What’s happening with Endex NL 12 o’clock settlement values?

Ever since the beginning of this year, we notice a strange phenomenon on the Dutch exchange for power forwards, www.apxendex.com. This exchange publishes settlement values twice a day. End-of-day values are published in line with other European energy exchanges. Particularly for the Dutch market, Endex NL is also publishing a settlement value at noon. Ever since the beginning of this year, we have noticed that these noon values are higher than the end-of-day values. Since the 9^th of May, for example, the Cal 13, baseload noon values ended higher than the end-of day values every single day.

 With the help of our analysts, I launched some further analysis. I found out that in the first four months of 2012, the noon values were higher than the end-of-day values no less than 77% of the trading days. This could be explicable in a fundamentally bearish market, however, this is not the case. In 50% of all days since the start of the year, the Dutch Cal 13 ended higher than the day before, meaning that essentially the market had as many bullish days as bearish days. The end-of-day price of the 2^nd of January 2012 for Cal 13 baseload was 51,3 euro per MWh. On the 27^th of April it was 51,4, which supports our argument that the market in the first four months was equally divided between bullish and bearish, making it all the more remarkable that on 77% of those days, the noon value was higher than the end-of-day value. As you can see in the graph below, the trend is clear, there is an increasing gap between noon values and end-of-day values, with noon-values ending higher on most days.

 

Our analysis unveils another astonishing fact. The noon values for endex NL 2013 baseload were on those 77% of the days on average 28 eurocents higher than the end-of-day values. If we look at the German EEX markets, we see that the intraday highs were on average just 24 cents higher than the end-of-day value. This indicates that the noon values on the Dutch Cal 13 baseload were pushed higher than the volatility on the German market over a whole day.

It is clear from the graphs above that something is going on at the Dutch power forwards exchange. We observe similar trends for the other contracts. It is recommended that the relevant authorities investigate what is going on. Especially since this upward tendency for noon values on the Dutch forward contracts is not without consequences.

About seven years ago a new type of contract was introduced in many European power markets, the so-called clicking or tranche model contract. Industrial consumers have en masse adopted this contract type.  A consumer agrees a pricing formula with his supplier, based on which he can “click” his price for a given period, for example a calendar year. The formula contains a market-based parameter, for example the Endex NL Cal 13 contract for fixing the price for consumption during 2013. By giving consumers the possibility of using multiple clicks, this contract type is a good response to the increased need for risk management of industrial consumers of power. Moreover, as the formula is based on a publicly available parameter based on effective trading, the consumers have the certainty of using a relevant and transparent pricing mechanism. Due to this, power exchanges such as Endex have gained extra importance in the liberalized energy markets. They are not only  a platform that allows suppliers to hedge the prices that they offer end consumers. They also constitute an important factor in the price determination for end consumers. Any problem with the pricing on these wholesale exchanges like Endex is not just a problem for suppliers, it is a problem for the market as a whole.

The noon value is of special importance to Dutch end consumers. They have developed the habit of fixing prices on that noon value. This is very comfortable. In other countries, buyers need to wait until the end of the day to know the value at which they are going to fix their price. In the Netherlands, the companies can arrange their price fixings over noon and go home at five. However, if these noon values are systematically inflated, the Dutch consumers are obviously paying a high price for this comfort.

We are not saying that there is not a plausible reason for the inflation of Dutch noon prices. But it is absolutely mandatory to find out what is going on and to exclude the possibility of manipulation.

Filed under: Market analysis, The market today, the Netherlands

The end of ‘speculation spring’?

In 2009, 2010 and 2011 energy prices were in a bullish trend by this time of the year. Certainly for electricity, there was a returning pattern. Year ahead prices rose during the first six months and then dropped back in the second half. We dubbed this phenomenon ‘speculation spring’ at E&C. During the first six months, the year ahead is still far in the future. This gives the market ample possibilities for speculation about the disasters that might affect the supply – demand balance by the time the year ahead is near. However, as the end of the year approaches, reality sets in. That cold winter that year ahead bulls counted on, doesn’t materialize. Governments across Europe shut down less nuclear power plants than expected. Demand for energy doesn’t recover in line with the economic recovery. The disasters don’t materialize and prices start to fall. Such speculation in forward energy markets is supported by the fact that market participants seem to systematically underestimate the price lowering effects of certain evolutions:

1. As I have commented earlier, there is a dogma of rising energy prices. Analysts systematically underestimate the combined effects of delocalization of heavy industry and increasing energy efficiency on natural gas and electricity demand in North-West Europe. We recently saw another example of this. Carbon dioxide emissions of ETS companies dropped by 2,4% in 2011 whereas the market had expected a maximum 1% drop and some even a 1% increase. If carbon dioxide emissions of ETS companies drop, this clearly means that large industrial consumers of energy are reducing their consumption.
2. The price moderating effects of increased inter-connection is also often under-estimated. Specifically in large countries, analysts tend to look at supply and demand conditions in their own country only. This is specifically true for analysis of gas markets which is largely focused on conditions in the UK.
3. Everybody has underestimated the rapid growth of renewable energy production in Europe. Even legislators are surprised by the developments and struggle to adapt policies as output outstrips their targets (see my previous blog). Many power market analysts predicted supply shortages for this period due to the closure of nuclear and older power plants. They never thought that the combination of increasing renewable production, more interconnectivity and rapid growth of renewable would be able to fill the supply – demand gap.
4. Gas storage capacity in North-Western Europe has been expanded by more than 60% in the past five years. Due to this, seasonality in the gas markets has been reduced as more gas from storages is available in the winter time and more gas to fill the storages is needed in the summer. Still, markets continue to worry over the effects of a cold winter on gas demand. The seasonality in the forward gas market is often exaggerated if you compare to the actual difference between summer and gas prices in the spot markets. As gas prices are the main driver of power prices, a similar mismatch of forward and spot seasonality can be seen in the electricity markets.

