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Global Trends in Energy Prices
| By Ian Parrett, Inenco Forecasting is a notoriously difficult task. Nils Bohr, the physicist said that “Prediction is very difficult, especially if it’s about the future”. If we want to discuss trend in energy prices, it’s important to identify which set of prices we mean. Let’s take electricity as an example. Generators sell much of what they produce to suppliers in, so called, bilateral deals and only the two parties know the price. Suppliers sell to customers at prices that include the wholesale costs plus transmission costs, overheads and margins. Whilst smaller users will receive a standard tariff, large users will negotiate rates so these too are unknown. There is another set of prices coming from the open wholesale market. Acting like any other commodity futures exchange, supplies are bought and sold. Suppliers use this market to fine tune volumes for delivery, financial institutions use the market to make profit and some large organisations buy from the market to meet their own needs. We can only get good visibility of the wholesale market but we have to be aware that it produces a skewed perspective. Outside of the short term the liquidity is low and it’s hard to set a realistic price for the long term. Allowing for these caveats, we’ll consider the trends within the wholesale markets for gas and electricity. Gas is often considered as a driver of electricity prices so we will review gas prices first. The latest forecasts made by National Grid show that the total demand will fall by about 3% across the coming year. This forecast is based on revised assumptions for weather. At the same time the forecasts see that the peak daily demand might rise higher this year reaching over 500 million cubic meters per day (mcm). For supply the general picture looks comfortable. North Sea production is expected to decline slightly but this is more than made up for by additional volumes from LNG and Norway. The fundamentals of the market suggest that prices should be fairly flat. There is an outside chance that if deliveries of LNG are low, or flows from Norway are reduced coinciding with sudden peak demand, the system will be put under pressure. This is likely to create spikes in the spot markets but not disrupt the trend. A quick glance at wholesale gas prices tells a different story. The market touched bottom in August 2009 as the full scope of the recession became apparent. Unlike most other economic indicators though there has been no lengthy trough. The trend in prices is up and has been so for a year. Brent Crude prices turned the corner about seven months before gas did and we may be seeing the traditional oil to gas price relationship returning to operation. Oil prices have now reached a plateau and if we see a similar pattern in gas, then it provides good evidence of the linkage. Over the longer term the situation becomes more complex. A resurgence of global economic activity will push up demand. The strongest growth is likely to be in Asia and with limited local production gas will need to come from Russia, Turkey or as LNG. At the same time if the promise of Shale Gas in the USA is delivered then LNG demand will fall significantly. These factors could balance out to keep prices relatively stable. The potential problem comes in the form of carbon pricing. As a generation fuel, gas is much less carbon intensive than coal but certainly isn’t either zero carbon nor renewable. We can expect to see carbon pricing applied to gas. Whilst renewable generation can in theory replace the gas fired stations, there is no ready alternative for gas as a source of heat. A carbon tax is likely to simply push prices up. In summary then, gas prices seem likely to rise then plateau in the short term and then be at the mercy of macro-economics in the longer term. In the final analysis carbon reduction measures may have the most significant impact on pricing levels. Until the recession, the price of wholesale electricity followed gas which in turn followed oil. Whilst the oil to gas linkage seems to been restored the electricity market has continued on its own path. In late 2008 concern about supply margins drove prices into uncharted levels which then crashed as supplies were restored and the recession impacted on the economy. Since then whilst there has been a slow upward trend prices have remained low. This is good news for businesses seeking supply contracts but is slowing down the development of renewable generation. On a marginal cost basis, because the investment is already sunk, coal and gas plants can produce electricity far more cheaply than new nuclear or renewables. This is what sits behind the renewables obligation and the feed-in-tariff. It’s also why large players like EDF are looking for a carbon support price of at least £40 per tonne of carbon to make nuclear build viable. The issue, however, is that in a time of economic stringency it’s hard to justify the level of subside we have, let alone look to increase it. Setting a market price for carbon seems to make the most sense, but if market prices should float upwards then the Government will feel less exposed to claims of increasing fuel poverty. So with electricity it’s possible that in the near future wholesale prices will stay flat and only start to rise on the movement of the gas markets. The current share of renewables is so low that although this is far more expensive to produce the price effect has been minimal. With subsidy being handled separately to power export then in the medium term the carbon costs may be carried by consumers without being fully reflected in wholesale prices. The big driver of market prices will be availability. There have been significant concerns about the loss of nuclear and coal fired capacity through this decade. With intermittent wind power being the main replacement there are worries that at times of high demand there will be insufficient power to go around. We’ve already touched on the results of low margins on prices. The new Industrial Emissions Directive has offered some hope in relation to the coal plants. Instead of having to face shutdown in 2016, their potential working lifespan has been extended to 2023. There is also some discussion of whether the existing nuclear fleet can be coaxed into a few more years of operation. The key question for medium term availability will be the degree to which carbon reduction will drive our energy mix. If there is a major push towards electric vehicles and heating then the potential for supply shortfall will be massive. There will have to be standby arrangements to use high carbon fuels to balance supply but it’s likely that at these times we will see very high wholesale prices. For both gas and electricity, the short term picture is fairly stable with classic demand and supply models looking to push prices up slowly as the economy recovers. The driver of future prices though is in our own hands as we pursue the policies of carbon emissions reduction. Energy use is the primary driver of emissions and it will be energy prices that will bear the costs. IAN PARRETT Inenco Tel: +44 (0) 1253 785 000 Email: Ian.Parrett@inenco.com Web: www.inenco.com |
