Fuel for Thought – Jan 6th

06 Jan, 2012

Oil, gas and power forward curve dynamics: There has been much debate as to the causes of the current backwardation in oil futures prices.  But tightness in the physical oil market looks set to continue into 2012 in contrast to softening conditions in the European and US gas markets due to robust supply and a milder winter.  The NBP gas curve has also flattened dramatically from a state of contango in mid 2011, in sympathy with oil market backwardation and reflecting the increasing threat of a European recession.  In contrast UK and continental European power curves, usually strongly influenced by underlying gas curves, are still exhibiting pronounced contango.

UK power market capacity mechanism:  In mid December the UK government announced its intention to introduce a market wide capacity mechanism.  This is a major intervention in the electricity market, with the effect of shifting generation revenue out of the wholesale electricity market into a separately administered market for capacity.  The government claims that wholesale market volatility threatens investment in new capacity and hence security of supply, an argument that fails to recognise that the biggest hurdle for investors is the uncertainty created by piecemeal government intervention.   DECC has provided scarce details of the mechanism design and the timing of the introduction of the capacity market will be a political decision at an undetermined point in the future.  The level of uncertainty surrounding the capacity market suggests investors are likely to wait for further clarity before committing investment capital.

Meanwhile UK renewable investment stagnates:  Despite the positive spin the government is trying to build around renewable investment environment in the UK there is little empirical evidence to support the claims.  Despite the government building its Electricity Market Reform (EMR) policies around support mechanisms for renewable capacity, investment was little changed in 2011 compared to 2010 and substantially below 2009 levels.  The investment slowdown is due in part to ongoing capital constraints, particularly given difficulty in obtaining finance as the debt crisis has deteriorated.  But the data is also evidence of an investment hiatus as developers wait for further clarity as to the details of the government’s EMR policies.

Picture of the week:

Barges transporting coal on a British canal.  The Freight Transport Assocation drew attention this week to the potential for once again using Britain’s Victorian canal system to transport fuel.  The FTA sees a huge potential for the transport of biomass to feed renewable power stations in the UK.