In most discussions with representatives of energy companies, you are consistently bombarded with scary stories of future energy shortages. Same stories on conferences. Even our new Belgian state secretary of energy Wathelet spread a scare story last week. At current low power prices, there would not be sufficient investment in gas-fired power stations which would lead to power shortages in Belgium, he remarked. A great display of policy consistency, I would say, as that same man had a law voted to freeze energy prices at current levels a week earlier. Ask any man in the street whether he thinks energy shortages are around the corner, and a large majority will say yes.

Energy shortages do occur … sometimes. During those few cold days in February, for example. However, have you remarked how short-lived the price spike was? If you look at the average spot price levels for North-West European gas and electricity of the past four years, you can only conclude that during most of the time there was more than enough energy.

Spot prices don’t lie. In most of our markets, spot price determination mechanisms have been installed that make sure that the price is a correct reflection of supply and demand of energy at that moment. It is much harder to speculate against spot markets, specifically in electricity markets where storage capacities are non-existing and gas markets where they are very limited. Because speculation in the spot market can only be physical speculation. Producers or traders have to consciously withhold capacities from the market to drive up prices. If you own a gas-fired power plant, and the electricity price that you can get is higher than your gas costs, you can turn in money by producing. You can’t say, I’ll produce and keep it in store for when prices are higher. Average spot prices in the gas and the electricity markets in the past years have consistently been lower than the average forward prices. This means that there has been sufficient supply to cover for the (declining) demand.

Forward markets are much more subject to speculation. Basically, if you sell on a forward basis you make a trade-off against the future spot prices that you expect. That opens up the possibility of speculating about supply – demand tightness. The further into the future, the more room for speculation: so many things can happen between now and the end of the year. This explains the “speculation spring” phenomenon” on the heavily traded year ahead contract. By the second half of the year, we saw in the past three years how reality kicked in. The supply reductions and demand increases didn’t materialize. The spot price remained at relatively low levels over the summer months. And if you are the 15^th of December and your spot price for power is still around 50 euro per MWh, it becomes hard to make your case for 60 euro per MWh for supply of power in the year that starts in two weeks. It is a law written in stone that as a forward contract gets near expiry, it will get closer to the spot market level.

Rising prices in the first six months, bear correction in the next six months. We saw this pattern three years in a row. Obviously, in our struggle with the unpredictability of energy markets, we are tempted to call this pattern eternal. If only life would be that easy. If only prices would be at their best level at the same moment year after year. Buying energy would become the easiest job in the world, just wait for the pre-determined moment and buy. If only … This year’s development, with speculation spring not taking off shows us once again that the reality is more complex. And we need to continue to be careful. Maybe in 2012, it will be the other way around. Maybe we will see a bull market in the second semester. Nobody can tell, it will depend on the extremely complicated equation of energy supply and demand.

Filed under: Energy demand, Forecasting, Market analysis, The market today

Brent price in euro per barrel at an all-time high

Have you recently visited a petrol station somewhere in a Euro country? Shocked by the price level? Well, unnoticed by the press, the cost of oil has risen to its highest nominal level ever. The Brent price ended the day at 120,11 dollar per barrel on Thursday the 16^th. This is well below the Brent-in-dollar peak of 146,08 on the 3^rd of July 2008. However, the euro was then trading at almost 1,6 dollar, whereas now the euro trades below 1,3. The consequence is an all-time high Brent-in euro price of 92,52 euro per barrel. That is the reason why filling your car these days is a costly affair on Europe’s roads.

Fortunately, Europe has managed to significantly reduce its dependence on oil products. Due to fuel efficiency standards, cars guzzle less fuel. Residential heating has been switched away from oil products thanks to environmental policy and the expansion of the gas grids. And environmental policy again, has reduced the usage of oil for industrial and power producing purposes. The consumption of oil in Europe is displaying a steadily declining trend ever since 2005.

High oil prices would have been bad news for almost every continental European consumer of natural gas three years ago, as they all had contracts with the price of natural gas pegged to oil prices. Fortunately, the end market in North-Western Europe is now massively switching to the gas-to-gas pricing of Hub markets (NBP, Zeebrugge, TTF, NCG, Gaspool, PEG). True, these gas prices have also risen in the past year, but not as much as oil prices. With the oil-indexed gas contracts of the past, natural gas would have cost more than 40 euro per MWh by now, just as it did in 2008. At the forward Hub markets, gas consumers can now fix prices below 30 euro per MWh and spot prices haven’t risen much above 25. However, natural gas consumers in countries where access to Hub markets is difficult (Spain, Portugal, Italy, Eastern Europe), have every reason to look worryingly at oil market developments.

