Price Risk Report - 31 July 2016

UK energy prices increased for the fourth month in a row, as intense volatility in electricity and gas markets was fuelled by news that Rough Storage would extend its ban on gas injections into the UK’s largest gas storage facility until at least March 2017. However, plummeting oil prices towards the end of the month limited electricity and gas gains. Gas prices were up 2.0% to 1.42p/kWh and electricity prices up 1.7% to 4.32p/kWh. Oil prices plunged 14.5% to $42.46/bbl, as concerns surfaced that a global glut of crude and refined products would drive markets lower, delaying a long-anticipated rebalance in the market. Coal prices were up 10.0% at $61.20/tonne while carbon permits were down just 0.9% to €4.47/tonne.

Beond Rolling Annual Indices since Jan-07

Beond Price Risk Report 31 July 2016
Source: Reuters

Gas and power volatile as Rough outage extended

Mounting winter gas supply risks continued to drive gas and electricity prices higher across the forward curve, despite faltering oil prices capping gains. The latest outage at Rough Storage ended more than three weeks earlier than expected, after testing at the affected well identified potential uncertainties in the remaining untested wells. Rough Storage will therefore continue testing, with no further gas injections taking place until at least March 2017. While limited withdrawal operations are expected to return to service by 1 November 2016, the UK’s gas storage inventories are expected to be at record lows this winter.

Unexpected supply glut leads to sharp drop in oil prices

Brent crude oil fell 14.5% over the course of July, settling at $42.46/bbl. Global oil markets saw a glut of crude and refined oil products resurface, after the US government reported an increase in US crude stockpiles, taking markets by surprise. A significant oversupply in refined products, reduced 2016’s demand forecasts for crude, making investors less optimistic about the prospect of oil markets rebalancing in the near future. The threat of resurgent US oil production with the rise of drilling rigs and a strong dollar added to weak sentiment in the market. With global supply disruptions seemingly coming to an end, it is difficult to say when oil markets are likely to experience a sustained movement above $50/bbl.

Pound steady, awaiting BoE decision on interest rates

The British Pound has struck a sideways tone against the likes of the Euro and US Dollar over the course of mid to late July, and the reason for this is understandable. The Pound is being driven almost exclusively by expectations for a policy announcement from the Bank of England (BoE) at their upcoming 4th August meeting. A big decision from the BoE looms, and taking a big position on the Pound ahead of such a decision would be very risky. The BoE is now the single most important factor impacting the value of the Pound as the policy measures will impact directly on demand for UK assets, as well as the cost of energy imports. Since Martin Weale, a leading BoE policymaker, said he would now support a cut to interest rates, markets are largely expecting this to happen in the next week, a decision that would likely see the value of the Pound decline.

US economic growth well below expectations

Hopes of US interest rate rises were pushed into the distance, as the US government announced GDP had grown at an annual rate of just 1.2% to the end of June, below the pace economists expected. Uncertainty over the direction of economic policy in a hard fought race for the White House is expected to slow US economic activity during 2016, as companies put projects on hold despite record-low borrowing costs. Given the incumbent President is a Democrat, the impact of Hillary Clinton winning the US Presidential election would likely be gentler on the global economy than if Donald Trump were to win the White House job. A Trump win is likely to mean more changes to policy, with headlines suggesting that, we would see marked changes in American politics. Foreign policy could see the biggest changes, with global economic implications likely if Trump’s policies see America insulated from some of its trading partners.

Non-Energy Costs

With the now defunct Department of Energy and Climate Change (now part of the new Department of Business, Energy and Industrial Strategy) deciding to bring the Capacity Market scheme forward by a year, non-energy costs for Winter 2017/18 remain particularly uncertain. The actual impact this charge will have on consumer bills will not become clear until the auction results are published.

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.

Views

Drivers that have the potential for prices to fall are: a sustained faltering oil price recovery; the LNG supply glut forming in Asia-Pacific; new LNG supplies exported out of the US; and faltering economic growth following the UK’s decision to leave the EU.

On the other hand, various risks also have the potential to push UK energy prices higher. Major price risks include: news regarding the impact of Rough Storage’s outage on energy prices during Winter 2016/17; long-term oil prices finding sustained growth above $50/bbl; a recovery in the US economy; tight electricity supplies in UK over the next couple of winters; and the falling value of the Pound making gas imports more expensive.

For the remainder of 2016, the uncertain status of Rough Storage is expected to provide significant volatility to energy prices, however no further news is due until November.

Recommendations

Current gas and electricity prices provide good value for energy buyers. Energy buyers preferring fixed price contracts may benefit from locking out prices for up to three years immediately, in order to take advantage of current low energy prices and avoid risk of further currency driven price increases. For clients on flexible energy contracts, we recommend implementing a hedging strategy to manage uncertainty, given the volatile nature of the risks created by the outage at Rough Storage. This would involve creating a flexible strategy 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.

Environmental taxes and subsidies also need careful negotiation to ensure that any fixed and pass-through components are fully understood and benchmarked correctly across different energy suppliers’ offers.

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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.