Whereas oil prices have continued with their seemingly ever-increasing run up, UK’s gas and power had a much more volatile month. By mid-month UK gas had touched highs not seen since 2011 for annual contracts and UK power reached levels never seen before! However, by the end of the month prices reduced off these highs but, nevertheless, still making history for month-end prices. Forward curves for rolling annual prices retained their backwardated structure underlining the continued strong bullish sentiment in the market. Nevertheless, even though the market currently includes various ‘risk-premia’, there are some signs, which indicate the steam could be running out of the market – though it is too early to say this with confidence.
Gas price volatility in September 2018 was quite high and driven by a combination of the oil market, carbon market, coal market as well as political influences. Gas fundamentals are still reasonably tight; higher coal and carbon EUA prices ensures gas demand for power generation remains robust. There have been a lot of gas outages over the past weeks and months and while this is fairly routine for this time of year, low storage levels have compounded the issue.
It is worth noting that UK gas prices currently include risk-premia related to several issues and these could be inflating prices excessively, depending on the issue i.e. (i) Brexit uncertainty adds concern about £/€ exchange rates, (ii) oil prices are high though the direct link between oil and gas prices has significantly reduced over recent years – OPEC and political uncertainties related to sanctions with Iran and trade disputes with China are all adding to uncertainties though in reality some of these are potentially opposing fundamental impacts, (iii) concerns that we will have another very cold winter, putting pressure on supplies, could be justified albeit very unlikely March 2019 will be as extreme as March 2018.
Nevertheless, structurally the market is still strong (backwardation) and, without a significant change in market sentiment, prices are still likely to stay firm.
Correlation with gas remains high (despite the recent commissioning of new wind generation capacity taking the total operational capacity for wind power in the UK to over 20GW) and together with higher coal and higher carbon EUA prices ensured annual power prices made all-time highs this month. Demand for power in continental Europe, particularly Germany, requires thermal generation from coal and gas, which is helping to drive power prices up throughout Europe with the gas risk-premia also feeding through to power.
The forward curve for rolling annual prices also increased its backwardation by the end of the month, confirming sentiment is still bullish. Prices were at their greatest in the middle of the month and so it will be interesting to see whether price reductions towards the end of the month are the beginning of a new trend or just a dip.
With oil prices continuing their upward trend, this has encouraged more shale production, making USA the largest global producer of crude oil, overtaking Russia; demand can currently support this, especially as OPEC maintain discipline and as sanctions start to take effect on Iran. Oil prices are now at 5-year highs, with a small number of analysts saying, for the first time since the crash, that $100/bbl is not out of the question again. However, most analysts see the higher prices encouraging further production, anticipate Iranian oil will find more homes than Trump imagines plus a possible reduction of demand from China as trade disputes with USA bite; all helping create a supply-demand imbalance in 2019 forcing lower prices.
What’s the Outlook?
For the time being the market structure still suggests higher prices in the short to medium term, however, there are signs that could indicate the market is reaching some stability. This could just be a rest before the market continues up or a plateau before prices fall. Events over the coming weeks and how the market responds will be interesting to watch. Risk-premia in gas prices look inflated and winter weather forecasts, while uncertain, do not look extreme. Over recent months the market has reacted bullishly to most news, however, during recent weeks the fundamentals have not followed through – if this market environment doesn’t change then we are in for higher prices during the winter, however, if fundamentals weaken and sentiment starts to fall off, prices and market structure could reverse.
Things to watch include up-coming weather forecasts and patterns, especially as clock change approaches, changes to risk premia and how Gazprom supplies respond to increasing numbers of LNG cargo deliveries.
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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