Cheaper gas helps reduce German power spot forecast errors

Author: Laura Raus

2016/06/03

Higher competitiveness of gas-fired generation in relation to coal has diminished differences between German EPEX SPOT and over-the-counter (OTC) day-ahead power prices.

This benefits traders who were struggling to predict exchange results after the launch of flow-based market coupling (FBMC).

Lower gas prices might also be the reason why differences between German day-ahead and intra-day prices have dropped.

Between 1 January and 2 June this year, the difference between the exchange and OTC German Day-ahead Baseload was more than €2.00/MWh on nine occasions, excluding weekend days that ICIS does not assess individually. Over the same period last year, the differences exceeded €2.00/MWh on 34 occasions.

The average absolute difference dropped from €1.82/MWh in 2015 to €1.06/MWh this year.

The differences are lower this year despite the launch of FBMC, a new market coupling method for exchange day-ahead trading in centralwestern Europe, on 21 May 2015. The new method, which aims at maximising the welfare of the whole FBMC region rather than considering markets in pairs when determining cross-border flows, made it more difficult to predict exchange day-ahead outturns, traders said after its launch.

Flatter merit order

“The difference is decreasing because the marginal costs of coal- and gas-fired power plants are very close to each other at the moment due to low gas prices,” ICIS analyst Jonathan Scelle said.

“This makes forecasting easier because the merit order is basically flatter than it used to be.”

A trader at a European electricity company agreed this is probably the main reason for smaller differences between exchange and OTC day-ahead prices.

The costs of gas-fired generation have dropped closer to the costs of running coal plants as gas prices have been more bearish than coal prices. For example, the Q2 ’16 gas contract expired at the benchmark TTF hub 44% lower compared to the Q2 ’15 expiry. On the European CIF ARA coal market, the Q2 product dropped 23% year on year.

Such fuel price changes translate into a flatter merit order, the ranking of available power sources based on their marginal costs. This is illustrated by flatter EPEX SPOT day-ahead volume sales curves. The flatter the sales curve, the less the price changes when demand changes.

With a flatter merit order, constrained supply that necessitates the use of gas-fired generation does not lead to considerably higher prices.

If, for example, renewable energy generation or cross-border flows are different than predicted and, against the expectations of market participants, gas-fired plants will be needed to meet the demand, the exchange Day-ahead result will not be much higher than it was under their assumptions, which are reflected in the OTC price.

Outlook

“The merit order should stay quite flat for some time,” the trader said.

This is mainly because carbon prices are likely to increase and support the competitiveness of gas-fired generation compared to coal, he said. Higher carbon prices increase the costs of gas-fired generation less than the costs of running coal plants as the latter are more polluting and need to buy more carbon emission certificates per each megawatt of power produced.

Moreover, coal prices are unlikely to drop, the trader said. The coal market remains fundamentally bearish, but coal prices have been strong recently, obtaining support from oil market gains and the risk of strikes at Colombian coal mines.

Gas curve prices have recently been supported by oil futures and upcoming supply curtailments in Norway, but they might shed value once confidence grows that a number of US LNG deliveries will head to Europe.

Intra-day

The difference between German day-ahead and intra-day prices has also decreased year on year.

Between 1 January and 2 June this year, the average absolute difference between the Day-ahead Baseload and average daily results of 15-minute intra-day auctions on EPEX SPOT was €1.12/MWh, compared to €1.29/MWh in the same period of 2015.

This is likely to be partly because the flatter merit order has reduced the risk of unexpected price spikes.

German day-ahead and intra-day prices are likely to remain capped at a relatively low level in the coming days, ICIS analyst forecasts show.

The EPEX SPOT Day-ahead Baseload will be below €27.00/MWh from the weekend until at least Wednesday of week 23, while 15-minute auction results will not exceed €38.00/MWh until at least Tuesday, according to ICIS forecasts. laura.raus@icis.com

A free trial of ICIS intra-day German power price forecasts can be accessed by clicking here .