High energy prices are particularly bad news for Europe at this moment. Financial markets continue to worry about the potential cataclysm that Greek bankruptcy could cause in Europe’s banking sector. Partly due to this fear, economic growth has stalled. This week Germany published a -0,2% figure for the last quarter. Policymakers across Europe are hesitating between austerity programs to reduce budget deficits (right wing) and policies to support economic recovery (left wing). High energy costs might push struggling businesses over the bankruptcy line. Other companies might have possibilities to pass through higher energy costs in the prices of their products. But is this increasing inflationary pressure a good idea at a moment that consumer confidence drops due to the fear of a Greek tragedy? We should all hope that the combination of a recovering US economy and a weak euro supports export-oriented businesses. But it is clear that the record high Brent-price is bad, bad news for Europe.

The reason for increasing oil prices is simple. OK, here in Europe we reduce the consumption of oil. And yes, the US is reducing as they have also embraced the reduction of fuel consumption by cars. However, such declines are completely undone by developments in emerging economies where the consumption of oil doesn’t stop from growing. On a worldwide scale, we consume more oil year after year. There is enough of if left for the time being. But producing it comes at ever higher costs, which explains the increasing oil price. Squeezing petrol out of the oil sands of Alberta simply is a much more expensive affair than drilling holes in the Arabian dessert. Of course, there is some risk premium added to the price, as the markets ponder the consequences of an oil embargo on Iran and the increasing risk of military conflict in the Persian Gulf. Of course, the forces of speculation are also back. But beware of under-estimating the underlying problem. The increasing demand in oil cannot be met with cheaply produced stuff. The marginal cost economics of oil markets explain the high prices and volatility.

Even if the world’s economy is growing at a slow pace at this moment, it is still growing in the emerging economies, and faster than anywhere else in the world. And countries like China, India, Brazil or Russia, haven’t managed yet to decouple economic growth from oil consumption increases. So, unless we get a repetition of the financial-economic catastrophe of 2008, there isn’t much chance that filling your car will get much cheaper in the near future.

Filed under: Market analysis, Natural gas, Oil, The economy, The market today

Heading for the second leg of the double dip?

The IMF has lowered its forecast for global economic growth in 2012 to 4%, down from 5% growth in 2010. Even if this seems limited, it would mean standstill and even recession in many economies of the Western world. The IMF cites two main worries:

 

1. The EU debt crisis seems to be running out of control. The policy of helping the Greeks only if they adopt ever more severe savings programs is clearly counter-productive. It pushes the Greek economy into a deeper and deeper crisis. With an imploding economy, it will become impossible for the Greeks to pay back their debts.
2. The US economy is growing, but at a very slow rate. It proves very hard for the US to find new sources of economic growth. The old recipe of stimulating consumption in the US doesn’t work, as the American citizens are still trying to reduce the high debt levels they built up by over-consumption in the two previous decades.

 

The IMF points out that there is a broader issue at hand, a reshaping of globalization. In the period 1990 – 2008, globalization was based on the following trade pattern. US policymakers stimulated their economy by lowering interest rates. American citizens borrowed increasing amounts of money to be able to spend much more than they could afford. A lot of that money was spent on consumer goods produced in emerging economies such as China, causing double digit growth in these countries. This strong economic growth caused commodity prices in general and energy prices in particular to spike sharply. Debt accumulated in the US, capital accumulated in emerging economies and commodity producers such as Saudi-Arabia. This balance got a perverse streak when the accumulated capital in emerging and commodity countries became the source of borrowing to the US. This mechanism resembles a drug dealer that borrows drug money to his junkie clients so that they can buy more drugs. Ever more sophisticated leverage instruments, like Credit Default Swaps (CDS) stimulated the excessive borrowing.

 

The spike in commodity prices was one of the main causes for the balance to derail. By 2008, Americans had to pay 4 times more for heating their homes and – most importantly – driving their gas-guzzling cars. Due to this increasing cost of life, more and more Americans could no longer pay back their mortgages on their houses. Due to the extreme level of leverage, this caused a broad systemic crisis of the financial sector and a subsequent deep economic recession as consumers worldwide stopped consuming.

 

To rebalance the world’s economy, the IMF points out that we need to make a double movement. The established economies of the US and to a lesser degree Western-Europe need to become less dependent on imports, the emerging economies need to become less dependent on exports. In the West-, we need to focus on the development of innovative, high-value industries that we can export to countries like China. The emerging economies have to bolster the development of a middle class that engages in the mass consumption necessary to stimulate home-grown demand. The economic developments of the past two years have shown that we are engaging in this rebalancing act. The Chinese economy returned to double-digit growth remarkably rapidly after the catastrophe of 2008. This was due to stimulus programs that lured the growing Chinese middle class into consuming more. Brazil is another good example of a growing emerging economy thanks to growing middle class consumption. Germany, and in its slipstream Belgium, have been good examples of how Western economies focused on export of high value goods and services can benefit from the economic growth in the emerging economies.

