UK forward power curve shrugs off capacity concerns

Traders on the UK wholesale electricity market have waved away concerns of a potential squeeze on capacity margins over the next few years, following a month of record falls on seasonal power products instigated by plummeting prices on European and world fuels markets.

The losses have occurred in spite of previous analysis by the transmission system operator National Grid and energy regulator Ofgem that the UK would be entering a period of increased threats to security of supply.

Supply margins

Ofgem’s most recent capacity outlook released last summer maintained a worst case scenario where surplus capacity could drop as low as 2% during winter 2015/16.

The analysis has been supported by models produced by National Grid as part of its future energy scenarios and has prompted the system operator to introduce a raft of demand-side and capacity-reserve schemes to safeguard future supply.

Discussing National Grid’s procurement of reserve services totalling 620MW of capacity from three combined-cycle gas turbine facilities for next winter announced last month, traders were unfazed by the effect of their exit from the wholesale market (see EDEM 15 December 2014).

“I think there’s plenty of capacity – no real issue there,” said a trader from an energy management company.

Far-curve slide

Forward power contracts have remained resolutely attached to the bearish direction of the British NBP natural gas market, which has seen its value eroded in recent weeks as its indexation to weakening Brent crude futures comes to fruition.

Winter ’15 Baseload power – the winter when Ofgem has anticipated the 2% margin squeeze – has had 8.5% of its value shaved off since 24 December up to Wednesday’s closing ICIS assessment.

The Peakload contract has lost 7.5%, reflecting some retention of risk premium through potential demand surges during peak hours.

Summer contracts have also been in a downward spiral since the start of December. One trader on Wednesday said the fact that the front summer had already broken through record lows made it difficult to predict where the losses would stop. “There’s no level to pin it on,” he said.

Further down the curve, the Winter ’16 and Winter ’17 contracts have also endured significant losses in the last couple of months despite liquidity on the contracts being more restrained than nearer in.

Winter ’17 Baseload has lost almost 11% in value since the start of December based on ICIS assessments.

“It doesn’t look wildly wrong to me,” said one trader from a commodities hedge fund of the Winter ’17 Baseload. “There are normally a few prices around. I think most people have a feel for where it should be.”

A £0.60/MWh bid and offer spread was evident on the contract as recently as Tuesday’s session, although it has not traded on the over-the-counter market since the middle of December.

No supply concern

The descent on the far curve comes as uncertainty shrouds the future of the UK’s thermal plant, with exacting EU environmental legislation threatening to force the early closure of coal-fired plants.

The failure of some plants to secure capacity payments from 2018 onwards in the recent capacity market auction has also removed economic bait to keep thermal plant running as profit margins continue being squeezed.

Asked of his opinion that some coal plant might find it uneconomic to run in the mid-term, the trader at the hedge fund said that the downward trajectory of NBP market could dampen such concerns.

“If the gas collapse continues, and ends up below coal switch, then those plants become marginal and rarely run,” he said.

He added that coal plant could survive in the margins because they would have the leverage to set a price at which they can justify turning on.

“If you knew you’d need to run to help balance the system, then in theory you’d just charge whatever makes it worthwhile,” he said.

He added that increasing quantities of renewable generation entering the system along with the capacity payments that many existing plants have earned are keeping supply concerns away from the market. Henry Evans