UK energy prices continued to fall with gas prices down 6.6% to 1.29p/kWh and electricity prices down 4.1% to 3.98p/kWh. Oil prices rose 2.5% to $49.56/barrel, coal prices rose 2.2% to $53/tonne and carbon permits rose 6% to €8.64/tonne.
UK energy prices extended their long eight month slide reaching levels not experienced since 2010, despite oil prices rising slightly this month.
Global markets steadied this month on reasonable economic developments, but remain wary of big risks remaining in the global economy. China announced official growth figures of just under 7% which was better than expected. US was the other main stabilising influence with reduced market expectations of the Fed increasing interest rates in December following weak manufacturing, disappointing slower jobs growth, zero inflation and a slow-down in GDP growth last quarter. In Europe, Draghi is considering further measures to loosen monetary policy to provide more economic stimulation. On the other hand, markets are becoming increasingly concerned of longer-term distortionary effects on investment markets from very loose monetary policies.
Press reports raised concerns in response to National Grid’s annual Winter Outlook report published on 9th October, mainly over an expected narrow generation margin of 5.1% available for this coming winter. The margin is calculated in reference to the expected highest demand period which tend to occur between 5-6pm during first half of December, or through January and February. This margin includes additional reserve capacity which is available National Grid. In prior years, National Grid maintained much safer margins of around 20% to cover extreme situations and allow for high levels of uncertainty around the assumptions used in the calculations. It is worth noting that forward wholesale prices have low sensitivity to these peak period supply risks as they only cover 5-6pm periods, but day-ahead prices are more sensitive.
The International Energy Agency published a report this month, concluding that the oversupply of oil will persist into next year, based on higher oil supplies from Opec and slower global economic growth. Iran will increase supplies following deal with west to halt nuclear weapons development in return for removing sanctions on buying their oil. Iran’s supply increase will overshadow the reduced output from US shale. The oversupply is also despite a 1.8m barrel/year increase in demand, to 94.5m barrels/day. Supplies during September were 96.6m barrels/day.
We believe that current energy prices provide good value, now at their lowest levels since 2010. Further downside risks include US interest rate rises, China economic problems driving global deflationary recession, oil prices resuming 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 price, we believe that the long-term risks are on the upside, with the resilience of the US economy ultimately leading to renewed global economic growth; oil prices recovering as suppliers struggle with losses at current prices; as new shale oil supplies from US reach their peak; as rising global demand soak up excess LNG gas supplies coming to market; 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 around volatile prices, given the emerging LNG gas glut and risk of slower economic growth. This would involve purchasing a flexible purchase contract and locking away prices in layered tranches.
Energy buyers prepared to take on some budget risk for even lower prices over the next several months, may prefer spot-based hedging strategies. Especially with an LNG supply glut forming and potential for Qatar LNG selling on the European spot markets. However we believe these strategies are becoming more risky given historically low forward prices.
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 will start to pass through to bills in 2015 and CMs 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, Managing Director, Beond, 07970 655249