UK Energy Market Report - August 2017

Commentary / Forecasts

Oil: The ongoing battle between market sentiment and fundamental supply demand analysis in determining the price of oil continues unabated. US crude stockpiles remain about 100 million barrels above the five-year average and hydrocarbon production rose to the highest level since July 2015. Shale oil producers have utilised new drilling technologies to drive down costs and can operate profitability with crude at $50/bbl with output expected to reach a record 10 million bbl/d by the end of the year. This is not the message which OPEC and its allies want to broadcast.

The meeting in Abu Dhabi between OPEC and non-OPEC producers was, in effect, an attempt by Saudi Arabia to apply an enforcement order designed to ensure compliance with the agreed cuts and send the right message to the market. So the sound bite battle continues and the oil price yo-yos around the $50/bbl mark. The one note of caution is the political situation in Venezuela, where disruption to production of debt defaults could result in oil testing the high $50/bbl level.

Meanwhile, big oil has also been making significant progress in lowering exploration and production costs and are starting to dust off projects which have been put on hold for the last three years. This will not result in an immediate lift in production given the time lags involved, but will meet the IEA projections of demand increase in the 2020s. In line with this revival, Shell has recently submitted a proposal to partner in two oilfields on the Iran-Iraq border which is expected to increase Iranian production by 600,000 bbl/d within three years.

EVs: Around 50% of the oil produced is for transport, the majority of which is for motor vehicles. The huge advances in Lithium-ion battery technology in recent years - applicable to both electricity storage systems and cars - heralds a significant change in the use of fossil fuels for both generation and transportation. This advance seems to have caught the oil companies by surprise and OPEC has recently quadrupled its short term forecast of EV take up. The recent announcement by Volvo that from 2019 all of its vehicles will contain an electric motor (i.e., will be hybrids) underlines the longer term decline in demand for oil. This has been reinforced by announcements from both the French and UK Governments - the latter banning the sale of new fossil fuel vehicles from 2040. It is too early to tell the impact that this will have on the electricity grid and need for additional generation although this has not prevented various alarmist headlines in the newspapers

The increasing role of battery storage as an integral part of the electricity system (putting aside the petty arguments over who should own them) will reshape the way in which the grid operates. A partial acknowledgment of these developments is the revision to the distribution charging methodology to be implemented from April 2018 (to be addressed in a future NUS Research Report).

Nuclear: Any discussion in respect of long term UK generation requirements soon comes around to the role which nuclear will play. The central role envisaged in the 200 White Paper now seems dated especially with the spiralling costs of the next generation plants and the recent announcement in the US that the two Westinghouse AP1000 nuclear plants under construction in South Carolina have been abandoned. A France looks to reduce its reliance on nuclear power, the decreasing cost of renewables generation and battery storage suggest that nuclear will be edged out by gas as the most suitable source of baseload generation. This will be some compensation to the hydrocarbon producers.

Coal: Continued demand from China and India has seen the pricing for the 2018 contract edging up. The future role of coal in European generation depends upon whether carbon capture technologies are able to demonstrate the same cost decreases which have occurred in renewables and batteries. A potential breakthrough in this area in the Allam Cycle which is about to commence large scale trials on a 50MW gas fired plant in Texas which will be watched with great interest by coal and gas producers alike.

Europe: The pressures on European electricity prices arising from the ongoing maintenance on the French nuclear generation fleet have largely abated and excess power has been flowing into the UK through the interconnectors despite the heat wave in the southern parts of Europe. On the political front is the Nord Stream 2 pipeline being promoted by Germany to bring additional Russian gas supplies to Europe despite the stated EU intention to diversify supplies. The US has now waded into this pond through the Senate resolution to impose sanctions on companies involved in funding Russian export pipeline projects. Gazprom is the shareholder, but the financial investors include engie, OMV, Shell, Uniper and Wintershall. We will watch how this situation develops with interest.

UK Gas: The volume of natural gas exported from the UK to Belgium via the interconnector pipeline rose to a monthly record in July. Elsewhere the ongoing situation in Norway regarding outages at the Norwegian Kollsnes plant has now been extended until the end of August which has increased volatility on forward prices. In addition the number of LNG cargoes received into the UK rose to 6 in July.

UK Power: Power contracts have reflected the movements seen in the gas market and reported a week on week increase. Given the overcast conditions, solar generation was reduced from the levels seen in July, although wind generation has increased due to a strong jet stream. The power system continues to be reliant on gas with nuclear generation in second place contributing around 25% to the ix.

Prices are pushing up, all October 17 supply contracts should now be in place.

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