Energy Markets in Crisis – 4 things you need to do

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Rob Morgan is the newly appointed Head of Energy at 4C Associates.  Rob has over 20 years’ experience delivering results throughout the energy/ utilities value chain. His expertise includes pricing/tariff analysis, wholesale trading/optimisation, solution development, stakeholder management and contract negotiation on both the buy and sell side.  At 4C Rob’s focus is on supporting our client’s journey to a lower cost energy net zero future.
Here Rob considers the recent turmoil in power and gas markets, its causes and the impact/mitigation strategies for 4C’s clients.

Even a casual observer will be aware of the turmoil that has overtaken the electricity and gas markets in recent months, with prices soaring and multiple small to medium sized suppliers being forced to exit the market.

Power and gas markets have seen volatility before, notably in 2008 when high oil prices coincided with unplanned maintenance outages across the UK’s nuclear generation fleet.  More recently the ‘Beast From The East’ caused prices to break out from their £40-60/MWh range.

However, the magnitude of the recent bull run is unprecedented, with the front annual (average of the next 2 trading seasons) prices shown above currently over double the highest level seen in 2008.

The fundamental drivers behind this event have been widely described as a perfect storm.

European gas storage is at historic low levels, and supply is poor; in part due to a game of who blinks first between Russia (aka Gazprom!) and the EU over the opening of the Nordstream 2 pipeline.

This has forced Europe to compete on price for LNG cargoes, in competition with strong demand from Asian markets.

Locally, in the UK we have seen unusually windless conditions, adding further to demand for gas, to fill the gap caused by low wind generation.

Finally, in mid-September, a fire reduced the capacity of the UK France power interconnector by half, adding further to the UK’s dependence on gas for power generation.

The market has reacted feverishly to these events, with within-day movements in the front annual of over £10/MWh.

Prompt contracts are even more volatile, on Wednesday 06 Oct the November gas contract rose from £3/therm, to over £4/therm, before closing at £2.66/therm.  This kind of volatility is completely unheard of and was caused by Russia saying they ‘might’ consider flowing more gas to Europe.

The Market is in turmoil, with suppliers, domestic and business energy users all affected

9 smaller energy suppliers have ceased trading, with the Ofgem price cap preventing pass through of higher commodity costs.  This has impacted approximately 1.75 million domestic customers.  Some reports have suggested that the 70 suppliers trading at the beginning of the year may be whittled down to 10 by year-end.

There are reports that some businesses are seeing increases in their energy costs, even where they thought their energy costs were fully hedged.  Others have been left with no choice but to buy energy for the forthcoming period at these elevated prices.

The majority of suppliers to the corporate sector are larger, with stronger balance sheets, giving them the ability to fully hedge their customer sales.  Some, but not all, are vertically integrated; meaning that that higher profits from generation can offset lower retail profits.  For these reasons, we do not expect the corporate sector to be impacted as deeply by supplier failures.  However, it is not inconceivable that a major corporate energy supplier may fail this winter.  In that situation customer hedges would very likely fall away, exposing the impacted customers to market prices at the time.

Whilst prices beyond the current winter are lower, they are still significantly elevated compared to last year, or even spring this year.  Therefore, even organisations with prudent energy risk management strategies, that are well hedged in the short term, will be facing price increases in 2022 and beyond unless there is a market correction.

Previous price events have been short-lived, with the market returning to ‘normal’ prices relatively quickly.

It is true that at some stage wind output will return to normal, the interconnector will be repaired and Nordstream will begin flowing.

The increased Asian dependence on gas looks to be a more persistent situation.  Without new sources of supply or a reduction in demand, the market will remain vulnerable to Russian manipulation or short term  supply interruptions

Whilst Russia’s comments on Wednesday have stabilised the market, for now, the volatility they caused demonstrates the knife edge the market currently sits on.  I market will very likely begin to get frustrated if the additional Russian gas doesn’t materialise.

In the meantime, all eyes will be on the weather forecast.  Early cold winter weather could further deplete gas storage, driving a fresh bull run, even from current prices.  Equally some of the risk premia in current prices could begin to fall away if we see mild weather up to the end of the year.

The reality is that nobody can say, with any confidence, what the market is going to do next, when prices will subside, and whether they will fall back to their historic range.

What does seem certain, is that we will continue to see episodes of price volatility as the energy system transitions to a zero carbon future.

In light of this uncertainty 4C recommend the following 4 step action plan to mitigate exposure to wholesale power and gas markets;
  1. Get the Basics Right

Ensure that your energy risk management strategy is fit for purpose; with the most appropriate contract, hedging strategy and stop losses in place to match your organisations goals, and attitude to risk.

If you have appointed an energy broker, ensure that they are part of the solution, not part of the problem.

  1. Reduce your energy consumption

Reducing energy consumption across your operation, by definition, reduces exposure to volatile energy commodity markets.  Ensure that you have accurately measured the opportunity to reduce energy consumption, with the costs of doing so quantified and budgeted for.

  1. Source Energy through Power Purchase Agreements

Power Purchase Agreements, typically with Wind or Solar generators offer 10+ years budget certainty, dark green environmental credentials and often, a significant cost saving when compared to elevated wholesale markets.

Even if your organisation is fully hedged for 2-3 years, you can potentially benefit from a PPA, selling back your previous hedge at a profit, and replacing it with the PPA.

  1. Generate power on site

Onsite generation has a competitive advantage.  As much as 60% (in a normal market!) of the total cost of energy supply is associated with ‘non commodity’ costs such as transmission, distribution, balancing and taxes/levies.  When power is generated on site some, but not all, of these costs can be avoided.

For this reason, onsite generation can be a very compelling option, with surprisingly short paybacks.

If you’re unsure, 4C can help.

4C can offer highly cost effective bespoke diagnostic evaluation across the 4 areas above, providing measurable and deliverable insights to evolve your energy strategy; reducing the cost carbon intensity and risk associated with sourcing your energy needs.  Contact Rob on 07480793942 or Allison at allison.ford-langstaff@4cassociates.com to discuss how we can help you navigate a way through this turmoil.

 

 

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