UK Energy Market Report - July 2017

Oil: Crude pricing is still showing signs of weakness and during the last month dropped to a low of $44.47/bbl before rebounding on the news of a drawdown in both US crude production and distillate inventories and a slight drop in the US rigs count. With Libya and Nigeria (both exempt from OPEC quotas) increasing production, and Canadian oil sands production increasing by 600,000bbl/d during 2017/18, fundamentals would suggest that there will be ongoing weakness in the oil price. This view is also supported by an influential US fund manager - a legendary optimist on oil prices - who has now turned bearish, based largely upon the continuing strength of the US shale oil production.

Middle East/LNG: Last month’s report noted the emerging regional crisis between Saudi Arabia and its allies with Qatar. However, several weeks on it would appear that these continued tensions have had little effect on crude prices, or indeed LNG deliveries to the UK. The UK received 4 shipments in June and is expecting 3 further deliveries by mid-July, including the first large shipments from the Gulf of Mexico. While this vessel contains sufficient natural gas to meet half a day of the UK’s typical summer gas load, it is an important move towards diversification of supplies.

Other interesting developments are that Japan Fair Trade Commission has lifted the restriction on utilities from reselling LNG cargoes which is likely to improve the trading in a commodity which is heading for oversupply - at least in the Asian market. In addition Qatar has announced a plan to boost output from the North Dome field by 20% and Iran have recently signed a 20 year agreement with Total for the development of the South Pars field - North Dome/South Pars are the same geological structure and is the world’s largest gas field.

Coal: Due in part to the demand from Chinese generators to meet the summer air-conditioning load, coal has been trading above $70/tonne, continuing the recovery which started early in 2016 (see chart). However, a recent report that China has banned coal shipments from being landed at some of its smaller ports could curb demand and reduce pricing pressure.

Europe: The continuing maintenance issues with the French nuclear fleet have reduced output and required more coal fired base load generation from its neighbours. As a result of the increasing coal price, this has led to the firming of European power pricing over the past few weeks and this has provided support to UK power markets.

There has been another round of talks surrounding potential EU reforms of the Emissions Trading Scheme. As a consequence there has been an uptick in the price of EUA carbon allowances, from EUR 4.8/tCO2 to EUR 5.2/tCO2 which particularly impacts coal and gas fired generation.

France has followed Italy in publishing an energy strategy and intends to phase out coal fired generation by 2022 (Italy 2030) while the market share of nuclear generation will fall by 50% by 2025 compared with a national 78% currently. This will require an ambitious programme to expand renewables to represent 32% of generation capacity by 2030.

UK Gas: Following an anticipated dip in pricing due to planned maintenance on the main interconnector to the continent, natural gas pricing recovered as deliveries from dropped Norway as a result of unplanned outages. This coincided with some warm, calm weather leading to high levels of demand for gas fired power generation to fill the gap resulting from subdued wind generation. However, in overall terms, gas prices have fallen back over the last month and are approaching the levels last seen in September 16.

Since our last report, Centrica has confirmed that the Rough gas storage facility is to close permanently. Winter 17 gas pricing was unaffected, as it has previously been announced that the facility would be unavailable during this period. Centrica are seeking approval to recover the remaining 6 bcm of gas commencing in October 17. If implemented, this could soften pricing for monthly contracts during the winter season.

Interestingly, gas forward contracts from Summer 18 onwards also failed to react to the closure news suggesting that it had been anticipated and already factored into pricing.

UK Power: As noted above, power pricing has generally firmed in line with increases in coal, carbon allowances and continental demand. In addition, with outages at 6 major plants and a lack of wind generation due to still weather conditions the generation spare capacity margin has suffered.

Perhaps the most significant announcements over recent weeks have surrounded the proposed Hinkley Point C nuclear power station. Firstly, another increase, this time of £1.5bn, in construction costs and the prospect that completion will be delayed until 2027. Secondly a report from the National Audit Office stated that the Department for Business, Energy and Industrial Strategy had “committed electricity consumers and taxpayers to a high cost and risky deal in a changing energy marketplace”. As EDF is now required to bear construction cost overruns, and with a new political realism in France, there is a chance that EDF may decide to call time on the project and negotiate an exit with the UK Government. In our view this would be the most sensible outcome.

Unlike gas, the electricity markets remain in backwardation - that is the longer priced contracts are cheaper than the near term ones - see the spread on the Annual Power contracts chart - which means that clients with October 17 renewals should be looking to secure two or three year contracts. For clients with October 17 contract renewals, we would recommend that these be completed as soon as possible to avoid any further upside risk to pricing.

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