A recent downtrend in spark spreads and location spreads for Italy’s Summer ’18 over-the-counter power and natural gas contracts might be short-lived, as traders look at strong Italian energy prices in summer 2017 as a historical reference point.
Storage-related hedging activity on Italy’s PSV gas hub in March could also strengthen the PSV gas premium to the Dutch TTF hub before the Summer ’18 product reaches delivery.
Spark spreads and locational spreads are two of the most important drivers on Italy’s energy markets. Spark spreads set the profitability of gas-fired power generation, while import strategies depend on locational spreads – which is the price difference between two geographical markets.
Short-term spread contraction
The PSV Summer ’18 premium to the TTF has dropped by around €0.10/MWh in January so far to hit €2.02/MWh on Wednesday, ICIS data showed.
Although relatively small, the moved the PSV closer to its typical €1.80/MWh premium to the TTF, a spread which reflects transportation costs for imports from north Europe to Italy.
As relaxing gas supply margins and mild temperatures forecast for January and February pressured the PSV front season, market sentiment turned more bearish on the near curve. A number of shippers having been taking out some of the risk premium they previously injected into the contract.
If temperature forecasts are confirmed over the next two months, PSV and TTF prices will converge further.
“If demand keeps being below the seasonal norm, it also means that storage sites will get to the end of the winter fuller than last year,” added a utility-based trader. This would reduce gas demand for injections in summer.
A change of trading activity by Italian power producers was also behind the narrowing of PSV-TTF prices.
When the availability of French nuclear power plants picked up at the end of the fourth quarter in 2017, Italian companies were able to import greater volumes of cheaper French electricity. This displaced part of Italy’s more expensive gas-fired generation and prompted a number of power producers to sell the strong spark spread aggressively on the forwards market.
Power producers selling the spark spread typically do so by selling the wholesale electricity product and buying the gas equivalent. The PSV near curve and summer contracts were supported as a result, feeding their premium to the TTF.
This trading activity tailed off in January, reducing the upward pressure on energy products with a summer 2018 delivery.
But traders have been hesitant to push down the summer spark and location spreads.
One of the main reasons behind the resilience of summer contracts is the historical reference points traders have on their screen from summer 2017. A hot summer with low hydropower availability and lower imports from France led to a demand spike from power producers in Italy and strong spark spreads.
In absence of reliable forecasts for summer months, several traders on the Italian wholesale electricity market are reluctant to sell off Q2 ’18 and Q3 ’18 products just yet.
“It won’t be easy for the curve to fall. You have the price references of 2017 supporting forward prices on the far curve and all the fuels trading at a pretty high level now,” one trader with a power producer said.
Gas storage auctions
Another bullish factor for Italian gas prices could auctions for storage capacity, which are held in March. Auctions usually spark hedging-related activity on prices two seasons ahead, as shippers who secured capacity buy products with delivery in summer and sell the winter equivalents to profit from seasonal spreads.
Storage capacity offered by Italy’s main storage operator Stogit for 2017 auctions was 16.7 billion cubic metres. In 2017 most of storage-related hedging activity took place in March, which lifted the Summer ’18 product.
Traded volume on the two front seasons in winter so far are in line with the previous year, which suggests that most storage-related hedging activity still has to take place.
Summer weather outlooks and hydro reserves will also be a major driver for the PSV front season further on. Italy relies on gas-fired power plants, which account for a large share of power production particularly in summer, when high temperatures drive cooling-related demand. firstname.lastname@example.org and email@example.com