Geopolitics trump fundamentals

The months ahead will be filled with uncertainty – and price volatility – as energy market participants assess the consequences of the escalating conflict in the Middle East and potential sabotage to the gas pipeline linking Finland with Estonia. Will these events override market fundamentals? Listen to a discussion of the key developments in UK and continental wholesale power and gas markets in the last quarter and the outlook for the coming months. 

Host: Snjólfur Richard Sverrisson, Editor-in-Chief, Montel

Guests: Jean-Paul Harreman, Director, Montel EnAppSys,
                  Paul Buckworth, Principal Consultant, Montel EnAppSys.

Transcript

Snjolfur: 0:05

Hello listeners, and welcome to the Montel weekly podcast. Bring your energy matters in an informal setting. In today's pod, we take a look back at the key developments in UK and continental energy markets over the last quarter, as well as discussing what the issues will be in the coming months. Will the downward trend in energy demand continue? What will happen to prices? And most crucially, does everything depend on the weather? I'm Richard Sverson and joining me today are two experts from Montel's. A warm welcome, Paul Buckworth and Jean Paul Harriman. Thank you. Thank you. Before we kind of take a deep dive into the report that you guys wrote about the last quarter and discuss the following ones. I'd just like to, you know, two recent events have sort of highlighted or thrown a lot of uncertainty into markets. And I'd, I'd like to start off with the, the Baltic pipe. Incident. We don't know what's happened there. The, , the gas pipe connecting Finland and Estonia suffered a massive loss of pressure. There's suspected sabotage. We don't know. But you know, I know we, we, we can't really speculate what happened here, but what are the implications for. for for the market here, the European gas and power markets. Paul, what's your, what was your initial reaction? Does this raise questions about the vulnerability of, of energy infrastructure?

Paul: 1:24

Indeed. Yes. Yeah. I think it, it does very much highlight that I think the, the trends that we've seen in recent weeks and months have seen. An easing, if you like, of the perceived pressures in the market that came about following the build up to and the aftermath of the outbreak of the Ukraine war, and some of those pressures have eased a bit, although we have seen jitteriness in the markets and spikes in market prices in response to short term events, but this latest development really does, I think, highlight that and bring into it. Thank you. Kind of clear view that potential vulnerability of, of supply to infrastructure exposure and risks such as that, and I think that will likely feed through into to market sentiment and, and, and potentially we see you. Prices spike even without further impact on, on infrastructure. Just the risk premium that, that will be there, it'll create its own pressures, I think.

Snjolfur: 2:33

John Paul, what's, what's your view here? I mean, we've seen incidents at both Nord Stream and now the Baltic Pipe. Neither of which we know exactly what happened, but is it more the gas infrastructure that's vulnerable or is, is the sort of power infrastructure also problematic here?

Jean-Paul: 2:49

Yes. Well, we've seen some, some studies on, on yeah, on, on the offshore industry as well. So offshore winds, of course, far away from any protection. So yeah, you would say that that has similar vulnerabilities. And it's just feeding into a little bit of the nervousness in of, of the markets. So we're seeing a very tight supply demand balance.. You can see even even rumors or, or, or sentiments are affecting prices quite quickly.

Snjolfur: 3:20

And what about the, the Arab Israeli conflict now? We've seen some horrendous incidents in, in the, in, in Israel and in Palestine. Is there risk here that there could be contagion into global oil and gas markets

Paul: 3:33

here, Paul? Very much so, I would have said any escalation. Is, will certainly feed through into market sentiment. I do wonder, and it's not my area, but, you know, any, any escalation that could draw other nations and produce the nations into any sanctions regimes would have likely have a major impact on energy supplies, gas and oil, and feed through into electricity prices. I think despite what I said earlier about the situation of having eased in, in recent weeks and months that there is still tightness there and, and the response to any events that we've seen is, is, is quite marked and that this is just an order of magnitude more serious than, than any of those other events that we've seen over summer that have fed through into, to pricing and... and supplied. Jean Paul, what's your,

