Oil: The competing forces of OPEC announcements regarding cuts in output against increased shale oil production and rising US stockpiles continue to remain the two dominant factors in the oil markets. Oil prices have traded in a narrow band of mid $50s/bbl over the past few months as a result.
However, some of these cuts have been offset by increased output of OPEC members such as Libya, Nigeria and Iran, who are not subject to the agreement, along with poor levels of compliance by non-OPEC members such as Russia. Moreover, when the increase in US shale oil production is taken into account - some 500,000bbl/d - the overall effect of the cuts have been largely offset. Global stockpiles remain bloated, with US oil inventories at an all-time high of 518 million barrels, some 35mmbbl up on the levels held at the start of 2017.
Hedge funds remain long on oil futures, possibly for the reasons outlined in our February Report. It remains to be seen whether market sentiment will prevail over market fundamentals which would suggest that a market correction is likely.
Economic Data: Chinese Government concerns about the massive growth in credit and its attempt to rein in lending, suggest that the impact of these curbs may well be felt in the wider economy, resulting in a further slowdown in domestic growth. The strength of the USD will become more of an issue as President Trump looks to implement his economic package which may explain the hedge funds attraction to oil as a $ hedge.
In Europe, economic activity rose to the highest level in almost six years as the recovery became more broad-based while the UK has recorded a healthy annual growth rate of 1.9%, although recent data points to an impending slowdown. The elephant in the room remains the record levels of Government indebtedness (higher now than during the financial crisis) which underlines how fragile the economic system remains.
Europe: Annual power prices were mixed over the course of last month in the two main European markets, with German prices initially down on higher wind generation and a nuclear reactor restart, while those in France were up on tight supply and rising demand. Both markets ended the month firmer, as EU ministers agree on proposed carbon market reform aimed at lifting prices.
Gas had a firm start to the month due to cold weather. However, gas prices ended the month on a bearish note as revised weather forecasts across Europe continued to provide downward pressure on the curve.
LNG: It is arguable that liquefied natural gas (LNG) is likely to have a greater impact on European (including the UK) power prices than the oil price. A side effect of the US shale success is the large amounts of gas that have become available and are seeking markets. The new US administration has an emphasis on driving energy prices down and a healthy export trade is likely to be established using East coast terminals which have previously been configured for imports. Europe is an obviously accessible market and the exporters are likely to compete strongly against Gazprom’s market share (which Gazprom will vigorously defend) resulting in falling gas prices over the next 5 years.
UK: The restrictions surrounding the Rough gas storage facility have been extended and it is now unlikely that there will be any further gas injections until April 2018. Gas and power prices eased across all near term seasons following the announcement, not surprising for the Summer 17 pricing but unexpected for Winter 17/18. The may reflect an expectation of increasing availability of LNG at attractive pricing in the market (see above) given that around 50% of the UK power generation is now gas based.
Summary: Over the last month the annual contract prices for both gas and power has declined significantly, and further out on the curve are in backwardation (see graphs). A combination of soft pricing, weak demand and milder weather should lead to prompt and curve prices easing further.