During February 2020, the initial impacts of Covid-19 (official name of the coronavirus) were seen and being speculated upon – as a result prices were reasonably volatile, reflecting the uncertainty affecting most markets, including financial markets.
After touching lows in early February, the UK energy markets bounced mid-month, only to drop again towards the end of February 2020. Rolling annual forward curves for both UK gas and power maintained their contango structure, despite the volatility, emphasising the conflict between apparent oversupply and the recognition that prices are historically low and could be set to bounce.
While weather conditions were very wet (mainly rain, rather than snow that might have been more usual for this time of year), temperatures were on average about seasonal norm; though as we have seen for much of this winter the weather has been oscillating between cold and mild conditions.
European gas inventory levels continue to be well over what is usually seen at this time of year, and there looks to be no let up.
While by the end of the month nearby prices had not changed much month-on-month, the rolling-annual forward curve for UK gas did increase its contango slightly, as forward prices moved up slightly. This move was primarily driven by a significant increase in volatility, due to uncertainties around the eventual impact of the coronavirus. Current fundamentals for gas look weak, with plenty of oversupply of gas and LNG, though technically there are indications of a change coming, with short-term indicators pointing up for all contracts, though medium and longer-term trends are still down.
The weather conditions, particularly wind and day-day temperatures, were very unsettled over February, though on average rainfall was significantly more than normal. These changing and quite volatile weather patterns meant gas was regularly called upon for power generation, adding some support to demand, offsetting times of lower heating demand. Nevertheless, prompt month and quarter prices remained relatively low, especially for winter, due to weak fundamentals and structural sentiment. Having said that, some nervousness in the market, encouraged by the oversold nature of the market following recent market falls, created volatile bounces on any bullish news; perhaps this is another sign we should expect sentiment to change in the coming months.
Much like gas, spot/day-ahead power prices were quite volatile. Notwithstanding the general coronavirus led uncertainty, weather conditions, with different storms coming in every weekend, meant that there was much switching of marginal generation type between wind-power gas-powered generation, creating the prompt price volatility. Nevertheless, forward prices ended the month only slightly above those at the end of January; contango did increase slightly as demonstrated by the rolling-annual forward curve shown.
The UK power market structure remains weak, and fundamentals are also erring to the bearish, however, some technical market indicators do suggest a change may be coming in the short-term. Having said that, indicators are by no means all bullish, and we should remember that forward power prices still have some way to go down before reaching 2016 lows.
Coal and CO2 prices generally moved sideways, again with some volatility. GB£/€ continued to strengthen during the first part of the month but fell away as we got closer to start of the EU/UK trade negotiations, when rhetoric picked up as ‘red-lines’ were starting to be drawn in the sand.
Oil prices were also reasonably volatile, particularly over the second half of February, due to expectations of reduced global demand, especially from China, offset by various rumours about OPEC production cuts. On top of that, equity markets took a battering at the end of February as concerns grew over a global recession – most of these moves were probably based more on conjecture than fact but it shows where the underlying sentiment is leaning. In truth, we won’t know where this is likely to take us until there is a better understanding of the longer-term impacts of any potential global pandemic.
Crude oil prices continued to flirt with contango, though a sustained change has not been established yet.
Energy Market outlook
Over the next few years it is true to say there is more room for prices to move up compared to down, though whether the ‘good’ prices available now will be the ‘best’ prices achievable and how long these ‘good’ price levels are available is not so sure – this is a judgement call about the client’s approach and attitude to market risk.
March weather forecasts currently show continued mixed weather conditions, with both mild and cold spells coming at UK in waves. April could well be colder than seasonally normal at the start of the month too. The financial markets are very jittery, driven by worries about a weakened Chinese economy pushing ‘the West’ into recession. Gas globally is well over supplied. All these factors could encourage US oil and gas producers to start cutting production and OPEC (+Russia) too. We are currently in a very confused market!
In previous market cycles we have seen the surge in retail buying, for April start renewals, be enough to tip the balance and trigger a reversal in sentiment; while this could happen again, this time around the global market uncertainty, surrounding the consequences and impact of the coronavirus, will probably dampen reactions in all directions.
The fundamental story is not quite as bearish for power, which still commands a relative premium over gas, though it will probably follow any overriding sentiment from macro-economic drivers.
The real questions now are (1) will the Chinese economic dip be big enough or for long-term enough to follow through to western economies and will the virus have a bigger impact in the West than currently expected (2) will oil and gas prices drop low enough to curb production sufficiently to create a genuine fundamental and sentiment shift and when will this happen?
March/April might have been a good estimate for when market sentiment might change though the coronavirus could easily push this back many months.
So, even though lower prices may be with us for a bit longer, the prudent approach would be to assume prices will be volatile; Flexible buyers can continue to let the contango do the work for them and watch for any signs of backwardation to return over the coming months. Fixed priced buyers need to decide whether they need to achieve the lowest prices achievable and be happy to risk the volatility or accept current prices are acceptably good.
Dr Tony West has worked for a variety of industry participants including Gazprom, Scottish Power, BP, RWE and Npower. Dr Tony currently advises on wholesale market developments and strategy.
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