Jean-Paul: 4:21

what's your view? Yeah, I think, I mean, the direct exports from Israel to the European Union are quite limited. I think yeah, it's, but it's the political effect of it. So if indeed other, other nations get drawn into the conflicts that may, yeah, I mean, a lot of the, a lot of the Arab world is our major suppliers of of, of gas to the world. So, yeah. It's a, it's a tight balance and the recent, recent history has shown that conflicts can get out of hand quite

Snjolfur: 4:53

quickly. It's a bit of a powder keg in a way, isn't it? Okay, let's go on to the, the, the, the, the quarterly reports that, that both of you authored for Enapsis. In Q3, we saw, what happened to prices, Jean Paul, on, on, on, in continental Europe?

Jean-Paul: 5:09

What were the trends here? Yeah, we've seen quite Quite a relaxation on, on, on prices. So we've seen a drop yeah, partly because of the dropping gas prices. Also the, the gas storages are quite full. The hydro situation is is, is quite comfortable. So you're seeing a lot of lower prices, especially compared to last year, but also compared to the previous quarter. And we're yeah, it's also produced some some extreme events in terms of negative prices. So Netherlands is, is is a clear example with with a lot of negative prices due to the, due to the immense solar development. But we've also seen negative prices in Scandinavia, which is quite interesting because that used to be in a region that was quite well safeguarded from negative prices. So Finland is the, is the, the, the biggest example where the, the nuclear power plant basically. Yeah, increased the base load level and, and yeah, that sort of results in in some surplus situations, but also the prices of GEOs have have increased quite considerably, which means that even if you run at zero, at a price of zero, you can still make money on, on your guarantees of origin. So, yeah, interesting, interesting developments.

Snjolfur: 6:31

And do you expect these trends to continue in the coming months as well? I know, you know, that we're entering the darker months as it were, so solar shouldn't have too much of an impact, but I'm sure it still have some some consequences. Yeah,

Jean-Paul: 6:44

well, we're going to see higher prices than this quarter, of course, because, yeah, it's winter and demand is higher. But yes, the wind is coming back, so we're going to see surpluses that last a bit longer. And I think looking at Scandinavia so in, in the past, we used to see flows from Scandinavia to the continent, basically nonstop. Over the summer we've seen reversal of it, reversal of interconnectors quite frequently. I think that's a trend we're definitely going to keep seeing. And,

Snjolfur: 7:16

and in the UK, Paul, what, what were the, the major sort of trends in, in, in the last quarter?

Paul: 7:21

Very, very much downward trend on I think similar to what John Paul has described in continental Europe that, that's driven by the linkage between gas and electricity prices, albeit the, the, the, there's a general downward trend well, through the whole year, really, but that's certainly continued through Q3. With the exception of some blips in July, which I think were related to prolonged or longer than expected outages in some of the gas fields. I think Nyhammer in Norway was the one I recall. And then in late August, early September, there was prospect of an Australian LNG strike disrupting. Supplies and that sent the worldwide gas prices and LNG prices upwards for a period and that that fed through into what we saw in electricity prices. Perhaps lesser extent of negative pricing in GB less, less pronounced, we saw intervals in early July, which I think was a windy period. And then in in early to mid September, where we saw another. Very windy period, so there's a high level of renewable. output coupled with the low levels of demand that we, we see at this time of year so it creating an excess of supply and that fed through into negative prices in the day ahead market in those, those periods. In the balancing mechanism, we probably see negative prices to a greater extent, but and, and those are localized and reflects transmission constraints. So don't filter through into the, the day ahead pricing and then in quite the same way albeit the customer ultimately pays the cost of those in their bills. Absolutely. I

Snjolfur: 9:14

mean, what, what do you expect in the coming months then, Paul? As, as John Paul has said, you know, there's more demand and the, the, you know, it's, but. Potentially that could be counterbalanced by more wind.

