UK Energy Market Report - September 2017

Commentary / Forecasts

Oil: Most of the focus in the last month has been related to the devastating aftermath of major storms. Both the US and Caribbean nations have a long road ahead to repair damage and rebuild infrastructure in the aftermath of hurricanes Harvey and Irma, the first of which forced the shutdown of almost a quarter of the US refining industry, much of which is based around Houston. This capacity is coming back on stream but European refined product prices spiked as European supplies were shipped across the Pond. As a side effect of the weather, US crude oil stockpiles rose by over 4 million bbls last week, the first increase since the end of June, as fewer people were using their vehicles. As most US production has not been affected by the worst of the storms, output has remained reasonably stable.

The firmer oil prices which we have witnessed over the last three months is probably due more to US politics than fundamental supply and demand. As we have noted previously, the oil price is regarded as a natural hedge to the USD and it has been the President’s intention to drive down the dollar to assist US exports. In this he has been successful with the dollar index witnessing a steady decline in the FX markets. The other aspect is that oil, like gold, is regarded as a safe haven when the international order is threatened with disruption - as we have seen with the sabra rattling between the US and North Korea.

However, as things both domestically and internationally return to order, we would anticipate some corresponding softening prices from current levels.

Coal: As highlighted in last month’s Report, coal has continued its upward trajectory and forward annual prices are now trading near 4 year highs. A steady flow of positive economic news from China, and production issues in both Indonesia and Australia are the main drivers behind the recent surge in pricing.

Europe: Increasing coal prices, along with firming carbon prices has had a knock-on effect on European power prices, with German power prices recording the highest levels since November 2014. Elsewhere, the decision by France to end all oil and gas production by 2040 is seen as largely symbolic, as oil output accounts for only 1% of total demand, but the proposed legislation is part of President Macron’s broader plan to take the lead against climate change.

SMRs: Readers of our monthly pricing reports will be aware of our opposition, on commercial grounds, to the new nuclear power plant underway at Hinckley Point. Those readers with longer memories may recall one of our Research Briefs published in July 2016 where we stated support for a number of smaller, more economical nuclear plants, which could be brought on stream sooner to meet the country’s looming generation capacity gap.

Small modular reactors (SMRs) are not new - versions have been powering the world’s nuclear submarines since the 1950s. A leader in the UK in this field is Rolls-Royce who is expected to publish this week a consortium report claiming that SMRs of 200-300 MW capacity can generate a commercial return at a price of £60/MWh - far below the 3200MW Hinckley Point strike price of £92.50/MWh. Both of these prices would be referenced under the Contracts for Difference (CfD) mechanism which effectively subsidies new technologies while the electricity market price (currently in the low £40s/MWh) remains below the strike price.

It is understood that the Government is to publish a techno-economic assessment of SMRs this autumn which may set out the case for pursuing this technology. In a separate, but related development, the CfD auction results achieved in 2015. This suggests that the UK can achieve a diversified generation portfolio (solar, onshore/off shore wind, nuclear and gas turbine) for prices not hugely above current market.

CCS: In the Research Brief referred to above we also expressed disappointment of the Government’s peremptory withdrawal in 2015 of funding from carbon capture & storage (CCS) pilot projects. It is interesting to see that the Norwegian government have grasped this opportunity and have proposed that their depleted salt caverns could form the basis of a plan European industry. Interestingly the reforming of natural gas (methane) into hydrogen is seen as the future of the current gas grid to decarbonise heating. The CO2 captured from the reforming process would need to be permanently stored, possibly in the UK depleted gas wells as originally proposed. Interestingly Leeds City Council has already embarked upon a project to convert their gas network to hydrogen as a pilot scheme.

UK Gas: UK gas prices have strengthened by almost 7% on the back of firmer oil and coal prices and the approaching winter season. Whilst fundamentals have remained reasonably balanced, some Norwegian outages have contributed to short term tightness in the system.

UK Power: UK power prices have moved with the gas market, with pricing firming along the curve. With temperatures below the seasonal norm forecast, and with a reduction in renewables output, pricing is likely to remain under pressure. This tightening of the market immediately prior to the start of the October contracts underlines the problem of leaving renewal decisions to the last moment.

ESOS Phase 2: We are now almost half way through ESOS phase 2 with reporting due by 5th December 2019. For those clients caught within this net, this is a reminder that you can work towards compliance by spreading the cost of the survey activity across several financial years and enable early identification of additional energy saving opportunities. If you would like to discuss ESOS please could our Energy Services team.

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