UK energy prices continued to trend lower with gas prices down 11.9% to 1.12p/kWh and electricity prices down 7.5% to 3.59p/kWh. Oil prices were down 18% at $36.46/barrel, coal prices were down 11% at $48/tonne and carbon permits were down 4% to €8.22/tonne.
UK energy prices ended the year with an acceleration of the 10 month price slide trend. The main driver this month was turmoil amongst OPEC members, openly competing for market share in an oversupplied market; the weak outlook for global economy; and a very mild winter.
Oil prices fell to an 11 year low following a break down in OPEC’s latest meeting, with Saudi Arabia and Iran failing to agree a reduction in output to support oil prices, or even the usual announcement to this effect. Iran now needs to undercut other producers to regain its market share lost over the oil embargo imposed by western nations over their nuclear development progress. In addition, Obama signed off new legislation freeing up US producers to export oil. Surprisingly, the number of producing shale oil wells in US increased by 17 despite the very low prices. There is a 1.5 million barrel per day of over-supply, which could be quickly absorbed as it only requires global demand to increase by 1.5%.
US signalled the end of prolonged weak monetary policies this month with a ¼ percent increase in official interest rates. This decision was made despite weak global economy and risks of US economy weakening. The main reason was concern of extended low rates distorting capital market and business investment decisions.
Europe took up the slack by easing their already loose monetary policy. This included extending quantitative easing over another six months to March 2017 and reducing banks’ deposit interest rates from -0.2% to -0.3%. This was mainly in response to a very weak recovery in European markets.
Chinese officials announced intentions to introduce looser monetary policies to counter risky economic situation, to be outlined in an economic plan to be published in March. The main risk to the global economy is whether China can navigate transition to economic growth driven by consumption, from growth driven by infrastructure investment, manufacturing and exports.
The mild winter has seen domestic heating demand 30% lower than usual at this time, driving spot prices to 30p/therm. The mild winter has also impacted on summer prices as gas storage has remained unused, which reduces the probability of stores needing to be refilled during the summer period.
A global climate change agreement was reached in the UN COP21 at Paris. This didn’t impact on short term energy prices but will have a long term impact from increased energy efficiency and investment in renewable energy sources. The Agreement included emissions peaking as soon as possible; a more aggressive target of 1.5 degrees temperature increase, down from 2 degrees; emissions performance monitoring; five year meetings to assess emission reduction progress and to modify plans if necessary; and provision of funding from developed nations to developing nations.
Current energy prices provide good value, now at their lowest levels since 2010. Further downside risks include US slow down; Chinese hard landing as they fail to transition to consumer based economy; oil prices continuing their downward trend; and the LNG supply glut forming in Asia-Pacific next year.
Despite these downside risks, which may be factored into the current very low prices, we believe that ultimately risks are on the upside, with the resilience of the US economy finally leading to renewed global economic growth; oil prices recovering as excess supply of 1.5% is soaked up by demand growth; and with very tight electricity supplies in UK over the next couple of winters.
Energy buyers preferring fixed price contracts should lock out prices for up to 3 years in order to take advantage of current low energy prices and avoid risk of increasing oil prices. However, we would recommend implementing a hedging strategy to avoid uncertainty and price volatility, given the big downside and upside risks outlined in the previous section. This would involve purchasing a flexible purchase contract and locking away prices in layered tranches.
When tendering your supply contracts, environmental taxes and subsidies need to be carefully negotiated to ensure that any fixed and pass-through components are fully understood and benchmarked correctly across different energy suppliers’ offers. Also ask about subsidy pass-through costs from Electricity Market Reform in particular CFD costs, which started to be passed through to bills in 2015 and CMs which will begin to be passed through in 2016.
Beond risk service and online risk tools include a broad range of innovative hedging strategies which can deliver considerable cost savings at no additional risk, by harnessing market uncertainty and price volatility. Also our tender service uses an online reverse auction which creates an intensely competitive environment to produce best prices and full transparency.
These views and recommendations are offered for your consideration and Beond makes every effort to ensure that the data and information in this report is accurate. However, due to the volatile and unpredictable nature of the energy markets, Beond cannot guarantee the accuracy of both the information and the recommendations provided. Beond does not accept any responsibility for errors or misstatements, or for any direct, indirect, consequential or other loss arising from any use of this information and/or further communication in relation to this information
Derek Myers, Director, Beond, 07970 655249