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A Unique Perspective
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A Unique Perspective | Flexi-Fixed
A Unique Perspective | Flexi-Fixed
Background Price formation gave rise to some extraordinary developments last year. Indeed, 2014 is likely to be remembered not least because of the incredible fall in oil prices. Back in January 2014 it seemed inconceivable that crude oil could have ended the year at anywhere as low as the $57/bbl that it did. During the first half of the year prices averaged close to $110/bbl, pretty much not far off where they traded the year before. In the middle of the year there were concerns that geopolitical tensions could lead prices to rise further. But a sudden and precipitous collapse set in so that by December the price was half of what it was in June.
“With uncertainties ahead - is it time to fix?” The October 2015 annual baseload electricity price has fallen by up to 20% since the start of 2014, with the underlying price of oil dropping by more than a half since last summer. Prices may yet have further to fall, but the risk of an upturn is ever more likely as we move from winter into the summer maintenance period with gas storage stocks needing to be replenished and the chance yet of a severe cold spell.
Prices were largely overtaken by the weakness in fundamentals driven by burgeoning supply and weakening global demand. Last year saw some exceptional global supply growth, driven by developments in North America. The phenomenal increase in shale oil production meant US output is now approaching the all-time highs of the 1970s. Despite disquiet in some quarters, Opec chose to leave its production target unchanged when the group met in November; the logic seemingly being that it might be prepared to forgo revenue in return for protecting market share. Opec is not expected to meet again before June and seems content for the time being to see low prices, even if it means that high-cost production becomes uneconomic.
The organisation and scheduling of a traditional fixed-price tender, through to securing the resulting supply contract, is time intensive and the opportunity to fix at favourable prices may be lost. Feedback shows that during the tender process fixed clients are not accepting prices offered on the tender day, believing prices refreshed at a later date will be lower. If there is a sustained upturn in wholesale prices, there may be a sudden influx from fixed clients wanting to secure contracts, placing increased pressure on suppliers’ resources, for even refreshed prices. In such cases suppliers may not be able to respond quickly enough to client requests, again risking the most advantageous contract prices being missed. The risk lies in the time it takes to tender and secure a fixed contract against wholesale market price volatility. The tender process could take a few days at best, but is more likely to take a few weeks, compared to the speed at which the wholesale market can react to adverse price indicators. This white paper analyses the fundamentals driving prices down and a forward view of our unique perspective on the wholesale market, followed by our recommendations on how to act with your business in mind. Read on to discover more.
Christopher Lydiard -Wilson Christopher Lydiard-Wilson Founder and Chief Executive Officer
EnergyQuote JHA, 66 Hammersmith Road, London W14 8UD United Kingdom. T: +44 (0)20 7605 2300 E: enquiries@energyquote.com
In 1992 Christopher founded, EnergyQuote JHA, he spearheaded the development of the world’s first energy e-procurement system to trade online in 1995 offering companies an alternative to traditional lengthy methods of procurement. Prior to energy, Christopher’s career was in stockbroking where he worked in the derivatives markets.
Current wholesale prices are not just a reflection of the price of oil. As noted above geopolitical tensions played their part. In particular, events in Eastern Europe have a bearing as conflict in Eastern Ukraine led to concerns over a disruption to gas supplies from Russia. In June gas supplies to Ukraine were halted following a dispute surrounding payment. Although gas continued to flow to the rest of Europe, the concern was that supplies could be disrupted, which provided some support to forward pricing over the summer. A series of trilateral talks between Russia and Ukraine, moderated by the EU, eventually resulted in a temporary solution with payment terms agreed for gas supplies during the winter. Consequently, news of the agreement led to a dissipation of risk. But developments in the region are once again leading to renewed concerns over further possible supply disruption as the payment terms for supplies beyond the end of March 2015 have yet to be agreed.
Oil prices halved in 2014
Geopolitical tensions have impacted wholesale prices
Wider European supply disruption could result in an increased reliance on LNG
Although the UK is not directly reliant on Russian gas, it could be affected by wider European supply disruption, which may mean an increased reliance on alternative supplies such as Liquefied Natural Gas (LNG). The dynamics of the global LNG market now appear to be more favourable than they have been, partly as a result of the fall in the oil price. Some LNG pricing mechanisms include an element of oil indexation so prices should now start to show the impact of weaker oil.