Paul: 9:25

Yes, yeah indeed demand will pick up as we move into the winter, so that, that seasonal pattern will, will re establish I mean in Q3, one of, one of the, the, the, the in fact, a lot of recent quarters, we've seen very low levels of demand against historical norms, and that reflects a number of things, I think there's price sensitivity to the high prices probably being the main one, but also some growth in renewable so embedded renewable generation, and even behind the meter renewable generation, so that reduces the apparent Thank Demand at transmission level. So, so that, that trend is, is still there. In terms of the growth of renewables, we saw high levels of renewable output in Q three. I think it was the highest Q three. We've, we, we've seen looking back at torical quarters the same quarter historically. And that reflects the, the underlying upward trend in, in installed capacity. Yeah, coming into the winter. Obviously solar will decline, that is very seasonal. Output wind wind tends to be less seasonal, but there is, there, it is higher in winter generally than summer, but the differential between summer and winter is, is obviously far less than. And for solar, but as, as

Snjolfur: 10:50

you mentioned as well, Paul, you know, the with the Australian strike and how jittery the market was or how prices spiked, not just in the UK and Europe, but across the world, the market is still very nervous as, as what's, as what's being reflected in in the price of gas this week on the continent and in the UK, given the situation in the Baltic pipe and the questions around infrastructure, as well as the Arab Israeli conflict. So we can expect maybe more, you know, more of the same kind of volatility going forward. I think

Paul: 11:22

so, you know, potentially accentuated because of the winter you know, increases in demand and there's less headroom, if you like, for to accommodate any shocks in the supply demand balance. So I think through the summer, there's certainly jitteriness there, despite the fact that storage was being filled and, and, and at high levels and, and, and you know, whatever short term. Disruptions that might have been the longer term trend was that Storage would be filled by the end of the summer. And despite that, there's still occasional jitteriness. I think going into the winter yeah, anything that impacts that balance and eats into any headroom that might be there will, will feed through into the market and, and, and we'll, we'll, we'll see. Sharp reactions to to data to any any such events. I would imagine

Snjolfur: 12:19

absolutely jumbo We talked a little bit about demand could what did you what are we seeing in in q3? And you know, there's a lot of talk about demand destruction, you know anything from on on the industrial side also households What what happened in q3? What can we expect over the coming? I mean months is any of that, you know that the industrial demand going

Jean-Paul: 12:40

to return. I don't think And that's going to return on the short term. So we've seen demand destruction in in the chemical industry, in the steel industry, in the paper industry. Some of that is shifting production to other continents. So yeah, if prices drop down low enough that that's might come back. But there's also some permanent permanent closures that, that have happened. So I think with demand now being at at similar levels than during, during COVID yeah, we're not going to see this. Come back to the old level anytime soon. Of course next to demand destruction, there's also demands creation slowly starting to pick up with power to X technologies and and people starting to develop yeah. Electrolysis and hydrogen generation sites. Yeah, that's a, it's a question mark how fast that's going to, going to come and how how big of an impact that's going to have. It's definitely not going to have a major impact this winter.

Snjolfur: 13:49

And maybe next year, do you think? The, the, the, the power to X being power to, to hydrogen generation, isn't it? Power to hydrogen production.

Jean-Paul: 13:56

Power to hydrogen, power to ammonia, yeah. That's so it, those, those assets don't take. Too long to build, but the permitting process can be quite quite lengthy, so it's it's a bit of a question mark how fast it's

Snjolfur: 14:09

going to go. So maybe something for later this decade rather than the next coming years. Yeah, absolutely. Paul, what's the situation in the UK?

Paul: 14:17

I, I think that's very similar. I mean, we've seen you know, industrial demand decline in response to high prices and, and possibly also domestic. Demand and e even demand flexibility schemes introduced to, to manage demand at at system peaks. Yeah, I, I don't expect that to, to, to come back at, at, at, at any, any great rate really. I think that will be a slow recovery process and demand

Snjolfur: 14:49

creation that John Paul mentioned. Is any of that happening in a similar way in the uk? Yes. Yeah.

