Market volatility in oil and energy prices is likely to persist
Rebounding oil prices and weakening sterling are just two reasons why volatility in the wholesale gas and power markets is becoming the norm, says Magnus Walker in his outlook for the next quarter.
During the past 12 months there has been a 45 per cent price swing in the wholesale power market, which was more than twice as volatile as the average movement of the five years prior. All the signs are that price volatility for both gas and electricity will remain high over the next quarter, so there are no signs of energy buyers being able to exit this “big dipper” rollercoaster ride anytime soon.
Our short-term view of both the gas and electricity markets for the coming months is neutral to bullish, with plenty of spikes along the way.
The strong potential for strengthening gas prices, alongside rebounding oil prices and signs of weakening sterling, combined with the usual supply and demand uncertainties of winter weather and intermittent renewables, are all likely to pile the pressure on wholesale gas and electricity prices.
Sentiment among oil investors is bullish. The extended OPEC production deal, an unlikely alliance between Saudi Arabia and Russia, and a predicted increase in global demand, have offered support to prices in recent months. As a result, we are seeing supportive increases of 2-3 per cent for gas and electricity contracts for delivery in the next few months, which has reversed recent decreases in energy prices. Rumours of a further extension to production cuts are expected to intensify ahead of OPEC’s next meeting in November and any resultant co-ordinated and implemented cuts into 2018 will likely result in a further firming of floor levels.
The negative impact of exchange rates on wholesale energy costs is likely to continue. Sterling is expected to weaken over the coming months as economic data continues to disappoint, while divisions within the Conservative party and concerns over Brexit negotiations, as the March 2019 deadline looms, will drive further negative sterling sentiment.
Although generation is expected to be strong over the quarter, supply margins may still see some tightness as ongoing concerns over French nuclear capacity could see interconnector imports limited. French authorities are currently delaying the return of some nuclear plants, which is increasing the likelihood of electricity flows reversing the traditional inward flows over winter months. National Grid is predicting a 10 per cent margin of available generation capacity over peak demand for the winter. While this is higher than previous years, the margin hasn’t been tested in the past few years because we have had a number of relatively mild winters.
Price movements will continue to be dictated by gas equivalents, with the outlook for gas prices also neutral to bullish. As such, the dominant driver of electricity prices over the coming months will remain the price of gas. We could see prices strengthen as the cost of generating electricity through gas-fired means potentially increases. This could be exacerbated by the requirement for more expensive coal-fired generation to help meet increased winter demand.
Electricity supply margins could benefit from stronger levels of renewable generation, however the inherent intermittence of renewable generation and concerns over interconnector supply will almost certainly see occasional price spikes. Demand is expected to pick up over the winter months and demand spikes are likely on very cold days as heating demand around the country picks up.
Gas supply is expected to be comfortable over the next few months, with deliveries of liquefied natural gas set to pick up and recent issues with Norwegian production expected to be resolved. The restriction on withdrawals from Rough storage could see supply tightness in periods of extremely cold weather. However the availability of withdrawals from Rough, even on a restricted basis, represents an improvement on the situation last year. Indeed, in its latest Winter Outlook, National Grid has said that despite Centrica’s closure of Rough, it expects there will be sufficient gas available to meet peak demand.
Prices are expected to be primarily driven by supply and demand fundamentals over the coming months. With weather conditions for the winter period unclear at this stage, it is difficult to determine the level to which demand is expected to increase, and to test the gas supplies across interconnectors from Europe.
While near-time prices are showing signs of strengthening, wholesale power prices beyond 2018 are currently historically low. For example, forward prices for 2021 are 10 per cent lower than the current trading period of 2018. Looking at price averages for the previous ten years, these current figures for 2021 are in the bottom fifth. Another positive is that despite recent bullish trends, current commodity prices remain well below the levels reached in 2014.
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