Price Risk Report 29 February 2016

UK energy prices continued their downward trend with gas prices down 3.4% to 1.06p/kWh and electricity prices down 1.5% to 3.49p/kWh. Oil prices were up 3.5% at $35.97/barrel, coal prices were down 4% at $44/tonne and carbon permits were down 17% to €4.98/tonne.

Beond Price Risk Report 29 February 2016

UK energy prices were lower on reduced demand and anaemic economic growth, despite oil prices rising for the first time in 12 months.

US economy resilient in face of global weakness

The robust US economic recovery, now several years long since the global financial crisis, has not run out of steam, contrary to market concerns, and despite weakness from the rest of the world. US continues to create a steady number of new jobs, with jobless claims falling further than expected this month. Inflation has also increased, rebounding from 0.7% to 1.4%, justifying the Feds move to increase rates in December.

Elsewhere in the world, economic growth is weakening and international trade is falling. Euro area GDP increased 0.3% quarter-on-quarter. Chinese exports were down 11% year-on-year and imports down 19%. German exports and imports were both down 1.6%. OECD has cut is world growth forecasts by 0.3%, to 3% for 2016 and 3.3% for 2017.

Oil prices consolidate after 12 month freefall

Saudi Arabia, Russia, Qatar and Venezuela agreed to freeze their output at (very high) January levels on the condition that other OPEC nations were also to agree. This has been supported by Iran and Iraq who have agreed but are believed to have no intention of following. Iran needs to continue increasing their output from low levels, following removal of western embargoes over their supplies, having agreed to halt development of their nuclear weapon technology. Markets are sceptical but believe that this is a necessary first step towards agreeing real supply reductions.

Prices spike to $37/barrel on Friday, due to supply disruptions equivalent to about 1% of total supply. This included 600,000 barrels/day from Iraqi Kurdistan through Turkey. On the same day, 250,000 bpd were disrupted from Shell’s fields in Nigeria, due to a pipeline leak. These have halved the oversupply of oil, bringing an estimated 2M bpd of over supply down to about 1M bpd.

Oil glut expected to prevail

The Paris-based International Energy Agency published its medium-term outlook, saying they expect the oil glut to continue for five years, with global demand growing 1.2m bpd annually, driven by Indian economic growth; but with supply outstripping this, with US output to rise 5m bpd to 14.2m, becoming the largest global supplier (after falling 800k bpd over the next two years), and Iran to add 1m bpd.

IEA says that oil stocks are currently 3bn barrels in western countries alone, and expect to add 1.1m bpd over the next 12 months.

Brexit referendum adds to heightened geo-political concerns

The risks arising from the Brexit referendum contributed to global uncertainties and price volatility as an exit would weaken the European Union and could lead to other exits. This is at a time of heightened geo-political tensions including Russian aggression in Ukraine and Syria; Middle East instability from Syria and Isis; China aggression in South China Sea land reclamation and fortifications; and North Korea aggression with nuclear missile development milestone and tests.

Views

Current energy prices provide good value, now at their lowest levels since 2007. Further downside risks include US slow down; Chinese hard landing if they fail to transition to consumption 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 2% is soaked up by demand growth; and with very tight electricity supplies in UK over the next couple of winters.

Recommendations

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

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