Energy from waste investment in the UK

UK EfW asset ownership is consolidating as technology matures, capacity increases and a track record of financing is established. We look at the key value drivers.

Timera Angle

How is NW Europe reacting to Rough closure?

The closure of Rough removes 70% of UK gas storage working volume & 25% of daily deliverability. How has the market responded:

  1. Higher seasonality: Loss of Rough withdrawal has driven up UK winter imports. Loss of Rough injection is causing greater summer UKCS exports to the Continent.
  2. Norway backfill: Norwegian production flex has been the key source of market response. NCS export volumes have risen in winter (+5bcm Win 16/17 vs 15/16) & fallen in summer.
  3. NBP vs TTF spread: Price spreads are reflecting changing flow patterns. NBP premium to TTF widened last winter (rarely much below IUK variable cost ~2 p/th). Sharper NBP discounts to TTF seen across the last two summers.
  4. Storage demand: Rough closure has left a hole in UK gas portfolios. This has coincided with a sharp increase in buying interest for alternative storage capacity in 2017.
  5. Price volatility: The loss of UK deliverability is translating into rising UK spot volatility in 2016-17. This reflects the UK’s greater dependence on import supply chains (e.g. NCS, IUK/BBL & LNG).

Russian gas strategy: price war with LNG?

‘I don’t expect it to be a really bloody price war’. Russian gas & oil expert Tatiana Mitrova interviewed on this Columbia Energy Exchange podcast. Good summary of strategic Russian gas & oil drivers and market impact.  Focused gas discussion starts 21 minutes in.

Key takeaways:

  1. Gazprom has signalled a change in strategic direction with EU anti-trust concessions e.g. spot indexation of Central & Eastern European contracts and removal of destination clauses.
  2. Gazprom ‘playing by the rules’, discounting price levels 35-40% vs old oil-index benchmarks and allowing customers increased contract flexibility. But unlikely to induce a price war with LNG imports.
  3. Russia flirted with China supply diversification but has realised growth potential is limited to Power of Siberia volumes. This has meant refocus on Europe as core market.
  4. Russian LNG export growth potential hit by sanctions constraining foreign participation. Unlikely to be volumes beyond Yamal and Arctic LNG.
  5. Nordstream 2 likely to go ahead, helped by 30 bcm reduction in Groningen supply. Provides route & supply source diversification insurance for EU, with private capital ready to foot the bill.

French nuclear outages threaten again

French nuke outages last winter caused extreme price spikes and volatility. Could it happen again this year:

  • Availability: France has 63GW of nuclear capacity across 58 plants, a key component of the NW European generation mix. Fleet availability this week is around 65%, well below normal entering Q4.
  • 2016 recap: Extended EDF outages relating to safety concerns over Areva forged reactor components saw French nuclear fleet availability remain under 70% through most of Q4 2016 and fears of deeper & more prolonged closures.
  • Outages: Current outages do not relate to identification of new safety anomalies. They are a combination of some delays with EDF planned outages and a temporary flood threat for the 3.6GW Tricastin plant.
  • Restarts: 12 reactors are due back in Oct & Nov subject to regulator approval. But the market is wary of EDF timelines given a record of poor communications and delays.
  • Market response: French winter prices have risen by 10% since the start of Sep, focused in Oct – Nov outage period. The response from neighbouring markets (e.g. UK, DE, BE) has been more muted.

Imminent risks due to safety related outages are lower entering this winter.  But there remains an ongoing threat of further anomalies being uncovered as EDF undertakes a comprehensive review of all components from Areva’s Creusot Forge foundry by the end of 2018.

A nuclear renaissance? Yes we’re serious.

