UK Energy Market Report – February 2018

Comment: The recent turmoil in the global equities market has spilled over into commodities with the retracement in oil prices (see below) being further affected by the general sell-off as investors looked to reduce risk in the face of increased market volatility. The markets remain nervous and we can expect further volatility in the coming months as highlighted in last month’s MPTR.

Oil: January has been an eventful month for oil with Brent crude rising to above $70 per barrel, a level last seen three years ago, before falling back with the general sell off of commodities and the strengthening USD. We noted last month the unlikely alliance between Russia and OPEC and wondered when the strains are likely to show. If the common enemy is US shale production, then the rise in US inventories and the prospect of increased shale production (US crude production which reached 10 million bbl/d in November, its highest level in more than four decade) suggests that the Russian/Saudi agreement over production cuts may hold for a while longer. However, as US inventories are still above their 5 years historical average, further softening in prices could be expected. Should there be any sign of wavering between OPEC and its allies around production cuts in the coming months, then further price falls could eventuate.

Coal: Coal prices have continued to ease as measures taken by the Chinese authorities to maintain domestic output weighed heavily on market sentiment. Pricing in Europe remains bearish as a result, with Calendar 2019 prices having significantly declined from recent highs to currently sit at under $76 per tonne.

LNG: LNG is playing an increasingly important role in the UK gas market, particularly following the closure of our major gas storage facility. Asia-Pacific has long been both a source and major market for LNG, with Japan accounting for nearly two-thirds of the purchases in this region. LNG has been traditionally sold on long-term fixed destination bi-lateral contracts between producers and end users with prices indexed to oil. However, this model has been changing amid rising exports, which are backed by contracts, often with intermediaries, that do not specify a destination. This has resulted in a much more liquid market, not dissimilar to oil, where an increasing number of LNG cargoes are sold more than once before they reach the final destination.

In another, related, development Japanese utilities have been allowed to re-export LNG for the first time, thereby enabling them to optimise their portfolios. In addition, in December 2017, Jera the largest buyer of LNG announced an intention to integrate their LNG trading operations with those of EDF thereby creating a leading position in the market. The increasing availability of LNG, not only from Asia Pacific producers but also the US and Russia suggests that this market is rapidly coming of age.

Europe: In January’s MPTR, we highlighted that there were renewed concerns in the Netherlands over Groningen gas production following another earthquake in the region. Since then, the Dutch Mining regulator (SSM) has recommended that output should be cut by nearly 40% from 21bcm to 12bcm per annum, and that these cuts should be implemented as soon as possible for the safety of the people in Groningen. The Government is set to determine the extraction volumes for the year to October 2019 by June this year. To put the proposed reduction in perspective, SSM is recommending a reduction which is equal to around 25% of the UK gas market.

UK Gas: The bearish sentiment surrounding UK gas has continued, supported by strong supplies and ongoing relatively mild weather. The announcement regarding the Groningen field did cause a short term spike in pricing which was short lived.

UK Power: Baseload contracts have taken direction from the underlying gas contracts, with current pricing also flat month to month and likely to soften in line with gas should the benign weather conditions continue.

We will be shortly production a short review on the changes over the last 5 years in both UK installed generation and generation output which makes very interesting reading. It emphasises the massive change away from coal to review generation in this period, and the latest energy auction for back-up generation capacity for the winter of 2021-22 has cleared as a price of £8.40/kW year which is just 40% of the clearing price for previous auctions. This underlines the massive change happening in the sector and calls into question the conventional wisdom that the next phase of market generation will be from base load gas generation.