Energy crisis continues, is your hedging strategy fit for purpose?

Energy costs are dominating the headlines, with the news that Ofgem will raise the Domestic Price Cap by the equivalent of 54% for the typical household, and the simultaneous announcement from the treasury of a £200 ‘smoothing loan’ to shelter households from some of the impact.   What is getting less comment is the fact that current forward prices, imply a further increase in the price cap this October.

Of course, this news does not impact commercial or industrial energy users.  Whilst many business groups, including the IOD, CBI and FSB have requested government support to help with high energy prices, none has been forthcoming.  Today is. Therefore, an opportune time to review the current energy market situation and outlook.

Electricity and Gas markets have taken a rollercoaster ride this winter.  Before Xmas we saw February UK baseload power hitting an all time high of £580/MWh.

Tight fundamentals in the gas market, driven by low European storage stocks, strong Asian competition for LNG and underwhelming pipeline gas flows from Germany impacted power and gas in equal measure.  The situation was periodically worsened by spells of overcast still weather (or Dunkelflaute, if you are German!), reducing wind and solar generation and adding to reliance on gas as a generation fuel.

Over the Christmas period the market turned bearish, first due to very mild weather and subsequentially due to reports of a so called ‘LNG Armada’ heading from US Liquifaction facilities to European terminals.   These ‘free on board’ LNG shipments are favouring Europe due to high stock levels and mild weather in Asia, causing a reduction in competition.  LNG will break all previous records in Europe, meeting  25% of total demand.

As a result of this improved supply position, and a lack of weather driven demand side shocks the market has stabilised,  albeit at price levels  circa 400% higher than this time last year.

The market remains concerned that European Gas in store has fallen to 40%, and is forecast to be virtually empty by the end of winter; adding to summer storage injection demand and supply risk next winter.  There is further concern that Asian demand for may yet pick up as their stocks deplete; leading to renewed price competition for LNG cargo’s.

The big story, is the risk of armed conflict in Ukraine leading to sanctions, and a consequent impact on Russian gas supplies to Europe.  For now the market response to this risk has been relatively muted, suggesting the risk remains low likelihood, but high impact.  Sentiment has, possibly, been calmed by suggestions that the Biden administration would arrange additional LNG deliveries to Europe in this situation.  Any energy buyers with open positions for Q1/Q2 should be mindful of the fact that Russia is currently supplying 40% of Europe’s gas needs.   At full capacity LNG terminals could increase January’s 25%, to approximately 40%; leaving a shortfall of 25% to be met by other flexible supply.  The worst case scenario would be a cessation of Russian supply, coinciding with cold weather and renewed Asian LNG demand.

Many in the market (not least the UK govt, grappling with the increase in the domestic price cap) are questioning how long this crisis will continue for.  The fact that front month and front winter gas and power contracts are trading at close to parity (Mar 22 power £177/MWh, Win 22 £182/MWh) suggests that the market believes we have a few bumps in the road to come yet.

At 4C we have noted that the impact of this crisis on our clients has varied hugely.  Those with robust energy risk management strategies, and discipline regarding use of stop loss triggers have been largely unaffected.  Some clients, with less robust strategies in place have seen a doubling of their energy bill.  As the crisis continues, clients with open positions for the coming winter will have some tough decisions to make in the coming months.

If you aren’t sure whether your energy procurement strategy remains fit for purpose reach out to 4C’s Head of Energy, Rob Morgan rob.morgan@4Cassociates.com  We would love to hear from you.

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