 

The rebalancing act is being played out, but it remains a very delicate one. Two events seem to be undermining it at this moment. The first one is the continuing systemic weakness of the banking sector. It is unbelievable that a middle-sized bank such as Belgian-French Dexia, has built up a position in Greek debt paper that becomes unsustainable. Where are the risk management practices of these institutions? The events with Dexia show that it is not unthinkable that we might see a bank toppling like Lehman Brothers did in 2008, causing a chain reaction that brings the financial functioning of this world to a standstill. The second event that is troublesome is the slow pace of growth in the US, which is having a very hard time to re-invent itself as an export-oriented economy.

 

The solutions will have to come from politicians. European politicians will need to find a workable solution for Greece. US politicians need to find solutions so that they become exporters to emerging economies. Politicians worldwide have to take measures to curb the risk-taking, downward-spiral causing behavior of the financial sector. There is an urgent need for bold economic policies. The good news is that economists seem to agree more and more on what policies are needed. The bad news is that politicians seem to lack the guts to enforce those policies. A world leader like Angela Merkel, seems to be so scared of the public opinion in her country, that her treatment of the Greek debt crisis becomes self-destructive. Barak Obama, is blocked by the extreme bi-partizanship of American politics, with a republican majority in Congress which is increasingly inspired by 18^th century economics (Tea Party) and that blocks every attempt to deal with the economic situation with ideological arguments.

 

Sometimes, the economy doesn’t need political intervention to find a new balance. However, if we look at the current figures, it doesn’t seem to be doing that. The chances that we are heading for the second leg of the double dip, increase with every day that the world’s political leaders wait to attack issues like the Greek debt crisis head-on. So far, the energy prices remain at a relatively high level. We are not in the phase of economic decline yet. However, we do see energy demand levels that start to drop, although some of that might be explained by higher than average temperatures in September. Anyway, we recommend everyone to keep in mind the possibility of an economic recession leading to a downtrend of energy prices in the next months. And we hope that this will not happen.

 

Filed under: Market analysis, The economy

Earthquake shakes energy markets

German Cal 12 power ended above 58 euro per MWh today. The disastrous events in Japan have sent ripples across the worldwide energy markets. A brief résumé of the consequences of the earthquake that we currently observe:

1. Oil prices have declined. The Brent traded below 110 dollar per barrel today. Oil traders fear that the economic disruptions due to the earthquake will reduce oil demand in Japan, the world’s third largest consumer of oil. For the moment, it looks like the earthquake has (temporarily?) stopped the bull run in the oil markets.
2. Gas prices increased rapidly. TTF Cal 12 traded above 27 euro per MWh today. Nuclear power production in Japan is out due to the earthquake. It is assumed that the MWh’s not produced by the nuclear facilities will be produced in gas-fired power plants. The extra MWh’s of gas will probably come with LNG shipments from (mostly) Qatar. This sparks fears that the LNG supply to Europe, so important in keeping European gas prices at a reasonable price level, will be reduced.
3. Power prices rallied. This was not only due to the rising gas price. The problems with Japan’s nuclear facility could mean the end of plans to keep nuclear power plants in Europe open for longer than originally planned. Today, German Chancellor Merkel even announced that seven nuclear power plants in Germany would be shut down immediately for safety controls. If other countries would adopt similar measures, we would see a severe shortage of electricity in Europe.

The energy markets have changed completely in less than two months time. Revolution and war in the Middle east and an earthquake in Japan have severely shaken the supply / demand balance. The short term price movements might just be speculation or panic reactions. They could also be the start of a further bull trend. But then the question is: can the recovering economy stand this combination of: 1. Commodity price inflation, 2. Severe disruption of one of the world’s most important economies, 3. A massive switch of insurance money towards the Japanese reconstruction? Is the current crash of stock exchanges the precursor of a new economic crisis looming? Or is it just a panic reaction?

No better illustration of the unpredictable character of energy markets than the past two months. Keep counting on that lack of predictability and spread your buying decisions is the best that we can advise in such circumstances. We have to watch carefully in the next days whether the spot gas prices continue to rise. Because that would clearly indicate that increased Japanese LNG buying is affecting supply to Europe.

For the longer term, it is clear that the Japanese disaster will affect the nuclear power sector. It was the Tsjernobyl disaster in 1986 that inspired European governments to decide to phase out nuclear power production. The 25 years that followed without nuclear incidents inspired those governments to turn back those plans of shutting down nuclear power plants. But what politician will dare to defend expanded lifetimes for nuclear power plants after what has happened in Japan? Let alone decide whether to build a new nuclear power plant. If the nuclear phase-out plans would be resumed, this would inevitably have consequences for power pricing in Europe. But that’s the longer term. No idea what it will bring, as every morning we get up in surprise over a new explosion or fire in the Japanese nuclear power plant.

Filed under: Energy history, Energy policy, Energy technology, Germany, Market analysis, The economy, The market today

Lybia and the day that oil prices were almost 120 dollar

It is with increased horror that I look at the images of Lybia. This shows the true face of dictators, they shun no crime in their lust for power. However, living in the West, I also feel shame. We live in our shelter of a free and democratic society. And we don’t protest when our politicians befriend these dictators. We don’t mind the foreign policy of “rather a dictator that is our friend than a democratic government that is hostile” . The hypocrisy of Western policy in the Middle East and Northern Africa was clearly illustrated by British PM David Cameron’s latest trip. He visited the Tahrir square in Cairo to express his sympathy with the pro-democracy protesters in the region. He was joined by British defense industry people that where on their way to a Defense expo in Abu Dhabi where they will try to sell their weapons to the Middle East’s autocratic regimes. What is the message here? We support your protest for democracy, but we also sell the weapons to shoot at you? (For more on this controversial trip, read the Huffington Post.)

