Price Risk Report 31 March 2016

UK energy prices continued their downward trend with gas prices down 0.6% to 1.05p/kWh and electricity prices down 1.1% to 3.45p/kWh. Oil prices were up 10.1% at $39.60/barrel, coal prices were up 2% at $45/tonne and carbon permits were down 1% to €4.95/tonne.

Beond Price Risk Report 31 March 2016

UK energy prices continued their 13 month downward trend breaking its correlation with oil prices which have increased over the last two months. Gas prices fall as the growing LNG supply glut and oil prices rise on a potential deal between OPEC and Russia to freeze oil output.

Vast new Australian LNG supplies come on-line

The huge Gorgon project is now completed with its LNG facility’s first cargo successfully departing to customers in Japan. This will ramp up to 15.6 million tonnes per year. In addition to this project, 9 others will result in a total of almost 100 million tpy of new LNG supply coming to market over the next few years. To put in perspective, global LNG demand is just over 300 million tpy with about 2/3rds coming from Asia. In addition there are new large LNG supplies imminent from Malaysia, Indonesia and Sabine Pass in US.

Potential oil output freeze deal between OPEC members and Russia

A 17th April meeting has been scheduled between OPEC members and Russia to try and secure a deal to freeze oil output to support oil prices.  Russia convinced Shia OPEC members to exclude Iran from the freeze as they are catching up from low oil output levels from last years’ western embargo.

At same time, US shale oil output is now falling in response to low prices. Output rose 0.7m barrels/day to 9.43m in 2015 followed by an increase of 1.25M in 2014. However, following recent month reductions, latest expectations for 2016 output are for about a 0.6-0.8M fall and further fall of 0.5M in 2017.

Aggressive Euro monetary response to sluggish global economy

In response to weak European economic growth, inflation and employment, Mario Draghi, President of the European Central Bank announced an ambitious monetary easing package to bolster European prospects. This involved cutting its key interest rates including negative deposit rates from 0.3% to 0.4%; increasing monthly quantitative easing purchases from €60bn to €80bn including corporate bonds; and payments to banks to encourage lending. But he also announced that it would not be necessary to push rates lower, dampening initial market enthusiasm.

The US economy muddled along with the Fed’s preferred inflation measures ranging from a stable 1.7% to a risky 2.3%. This, combined with low but stable growth and consistent employment creation led Janet Yellen, the Fed chairman, to present a dovish view on the prospect of interest rate rises this year.

Asia looks bleak with concerns around deteriorating China international trade with exports dropping 25% and imports fell 14%. In addition, their manufacturing sector is now shrinking and their jobs market deteriorating. Also Japan may be in recession, following GDP contraction in Q4-15 and a -6.2% fall in industrial output last month.

Uncertain next generation of nuclear starting with Hinkley Point

Although no implications for prices within our three year timeframe, the French are becoming increasingly concerned about the delivery risks of building Hinkley Point by 2025. The current arrangement places 80% of the over-run costs onto EDF and the French government. There are splits within EDF ranks about whether they should proceed with the development, which saw their CFO resign and the leaking of an internal EDF white paper explaining the high risks and proposing a redesigned simpler solution. EDF have now set the 17th May for their final decision. The UK faces high risks of delays as the plant will supply 7% of total demand and will replace the final coal fired generators which are now closing faster than expected.

Views

Current energy prices continue to provide good value. Potential further downside risks include US Fed increasing interest rates, a Chinese hard landing as they try to transition to consumption based economy; faltering oil price recovery; and the LNG supply glut forming from new supplies from Asia-Pacific and US.

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 and new Capacity Mechanism costs.

 

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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