Analysis: NBP prompt to Winter ’15 link solidifies, drives UK power

Britain’s NBP day-ahead gas price has become a far stronger driver of longer-dated UK power and gas contracts in the first few months of summer compared to the same period last year, ICIS figures show.

The tight correlation, which allows traders to assume a close link between the immediate, fundamental-driven short-term outlook of the British gas market and the longer-term value of UK power as well as the NBP front season, has been driven by low storage stocks in advance of winter.

The correlation coefficient, a measure of the strength of the relationship between two variables, for the NBP Day-ahead contract and the Winter ’15 product was 0.94 from 1 April to 16 June. This compared to 0.85 for Day-ahead and Winter ’14 over the same period a year ago.

The correlation coefficient operates between -1 and +1. Values closer to +1 imply two variables are moving in line, while figures near -1 show the variables are linked but move in opposing directions, known as an inverse correlation. A zero value implies no correlation.

Strong relationships can be exploited to price the contract which tends to follow its peer.

While the NBP Day-ahead to NBP Winter ’15 link exists, there is also a correlation between next-day delivery British gas and the UK power Winter ’15 product. This is because gas-fired generation is a marginal fuel in the UK power mix and plays a key role in setting power prices.

The correlation between the UK power and NBP Winter ‘15 products was just below 1.0 from the start of 2014 to 16 April this year.

But this long-standing link has been pressured since 1 April, falling to 0.95, as both coal and gas have been operating as marginal fuels in the UK dependent on the efficiency of any given plant due to the relative tightness of profit margins (see EDEM and ESGM 23 June 2015).

Low gas stocks

Summer, with its warmer weather and lower demand on an island highly reliant on gas-fuelled heating, is an opportunity for gas storage sites to be replenished. However, UK gas stocks were just 32% full on Tuesday compared to 77% a year ago.

Storage injections are dependent on the financial incentive to actually inject. But strength in the prompt NBP market, combined with a weak Winter ’15 price, has flattened the seasonal contango. This has meant the cost of storing gas for the coming winter is higher than the spread between summer and winter prices, making gas storage an unprofitable exercise.

The UK gas Day-ahead product was at an average discount to the NBP front winter of 4.34p/th from 1 April until Monday 22 June, according to ICIS data. This was much lower than the average discount of 16.30p/th over the same period in 2014.

The sensitivity of injections – and therefore the robustness of stocks over this coming winter – to this spread explains why day-ahead gas prices have become a bigger price driver for longer-dated contracts.

“Summer fundamentals play a bigger role,” one power trader at a trading house said last week.

Replenished

However, traders were not overly concerned with the storage situation, on grounds that stocks would yet be replenished by the end of summer.

This is reflected in a relatively narrow discount of 3.675p/th held by the Q3 ‘15 contract to its Q4 ’15 peer on the NBP at Tuesday’s close, one UK power trader said on Wednesday. This compared to a premium of 15.175p/th on Q4 ’14 over Q3 ’14 a year ago, ICIS data showed.

Other market participants said Winter ’15 could actually be drawing direction more off other contracts such as Q3. “There is a decreasing correlation along the curve,” one trader said.

In terms of the outlook, the Dutch government’s decision to limit output from the Groningen field is currently being digested by the British gas market, providing some underlying support to the Winter ’15 product.

The giant L-gas field does not directly supply the predominantly H-gas British market but other Dutch gas fields do supply Britain via the BBL pipeline under the terms of a long-term 8bcm/year contract between Centrica and producer Gasterra. Lower Dutch production could impact Britain if more H-gas is needed for conversion to supply domestic customers in the Netherlands.

The British prompt market is also supported by an increased need to replenish storage, which remains far below the five year average. ben.lee@icis.com, albert.evans@icis.com and abigail.beall@icis.com