It is hypocrisy, but it is also understandable. The Middle East and Northern Africa have an immense economical importance for the West. They produce the bulk of the oil and the natural gas that fire our economies. The recent unrest has pushed these prices through the roof. The gas price for 2012 is already trading around 25 euro per MWh and Brent oil prices traded near 120 dollar per barrel on the 24^th of February. Everyone of us will feel the consequences of the rush for democracy in the Arab world the next time that we fill our car. Is it therefore surprising that we sometimes prefer the stability of a dictatorship? As Berthold Brecht told us ‘Erst das Fressen, dann die Moral”, it is human to put economic interests before ethics. The current situation in Lybia should inspire modesty in the West. We are not the super-ethical beings that can impose our moral superiority upon the rest of the World. We were shaking Colonel Kadhafi’s hand in exchange for his oil. We even got fascinated by his extravagancy, the tents and camels and female bodyguard that he brought in his many recent visits to our capitals. I am not judging anyone. I am only observing that we are only humans. And that we sometimes confuse madness with bling.

The 2008 financial crisis confronted us with the madness of financial markets. Politicians claimed that they would curb the extravagancies of speculative behavior on the markets. And what did we see yesterday morning? A seven dollar price increase in 20 minutes. This reminded us of 2007 – 2008 when similar crazy price moves were observed in the oil markets. What have we learned from the financial crisis? The manic-depression-like movement of energy markets continues. Buyers of energy continue to be confronted with volatility and unpredictability. Until one month ago, we warned energy buyers that rising gas prices should not be taken for granted. There are sufficient gas reserves on this planet for gas to be cheap for some decades to come. But we also warned that supply interruptions from the Middle East could push up prices. Of course, nobody could say then that a few weeks later the whole region would be on fire.

It is not madness that energy prices rise when revolutions brake out in the region that has the largest energy reserves of the world. We are particularly worried about gas prices. We are now in the last weeks of the coldest winter in decades in North-West-Europe. However, our gas prices didn’t rally to previous heights. This was due to LNG ships unloading gas nearly every day in our import terminals. Eight in ten of those ships came from Qatar. These were the marginal MWh’s that kept the system sufficiently supplied. So far, no trouble has been reported in the gas-soaked emirate of Qatar. But trouble in the Suez Canal or in the Strait of Hormuz, the sea passage between Iran and the Arabian peninsula could mean that the LNG ships fail to reach Europe.

However much we sympathize with the protesters in the Arabian countries and in Iran, from an economic point of view this is bad news. Continuing instability will affect the output of the oil and gas industry, as is now already seen in Lybia. This will cause rising energy prices. Moreover, the economy of the region is coming to a standstill. This is bad news for the recovering world economy. These countries are huge importers of consumer goods (the lack of jobs in domestic industries is one of the main reasons for the fiery protests). If people in that region buy less, this will affect the economy. China, whose growth has powered the recent economic recovery, exports ¼ of its goods to the Middle East and Northern Africa. We are starting to fear the disaster scenario of stagflation. Energy prices that continue to grow due to supply cuts while the economy is going into recession. If supply drops faster than demand drops due to economic recession, we will enter this scenario. Both from an ethical and from an economic point of view, we sincerely wish that all these countries make a rapid shift towards a peaceful democratic government. But how likely is that? Therefore, as an energy buyer, you better prepare for a continuation and worsening of the current market situation. We obviously cannot predict the outcome of the current political crisis. But we fear that a swift return to normality is idle hope.

In the longer term, the current situation should be another motivation for Western governments to promote energy independence. Promote the widespread usage of the energy sources that we have in our own region, such as renewable energy and shale gas. In that perspective, the peoples of the Middle East might be shooting in their own foot. But would you care about the longer term economic consequences when you are fighting for your life in the streets of Tripoli?

Filed under: Energy policy, Market analysis, Natural gas, Oil, The economy, The market today

100 dollar oil: back where it all started?

Yesterday the Brent has traded above 100 dollar again. This is its highest level in 28 months. The first time that the oil price broke above 100 dollar was on the 28th of February 2008. It was then followed by a speculative craze that pushed the Brent price all the way up to 146,08 dollar per barrel. By that time oil demand in the US, the key oil consuming region, was going down. More and more US citizens defaulted on their mortgages and one of the reasons for this was the derailing fuel budgets. It is clear that rising fuel prices and their consequences for other commodities such as food was one of the reasons for the 2008 financial crisis.

This time, the consequences for European consumers of oil products and oil-indexed natural gas are even more severe than in 2008. Back then, the euro was worth 1,5121 dollars whereas now its value has declined to 1,3692 dollars. This means that in euro, a barrel of crude oil is now more than 10% more expensive than in February 2008.

