Power liquidity watch: Northwestern European volume shifts back from prompt to curve

Increasing hedging, oil price rises, volatile renewable generation forecasts and increasing exchange trade are driving a shift in liquidity from the shorter-term prompt to the longer-term forward curve across northwestern Europe, market sources have told ICIS.

In the first five months of this year, prompt volume traded at the over-the-counter (OTC) power markets in Germany, the UK, France, the Netherlands and Belgium fell by 19% compared to the same period last year, while curve volume increased by 25%, according to ICIS data.

The greatest increases were seen on the far curve, with Year+1 and Year+2 volume increasing in Germany, France, the Netherlands and Belgium, while volume increased on all UK seasonal contracts.

One of the factors driving the increased liquidity on the curve was sustained bearish sentiment at the start of the year, which encouraged traders to lock in prices by hedging output forward.

For instance, company results from the first quarter showed that some of the main European utilities increased their year+2 hedging ratios for thermal plant production in comparison to the same period in 2015 (see EDEM 13 June 2016).

These hedging strategies helped to shift volume toward the far curve across northwestern Europe in the first three months of the year.

To put the shift in its longer-term context, it marks a reversal of a pattern that emerged three years ago when the backwardated state of many European electricity markets combined with the steady rise of renewables deployment drove a drop in overall liquidity as companies shifted focus from the curve to the prompt (see EDEM 16 August 2013).

Oil price rises

Volume traded on the far curve has also been boosted over the past two months by strength in the fossil fuels complex, with oil prices seeing the most notable gains.

These oil price increases filtered through to prices on far curves across European power markets, and the presence of improved power plant profit margins, even for short periods of time, encouraged generators to trade further out on the curve given the bearish assumptions made at the start of the year.

The announcement of a carbon price floor in France in late April also boosted prices on longer dated French contracts, again encouraging trading further out on the curve. Though this mainly affected the French Cal ’17 and Cal ’18 contracts, it also helped to lift neighbouring markets in northwestern Europe.

Erratic renewables

Several sources have recently bemoaned the inaccuracy of renewables forecasts, in particular solar, which have resulted in volatile intra-day pricing.

Variation in renewables output can have a significant price impact because of its low marginal costs compared to other conventional generation and consequent priority in the merit order. Changes to renewable forecasts can therefore require much more expensive thermal generation to step in or withdraw from the market, which creates volatility in pricing.

“I can only guess it’s people not wanting to have so much exposure on the prompt because it’s difficult to manage,” one trader from a supplier previously told ICIS about the UK market (see EDEM 9 June 2016).

A second trader from an energy services company said that renewables uncertainty was also moving traded volume to the curve in Germany.

Exchange

OTC prompt liquidity has also shifted to exchange platforms in some national markets over the past year, figures show.

Accessibility to more refined prompt products offered by exchanges encourages some traders to use those platforms instead of the OTC method, where a company must always be prepared to be on the other end of the deal.

“They do offer more flexibility to shape your position on a half-hourly basis,” a source from a renewable energy company previously told ICIS in reference to the UK market.

For the day-ahead market, the trend of activity moving from the OTC to exchanges has been seen in both the UK and France, with year on year day-ahead volume traded on the exchange increasing in the first five months of 2016, while OTC volume has fallen.

However, comparing OTC data to exchange auction figures for the day-ahead, the same trend has not been seen in Germany, the Netherlands or Belgium. For example in Germany, EPEX Spot exchange volume has fallen by a greater percentage than OTC volume over the period in question.

Outlook

With power prices increasing, the profitability of coal- and gas-fired plants has improved over the past two months and some market participants are becoming slightly more bullish on the prospects for profit margins.

This could lead to falling curve liquidity over the next few months as stable or gradually increasing profit margins would not incentivise generators to lock in margins on the forward market. However, if sentiment was bullish enough to entice generators to buy back power from the market and take a position that was longer than their forecast output, then liquidity could continue to increase.

However, one market participant doubted this would happen. “Unless generators begin to reconsider their hedging strategies and buy power back from the market, which they might theoretically do if the fossil fuels complex remains strong over a sustained period of time, I see no reason for high liquidity this summer,” a trader active on the French market recently told ICIS (see EDEM 10 June 2016).

But it is difficult to anticipate the hedging strategies of companies given the current uncertainty over the future direction of prices.

“Hedging has become a tricky issue for utilities. They are struggling to get the right strategy to maximise profits,” Matteo Mazzoni, market analyst at research company Nomisma Energia said. “When it comes to prices nobody knows where the bottom is at this stage,” he added.

However, curve liquidity in northwestern Europe will continue to be supported by the variability of renewables forecasts. As more renewable generation is connected to the grid across the region, volatility in prompt prices is likely to increase, which encourages risk-averse companies to increase their trading on the curve to take advantage of more stable prices. matthew.jones@icis.com