During May 2015, UK gas and power prices moved slightly lower, despite a small spike during the first week of the month. LNG supply was good as a consequence of lower demand in Asia. In line with this, rolling-annual forward curves again show a contango structure, indicating the market’s weak sentiment with any bullish feeling more a matter of nervousness than fundamentally driven. Oil was also slightly weaker this month, however, the impending summer season provided some support to the forward curve, though the contango hardly changed.
Gas prices in May 2015 was a story of two supply markets. LNG supplies to UK were steady throughout the month whereas Norwegian supplies were more limited, again experiencing volatility in supply volumes due to continued maintenance issues. The stronger £/€, following the Conservatives’ election win, also put downward pressure on prices. Towards the end of May, as the weather improved, demand also reduced; as we enter the summer, demand usually becomes less volatile with supply, storage and other maintenance issues becoming the main drivers in the market. Of note here, despite Gazprom’s forecast that production will increase 1.5% year on year, Norway is now Western Europe’s largest gas supplier, pushing Gazprom into second place. However, a consequence of this is that the recent instability in Norway’s supply will likely manifest itself as increased price volatility in the market. Also of note is the forward curve for rolling-annual gas prices, which maintained the same slight contango structure indicating underlying sentiment is still predominantly bearish with longer dated forward prices representing the nervousness about future oil prices and perhaps more importantly the impending outcome of on-going studies related to the Groningen gas field production levels.
As with gas, the power market was generally weaker in May 2015. Lower temperatures in mid-May were generally offset by higher wind generation and so prices generally mirrored the gas market price movements. It should be recognised that one impact of reduced coal generation, as a consequence of various emission regulations, is that power prices will become increasingly volatile throughout the year, primarily as power prices become more correlated to gas prices. Furthermore, as renewable generation volumes increase, power price movements will also increasingly reflect weather extremes, causing spikes both up and down, though this will be more relevant in winter – an unfolding story to watch. Like gas, the forward curve for rolling-annual power prices remained in contango structure indicating weak market fundamentals and associated sentiment. Some increases in forward hedging as a consequence of the sustained lower prices may also be supporting the longer dated term structure.
Brent prices dropped slightly during May 2015. However the forward curve shape hardly changed. As anticipated, by the end of the month, crude inventory draws showed evidence of higher refinery utilisation. However, rises in US production and strong production in the rest of the world mean that oversupply concerns are far from over. Nevertheless, oil prices are already below levels needed to balance budgets in all but a couple of key oil producing countries. With forwards markets suggesting that the drop in prices is more permanent than temporary, a period of adjustment to the new levels will therefore be necessary; perhaps unsurprisingly Kuwait, UAE and Saudi Arabia are considered best placed to weather a lower oil price environment.
What’s the Outlook?
Following a somewhat surprising outright election win for the Conservatives, £/€ rates improved, bringing down UK gas prices, while at the same time market confidence improved because of expectation for a continuation of current energy policy, without too many significant shifts in direction. Furthermore without the threat of the Labour devised cap on energy prices, or worse the Greens holding the balance of power with Labour, investment confidence will grow. Any impending EU in/out referendum is not expected to have too much impact on the UK energy market at this time as on-going pan-European energy initiatives are not expected to be affected. Of immediate interest is the pending result of studies related to Groningen field production levels. Nevertheless, that apart, the current forward curve structure and market moves continues to benefit those utilising a shorter term hedging strategy. However, market uncertainty remains quite high encouraging greater interest in forward hedging. Oil prices have been an important feature of this uncertainty. Some analysts now believe that a sustained oil price rally into the summer will be more challenging, however, price support may come in the form of the seasonal pick-up in demand during the US driving season. Indeed unlike previous recovery periods, it is not expected that this cycle will be accompanied by significant OPEC production cuts or aggressive monetary easing by global central banks, which in the past have been important features to sustain an oil price rally. Furthermore, physical oil market balances for first half of 2016 are looking nearly as weak as the first six months of this year. Whether this weakness reveals itself will ultimately be in the hands of OPEC and their production intentions.
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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