There are parallels to be found with the situation in 2008:

• The underlying fundamental is similar: the 10% growth rates of emerging economies, foremost China, sucking up commodities faster than production can grow.
• It’s not only oil that is rising, metals, coal and soft commodities are also contributing to general inflationary pressure.
• Analysts’ hysteria is contributing to the bull run. This morning already you can read plenty of articles of enlightened minds that “forecast” even higher levels.
• Opec claims to have spare capacity but refuses to bring it to the market, saying that there is more than enough oil in the market.
• The contango in the market has almost disappeared and turned into backwardation, meaning that the further you go into the future, the cheaper the price at which you can buy oil. To some, this is proof that the bullish sentiment is unsupported.

However, we also see two important differences:

• In February 2008, we crossed the hundred dollar barrier at a moment of solid economic growth in all parts of the world. This time, we cross it at a moment of fragile economic recovery in the Western world. The traditional medicine for curbing inflation is raising interest rates. Governments hope that this will inspire citizens to save more and spend less and companies to invest less. This would obviously reduce demand for commodities and can stop the bull run. But on the other hand, it would also kill off the beginning of a recovery that we have seen in recent months. Moreover, it’s not only governments in the West that fear inflation. Authoritarian regimes across the globe know that many revolutions have started with a middle class that reacts to a rising cost of life. It is therefore not surprising that the Chinese government is taking steps to reduce inflation. But it is clear that these steps will reduce growth in China, the growth that has been the engine of recovery in many other parts of the world, as far as Germany. The Chinese government can see good examples of the danger for the regime of inflation happening before their eyes in the Arab world. The people on the streets of Cairo quote rising food prices as one of the reasons for their anger.
• This brings us to the second danger. Geopolitical tensions have always been cited as a reason for oil price increases. But if you look back in history, you can find only two occasions of serious oil price inflation due to political conflict. The first one was in 1973 with the Yom Kippoer war and the ensuing blockade of the Suez Canal. The second one was in 1979 with the Islamic revolution in Iran. The Gulf Wars for example, had only a limited effect on oil prices as Saudi-Arabia stopped initial price increases by pumping up more oil. Opec is now claiming again that it will open the valves if the Egyptian crisis would cause restraints to the world’s oil supplies. However, the current situation bears some very uncomfortable analogies to the two previous occasions of politics leading to oil supply crunches. There is a danger that if Hosni Mubarak is ousted, he will be replaced with a regime that is much less friendly with Israel. It might even be an Islamic government. War between Egypt and Israel would disrupt supplies through the Suez Canal. Fear of this scenario was the reason most cited for yesterday’s push above 100 dollar.

Overall, and as always, the picture for the next months is complicated and unpredictable. Mister Mubarak might survive the crisis. He might be replaced by mister El Barradei who seems to be a peaceful figure (he has a Nobel prize on his desk to remind him of that). I have read in many books and articles that the Egyptian Muslim Brotherhood has developed more in the direction of Turkey’s moderate Islamic party than in the direction of radical Islamism. It is clear that no one can predict what will happen in Egypt. And even if Egypt becomes a broader conflict with ramifications for oil supplies, it is not clear whether oil prices can continue to rise. My best guess is that it will cause a new recession as governments raise interest rates and middle classes see higher commodity prices cutting into their buying power.

The economic picture of the past decade looks really bleak. A large part of this planet is growing towards a better future by growing their economies rapidly. This leads to spectacular boom phases. But the planet is unable to support that growth with sufficient commodities. The consequence is high inflation cutting into buying power which leads to spectacular busts. There is a shimmer of hope however and it lies in the third difference with the situation in February 2008. This time, many gas consumers in the West are not affected by the rising oil price. They buy gas in the Hub markets. In Europe, these prices haven’t risen much higher than 20 euro per MWh even in the coldest winter in decades. In the US, prices are half that thanks to the shale gas boom. The developments in the gas market show the way out of the boom and bust cycle. We have to reduce our dependence on scarce commodities such as oil.

Filed under: Energy history, Market analysis, Oil, The economy, The market today

Gas markets Europe 2010 – 2011

The past month has been a bit low in blogging activity, due to my being busy creating a report on the European gas market. Research of supply and demand figures brought me some surprising insights. You can read an extract of the report by clicking on the link below. Please read the executive summary of the report below. Contact me at benedict@eecc.eu if you want to receive a full copy of the report.

Executive summary

• ‘Energy can only get more expensive’, is a common belief among energy buyers. However, we have recently seen that natural gas prices remained relatively low, even when the economic activity picked up. Oil prices rose, so the gas prices on the Hubs became structurally lower than oil-indexed gas prices.

 

• The biggest natural gas reserves in the world are to be found in the Middle-East and not in Russia. However, the Middle-East are currently only the world’s fourth largest producer of natural gas, meaning that huge reserves are untapped. Gas production in gas reserves giants Qatar and Iran has started to rise exponentially in recent years. This explains the presence of excess gas volumes in the world markets.

 

• The US has increased its production of natural gas by 16% due to the development of shale gas. In 2009 they were the world’s biggest producer of natural gas, bigger than Russia. We have always known that beyond conventional gas reserves, a lot of gas was trapped in this shale layer. Only, it was always thought that it was impossible to produce gas from these layers without excessive costs. Recently production techniques have been improved, and the energy companies claim that it is now possible to produce shale gas at a cost that is lower than the production of conventional gas. The possibility to economically produce shale gas boosts the gas reserves of the world.

