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

Can the world be powered without nuclear?

The nuclear disaster in Fukushima is still far from over. I am not a nuclear scientist or a radiation specialist, so it’s as hard for me to judge how much harm has been done exactly to the environment and human health. As an energy market specialist however, I am pretty sure that this event will influence energy and environmental commodity markets in the coming years. I was surprised to find this report by the WHO, the UN outfit for worldwide healthcare. It states that the deaths caused by the Tsjernobyl disaster are actually much lower that often presumed. Again, I am not scientist enough to judge the truth of this statement or the solidity of the analysis that led to it. But it could be that nuclear disasters are a little bit less apocalyptic then we mostly presume.

However, such scientific evidence will never win from the popular perception. As of now, the world’s population has these images in their memory of men in radiation suits and with masks on scanning little babies with spooky devices to check whether they are contaminated. This has already become an important political reality. Last Sunday the German Green party made a historic victory in elections for the regional parliament of Baden-Würtemberg. The region is home to six of Germany’s seventeen nuclear power plants. The Greens have pledged to shut them down. Italy has delayed its plans to build its first nuclear power station by two years.

 

Politicians across Europe that have previously decided to turn back nuclear phase-out schemes try to save their skins by promising their voters a thorough stress-test of the nuclear power plants. I am afraid that these tests might lead to further shut-downs. The stress tests will undoubtedly unveil security failures. A few years ago, a Belgian activist managed to get on the premises of the Doel nuclear power station. According to her, it was very easy to get in. Electrabel, the operator of the Doel plant claimed that she never made it to the nuclear part of the plant. However, the Fukushima disaster has shown us that the non-nuclear part is vulnerable as well. If somebody gets in and seriously damages the pumps that are to supply the cooling water, what happens? Are nuclear facilities really capable of surviving a plane crashing on top of them? And again, as Fukushima has shown us, will the non-nuclear facilities on the sites pass the stress-tests?

If security issues arise in the stress tests, I believe that politicians will most likely copy Angela Merkel and shut down plants. In the post-Fukushima era, no politician will want to take the risk of keeping open a power plant that is not declared 200% safe. Any small issue with safety will lead to temporary or even definitive closures. Therefore, these stress-test swill also be a period of stress for the energy markets.

In the past weeks we have clearly seen how the markets react to the shutting down of nuclear power plants:

1. Power prices obviously rise as less supply of electricity is available and extra, gas-fired power plants with higher marginal costs need to be fired up.
2. This causes increases in gas prices as well, as gas demand goes up.
3. Less nuclear and more gas-fired power means that more carbon dioxide is emitted, which results in rising emission rights prices.
4. The higher prices for gas and emission rights feed back into the power price.

So far, these effects have mostly been observed in the forward markets. In Germany, the Netherlands, Belgium and France, Cal 12 electricity now trades at almost 60 euro per MWh. The spot price has continued at a reasonable level. This clearly signifies that the forward price increases signal a fear of supply shortage, but in the real world, no shortages have occurred yet, even if 7% of Germany’s power capacity is down. Spare capacity and cross-border trading explain why no supply crunch has occurred yet. However, we should watch very carefully at what happens in Q2. This is traditionally maintenance season and a lot of nuclear power stations across Europe are up for planned maintenance. If some unexpected shutdowns due to stress-test issues would be added to that, we could see a supply crunch materializing.

For the longer term, it is highly probable that in many countries the plans for building new nuclear power plants or for keeping existing plants open for a longer period will be ditched. This obviously raises the question whether the world is capable of powering itself without using the nuclear option. According to this article in the Economist we can. They point out that nuclear power plants produce only 14% of the world’s energy. In recent years we have seen several countries grow to 20% shares of power production for wind and solar, countries such as Germany, Denmark or Spain. If the whole world would follow that lead, we could replace nuclear power plants by renewable power plants, without pumping extra CO2 in the air. (Pro-nuclear proponents often make the argument that without nuclear power plants we cannot reach the Kyoto targets). Of course, if our electricity consumption continues to grow, or starts to grow even more rapidly, e.g. because we all start driving electrical cars, the 14% target will become ever more challenging.

Buyers of energy need to be aware that this transition will come with a high bill. German power consumers currently pay 35 euro per MWh for green energy, money that goes to the producers of green energy in the shape of a feed-in tariff. This makes Germany one of the most expensive countries in Europe for industrial power consumption.

Even if we can transfer to a non-nuclear power production in the world as a whole, in Europe, this will be significantly more difficult. The proportion of electricity produced in nuclear facilities in Europe is twice as high as in the rest of the world, almost 28%. Face it as it is, Europe is the must nuclearized zone of the world. France for example, produces as good as all its electricity with its 58 nuclear plants. This can’t simply be replaced by renewable energy, which due to its intermittent character cannot provide all the energy. When the sun doesn’t shine and the wind doesn’t blow, you need another technology to make the power. That technology is likely going to be natural gas-fired power plants due to a variety of reasons:

• Gas-fired power plants have a lot of flexibility for firing up and scaling down the production. This makes them very suitable as stand-in power stations.
• The economics of gas-fired power plants also fit perfectly well with the economics of renewable power stations. With their low investment costs and high fuel costs, they are the marginal power stations of choice.
• Recent developments in the gas markets, such as the development of Qatari LNG business or the shale gas development have inspired optimism that we might have a lot of the stuff left.
• Natural gas burns cleaner than coal, which emits roughly twice as much CO2.

