The escalation in tensions between USA and Iran at the start of the year, as a consequence of the US missile strike that killed the top Iranian general, kept the UK energy market relatively steady for the first two weeks of the month. Thereafter, as market nerves settled and the fundamental reality of the supply-demand (im)balance returned to focus, forward prices subsequently fell approximately 15%.
The rolling-annual forward curves for UK gas and power remained in contango throughout the month; emphasising the underlying weak sentiment.
European gas inventory levels did continue to reduce over January 2020, though not to the extent usually seen at this time of year, due to relatively mild weather conditions across Europe and unremitting delivery of LNG cargoes.
The weather forecasts and day-day temperatures were mixed over January, though on average milder than normal. This together with a healthy supply of LNG to Europe, kept the downward supply-demand pressure on UK gas prices. The rolling annual forward curve for gas, maintained its contango structure, underlining the continued weak sentiment.
Political tensions in the middle east supported prices during the first two weeks of the month, though the ease with which prices dropped, when the tensions subsided, indicates that the traders in the market may have used the early month price support to create, so called, ‘short positions’ – in order to benefit from price drops in the future. By the end of the month, rolling-annual prices were trading lower than the lows of 2016 and sentiment is still weak. Most market signals (i.e. fundamental, technical and structural) are still showing bearish tendencies; further indicating lower prices are still possible as we progress through February.
However, bearing all this in mind, while expectations are that prices will probably go lower, it is reasonable to assume that volatility could increase significantly on any bullish fundamental news.
As we have seen over much of winter, UK power prices in January 2020 continued to behave similarly to gas, dropping around 15% in price across the curve by end January. Sentiment in the power market continues weak, with the forward curve for rolling-annual prices maintaining its contango structure.
Throughout January we have seen renewable (solar and wind power) generation meeting approximately one third of demand; if current weather conditions (mild and low pressure) are maintained, this high level of zero (low) marginal cost generation will continue – often at this time of year the weather is driven by high pressure, and can be cold with clear skies, which are poor conditions for wind power production.
Nevertheless, unlike gas, prompt year prices are still above the lows of 2016, albeit only 10% above, suggesting there is only little technical resistance to prices dropping further.
Coal and CO2 prices generally moved down during January, whereas GB£/€ continued to strengthen following the general election; all adding to market weakness.
Technically, the only cause for concern for prices is the potential for the market to be ‘over-sold’, due to the inclination of market players to be holding a short trading position, and therefore making the market extra sensitive to ‘news’ spikes.
Apart from the early part of the month, Brent, and other global oil-dependent markets, have also been week; forward oil curves are slipping in to contango – the first time for several years. Initially this was a consequence of the reduction in middle east tensions but latterly because of the developing coronavirus crisis in China. Demand for oil and LNG into China has dropped markedly and there is a rising concern that many deliveries will be turned away, citing force-majeure.
OPEC are considering a production cut of almost 500,000 barrels/day, which will go some way to restoring the supply/demand balance, though the financial markets are also worried about other negative economic impacts too.
Fundamentally, there may have to be a total re-think by market analysts, depending on the eventual significance of the coronavirus epidemic on macro-economics.
What’s the outlook?
Annualised gas prices, and maybe power prices before long, are entering unprecedented low levels, while at the same time most market indicators continue to be bearish.
February weather forecasts continue to be mild, albeit March and potentially April, could well be colder than seasonally normal. Oil is also looking weak, driven by worries about a weakened Chinese economy dampening demand. UK Gas prices have already moved lower than 2016 and is well over supplied; the next target could be from pre 2010 when prices were last at these levels! UK power, which still commands a relative premium over gas, is also likely to trend lower, allowing flexible buyers to continue benefitting from prices rolling down the contango.
Most commentators now expect UK and global wholesale energy prices to drop further. The real question is how low will prices go and for how long; these are not so easy to answer! Will the coronavirus epidemic develop into a global pandemic and potentially precipitate a global economic downturn, or will it be kept under control and Chinese demand return? What prices will encourage US oil and gas producers to start cutting production and can OPEC get it together to sufficiently reduce the over-supply of oil. The market currently seems to be considering the bearish outcomes more, so is the bearish news already in the price?
Even though indications are that lower prices may be with us for a while, the prudent approach would be to assume prices may go a bit lower but might not stay there for very long, before producers act to rectify the situation. Purchasers can use the time to get purchase approvals in place and be prepared to transact promptly. Flexible buyers can let the contango do the work for them and watch for any signs of backwardation to return over the coming months.
When it becomes clearer what the impact of the coronavirus is on global economics and energy demand, we can then re-visit the situation for future strategy.
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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