 

• Shale gas production has already had an impact on gas prices, as it made more LNG available to the European market as less was needed in the US. If the US continues to expand its gas production, it might even start exporting LNG. There is also potential for shale gas production in Europe and in China. If all this shale gas production is developed, the world’s gas supply situation will look completely different. However, this whole shale gas development could be turned back due to environmental impact of the shale gas production. It is too early to decide what the further development will be.

 

• As of 2011, the Nord Stream gas pipeline will bring additional gas from Russia to Germany, 22,5 billion m³ of capacity in 2011 and 45 billion m³ in 2012.

 

• Natural gas demand in Western-Europe peaked in 2004 and then started to fall. This is contrary to popular belief that energy consumption is continuously growing.

 

• Although the growth rate of power consumption is slowing down, it is still growing. Deployment of electric cars would speed up this growth of electricity demand. Most of these extra MWh’s of electricity are now produced from renewable energy sources. But the growth of demand is faster than the growth of renewable. This means that extra power plants will need to be built. Plans to shut down nuclear power plants in countries like Germany, Belgium, the Netherlands and UK have been turned back, meaning that fewer power plants will need to be built. How much of the new power plants will be gas-fired will depend on whether new nuclear and (clean) coal-fired power plants can be developed. Which plants will be built is subject to political decisions. It is therefore madness to try to predict how much extra gas will be needed for new gas-fired power plants.

 

• A multitude of factors will determine whether gas supply will continue to grow and/or gas demand will continue to fall. Therefore, it is impossible to predict whether the current situation of over-supply will continue or not. The important news is that it is not unthinkable that we might see some decades ahead with abundant natural gas available to our markets, resulting in lower gas and electricity prices. Therefore, corporate energy strategies based on the adagio that energy can only become more expensive, should be adapted. Guidance on how to do this can be found in the conclusion of this report.

Filed under: Belgium, Energy demand, France, Germany, Market analysis, Natural gas, UK

The troubles with Endex

This morning a worried client called us to ask why the Dutch Cal 12 peakload had shot up by 3% yesterday whereas all other prices in the Dutch electricity market were down. The answer to that question is stupefying.

Somewhere last year, the members of the Dutch power exchange Endex started to complain that it is annoying in their international power trades that the peak hour definitions in the Netherlands are different than in Germany. Not strange, if you consider the amount of Dutch – German power trades. In the Netherlands peakload runs from 7:00 in the morning till 23:00 in the evening, whereas the German peakload runs from 8:00 to 20:00. Annoying, I can imagine, if you want to stage a Dutch – German cross-border peakload deal. So Endex listened to its members and introduced the Dutch “super-peak”, running from eight till eight like the German peakload.

However, the retail market departments of those members remarked that they had a few thousand contracts running with industrial clients that have pricing mechanisms where the price is built based on the old seven to eleven peak. So, Endex decided to continue publishing the old, normal peak. The Netherlands became the only country I know with three instead of two energy contract types: baseload, peakload and super-peakload.

And then the story takes the stupefying twist. Trading three contracts per time-period, that would be of course a difficult task in a market that isn’t really excelling in terms of liquidity. Multiplying the number of tradable contracts on an exchange where volumes on many products are already extremely thin is indeed not a very good idea. So Endex decided that trading would be limited to the new eight-to-eight peakload products and that the old seven-to-eleven peak would be ‘calculated’. So, if you have recently fixed a peakload price in the Netherlands, your price was not based on an a value coming from real market trades but rather from some sort of calculation. As such, all peakload prices clicked since the 29th of April 2009, when the super peak was introduced, were calculated prices.

Of course, the calculated price is derived from real traded prices, so you could claim its reliability. However, an important factor has been added to that reliability-question: the reliability of your calculation methodology. I haven’t taken the trouble of analyzing the arithmetic of the formula, but however, this is asking for trouble. Any formula, and this one also, will have some constant factors. The formula looks sophisticated, but it basically comes down to a simple principle. You take the twelve hour peak price and the baseload price and you multiply them with something. By doing that, you make the relationship between different market prices constant, whereas in practice it changes every day. So you can seriously question the practice of applying ‘calculated’ market prices.

What is even more absurd is that the formula sometimes turns out an unexpected result, namely a calculated seven-to-eleven peak that is higher than the eight-to-eight peak. As a proof that the formula is cranky, that one can count. How could it be possible that demand for electricity would be higher in the evening between eight and ten? We are not in Southern Europe, most Dutch people have stopped working and are sitting in their house with a small lamp on by eight o’clock. Many industries work on a nine-to-five schedule. Demand for electricity goes down in the evening in the Netherlands.

So Endex decided to ‘remedy’ that. They made an extra rule that whenever the price for the seven-to-eleven is higher than the eight-to-eight peak, they will reduce it by 3 euro per MWh. And that’s exactly what happened in the past weeks with the Cal 12 contract. The formula gave higher prices for the old peak, so it was reduced by 3 euro’s. Yesterday, the formula gave a normal result again and the minus three euro rule was no longer applied. The result was that the price jumped up by 2,22 euro’s. So, we now have peakload prices that shoot up and down by some euro’s, not due to the underlying economics, but due to the versatility of an ill-shapen calculus.

