During April 2015, UK gas and power prices generally moved down, again due to milder than normal weather, despite some gas supply disruptions. In line with this, rolling-annual forward curves have flipped back again to a more contango structure, indicating the market is still not ready for a continued bullish trend. However, oil showed more resilience as US stocks began to show signs of the impending summer season providing price support.
Gas supply/demand volatility continued during April 2015; with some uncertain day-to-day supply from Norwegian gas fields and continued concern about storage availability for winter 2015 supplies, particularly Q1 2016. However, whereas there was seasonal normal weather during the first week of April and a few colder days at the end, generally April was dryer and warmer than expected and together with sufficient LNG supplies prices were able to drop slightly over the month, helped also by a slightly appreciating Sterling FX rate. Price declines might have been greater if it hadn’t been for some support from the oil market, which trended upwards somewhat. Also of note is the forward curve for rolling-annual gas prices, which flipped back to a slight contango structure indicating we have not yet seen an underlying sentiment change to a bullish market. However, longer dated forward prices have increased slightly, probably because some buyers have been encouraged to fix forward contracts early, pushing offer prices up.
As suggested last month, the power market was less convinced of a sentiment change and consequently in April we saw a bigger drop in prices across the month than gas, though still only moderate price falls, albeit carbon and coal prices were slightly stronger. Renewables production was again an interesting influence on prices; whereas wind-power generation was down, this April was the sunniest since Met Office records began in 1929 – in Morpeth, Northumberland, where records are longer-running, they saw the sunniest April for 110 years, with 265 hours of sunshine, almost double the average. However, like gas, longer dated forward prices moved up slightly, driven by increased volumes of forward hedging.
Brent prices showed some recovery throughout April 2015 with spot prices trading up more than $10/bbl. In line with this, contango further reduced and consequently a drop in floating storage inventories is envisaged during the second half of this year; viewed as the next step in the normalization of the crude oil market. Oil product demand growth in Q1 was the strongest since 2003, suggesting that lower prices are stimulating demand and the recent smaller US inventory builds is a sign of things to come, as refineries return from maintenance over the second half of May. Market commentators expect this trend to continue to a lesser degree over the balance of the year, helping to tighten oil market balances and contributing to a mild price recovery. In the near term a contraction in US crude oil production growth in May is also expected to be an important signal point for the US oil market. Finally, as a result of the Iran framework deal it is anticipated that while more Iranian oil should reach the market in 2016, many uncertainties remain including whether the eventual increase will be mitigated by OPEC accommodation.
What’s the Outlook?
Whereas market fundamentals continue to look balanced to slightly long, meaning prices should stay level or weaken, some players remain uneasy; also encouraged by the slightly stronger oil market – supported by the usual summer driving demand. The nervousness manifests itself as increasing forward hedging, which gives an upward ‘skew’ to the forward market offers, perhaps exaggerating the contango, and potentially benefitting those with shorter term buying horizons. On top of this, there is uncertainty surrounding the UK election result and any potential impact on prices. While the UK election result is very unlikely to have any immediate impact on the wholesale market, which is driven more by supply/demand fundamentals than short term politics, unless they directly impact demand of course, some outcomes could have a medium to longer term impact on retail prices. For example, in the unlikely event the Greens were to gain a majority, renewable subsidies would surely increase and even if the Greens hold the balance of power in a coalition we could see some impact. Perhaps a more likely scenario is a Labour government (majority or in coalition), which has a policy to cap retail energy prices (domestic at least). Whereas this might sound attractive to buyers, there are a few things to be considered:
(i) an increasing portion of the retail price is not energy price related but subsidy, tax and levies, which have already been agreed to and will need to be funded elsewhere – by other tax rises or government borrowing.
(ii) from an economics point of view, ‘caps’ in markets historically tend to become ‘targets’, even if fundamentals point elsewhere, so capped prices could be higher than they ought to be.
(iii) market design will need to be changed again if retail prices aren’t allowed to operate as a market and this will certainly lead to further disruption, potentially compromising the efficiencies that do exist, and probably further constrain the investment needed.
One thing that is almost certain is that the energy demand on election night, 7th May, will be higher than normal off-peak levels.
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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