Paul: 14:54

There, there's various schemes for. Electrolysis and hydrogen production that we're aware of. And also electrification of heating is at a commercial and industrial level. We're seeing seeing potential development of that. And also the domestic level, I guess. You know, the government is, is, has. Very much been pushing heat pumps as a solution. So that that's definitely the direction of travel The extent to which we see it in the in the immediate near term is is probably limited But it it will start to to happen.

Snjolfur: 15:33

There's been obviously some rollback. We discussed this in a previous podcast rollback from the present government as well and which maybe could hit demand in the coming year or two, would you, would you say that, would that, would that be too, too too hard to, to make that judgment call there?

Paul: 15:50

Yeah, I'm sure it will I'm not sure what the, the, the latest position on heat pumps is, but certainly on electric cars, the, the mandates. Been pushed back from 2030 to 35. I think there's probably a similar delay in, in, in the heat pump targets. So and that'll Inevitably, I would think, feed through into the customer's appetite for these things, if there's that uncertainty there, or the, you know, lack of mandate for it, then, then, then I think we'll see a slower take

Snjolfur: 16:22

up. Absolutely. John Paul, turning to... Electricity generation. What were the main trends you saw in the last quarter? I know the big story was solar in the Netherlands,

Jean-Paul: 16:33

wasn't it? Yes. Yeah. Solar in the Netherlands produced a minus 500 price at some point. We've we've seen many second round auctions in the day at market until the rules were changed. So surprisingly we didn't get to a situation where the, the minimum price on the, on the day ahead market changed that was, there was a, there were a few near misses there. So that was definitely an interesting an interesting events on, on the market with such a small country having such a large effect on basically the whole country continent. So Germany is is, is also seeing this, this huge solar development. We're seeing Hungary starting to catch on. We're seeing Poland but even the Scandinavian countries starting to develop quite a lot of solar. So yeah, that is, that is a trend that is ongoing and will. Continue to go for a while because, yeah, it's just an easy thing to do. If you, if you're a household, put solar panels on your roof, that reduces your energy bill. At least it does if you're not in the Netherlands and you don't have a market index based contracts on hourly level, because then Sunday mornings can get quite expensive. We've, we've actually seen people asking on Twitter if you live in the neighborhood, please come charge your car on Sunday morning because otherwise I have to pay. So yeah, quite, quite interesting developments. But yes, so increasing renewables is, is the main headline. We've seen some, some closures of capacity nuclear in Belgium and Germany, but despite Those closures we've seen lower gas and coal and lignite production across Europe. So, yeah, the, the extra, the extra renewables are offsetting the, the closures of the nukes which is, which is interesting. It also means that there's a lot of slack in the system. So if we get a harsh winter, there's, there's enough gas and coal capacity to run fill the gaps. So there's definitely not. Or at least not looking like it right now, a security of supply issue. Obviously

Snjolfur: 18:48

the, the boost to the market was with increased availability of the French nuclear fleet as well.

Jean-Paul: 18:53

Absolutely. Yeah, that, that was the thing I was, I almost forgot. So the French have gotten their act together and basically improved the availability of of nuclear assets by about 35%. They're still not at. The historic average levels, but they're a lot better and the assets are coming back slowly for the winter as well. So that's looking a lot less dim than last year. Perfect.

Snjolfur: 19:19

And so the story would be really increased renewables production, less fossil fuel on the continent. Yeah. And what, what, what's in, and in, in GB Paul? Very similar.