A combination of renewable and gas-fired power plants seems to be the most likely option for a non-nuclear power market. Switching over to this market will demand huge investments. Part of those investments will be passed through to the end consumer in the form of feed-in tariff financing or green certificates to support the construction of windmills and solar panels. The gas transport infrastructure in a country like France will need to be expanded. And the increased demand for gas will put pressure on the gas markets. The volatility that we have recently witnessed in power and gas markets is therefore likely to continue.

Nuclear power enthusiast minted the term nuclear renaissance a few years ago to describe the trend that they saw of a return to more nuclear power production. However, if you look at the graph below, you will notice that in Europe the share of electricity produced in nuclear power stations has systematically decreased in the past ten years. The situation in Fukushima could speed up this decline.

Filed under: Climate change, Energy history, Energy policy, Energy technology, The market today

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

E&C comments the market situation on regional television (in Dutch)

Sorry for our international viewers, the interview was with the regional television, hence in Dutch.

E&C kwam gisteren in het nieuws. Naar aanleiding van de hoge energieprijzen kwam de regionale televisiezender WTV-Focus langs in ons kantoor in Kortrijk. Wat voert zo’n energie inkoop consultant eigenlijk precies uit, kwamen ze vragen.

http://www.focus-wtv.tv/programma/wtv/olieprijzen-blijven-stijgen

Filed under: Belgium, 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

Deutsche Börse – NYSE merger and the German energy market

“Erfolgsgeschichte”, that’s the beautiful German word for success story. And that is clearly what the recent German economic history reads like. The German economy has recovered more rapidly from the 2008 crisis than any other traditional economy. The whole country seems to be vibrating with a newly found self-confident entrepreneurial spirit. This economic success is not without political consequences. At the latest EU Summit, statesmen from other European countries saw an unprecedented German assertiveness. Miss Merkel’s argument seemed to be: “since Germany is the best-performing economy of Europe, all other countries should adopt our economic policy”.

Today, a next chapter in the success story of the German economy is written. The Belgian business newspaper ran as its headline today “Deutsche Börse takes over the New York Stock Exchange”. The headline is exaggerated as headlines should be. Deutsche Börse is not taking over, it is merging with the world’s most famous trading place on Wall Street. But as 10 of the 17 top jobs in the new company will be held by Germans, it is clear that Frankfurt is the leading dancing partner. So, to continue in hyperbolic language, who would have thought that Germans would once run Wall Street?

I guess that in the next years we will be able to buy many books that explain in detail for what reason the German economy recovered at such a rapid pace. I don’t have the arrogance to share more than an observation with you on this topic. In recent years, I have done a lot of business in Germany. What I have come to appreciate especially in the way Germans do business is their ability to balance discipline and creativity. This can also be observed in the policy adopted by the German government to recover from the crisis, a policy which they would like other European countries to copy. It is a cocktail of budgetary discipline and increased entrepreneurial flexibility, e.g. by relaxing rigid employment conditions.

The question is of course, whether we can see a similar positive, vibrating development in the German energy market. Many would argue that this is not the case. In my opinion, the German energy market is still facing two major issues:

1. The non-commodity part of the energy bill is higher in Germany than in any other country. As I have written earlier in this blog, Germany has developed its green power production remarkably fast. But it comes at a massive cost of now 35 euro per MWh. On top of that, grid fees are the highest of any Western-European country. The reason for that is very simple. There are more than a thousand different grid companies, all of which have fixed costs. Michèle Bellon, the CEO of ERDF, the French electricity distribution grid operator, probably has a decent salary. But the French pay just one CEO salary for having electricity distributed in 95% of their country. The Germans pay a thousand CEO salaries for that same service.
2. To some extent the German energy market remains stuck in archaic structures. There are not only a multitude of local grid companies, the Stadtwerke, most of them also continued to run a supply business after liberalization. What is the future of such companies? If they don’t develop a commercial approach to attract customers outside their traditional supply area, they are sitting ducks, waiting for new suppliers to steal away clients from them. As the Stadtwerke are run by local politicians, they often lack the willingness to expand the business beyond their locality.

In many cases we observe negative consequences of the archaic market structure with buyers of energy. I have already praised the unique German cocktail of discipline and creativity. However, sometimes the discipline takes over and becomes conservatism. This is nurtured by the local supply companies that rely heavily on the decades long relationship that they have with a client to convince him to continue working with him. But when these local companies are small, they often lack the ability or willingness to develop the new energy buying solutions to face today’s energy market challenges and grasp the opportunities. German energy buyers then continue to sign fix price contracts for electricity and oil-indexed gas contracts, out of habit, and not based on a genuine analysis of their risk exposure in the energy markets.

