Whereas UK’s energy prices were quite volatile during December 2017, particularly for this winter’s delivery, prices ended the month pretty much where they started. As might be expected, market movements were primarily related to changeable weather conditions, though there was some fundamental impact related to short term disruptions to supply in Europe because of the explosion at the Baumgarten (Austria) gas hub.
Oil prices while also somewhat volatile, but in contrast maintained its strength, with prices firming generally; partly due to better than expected demand in US but also related to various supply disruptions (including Forties) and political concerns.
The rolling-annual forward curves for both UK gas and power changed little over the month, providing no hints of any change in market sentiment, with both markets holding their slightly backwardated structure.
After a colder than normal November, December 2017 disappointed those betting on a white Christmas with the changeable weather swinging between colder and warmer than normal conditions; interestingly a white Easter is historically more likely than a white Christmas.
Despite increased supply disruption risk (i.e. Forties and Baumgarten incidents), by the end of December, prices had changed little over the month and are still no higher than what forward contracts could have been purchased for this time last year. However, in mid-December, the rolling-annual forward curve prices did briefly breach recent highs. Accordingly, from this month the regular chart also shows the highest rolling forward prices in the last 3 years.
For comparison purposes, this month I have added an additional chart showing the year-end rolling annual forward curves for the past 5 years.
Power prices in December 2017, behaved similarly to gas, again driven by the changing weather. Sentiment in the power market changed little, with the forward curve for rolling-annual prices maintaining its backwardation. In fact, the forward price structure is almost identical to this time last year demonstrating how in a backwardated market contract prices generally just roll up the curve as time progresses, which supports why backwardation normally indicates that buying forward is beneficial.
As for gas, the additional chart, with the year-end rolling annual forward curves for the past 5 years, shows the current prices are still well below the higher prices in 2013, and furthermore for power, forward years look relatively good value, indicating that locking in some forward years should still be beneficial.
Brent prices continued firm during December 2017, with annual prices achieving levels above $60/bbl and month ahead prices well in to the mid-60s. Many analysts believe that if prices remain at about $68/bbl for a significant period (say up to 6 months) it could begin to change the supply outlook and meaningfully dampen the supply/demand balance expected for future years. In the absence of a demand surprise this year, oil analysts see prices eventually moving lower before recovering on a more sustainable basis over the medium term.
What’s the Outlook?
This year’s weather forecasting models, that predicted generally unsettled conditions (i.e. varied with more precipitation), have generally been spot on and will probably hold true for the rest of winter. On average the winter may now be slightly colder than normal though few forecasters predict any prolonged very cold spell in UK; early Jan is anticipated to be mild, as is February, whereas mid/end Jan is expected to be cold. If the predictions for February hold true, we may see an early onset to Spring. In the meantime, buyers should watch for changes in sentiment during the period and if the market structure doesn’t look to be flipping towards contango, it is likely that forward hedging should be accelerated, particularly for power, so that the current backwardation can be taken advantage of.
Dr Tony West was formerly Director of Trading and Marketing at Innogy (now Npower), Head of Trading at Scottish Power and amongst other senior wholesale trading roles recently advised Gazprom on their power business development strategy.
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