Price Risk Report - 31 May 2016

UK energy prices increased this month with gas prices up 7.2% to 1.22p/kWh and electricity prices up 5.2% to 3.83p/kWh. Oil prices were up 3.2% at $49.69/bbl, coal prices were up 5.2% at $48.15/tonne and carbon permits were down 18.5% to €6.09/tonne.

Beond Rolling Annual Indices since Jan-07

Beond Price Risk Report 31 May 2016
Source: Reuters

Reduced volatility saw energy contracts trading in a relatively narrow range, although UK gas and electricity prices both increased for the second month in a row, tracking a bullish oil trend that has been on an upward trajectory since mid-January. Oil prices continue to recover as excess supply of 2% is soaked up by demand growth.

Slower growth in oil prices

Following three months of solid gains, oil prices rose 3.2% during the month of May. Supply disruptions were curtailed by bearish sentiment as Brent crude oil tested the psychological $50/bbl mark. In the short-term, production outages in Nigeria, Libya and Canada briefly supported a more bullish view of market, but pledges by Saudi Arabia and Iran that they will continue to ramp up output offered a bearish counterweight that limited gains.

Iran’s oil ministry confirmed that it had no intention of halting the increase in the production and exports of oil. Iran’s crude oil exports have reached 2 million barrels per day (bpd), with the figure likely to reach 2.2 million bpd by the middle of summer.

Additionally, a sustained break above $50/bbl could encourage an increase in drilling, especially in the US shale oil sector. This would increase production and help maintain the oil market’s current global oversupply. However, what is perhaps more likely is that prices in the $50 to $60/bbl range would be high enough to ease some of the pressure on producers, while still low enough to boost spending on other goods and services.

Strong consumer spending despite slower economic activity

US economic activity growth for Q1-2016 slowed compared to the previous quarter, although not as sharply as initially thought. GDP rose at 0.8% as opposed to the 0.5% pace reported last month. US inflation rose from 0.9% to 1.1% in April. Federal Reserve chair Janet Yellen said she expects interest rates to rise in the coming months if the US economy continues to improve as predicted and jobs continue to be generated.

Economic confidence in the eurozone rose for a second straight month in May, as the European Central Bank (ECB) prepares to present updated economic projections that could provide more information about the success of its stimulus program. Both the inflation and growth projections are expected to be revised upwards at the ECB’s next meeting in early June. Unemployment in the European Union fell to a seven-year low of 8.7%, compared to 9.6% in the same month last year. German unemployment fell to 6%, its lowest level since German reunification in 1990. The decline reflects the strength of the labour market in Europe’s largest economy.

After showing some hope in March, China’s economy took another hit in April. China’s trade performance recorded a sharp decline as slowing economic growth in Asia took its toll. Chinese exports fell by 1.8% compared with the same month in 2015, while imports fell by 10.9% over the same period.

Gas and power markets register modest gains

Gas and power markets were largely range-bound last month, recording only limited gains across the forward curve. Given the broadly balanced nature of underlying fundamentals, moderate price gains were largely driven by bullish oil markets and speculative buying from traders. The UK has taken delivery of a large number of LNG cargoes in recent months, but uncertainty surround gas storage levels and electricity supply margins ahead of the peak winter consumption period has fuelled buying interest.

Views

Potential downside risks include: a faltering oil price recovery; the LNG supply glut forming in Asia-Pacific; new LNG supplies exported out of the US; the US Fed increasing interest rates; and Chinese economic struggles as they try to transition to a consumption based economy.

Some of these downside risks have already been factored into the current low prices, and therefore we believe that risks are ultimately on the upside. Major upside risks include: oil prices finding sustained growth above $50/bbl; the resilience of the US economy finally leading to renewed global economic growth; and very tight electricity supplies in UK over the next couple of winters. As such, current gas and electricity prices provide good value for energy buyers.

Recommendations

Energy buyers preferring fixed price contracts may benefit from locking out prices for up to three years in order to take advantage of current low energy prices and avoid risk of further oil price increases. 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.

Beond Risk Services

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.

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.

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Disclaimer: 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.