Timera Angle

UK T-1 auction implications

5 takeaways from the T-1 auction results:

  1. Coal closure The 1.8GW Eggborough coal plant was unsuccessful in the auction and will close end of Sep 2018. 0.4GW Fiddlers Ferry U1 also missed out. No surprises here given weak dark spreads. T-4 auction may precipitate further coal closures.
  2. Peaker build 1.0GW of new peakers/DSR were successful in the auction, likely dominated by early delivery of already committed capacity.
  3. Next winter Otherwise Win 18/19 set up looks similar to Win 17/18. 1GW Peterhead CCGT survives another year (lower TNUOS costs). 0.6GW Drax unit 4 missed out in T-1 but is scheduled to return from biomass conversion by Nov 18.
  4. Peak pricing Replacing coal with high variable cost peaking/DSR capacity should continue to support super peak prices.
  5. System transition Grid continues to face diminishing control/visibility as transmission connected assets close. This focuses the need to push through with reforms of balancing & ancillary service markets and system charges.

UK suppliers wiped out by market risk

Two small suppliers have ceased trading this winter, with wholesale market risk exposures playing an important role. 5 things to consider:

  1. No surprise Player entry and exit are characteristics of a well functioning market. Supplier failures are also consistent with an increasing number of new entrants. Regulators should not overreact to signs of a competitive market.
  2. Managing market risk Hedging isn’t trading. It is more like margin insurance. You need to understand what risks are covered and how much cover costs. Determining whether hedging is ‘expensive’ depends on the level of cover.
  3. Shape risk The UK power market makes hedging retail shape difficult. Market dynamics mean this may get worse rather than better.
  4. Market vs sales Properly reflecting market risk in product pricing decisions is both complex and critical. This can often be overlooked as a priority in a sales driven business.
  5. Market access Route to market services for small suppliers are expensive and limited by credit. The need to balance business growth with maintaining good credit worthiness is essential to be able to manage market risks effectively.

UK power transition & flex asset value

The UK power market is undergoing a transition with major implications for flexible asset value. 5 key takeaways:

  1. Capacity mix transition Structural transition in UK supply stack continues apace. Renewables (low SRMC) and engines/batteries (high SRMC) are replacing coal & CCGTs (mid-range SRMC).
  2. Price shape & volatility Stack changes increase price shape & volatility, pushing asset value into prompt. Changing load patterns & long duration batteries should dampen impact over time.
  3. Flex investment battle Engines, CCGTs, batteries & DSR competing at margin to provide capacity. There is no clear winner. Cost of capital, value management & market access are key.
  4. Value management Flex asset value is being realised in prompt horizon & BM. This means higher risk and more complex hedging & optimisation. Value extraction requires scale & sophistication.
  5. Market access Key asset owner decision: ‘in-house’ or ‘out-source’ market access. Outsourcing can provide scale & sophistication. But contract structure must be water-tight.

More details in our briefing pack Capacity mix transition driving flexible asset value.

Power asset ‘end of life’ economics

Decarbonisation policy and renewable penetration are bringing ‘end of life’ decisions into focus for thermal asset owners. 5 things to consider:

  1. Adding value: Investing in enhanced asset flex (e.g. lower MSG) can unlock value via alleviating constraints in capturing price shape & volatility.
  2. Conversion: Owners of older CCGTs are reducing running costs and extending asset lives via GT conversion i.e. ST bypass.
  3. Decommissioning: Site value and re-use of infrastructure are important. Deferral of closure capex can also have a big NPV impact, particularly for coal plants.
  4. Capacity prices: End of life economics are often structured around capacity bids as the balancing item i.e. bid required to remain open.
  5. Optionality: Key to maximising value is cleanly defining and valuing different interdependent exercise decisions (e.g. flex upgrade, convert, mothball, close).

LNG charter rates sharply higher

Strong Asian LNG demand this winter is driving up spot charter rates for LNG vessels. 5 things to watch:

  1. Rates Spot charter rates have tripled since Q2 2017. Daily rates for a 160k m3 TFDE vessel rose from $25k to around $80k from Q2 to Q4 2017.
  2. Other costs Market tightening has also increased the ballast bonus & positioning fees being commanded by vessel owners (above headline daily charter rate).
  3. Drivers Increased demand for vessels to take advantage of higher spot prices in Asia and new liquefaction capacity coming online.
  4. US exports Rising charter rates have an adverse impact on US export economics i.e. increase the strike cost of the US vs Asia/Europe spread option.
  5. What next Spot charter rates have risen well above term charter rate levels (e.g. for 1 year). Spot rates are likely to cool as Asian spot cargo demand subsides with the winter.

Timera Snapshot

Changing Russian gas flow patterns

The chart shows the monthly profile of gas pipeline imports to Europe. Imports are dominated by Russian flows which have traditionally displayed a pronounced seasonal profile, driven by long term contract nominations.  But the flow profile has changed over the last two years.  Gazprom has been more actively marketing gas volumes into Europe.  This has increased imports across summer periods, dampening seasonal shape.  Russia is also favouring Northern import routes, which is eroding the impact of seasonal flex provision from large storage facilities on the Ukraine route.

UK 2021-22 capacity auction carnage

The T-4 auction data out this morning allow deconstruction of a shock result.  The table above lists plants that failed to clear the auction. Older coal and gas turbine units were pushed out by new interconnectors, peakers and DSR.  The surprise was not so much the plants that failed, but the price level at which they exited.  Unavoidable fixed costs and weak wholesale margins pointed to exit prices for older coal & GTs above 20 £/kW. Instead a battle of attrition drove the clearing price down to 8.40 £/kW, setting up 8GW of large plant closures early next decade.

2017 UK gas market load duration curve

The UK load duration curve for 2017 illustrates some key characteristics of UK gas supply. Domestic production flows to a relatively flat profile (little flex). Norwegian imports have a pronounced seasonal profile, more so since Rough has been withdrawn. The interconnectors (IUK and BBL) are also providing seasonal flex and acting to cap deviations of NBP from TTF.  But in a post Rough market, it is fast cycle storage that is providing key deliverability to meet demand on peak days.

UK gas vol: 2 steps forward, 1 step back

2016-17 has seen the start of a structural recovery in spot gas price volatility. This has been helped by a big increase in CCGT load factors and the closure of Rough.  ‘On the day’ volatility roughly doubled from 2015 to 2016.  The recovery paused in 2017, with volatility falling back to around 2012 levels. But spot volatility is still well above 2014-15 with increasing import dependency, intermittency & ageing infrastructure likely to support a further recovery into next decade.

UK seasonal gas price spread revival

UK summer/winter price spreads have risen by more than 50% over the last 12 months, with front year spreads currently at 9 p/th. The recover reflects a strengthening seasonal price signal since the closure of Rough and winter Asian LNG price spikes (caused by limited Asian storage, cargoes pulled away from Europe supporting winter hub prices).  Greater Norwegian flow flexibility is dominating replacement.  But the UK is also relying more on seasonal flex from IUK/BBL and LNG imports.

German CCGT margin recovery

There has been a clear uptrend in German Clean Spark Spreads (CSS) over the last 2 years (see chart).  Baseload CSS has recovered towards zero from levels below –10 €/MWh. Peak CSS has broken above 10 €/MWh.  The recovery in CCGT margins has been driven by a big rally in coal prices, with coal plants dominating marginal price setting in Germany. Clean Dark Spreads (CDS) have been relatively stable over the last 2 years, as rising coal prices have pushed power prices higher.