Annual UK energy prices continued to firm in May2018 with both UK power and gas breaking recent highs, touching a 10% month on month increase before falling back partially, nevertheless ending the month 5% up over all; albeit slightly less than last month’s increase. Prices were driven by a combination or higher oil, coal and CO2 prices plus a weakening GB£, which coincided with some unplanned outages in Norwegian gas production. Weather conditions also conspired to work together, especially when energy prices were peaking mid/second of the month.
The forward curves for rolling annual prices maintained their backwardated nature, which did slightly increase, reflecting little change in the strong market structure and sentiment.
UK Gas prices continued to increase for most of the month, and despite warmer than seasonal-normal temperatures on average, weather conditions led to increased gas demand for power generation. With coal prices driving up CO2 prices, this put gas as the focus for power generation even more so. Consequently, when market players also heard of unplanned production outages from Norway, the fact that gas prices reached highs not seen since 2014 should not come as too much of a surprise. On top of this, the only (relatively) cold snap coincided with these outages. However, during the last week of May 2018, when temperatures rose again and demand abated, gas prices lost half the gains made previously in the month.
Changes to the forward curve for rolling annual prices reflected the market strength, increasing backwardation again slightly, indicating strong underlying market sentiment.
Movements in UK power prices were generally consistent with the gas market, though if anything even more extreme. During May 2018, the generally warm high-pressure weather conditions, while being good for solar power production, resulted in low yields from wind farms. As mentioned above, this meant a heavy reliance on thermal generation (primarily gas fired CCGT) for power production. Accordingly, power prices were very sensitive to gas supply issues, in fact so much so that when prices peaked during the 3rd week of May, we recorded annual prices not seen since summer 2011!
The other unusual occurrence in May, again as a consequence of weather and UKs increasing reliance on intermittent renewable energy, was that during the warm and sunny spell early May, within -day ‘peak’ prices traded significantly lower than baseload and off-peak prices. The full impact of this is complicated but, needless to say, it is not helpful for market dynamics, investment, long term supply security and particularly consumer cost.
As for gas, the forward curve for rolling annual power prices maintained a relatively strong backwardation, so continuing to imply sentiment is for higher prices over the medium term.
Brent crude oil prices were strong again in May, reaching close to $80/bbl (last seen in 2014) primarily in response to concerns surrounding US sanctions against Iran and Venezuela, potentially impacting crude oil supplies. However, this was politically offset towards the end of May as OPEC suggested relaxing production constraints to replace any export reductions from Iran and Venezuela. Longer term, many industry analysts are expecting supply to improve, restricting price levels as we approach 2019.
What’s the Outlook?
For at least the past 9 months the Energy markets have been very challenging for buyers, and while many were particularly caught out at the end of this winter, if a longer-term view had been taken, using the forward market structure as a guide, some ‘pain’ may have been reduced.
From a trading perspective, if previous decisions made have gone against you, but were made for rational reasons, they must be treated as learning opportunities; the truth is ‘we are where we are’ and past prices are now history; we need to base new decisions on the situation and prices.
In markets as we have seen recently, where many factors line up to simultaneously drive prices in one direction, there is a risk that the euphoria creates a price bubble; at such times buyers should avoid rushing in to decisions and should spread any buying out in order not to risk buying all on one day, which could just be a spike – give time for the dust to settle.
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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