It would be funny if less money was involved. Just imagine that you are an owner of a CHP and that you have made a deal two days ago for selling Cal 12 seven-to-eleven peakload to the grid based on the Endex-price (a common practice). Yesterday, all of sudden, you could sell at a price that is more than two euro’s higher. Or an even more common practice. Power markets have come down in the past weeks. Let’s say that as a buyer you told your boss yesterday that you recommended not to buy the peakload because it was in a downtrend. How are you going to explain to him that it shot up by 2,22 euro per MWh due to some incomprehensible calculation?

This whole story raises two big questions:

1. This problem points to a larger problem regarding the continental European energy market. End consumers have fixed contracts with their suppliers where they use the power exchanges such as Endex as the benchmarks to set prices. That is quite logic, as the exchanges are a very transparent mechanism of price revelation. However, most of these exchanges so far, have failed in developing a liquid future market. Therefore, you can seriously question the reliability of their prices. This peak – superpeak farce is a sad illustration of that. How can we find a reliable price benchmark for retail contracts?

2. How is it possible that Endex and its members have manufactured this cranky solution, obviously without much consideration for its consequences for the end consumer of energy? Are they even aware of their huge responsibility as provider of price benchmarks for end consumer power contracts? How is it possible that inside power companies the trading departments ask for the creation of the superpeak, when this obviously creates a problem for their sales departments?

(Numbers of trades and trading volumes at the Endex NL power futures exchange have hardly changed in the past five years. In the first seven months of 2010 the average traded volume was a little bit more than 2,2 TWh. That is far too small to speak about a liquid exchange.)

Filed under: Market analysis, The market today, the Netherlands

7 questions that will determine energy prices in the next decade

I am not in the forecasting business, so futurology is even less my cup of tea. Still, last week, in the margin of the E-World fair in Essen, I had a very interesting conversation with a client. Over dinner, we discussed the current outlook for the energy markets and some interesting ideas popped up. We are today facing some evolutions which will very probably have an important influence on worldwide prices for oil, coal, gas and electricity. Asking these questions is interesting in itself. Anyone with a good sense of reality will acknowledge that making a forecast about the outcome of any single one of them is impossible. The energy prices of the future will be determined by the combination of outcomes of all of these questions, which makes it even more difficult to forecast them. So, according to me, these are the issues:

1. Will we all drive an electrical car in ten years? Car companies, and even governments, are betting heavily on this. Today, oil is mainly consumed for transportation. If we all (or most of us) drive an electrical car, the consumption of oil will fall in favor of electricity. Where will that electricity come from (see questions 4 and 5)? Will this cause prices of oil to fall and prices of coal and natural gas to rise?

2. Will the peak oil theory materialize? According to some we are already witnessing the peak. According to some dissidents from the International Energy Agency, oil producers are not able to produce more than 90 million barrels per day. They claim that they were forced by their organization not to tell the world about this fact.

3. Will there be a post-Kyoto climate change policy? And how stringent will that be? Will Europe continue to try to be the best of the class? Or will it be joined by the other countries? And if Europe is that lonely front-runner, how enthusiastic will it continue to be? Or will it rather scale down its efforts? Or is the drive towards greenery unstoppable, even without a world agreement on climate change efforts? This will obviously have impact on the outcome of other questions such as 1 or 4 or even 6.

4. Will renewable energy technologies such as wind or (large-scale) solar become competitive with traditional methods of power production? Or will these technologies continue to need state aid to become widespread? The outcome of this question obviously depends on what the outcome of all the other questions is on the energy price. The higher the energy prices, the more competitive the renewable energy technologies will become. But then, because of their low variable cost, renewable power production pulls down the electricity prices.

5. Will shale gas cause a glut of natural gas in the United States, Europe or China? Shale gas is now being produced and all big energy companies (even Exxonmobil) are investing in it. If it is really recoverable in the quantities such as announced, even with a huge increase in gas consumption, we are not facing a gas supply shortage in the next decades. With abundant gas around the corner (Germany and Poland are said to have big prospects in shale gas), the fundamentals of energy shortages change completely.

6. Are we really at the brink of a nuclear renaissance? In Asia, many new nuclear power plants are being started up. In the US, Mr. Obama is betting on nuclear also. In Europe, governments are more hesitant. As with renewables, the low variable cost of nuclear tends to pull down electricity prices (which again, makes investment in nuclear less interesting).

7. Will Europe continue to be a liberalized energy market? It’s hard to see a way of turning it back. Is it possible in democratic, open market countries to create new monopolies without a cavalcade of court cases from the heavily disadvantaged competitors? But on the other hand, consumers (voters) and their governments are growing increasingly frustrated with the results and – logical – consequences of energy market liberalization. But maybe, the market will take some hybrid shape, something in the line of what France is currently trying to create.

None of these questions is hypothetical. I am not speculating about some undeveloped question, such as the possibility of nuclear fission. Electric car technology is being developed, peak oil theory discussed as a real possibility, Copenhagen was a failure to reach a post-Kyoto agreement, prices per kWh of renewable electricity are falling, the gas market is massively investing in shale gas, nuclear power stations are being built in Asia and the discussion on liberalization was opened even in ultra-liberal Britain last week. These are all factors that will determine the price we will pay for energy in the next decade. And moreover, new questions and issues will pop up.

Filed under: Energy history, Energy technology, Forecasting, Market analysis