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A Unique Perspective | Flexi-Fixed
Mild temperatures kept the demand for gas low in 2014
A Unique Perspective | Flexi-Fixed
Gas and power prices are at relative lows on the wholesale market. The first quarter of last year saw seasonably mild temperatures, which kept the demand for gas relatively low and the system well balanced with strong imports and healthy storage stocks moving forward into the summer. This had a downward impact on gas prices, and as gas sets the marginal cost of power, electricity prices have also been driven down, with weaker coal also impacting. The annual October 2015 baseload power contract has fallen up to 20% since the beginning of 2014 and it is around 15% less than if the forward annual October contract had been purchased this time last year.
UK Electricity Forward Curve 58 56 54
£MWh
Annual October 2015 baseload has fallen up to 20% since January 2014
52 50 48 46 44
October Year 2015
15 Fe b
D ec 14 Ja n 15
14 O ct 14 N ov 14
Se p
14
Ju l1 4 Au g 14
Ju n
M ay
14
14 M ar 14 Ap r1 4
Fe b
Ja n
14
42
October Year 2016
Rolling Front Month Brent Crude Oil
$/bbl
Weaker coal has also driven down power prices
120 110 100 90 80 70
15 Fe b
D ec 14 Ja n 15
O ct 14 N ov 14
14 Se p
Ju l1 4 Au g 14
14 Ju n
14
M ay
14 M ar 14 Ap r1 4
Fe b
Ja n
14
60 50 40
Rising Non-energy Costs Upgrades to the electricity network at national and local levels are likely to see further increases in transmission network and distribution use of system charges (TNUoS and DUoS) over the coming years as investment is undertaken. TNUoS tariffs for 2015/16 will be higher to take into account inflation, network investment, both onshore and offshore, and other costs. Costs are recovered from both demand and generation, with the draft tariffs showing the demand proportion slightly higher at 77% in 2015/16 compared to 73% in 2014/15. In total £2.655 million will be recovered from TNUoS in 2015/16, a 7% increase year-on-year, with £2.042 million recovered from demand, a 13% increase compared with 2014/15. As a result National Grid expects an average increase in half-hourly demand tariffs of £5.15/kW in 2015/16 compared to 2014/15. The largest increases of up to 39% are in Scotland, the lowest of 11-14% in the South and 15-18% in London, the Midlands and the North. The new RIIO (Revenue = Incentives + Innovation + Outputs) model for network regulation will take effect for the eight-year period from April 2015 for distribution network operators. This aims to drive benefits for consumers by providing strong incentives to delivering a low-carbon, sustainable energy sector at value for money for existing and future consumers. Western Power Distribution’s business plan was settled early, with the remaining plans agreed late last year. Over the next eight years £24 billion will be spent on the local electricity network, in order to renew, maintain and connect new small-scale renewable generation. There is a reduction in allowed revenues of around 5% on average over this eight year period relative to the current price control. Under the government’s electricity market reform arrangements, contracts for difference will support new renewables capacity. While the total cost will be capped under the Treasury’s levy control framework, it will ultimately be borne by consumers and is expected to increase rapidly from April as new capacity is commissioned. Subsidies will also continue to be provided to small-scale renewable projects through the feed-in tariff mechanism. Rising levels of micro-generation capacity and existing renewables capacity through the Renewables Obligation will also support the cost of subsidies, which will continue to be passed through to consumers.
