UK prompt electricity price spikes could cause reversal of curve hedges

Utilities that have sold generation on the forward curve for this winter could be tempted to buy volumes back and sit on them in anticipation of further price spikes this winter, sources have said.

It follows a week of record settlements on UK prompt wholesale electricity products on both the OTC market and exchanges. A combination of higher-than-expected demand from air conditioning units, summer maintenance on power stations and several unplanned outages have pushed peak demand forecasts above available generation in the market on some days.

The bullishness affecting the market was unabated on Thursday, as the contract for Monday’s baseload delivery continued to trade at £200.00/MWh, four and half times the average day-ahead baseload settlement this year.

“It’s a real wake-up call for the forwards market,” said one ex-utility analyst with ten years’ experience. “Yesterday [Wednesday] was a reminder for the first time in a decade that prices can go mental.”

Spark spreads – indicators of the notional profit margin for gas-fired generation excluding the cost of emissions – climbed to exceptional highs for prompt and curve periods, according to ICIS calculations at Wednesday’s close.

The Day-ahead spark spread was propelled to £128.39/MWh as power for immediate delivery traded close to its highest ever value.

Meanwhile, the October ’16 and Winter ’16 spreads were calculated at £26.41/MWh and £20.83/MWh respectively at the end of Wednesday’s session, both records for the delivery periods but considerably lower than the day-ahead settlement.

Hedging dilemma

“Everyone will be sitting down and thinking how many times this [prompt spikes] will happen this winter,” the source said.

“The big impact will be on what the generators decide to do. They could decide to unhedge a couple of units, buy them back and wait for the Day-ahead. Otherwise, you’re forgoing that profit.

“Now the sparks have risen a lot, there’s a lot more at stake. They will be cautious about selling into the curve and getting excited about whether they can get the £1,000.”

Offers of up to £1,500/MWh were already being accepted by system operator National Grid in the balancing market on Wednesday.

However, generators would be playing a dangerous game if they left the bulk of their hedging to the prompt, according to Inspired Energy’s risk manager Nick Campbell.

“It is a risky business,” Campbell said. “It depends on the hedging cycle. If it was forward sold, then the buy-back probably will be in the money but what happens if we don’t spike?” he said. He added that the gains on prompt contracts in recent days had not translated to anywhere near the same gains on the front winter.

Others in the market are preparing for similar periods of prompt volatility this winter.

“This is the shape of things to come,” said LG Energy Group’s head of trading Serge Mazodila. “We’re now less flexible and more prone to volatile prices as renewables fill the gap but are more sporadic at times.”

“The old coal stations are going to make us pay through the nose to come online throughout the winter,” he added. henry.evans@icis and christopher.somers@icis.com