By Richard Frape, Director of Market Services, Spectron
UK gas and power prices rose 25% over the course of 2010, ending the year on a surge as the coldest December in 100 years propelled consumption levels higher and pushed short-term gas prices towards a two-year high. Prices then started to ease sharply at the start of this year, but have since been catapulted higher again by a triple whammy of majorly bullish events – the Japan crisis, the outbreak of Arab unrest and the introduction of a larger than expected UK carbon tax. Prices are now double their levels a year ago (for front Annual gas – March 2010 to March 2011). But are these events likely to have a lasting effect on prices and what are the other key issues to look out for this year that will be driving market direction?
Firstly, it is probably worth noting that the late 2010 surge was in fact much smaller than might have been expected given the intensity of the cold weather not only in the UK, but across Europe and the rest of the northern hemisphere, including super energy guzzlers the US and China (which helped drive oil and coal prices to 27-month highs). The UK system coped remarkably well and supplies were never excessively squeezed, largely due to the arrival of record numbers of liquefied natural gas (LNG) tankers, while demand remained tempered by continuing economic uncertainty.
A fresh record for LNG deliveries was again seen in January, as the addition of significant new global LNG capacity this year – yet more in Qatar, but also in Australia – helped foster a perception that UK supplies would remain plentiful for the coming months, weighing on prices. But the Japanese disaster was a complete game-changer. Fears of largescale LNG diversions to Japan stemming deliveries to the UK caused a u-turn in sentiment and pushed the markets higher.
One only has to look back a year to see how fickle LNG supply can be at the best of times and how quickly it can change. In early 2010, the expectation of a global LNG glut was exerting strong pressure on UK gas prices, but by April prices were roaring higher as the Qataris took significant parts of their LNG production capacity offstream for extended maintenance. The maintenance season is expected to be shorter and more limited this year but may still affect supplies. Also, new LNG import capacity is due onstream this year in south-east Asia, Latin America and the Middle East, which may increase competition for LNG shipments; although some analysts suggest a current LNG production overhang is more than enough to satisfy this new demand and the increased Japanese requirements, so supply concerns may have been overstated.
While the weather has also improved, and taken some of the upwards price pressure away, some forecasters are predicting the UK will be colder than normal over the next three months. Any further bouts of unseasonably cold weather could reignite supply and storage concerns. On the other hand, Rough, the UK’s main storage facility, despite starting the year just 45% full – a much lower level than in recent years, has seen stocks recover strongly, which could reduce the amount of replenishment buying over the Summer.
UK gas and power prices have been decoupled from oil prices for much of the last year (often moving in different directions) – so what has been happening to oil has in some ways been irrelevant. However, the fact that oil prices have now broken above the the psychologically important $100/barrel level has changed this, and gas has shown signs it may be falling back under oil’s influence again. Geopolitics has been thrust squarely back into driving seat of the whole energy complex for the first time since 2008 and fears of another oil bubble could lead to other energy markets ramping higher in tandem, with speculative buying adding to the momentum. One saving grace may be that crude oil prices in the US have struggled to stay above $100/barrel – which may dampen the upside potential.
Currently energy price movements are also significantly correlated to financial market movements, with news about the state of the economy driving sentiment, particularly on the longer term markets. While economic recovery seems inevitable, fears over double or multiple dips may continue to keep the market in check.
Coal prices have been a key background driver of UK power and gas prices, and hit their highest levels since 2008 on the back of the Queensland floods disrupting production. But as production has returned to normal, prices have come under some pressure again. On the flip side, India’s coal minister says imports there may double this year, and analysts say that Chinese imports may increase by 27%, which will help shore up values.
Several new power plants are due to come onstream over the next few months in the UK, improving production capacity and also reducing reliability concerns over ageing infrastructure. At the same time the operating lives of two UK nuclear plants have been extended for five years, and extensions of between 5-20 years are currently under discussion at other plants, which is all good news for the supply outlook, although several older plants have also just been mothballed for a year. Meanwhile the start-up of the BritNed interconnector cable between the UK and the Netherlands (commissioning flows initially but commercial volumes from April) will also give the UK an extra 1,000 MW exposure to Continental prices. This could help ameliorate or exacerbate price spikes, depending on market conditions at either end of the cable.
However, the planned UK power market reforms, which are set to be finalised this year, remain one of the greatest uncertainties. News of a new carbon tax from 2013, which will increase generation costs, added almost 5% to UK long-term electricity prices the day after it was announced, and further reform will only put further upwards pressure on prices, many believe, as costs are passed down the supply chain.
In the longer term, diversity of gas supply sources will become a more important issue, particularly if the global nuclear backlash following the problems at Fukushima causes another “dash for gas”. UK gas production continues to decline by 8-10% annually so the reliance on other sources of gas will only increase over time, despite glimmers of hope following new discoveries West of Shetland. At the same time Norway, our biggest gas exporter, has indicated its gas production may decline from 2015; it has slashed its estimates for undiscovered gas resources by 31% following a lack of significant new discoveries last year. (Norway, which supplies Europe with 20% of its gas, has seen its oil output decline by 50% since 2000).
But Europe is already making plans for new gas sources, with pipelines to the gas-rich former Soviet states being built, Iran also expressing an interest in using these pipes for westwards gas exports. Israel may too become a key new gas exporter – the biggest natural gas deposit discovered in the last ten years has recently been found off its coast. At the same time the goldrush to bring shale gas production onstream across Europe is bubbling away in the background, while reserves of “unconventional” gas from other sources – hydrates, coal-beds, tight gas etc. seem to be revised upwards almost daily. While the world has or is reaching a peak oil scenario, it is awash with gas, seems to be the conclusion. The key question is how gas will feature in the UK’s mix of energy sources going forward, as legislation continues to focus on a move away from fossil fuels, including gas, and cleaner energy may be a more expensive alternative.
Spectron is a leading provider of market data and analysis for the gas, power, emissions and coal markets in the UK and across Europe.