Paul: 19:30

Yes. Yeah. We saw very high levels of renewable output in Q3 coupled with lower demand. And that's really squeezed the, the, Requirement for gas fire generation. So the, the, the figures for CCGT output look really quite low by historical standards. I think sort of 20 terawatt hours for the quarter, whereas you know, 25 terawatt hours for Q3 is, is a typical figure for. Previous years for gas fired. Yeah. Yeah. So that, that's certainly reduced the, the, the requirement for gas fired plants interconnector. So we've in all quarters this year, GB has been a an importer of electricity again after I think the three quarters where we were last year where we, It's a combination of the French nuclear outages and the long drought last year that the GB was in the unusual position of being an exporter of electricity. Actually the other factor in that was that because of the LNG facilities in, in GB we were able to import gas. And. Convert that into electricity and export the electricity to, to the European markets as a and, and, and displace the requirement for gasified generation in, in Europe, which which was more affected by the, the Ukraine war and, and, and didn't have the same LNG capacity. Yeah, and I think we saw that a consequence of that last year was the, to push up the. Price of CO2 allowances in the UK relative to the European scheme, and we now seem to be seeing the converse of that so the differential's gone the other way now and in recent weeks and months, that's, that's now at a discount to the European scheme, albeit we do have the the, the kind of unilaterally imposed CPS scheme that applies an additional carbon charge. What's that an

Snjolfur: 21:44

abbreviation for,

Paul: 21:45

for those who aren't in the know? Sorry, that's the Carbon Price Support. Okay. It's the Climate Change Levy Carbon Price Support. Mm hmm. Tariff, so it's a fixed tariff per megawatt hour of input fuel. Aren't inputs

Snjolfur: 21:59

from Norway up as well, Paul in

Paul: 22:02

Q3? Yes, yeah, it's been consistent Imports from Norway, I think through for it was a whole year. Yeah, there's been a few occasions where it's gone the other way, but they're very isolated. That's that's a contrast to last year where we did see more along periods of exports from GB into Norway, which I think was a consequence of the drought that we saw. Through, through the summer months last year. Absolutely.

Snjolfur: 22:32

And what, what, what are your expectations then for the coming months in terms of generation, generation in the UK? Is it going to, is gas going to come back? I mean, what's, you know, you're expecting potentially more wind, but solar's not going to have that much of an impact. So what are going to be the main generating facilities going forward?

Paul: 22:52

Yeah. Solar, decline, wind, should, should be there, but the, the underlying seasonal increase in demand will, will, will push demand up and it will be gas that, that

Snjolfur: 23:04

fill the gap. Excellent, Paul. And just to sort of round off, I think, you know, a lot depends, as I said in the intro, on, on temperatures going forward here. What, what are you, what, what's the winter looking like at the moment, Jean Paul? I know it's a bit hard to say, and you're not a meteorologist, but what are, what are your kind of expectations here?

Jean-Paul: 23:24

So. I mean all the, all the building blocks were, were nicely in place for a very moderate winter in terms of of energy prices. So the gas, gas storages were, were nicely filled. The hydro situation is, is better than average. So, so that looks all pretty, pretty comfortable. I mean, even, even a harsh winter would not really put us in any any problems apart from sentiment maybe. But yes, we're seeing now quite a lot of political or geopolitical movements which, which just introduces additional additional uncertainty in the market. Which means that even if the fundamentals are right we may still see yeah, pressure on upward pressure on the prices. So that risk, I think, is is considerable. I think we're definitely going to see volatility based on, on changing information. And I do think, I think there are, yeah, there are parties that have a benefit in having or creating uncertainty. So, yeah, it's there's, there's all kinds of things happening at the same time, but fundamentally it looks whole. very moderate for for the winter. The situation, supply situation would be very good if we if there wouldn't, wouldn't be these geopolitical pressures.

Snjolfur: 24:50

And Paul, finally, you know, do, would you agree with Jean Paul here that geopolitics trumps fundamentals going forward?

Paul: 24:56

Yes, I think so. Yeah. The, whatever the fundamentals are and if the fundamentals are robust, then geopolitics has the, has the, the capability to, to... Change those fundamentally in a very short space of time and just fundamentally change everybody's assumptions as to, as to market stability and security. Yeah. And, and, and importantly, the sentiment around that and the, and the risk premiums that need to be factored into, to market trading activity.

Snjolfur: 25:31

Absolutely. So we'll, we'll see what what the next few weeks bring it's, it's certainly looking on very uncertain at the moment, but in the meantime, gentlemen, thank you very much for being guests on the Montel weekly podcast. You're welcome.

Paul: 25:44

You're welcome. Thank you.