Further transmission and distribution cost increases are expected as a result of upgrades to the electricity network
Over the next eight years £24bn will be spent on the local electricity network
New renewables capacity will be subsidised through contracts for difference
Rolling Front Month Brent
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A Unique Perspective | Flexi-Fixed
Non-energy costs are expected to increase over the medium term
A Unique Perspective | Flexi-Fixed
The Forward Outlook
£100
£80
£17.13
£19.72
£24.37
£14.73
£MWh
£60
£26.19
£27.42
£17.14
£18.06
£46.32
£48.32
£48.50
2015
2016F
2017F
£16.96
£15.43
£46.84
2014
£55.11
£40
Tax, levies, charges Transmission & Distribution Energy & Supply
£20 £0
150
50% 142.7
140
136.0
130
45%
Index
124.9
120
115.1
110 100 90
40%
Percentage of total
Non-energy costs as a proportion of the total cost has increased as wholesale costs have fallen
2013
100.0
2013
2014
2015
2016F
2017F
35%
Non-energy cost index (2013=100) (left axis) Non-energy at % of total cost (right axis)
Transmission and distribution charges and renewables subsidies make up the majority of non-energy costs
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Indicative Fixed Price Breakdown Energy & Supply Transmission & Distribution (Taxes) Climate Change Levy (Charges) Supplier Settlement Fees (Charges) Risk Premium (Charges) Renewables Obligation (Charges) Feed in Tariff (Charges) Supplier Margin (Charges) Contracts for difference End User Price
2013 £/MWh % £55.11 63.4% £14.73 16.9% £5.24 6.0% £0.02 0.0% £0.42 0.5% £8.66 10.0% £2.43 2.8% £0.37 0.4% £0.00 0.0% £86.98
2014 £/MWh % £46.84 56.1% £16.96 20.3% £5.41 6.5% £0.02 0.0% £0.35 0.4% £10.31 12.3% £3.25 3.9% £0.38 0.5% £0.00 0.0% £83.51
2015 £/MWh % £46.32 53.8& £15.43 17.9% £5.54 6.4% £0.02 0.0% £0.21 0.2% £12.80 14.9% £4.06 4.7% £0.34 0.4% £1.40 1.6% £86.11
2016F £/MWh % £48.32 52.7% £17.14 18.7% £5.74 6.3% £0.02 0.0% £0.21 0.2% £13.29 14.5% £4.88 5.3% £0.33 0.4% £1.72 1.9% £91.65
2017F £/MWh % £48.50 51.6% £18.06 19.2% £6.09 6.5% £0.04 0.0% £0.21 0.2% £13.73 14.6% £5.02 5.3% £0.33 0.4% £2.00 2.1% £93.97
Relatively mild temperatures during the first half of this winter helped to curb significant increases in space heating, which combined with high levels of lowcarbon generation and relatively weak spot gas kept spot power relatively low. A settled cold spell in mid-January failed to significantly lift spot power. The availability of the nuclear fleet in the UK is expected to be good for the foreseeable future, with all units generating for much of January, although some maintenance is scheduled during the first quarter of this year. EDF Energy’s units at Hartlepool and some at Heysham, which were taken offline last year as a precautionary measure following a boiler fault, are currently running at 70% capacity. There is a slight risk that these units will be given a complete overhaul during the summer. EDF Energy has extended the life of its Dungeness B nuclear station by 10 years to 2028. Wind capacity continues to be installed, both onshore and offshore, with generation increasing year-on-year. There was a 15% increase in electricity generated from wind in 2014, up to 28.1TWh. Overall wind provided 9.3% of total electricity supply, a 1.5 percentage point increase year-on-year. In December 2014 there was a new monthly high of 14% of all electricity generated by wind, with a new quarterly record of 12% in Q4 2014. The intermittent nature of wind power means higher spot power volatility as thermal generation is required to make up any shortfall. Wind speeds, and therefore generation levels, tend to be higher during the winter months, while generation tends to fall during the summer, adding upside to intra-month spot power volatility. The winter peak system margin will continue to be squeezed as coal-fired plants are closed under environmental legislation. National Grid will extend the use of its new balancing services to generation in winter 2015/16, a pilot was held for demand side response a year early for winter 2014/15. Margins have been comfortable so far this year as a result of the mild winter, but this may not be the case next winter. The proposed reform to the carbon market has added some upside premium to carbon, and therefore power, although member states are as yet to agree on a date for implementation and whether this can be done before 2021. A final decision is by no means clear, although it is hoped that member states will agree on the course of action by July this year.
Nuclear availability is healthy and wind capacity continues to expand
Demand side response will participate in new balancing services in winter 2015/16
Carbon market reform is expected to support power prices further
Coal prices have continued to weaken, as a result of increased Russian and Chinese throughput, limiting the upside to forward power contracts. In Russia the Rouble has weakened and in China export tariffs have been lifted.
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Our energy recommendations Given the market outlook, it is clear that current wholesale electricity prices are extremely advantageous and consequently EQ recommends that clients either fix their October 2015 supply contracts at the earliest opportunity or alternatively, take advantage of our Flexi – Fixed product. This new product affords the flexibility to secure the supply contract for a two-year period from 1 October 2015 while retaining the option to secure the underlying energy at any time prior to the supply contract start date.
If you would like to know more please contact your Relationship Manager
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Š EnergyQuote JHA. All rights reserved. EnergyQuote JHA is the trading name of Energy Management Brokers Limited (Registered No: 2500956). Registered Office: 66 Hammersmith Road, London, England W14 8UD. EQ0243.02.2015.