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What to look out for this winter

Through much of the summer, market participants have been waiting for gas and electricity contracts to soften and pull back to levels closer to those seen last year, unfortunately there has been no letup

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Through much of the summer, market participants have been waiting for gas and electricity contracts to soften and pull back to levels closer to those seen last year, unfortunately there has been no letup in coal (API2: $102.15/tonne, up 16% yoy), oil prices (Brent: $84.11/bbl, up 51% yoy), and carbon (€21.34/tonne, up 216% yoy) has been on a tear, resulting in gas switching (and thus gas demand) accelerating across much of North West Europe.

We have now hit the winter season with NBP prices for Jan-19 at 78.75 p/th (up 48% on the Jan-18 contract this time last year), TTF (the European gas benchmark) at 28.37 €/MWh (up 55% yoy) and UK baseload electricity prices for Jan-19 at 73.74 £/MWh (up 37% yoy). Risks are piling up for a season of potentially uncontrollable price spikes. Besides the risk of a prolonged cold winter, ChangingEnergy identify four key trends below which have been in evidence of late and are likely to sustain through this winter.

Five Key Trends
Robust global coal and oil demand

Higher demand for coal and oil - IEA estimates are for 1.5 mbpd growth in oil demand in 2019 - typically mean higher gas prices, as consumers look to source cheaper alternatives and switch to (lower carbon-emitting) gas. While gas demand across Europe has shot up this summer, Reuters Market Intelligence have suggested that we may have reached a point where not much more coal for gas switching can take place this winter, without risking storage reserves.

Asian demand

China has been the primary driver for both renewed coal demand and increased gas demand with LNG imports especially seeing a spike in demand (first eight months of 2018 up 48% yoy to 32.6 mt – about six times as much LNG as the UK imported in 2017) as China attempts to reduce its dependence on highly polluting coal. Though the LNG ramp-up started in Win-17, due to hotter than expected weather in Asia, increased LNG and coal consumption have continued through summer. Coal has partly increased (up 3.9% for the first half of 2018) as a result of boomeranging Chinese policy on reducing coal imports / containing pollution against protecting operations at domestic mines.

LNG redirects

Supplies from Qatar that would have normally been sent to Europe and the UK have gone instead to Asia, as its been more attractive for producers to sell it there. Some LNG has even been redirected from Europe to Asia to exacerbate the supply issue.

Predictions of increased European LNG supplies in Q3 barely materialised and in fact new global gas flow dynamics have OIES arguing that European storage facilities could be used as a strategic global gas reserve to the benefit of the EU as China ramps up its LNG demand. The EU has a significantly higher share of gas storage than the rest of the world as a proportion of consumption (33%, post Brexit and should Ukraine join the Energy Union).

Cost of carbon

Meanwhile the cost of carbon has shot through €20/tonne as the new Market Stability Reserve mechanism (to address historical oversupply issues) has proven effective ahead of its implementation, adding further upside to wholesale electricity prices as generators have to recover the additional cost of EUAs and pass thru to suppliers.

European coal to gas switching

With coal and carbon prices so high, European suppliers have had to switch to gas (both pipeline and LNG) from the inflated wholesale market.

(Continental) European gas suppliers have also been struggling to fill storage facilities for winter, partly due to declining output from the Groningen field off the Dutch coast. Alternative sources of gas, including UKCS gas production has been sourced to fill this gap and it may well be a question of whether there is any cheaper gas left (relative to coal) to switch to this winter. There is however some slack in the system for reverse switching (gas to coal); 20-25 mcm/d could occur if coal prices stabilize and gas prices rise and find a floor at 75 p/th.

Of course, if we have a milder winter*, we could see a decent sell-off, with March in particular a key month as suppliers unwind reserves and sell off excess inventories bought in anticipation of a worst-case scenario.

* The Met Office 3 month outlook suggests a higher probability of the North Atlantic Oscillation (NAO) being in its positive phase, implying milder than average conditions. However, there are other forecasts which somewhat sensationally suggest prolonged colder weather from December through January.

Non-commodity charges

CCL hike to come, but no FiT ?

Albeit only on a % share basis, one benefit of inflated wholesale prices at the moment is the reduced share of non-energy costs in the final delivered energy price.

Government proposal to scrap feed-in tariffs from March 2019

Both generation and export tariff are under scrutiny and scrapping the FiT scheme could potentially lower bills by £5k for a business consuming 1 GWh. But for any business looking to self-generate, scrapping the feed in tariff scheme would arguably erode the business case. That said, avoided wholesale costs at the moment are more than likely to compensate.

Hike in CCL to come April 2019

All businesses will have to pay substantially higher climate change levies of 0.847 p/kWh for electricity (up 45%) and 0.339 p/kWh on gas (67% increase). That’s about 5-10% on your final bill.

Decarbonisation, decentralisation and digitalisation continue to squeeze traditional suppliers, but bring innovation

Bloomberg have reported 5.5m UK customers switched electricity supplier last year – still only 18% of the total market - while small suppliers are now 22% of the market, from a starting point of zero in 2011. Startups Labrador and Look After My Bills (Dragon’s Den biggest investment!) are also now offering automated switching (the shape of things to come ?), while Octopus Energy has secured Korean financing to continue its successful upstream sourcing of solar PV generation.

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