Hinkley C may have been the nail in the coffin for large scale nuclear. But we are increasingly interested in the evolution of small modular reactors (SMRs). Here’s why:

  1. Safety: Small size (<300 MW units). Underground installation to neutralise seismic & impact threats. Relatively small radioactive inventory. Substantially reduced meltdown threat. All these mean SMRs are much safer than large scale nukes.
  2. Technology: There has been little evolution over the last 50 years of the light water reactor design dominating large scale nuclear plants. In contrast, SMR evolution more closely resembles electricity storage with innovation across multiple technologies & companies.
  3. Costs: The vision for SMRs is to move away from complex unique reactor designs to a component production line model. Develop a successful design and then replicate in scale to drive down costs (as for wind & solar).
  4. Application: SMRs are a dispatchable (& potentially flexible) source of emissions free baseload output. Unit size & safety means they can be located close to demand centres, or installed in groups to provide larger scale output (e.g. on brownfield sites).
  5. Progress: 4 SMRs are already under construction across Argentina, Russia & China. Licensing approval is the major hurdle in developed countries (a 3-5 year process). But the first SMR application in the US was submitted in Jan 17 by NuScale who are also now targeting the UK. They are only 1 of more than 50 US companies focused on SMRs.

Hitting a 2 degree target needs nuclear as well as renewables. SMRs could be the backbone of a nuclear renaissance.

Coal rally driving up European gas hub prices

European spot coal prices have risen by more than 20% since the start of the summer to 93 $/t.  This rally is having some important knock on impacts:

  1. Hub prices Coal prices are dragging up European gas hub prices via lifting gas to coal plant switching levels as we explain here.
  2. Power sector The competitive shift in favour of gas plants has seen CCGT load factors rise over the summer in key power markets such as UK, Germany and Italy.
  3. Gas demand Pan-European gas demand is rising again in 2017, driven by switching dynamics in the power sector.
  4. LNG prices Asian spot LNG prices, anchored by transport cost differentials from liquid European hubs, are also being driven up by rising TTF/NBP prices.
  5. Transatlantic spread The coal driven boost to European hubs has significantly widened the NBP/TTF vs Henry Hub price spread (now above 3.50 $/mmbtu across the coming winter).

Timera Snapshot

What next for commodity prices? Watch the USD

The commodity price slump in 2014 was accompanied by a big USD rally. Since then the USD has been largely range bound.  But the USD is falling in 2017, supporting a recovery in prices of many commodities (e.g. coal & base metals). The USD index is currently testing a 3 year support line (see chart). We are watching closely to see what happens next as an indicator for direction of commodity prices.

US export contract margins rise into winter

As coal prices help drag up NBP and TTF, the trans-Atlantic gas price spread to US Henry Hub is widening into winter (now 3.7 $/mmbtu for Nov 17).  Variable transport costs to Europe sit in a 0.9 -1.5 $/mmbtu range depending on what cost components shippers treat as sunk and fuel oil vs boil off use (see chart). US exports may even temporarily cover fixed tolling costs of contracts (2.25-3.50 $/mmbtu varying by contract), given winter rally in European and Asian spot prices.

Coal rally continues with strong backwardation

Coal prices are currently a key driver of European gas & power markets.  Strong coal prices in 2017 are causing switching to CCGTs across power markets, driving up gas demand and hub prices.  The chart animation shows the ARA coal curve transitioning from contango (through the major price decline 2011-15) to backwardation (as the market has tightened again in 2016-17). Price strength this year is being driven by China.  Infrastructure stimulus is supporting Chinese commodity demand at the same time the government continues to rationalise domestic coal production.

Russian gas exports continue to rise in 2017

Gazprom exports to Europe have increased again in H1 2017 (up about 12% vs H1 2016). Exports are underpinned by long term oil-indexed contract volumes (see chart). But evidence continues to emerge this year of Gazprom (i) looking to expand market share via hub based sales (ii) allowing greater hub indexation in contracts e.g. via TTF price corridor mechanisms and (iii) moving towards greater supply flex management at hubs.

Derisking drives down UK wind CfD bids

The 2nd UK CfD allocation round for renewables saw 3.2GW of offshore wind and 150MW of waste energy & biomass CHP projects successful (see table). Offshore wind costs plummeted to 58 £/MWh, half that of the 1st CfD round in 2014. This sets up the continued roll out of significant volumes of offshore wind through the 2020s.  Tech innovation is helping cost reductions (e.g. larger turbine sizes).  But lower bids are also driven by government de-risking of project cashflows via the CfD price guarantee mechanism.  It is this that is driving down the cost of capital for offshore wind into single digit IRRs.

Timera take on European midstream asset value

See here for analysis of LNG vs Russia dominance of European import growth and implications for midstream asset value.