As the winter gives way to spring, many energy users are asking what the energy price outlook for summer and beyond looks like. The decimation of energy prices over the last two years has led many consumers to now view the early 2016 market volatility, particularly in oil, as a signal that prices have bottomed out. Within the confines of a few hundred words, I will try to highlight the likely key drivers over the next few months and try to reach a conclusion on the likely best course of action for the commercial energy buyer.
Gas fundamentals. In the short term the fundamentals look set to remain strong. A relatively mild winter has meant gas supplies, particularly from long range storage have been up to the job of moderate demand. Lagging the 5-year average into this winter, modest depletion rates mean that we now sit comfortably ahead of 2013 and 2015 March stocks, suggesting that required injection rates over the summer will not prove overly onerous. LNG volumes in February proved strong as increased global production capacity and weaker Pacific demand ensured that the UK remains very attractive to exporters. Gas demand has proved unexceptional this winter despite a higher reliance on gas-for-power generation. Moving into the summer, the usual maintenance schedules (Norway in Q2 and the UK in Q3) will make even modest demands difficult to deliver on occasion, whilst the withdrawal of 4.5GW of baseload coal from the generation mix will further support gas demand from power generators. Counterintuitively, power generation loads become more important in the summer months as their % of total demand rises from an average 15% in the winter to over 20%.
Power fundamentals. The dynamics around summer generation have changed significantly over the last few years as renewable capacity from wind and solar has increased. Peak premiums have narrowed and import volumes remain high with many European markets struggling to balance during peak hours and looking to offload output. The closure of coal generation will decrease generation diversity during the summer at Fiddlers Ferry (1.5GW), Rugeley (1GW), and the movement of Eggborough (2GW) to the Supplemental Balancing Reserve as a peak winter reserve station will decrease generation diversity during the summer. Nuclear plant maintenance may cause a few issues, particularly if NW Europe suffers an exceptionally hot summer. Carbon has proved yet again why it is a failed market, having dropped 40% since December with carbon credits now trading at €5/mt.
Oil. Regardless of gas and power fundamentals, longer term gas prices remain closely correlated with crude and product markets. The front-month oil price has recovered 32% from its January low of $28/bbl despite immediate fundamentals suggesting in the short term the oversupply issue is getting worse. That said, if we discount the bear market rally theory, we are left looking at the likely tightening of the market towards the end of this year and into next. The oil market is looking to the horizon and the fear factor with so many investors short has been high. In the US, active rigs are now at levels almost pre-shale and are 25% of the peak. Some high profile producers are defaulting on bond and loan payments, suggesting a funding crisis. (Have you wondered why the banking sector is looking so beleaguered?) Dial in stronger demand in the US ahead of the traditional summer peak and OPEC’s sabre rattling about production freezes, it’s difficult not to see why the market has reduced its exposure to the upside. Brent looks unlikely to break out from sub $40/bbl in the short term ahead of any real supply turndown. Overproduction is estimated at 1-2 million barrels per day with Russian and Iraqi production at record highs, Saudi near record output and Iran looking to recover its share of the market. Additionally, stocks in the US are at all-time highs.
Economics & Geopolitical Conditions
Economic growth has slowed through 2015 and the OECD has forecast global growth down to 3% from 3.5% for 2016. Lacklustre Chinese conditions have dominated the outlook, particularly for commodities. Oil demand is still forecast to grow this year and evidence of increased product demand is beginning to emerge in the US. Global politics remains volatile with the Middle East still a cause for concern in terms of stability. The sideshow over Britain’s potential exit from the EU is keeping sterling weak and supports imported energy prices. It looks increasingly likely that the ECB will expand its QE programme in Q2-16 as it looks to stop the EU recovery stalling and this could boost asset prices. Finally, with the US Federal Reserve backing away from further short-term increases in interest rates and the country entering a presidential election year, it would appear that there are likely to be many headlines for the markets to trade.
Conclusion
Gas and power commodity prices remain at multi-year lows. Summer prices should remain weak based on current fundamentals. Volatile oil prices and real concerns over the UK’s ability to generate enough power in a severe winter suggest to me that the balance of risk is definitely tilted to the upside. Markets shouldn’t run away based on the fundamental outlook, but with high volatility levels characterising oil and equity markets thus far in 2016, it would remain prudent for energy consumers to de-risk and take profits. Historically, at least, power and gas markets trend and this one looks to be entering a new phase. Finally, I’ll leave you with this thought: when it looks cheap it probably is!
Written By – Jason Durden