I am not too negative about the German energy market however. We do see the discipline – creativity cocktail manifest itself in many – surprisingly rapid – evolutions:

1. The German gas market is developing at light speed. We now find gas contracts based on Hub prices available for almost every client. Prices can be spot based with good possibilities for forward hedging. We can see most suppliers still struggling to develop the right approach, but such contracts are almost as good as anything you can find in for example the UK or the Netherlands.
2. Especially as I come from Belgium, I’m surprised to find in Germany a country with a government that takes decisions and implements them relatively efficiently. This is probably why German politics succeeded in coming out of the crisis the way they did. We also observe it in the energy markets. One of the main issues with deregulating the German market is having free access to grids arranged in a country with such a massive amount of grid companies. Even the transportation grid is split up in a multitude of different grids. In the past four years, the German authorities have worked very hard on assuring free third party access and with great success. In the electricity market, any supplier can now supply to any client anywhere in the country if he wants. For gas, some restrictions remain, but they are removed at an extremely rapid pace.
3. Thanks to the multitude of energy companies in the country, the supply market is very vivid and competitive. The German power market, for example, is not dominated by a single large supplier such as EdF in France or Electrabel in Belgium, there are four big players in the power market: E-On, RWE, Vattenfall and EnBW. Next to that there are several local suppliers or conglomerates of local suppliers that have developed a nation-wide business, players such as EWE, MVV, Trianel, N-Ergie, etc. And then there are new players, newly created companies such as Natgas or Gasag in the gas market. One of the consequences of this vivid competition is that new products such as a tranche model contract for buying gas on the TTF or NCG have been developed very rapidly.
4. Leipzig-based EEX is the most liquid of all continental European energy exchanges. I remain skeptical whether the energy markets will develop as exchange-traded or as OTC markets. But if the exchange-traded model prevails, the EEX will be the big name in Europe. A little bit like Deutsche Börse in the stock markets?

The German energy market is full of opportunities. And I am confident that the newly-found economic self-confidence will inspire the creativity in German companies to grasp these opportunities.

Filed under: Energy history, Energy policy, Energy suppliers, Germany, 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

Why emission trading should be suspended permanently

Emission trading has been suspended for more than a week now and it is not clear yet when the market will open again. The reason is fraud, again we should say. What has happened?

Underlying the carbon market in Europe is a system of national registries. If you are a company that is participating in the emission trading, you get an account in this registry. The emission rights that you get from the government (your allocation) are then put into this account. If you make a trade, for example you sell rights, they will move from your account to the account of your counterparty. The whole system is run over the internet. Smart fraudsters have found a way of hacking the registries. They get into people’s accounts, grab the rights that are there, transfer them to their own account and rapidly sell them in the spot market. By doing this, they have recently made some 30 million euro’s. The registries of Austria, Czech republic and Greece were affected.

I think it’s not surprising that this happens. Emission rights are money and where there is money there is fraud. Moreover, the market was created from scratch in 2005, which is also true for the IT-infrastructure that is to support it. That probably explains the loopholes in the security systems. The authorities are now ramping the security up and are refusing to re-open the registries for rights transfers before they have everything tested. This standstill is not without consequences. If there is no possibility of transferring rights from one account to another, there is no possibility of spot market trading. Therefore there has been no more spot market trading since the suspension. How long can this last?

Regular readers of this blog will know that my enthusiasm for emissions trading is very low. It is a classical example of a great idea that turns into a bad practice for several reasons:

1. Emission trading creates an immense amount of organizational difficulties. Protection against fraud is a good example of that. But also for the participating companies, the system creates an important extra administrative workload. They have to lobby for allocations, manage the account in the national registry, report on emissions, have those reports audited, manage trades, etc. I can hardly imagine that this paperwork is beneficial to the environment.
2. Both trading periods in ETS were over-allocated. As long as the system is over-allocated, it is not contributing to the reduction of emissions of carbon dioxide. It creates an extra – unasked for – source of income for those that have laid their hands on the excess emission rights. And it creates an extra cost for electricity consumers as power producers hedge the costs of emission rights by incorporating them in their pricing.
3. And even if allocations were short, I still doubt whether emission trading would contribute to reducing carbon dioxide emissions. I’ve discussed this with a client last Thursday. He asked me what my prognosis for long term emission rights prices is. The only sensible thing I could answer was ‘somewhere between zero and infinity’. And he responded, ‘Well that is why we don’t take into account savings on emission rights when we make a decision on investment in increased energy efficiency’. The price signal is too shaky to be significant.

Emission trading has missed its goal (reducing emissions of carbon dioxide), has created unnecessary administration and has also been a source of financial fraud at several occasions. What more does it take to make this suspension permanent?

There are a few thousand people winning money by having a job as a consultant, trader, broker, software developer, auditor, journalist etc. in the emission rights market. They will do all they can to keep this monster alive that they have contributed in creating. The EU has prided itself about the creation of emission trading across the planet. Admitting that it is a failure isn’t very easy. But is it really so hard for common sense to win? How much more money needs to get lost?

Filed under: Climate change, emission trading, The market today