February 2015 was a more volatile month for prices. By the end of the month all prices had moved higher than end January levels as a consequence of cold temperatures, higher crude oil prices and news of production caps impacting the large Groningen gas field. The stronger wholesale prices are being reflected in I&C/SME retail offerings, however, generally speaking annualised UK energy prices were still at similar levels to those at the turn of the year and well below prices this time last year.
While prices seemed volatile during February 2015, such volatility is not unusual for a February, which often contains the coldest week of the year as well as being the end of the winter from a meteorological perspective. Nevertheless, by the end of the month forward UK gas prices were trading approximately 10% higher than the end of January 2015, driven primarily by 3 factors:
- Production flows from the Dutch Groningen field were capped at a slightly lower level than previously advised. The market responded by adding a ‘risk premium’ awaiting an expanded investigation in to possible connections between production levels and local earthquakes and whether this might lead to further cuts in planned production beyond next summer. There may even be some premium associated with the risk of a wider impact on production from other fields, though currently this should be considered an over-reaction by the market. It should be noted that this cap on production at Groningen did not appear to create any real shortage in the UK supply/demand balance on a day-to-day basis.
- Slightly colder than normal temperatures during the early weeks of February increased flow rates from longer term storage though overall storage levels and LNG deliveries were still good.
- Crude oil prices increased off their January lows as some US producers cut output.
Increased tensions in Ukraine did also add to risk premiums in mainland Europe and consequently there was some knock-on to UK prices, though again we have not seen any real shift in the fundamental supply/demand position.
Protracted negotiations between Greece and the other Euro-zone countries have kept pressure on the €, which helped counteract the upward movement of prices somewhat.
Directionally, wholesale power prices also moved up during February, driven mainly by movements in gas, however, UK Spark-spreads (i.e. the market reference for the profit margin from gas generation) continued to trend lower, despite erratic wind production adding uncertainty; UK Power prices were generally about <5% higher than end January, half the increase of gas. Gas continued to be the dominant source of generation capacity, despite good availability of coal generation, demonstrating market risk premiums were more a function of market ‘jitters’ rather than any significant supply disruption; coal prices also firmed over February taking its lead from oil.
Brent prices managed to recover from the lows of January following some curtailment of US production and downgrades to Colombian crude oil production growth estimates. However, many oil market analysts are doubtful that the recent 10-15% price recovery will develop into a more meaningful upswing, at least in the near term, pointing to the steep contango present in Brent and particularly WTI forward curves, as a result of record builds in US crude oil inventories (see last month’s outlook). In the absence of a lifting of the US crude oil export ban, increasing attention will be paid to the WTI-Brent spread, which has widened out to its largest discount for more than a year – once storage fills there is currently nowhere else for it to go, except on ships!
What’s the Outlook?
The next few weeks, as we move from winter to spring, will be an important indicator of the tone for the rest of the year. If the temperatures stay cold and gas storage continues to draw at recent rates, this may provide enough support to hold prices stable or even provide a little support if nervousness over supply disruptions later in the year develops. However, if there is any prolonged period of warmth during early spring we could see a loss of much of the February price gains; the supply/demand position for energy in UK is fundamentally still looking comfortable and if storage demand is less than usual during 2Q15, prices will again come under pressure. As a personal indicator, take a note of when you turn your central heating off (is it earlier or later than usual?) – once the central heating is turned off it rarely gets turned back on again!
Dr Tony West has worked in a variety of institutions at a senior level; most recently as Head of Power Business Coordination at Gazprom Marketing & Trading, spearheading Gazprom Group’s move in to gas-fuelled generation, having developed the group strategy in the context of securing demand for Gazprom’s gas, and prior to that as Head of Trading at Scottish Power.
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