as paltry storage volumes exacerbate stressed electricity capacity and flexibility margins. Electricity prices spiked to the highest level in 10 years last November on French nuclear safety concerns, and with increased reliance on intermittent wind and peaking plant, the price spikes seen last year may even be surpassed this year should the UK experience a cold winter.
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