Energy Broker: January 2016 Market Report

UK Wholesale Gas Prices - Pulse Business Energy

Energy Market Report Glossary

Wholesale energy markets were mixed and reasonably volatile over January 2016 with the month split into three periods: markets were flat during a quiet early January, ahead of another China and oil led drop by mid-month, exaggerated by the likelihood of an earlier than expected return of Iran oil to the market. However, as the end of January approached, prices picked up significantly, regaining much of the earlier losses on the back of OPEC production cut rumours and some cold weather eventually hitting the UK and Europe. By the end of January, UK energy prices were flat to slightly up on the month, depending on the time period, setting a strong tone for early February. Interestingly, this increase in price volatility was apparent across financial markets too, including equities and Foreign Exchange, and may be a feature of all markets in the coming months.

Movements in the forward curves for the rolling annual prices tell quite a varied story, with gas increasing its contango implying the market is still concerned about a further drop in price due to plentiful supply, whereas power has increased backwardation to the 2 and 3 years forward but is developing a contango structure in the first year suggesting real uncertainty in the market.

Forward gas prices ended January 2016 at very similar levels to where they started though the more nearby (spot and month ahead) prices, despite being more volatile, actually ended the month lower; albeit prices were moving up from the lows of the month. As a consequence, forward curves for rolling annual prices, showed increased contango, as evidenced by the chart, underlining the well supplied market and underlying concern that oil may still not have found real fundamental support. The implication here is that gas can still drop further. The key elements to watch over the coming weeks and months will be (i) whether the supply/demand situation for oil becomes more balanced or not and (ii) the movement of LNG, particularly whether there is a general shift in destination to Asia or Europe.


UK Wholesale Electricity Prices - Pulse Business Energy
As we have seen in recent months, power prices have been increasingly correlated to gas with the exception of spot and day-ahead prices, which have been well supported due to inconsistent renewable generation and colder temperatures. The volatility and uncertainty in nearby power prices was also reflected in the forward curve for rolling annual prices, which is tending to contango (a weaker and more bearish sentiment) in the early years but more backwardated (stronger and tending to a bullish sentiment) in the later forward years – this reflects the uncertainty in the market regarding gas and oil but also continued concern about capacity availability in more seasonally normal or even colder years in the future; the market is clearly not sure about future trends having seen so many ‘false bottoms’ to the market over the past 9 months. With such a market, it is reasonable to hold off fixing 2016 requirements but still prudent to capture some of the forward year prices if it is possible to achieve some backwardation.

In general, Brent prices continued their relentless drop, breaking through more support levels this January, even trading below $30/bbl, before making a 13 year low around the middle of the month. We have seen some recovery in price towards the end of the month though much of this was driven by ‘hopeful’ rumours of production cuts from the main producers. Nevertheless, some respite in the price drop is reasonable to expect, however, several factors have played a part in pushing crude oil prices below $30 per barrel, including high inventory levels of US crude oil, uncertainty about global economic growth, volatility in equity and non-energy commodity markets, and the potential for additional crude oil supply from Iran to enter the market; internationally, crude oil and petroleum product inventories have been growing since mid-2014 and are currently above five-year averages.

What’s the Outlook?
The 2nd week of February is usually the coldest week of the year and so with temperatures steady around seasonal norms, we are likely to see the market hold some support. However, unless we see seasonally cold weather towards the end of February or extended into March, we are unlikely to see strong upward pressure on prices without some significant developments in the oil market, say via some intervention from the OPEC and non-OPEC producers. In fact, based on the UK and European energy markets alone, without an extended cold period, gas inventories are plentiful and sentiment would suggest a further downward move in Spring.

As mentioned in previous reports, any real development of backwardation in the rolling-annual forward curves remains the indicator to watch and without a sustained shift to backwardation, the most successful purchasing strategy will probably be to continue delaying buying decisions as late as risk appetite can accommodate, but buying forward as and when there is backwardation.

The macro feature to watch out for is the state of the Chinese economy – if this starts to pick up it could be the trigger to turn the oil market. However, the fact that lower oil prices has not already sparked a more significant recovery in China perhaps suggests such a recovery may not be imminent.

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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