Fuel for Thought – Aug 5th

05 Aug, 2011

Gazprom and Ruhrgas ride into battle over oil indexation: Europe’s large gas producers have had a difficult time defending gas contract oil indexation during 2009-10. European spot prices have fallen below long term contract prices causing significant pain to generators and suppliers, bound via ‘take or pay’ conditions to pay higher oil indexed prices. But the 2011 tightening in the global LNG market is causing this relationship to re-converge with winter 2011/12 forward hub prices already consistent with the oil indexed alternative. While these conditions prevail producers are firmly back on the front foot in defending oil indexation.

Drax wary on spreads and Electricity Market Reform: The EMR policy announcements last month focused on support for nuclear and renewable capacity. But it is thermal capacity that will be critical for maintaining security of supply over the next decade. In an environment of depressed thermal generator margins, the government is steering a dangerous course with its market reform. EMR appears to be attempting to retain the existing competitive market structure while overlaying a toolkit of policy interventions which allow it to influence market outcomes. Recent comments by RWE, Centrica and now Drax on EMR are an indication that this approach is unlikely to be well received by thermal plant owners and investors as we explore in a blog article on Monday.

The only way for gas is up ? There have been some very bullish predictions for global gas prices over the last few months based on forecasts of rampant Asian demand and constraints around new LNG supply. What is receiving less attention is the potential threat to global demand and commodity prices from a slowdown in economic growth. Recent economic data in the US and China point towards a moderation in growth, and commodity markets including oil have sold off aggressively this week. The emergence of systemic risk from the European and US debt crises has the potential to accelerate this slowdown dramatically as we explore in more detail here.

New RWE Essent Dutch plants: There is a game of prisoner’s dilemma unfolding in the Dutch power market. Around 8 GW of new thermal capacity has been recently commissioned or is under construction, with several more GW in the advanced stages of planning. RWE may see strategic value in its new gas plant from a pan-European perspective, but Dutch generators are likely to suffer a very difficult margin environment over the next few years.

Picture of the week:

The oil-fired Bankside Power Station operating in 1963 in Southwark, London. The building which now houses the Tate Modern Gallery was designed by Sir Giles Gilbert Scott, the innovative designer of Liverpool Cathedral, Battersea Power Station and the red telephone box. The chimney’s height was limited in deference to the spire of St Paul’s Cathedral, which stands on the opposite side of the Thames.