Industry NewsAs a new decade dawns, the effects of events from the last year in the energy sector and further afield are still being felt worldwide. Here, Veronica Truman takes a look back over 2009 and offers a view of the factors that will affect energy purchasing in 2010.
Perhaps more than any other, the events of 2009 have set the agenda for the 12 months ahead, if not for the next decade. The climate – both economic and environmental – has taken centre stage and will dominate the energy markets for the foreseeable future.
2009 in summary
As the new year dawns, concerns will be focused upon the delivery of Russian gas supplies and whether transit nation Ukraine can pay its monthly gas bill to Russia's Gazprom. The issue is high on the agenda for all parties, with the implication that if payments are not met, then supplies will be curtailed into Ukraine – as they were in January 2009 – potentially impacting forward flows into Europe. Whilst most parties indicate that the issue is economic in nature – due to the current recession in Ukraine – there is an undeniable political dimension, with loans to the nation contingent on a number of reforms.
This is just a one example of how politicised the energy market has become. As the UK moves to become a net importer of gas, our susceptibility to supply disruptions further afield is significantly increased. This factor, combined with the need to reduce carbon dioxide emissions, has formed the basis of the UK government's Low Carbon Transition Plan (LCTP). The plan aims to reduce the UK's reliance on imported gas, raising the capacity of renewable generation and, perhaps more controversially, nuclear power.
As part of the proposals, the deployment of 'clean coal' technologies in the shape of carbon capture and storage (CCS) has been highlighted, but this strategy was dealt a blow in recent months as many suppliers who had planned to invest in this area announced they were to delay or scrap CCS development. The reasons behind the U-turn include economic constraints as a consequence of falling energy demand and changing investment priorities. Greater support from the government and a streamlining of planning processes will be needed in order to make CCS commercially viable.
The issue of 'how to keep the lights on' reached a head with the closure of numerous coal-fired plants – due to the Large Combustion Plant Directive (LCPD) – as well as nuclear stations that are reaching the end of their generating life. The LCPD had a major impact on generation patterns in 2009 and on wholesale prices. As the LCPD limits the run-time of affected plant, it has injected a fresh sense of uncertainty over when and what generation assets may be available at any given time, depending on the plant operators' specific LCPD strategy.
Operating power stations that have opted-out of the LCPD triggered a change in the merit order, displacing gas as the marginal fuel of choice. 2009 saw gas being driven by the movements in crude oil prices, despite the UK gas market ending oil-indexation over a decade ago. The problem is the aforementioned move by the UK to net import status due to the maturity of indigenous gas resources. This has meant the UK is sourcing more gas from Europe where oil-linked gas contracts still dominate.
The increased use of liquefied natural gas (LNG) – a consequence of the UK's increased import capacity – has added another pricing dimension to gas. The use of this fuel is being driven by the desire to diversify import opportunities, therefore increasing security of supply, given that the UK tends to be at the end of traditional pipeline routes.
A side effect of the increase in the use of LNG is the development of a link between the UK and US Nymex Henry Hub prices. The US is a heavy user of the fuel and the differential between the two markets has been taken as an indicator of the cargo's final destination. However, most LNG deliveries are made under long-term contracts at present and are largely insulated from day-to-day price variations.
The volatility of crude oil prices continued to make headlines, with Dated Brent crude oil trading between $32 and $79/barrel in the last 12 months. The economic climate has been a major driver behind this instability, with increasingly diverse views on the potential scale and timing of any recovery. Throughout 2009 there were regular and significant day-on-day changes in economic indicators such as unemployment data and variations in currency values, particularly the US dollar.
The past gives an indication of the future
Looking ahead for 2010 the most pressing issue will no doubt be the development of the relationship between Ukraine and Russia, with Ukraine set to hold its elections in early 2010. It is widely speculated that the internal political disagreements between Ukraine's Prime Minister, Yulia Tymoshenko and the country's President Viktor Yushchenko, have been a major factor behind the payment issues. It is presumed unlikely that Viktor Yushchenko will retain his current position – given low approval ratings – and therefore the winner of the election will central to developing a more positive relationship with Russia, with the rest of Europe hoping some stability will be achieved.
The supply disruption at the start of 2009 – which left many eastern European countries without gas – has led the European Union to find ways to diversify away from Russian supplies. One project under consideration is the Nabucco pipeline between Turkey and Austria which would bypass Russia. Construction of the pipeline is expected to begin in 2010, but it is already facing competition in the shape of the Russian-backed South Stream and Nord Stream pipelines. This may well result in the energy companies involved in these new links ensuring that their pipeline becomes the dominant supply route for Europe.
For many end-users, the introduction of the Carbon Reduction Commitment Energy Efficiency Scheme (CRC) will alter the way they use energy. Effectively, the CRC is aimed at capturing installations not currently included in the European Union Emissions Trading Scheme (EU ETS). The scheme will require the vast majority of UK business to account for their carbon emissions and ultimately will cap these emissions or impose financial penalties. The CRC will be launched in April 2010, with the first 12 months being purely an accounting year.
April 2010 also sees the introduction of new system charges for electricity and with it a major change in how delivery charges are structured. Annual changes in transmission and distribution charges in April are common and are in-line with the price controls negotiated by network operators with Ofgem. However, the regulator has attempted to improve the transparency of these charges by implementing a uniform approach to structure and methodology across all the various distribution companies.
Therefore geographical location is likely to dictate who will win and who will lose in the charges lottery. This may also impact contract negotiations now and further into 2010. Businesses should be very careful when considering whether to take all-inclusive or transportation pass-through contracts – in some cases suppliers may limit customer options as they seek to mitigate their own exposure to the charges.
In upcoming energy contract negotiations the dominant factor will remain wholesale energy prices. As well as the aforementioned supply developments, the global economy will remain a strong contributory factor. While many countries have officially exited recession, many more – including the UK – are still in negative growth. As well as the impact on demand affecting prices, the economic climate is also reducing the incentive to invest in energy assets. The stalling of investment may well result in additional costs – due to higher wholesale prices – in the future, in order to meet demand requirements in the years to come.
Another economic factor is the prospect of a double-dip recession. Countries may be showing signs of recovery, but the steps taken to get to this position, along with the market and consumer reaction to these signals, could well lead to some nations falling back into recession in 2010.
2009 has seen crude oil show strong sympathy with economic signals and this is unlikely to change in the near-term. As such, consumers should be prepared to deal with the ramifications of continued volatility in the energy market, particularly as it also seems clear that the UK gas and electricity markets will remain tied to oil for the foreseeable future. One mitigating factor to the oil link could well be the continued growth of LNG, although one could argue that it would shift the influence on UK gas prices from one globally traded commodity to another.
With wholesale price volatility set to continue – if not increase – the way businesses buy their energy is likely to alter dramatically, with a continued push towards flexible contracting. Suppliers, for their part, have been keen to promote this trend, providing attractive propositions for consumers. However, a sound risk management strategy is essential for any business entering such a contract.
Traditionally, the move to more flexibility in energy contracting has predominantly been the option of larger business, but this has started to change over the last few years with the development of Portfolios. A Portfolio allows a group of smaller businesses to aggregate their volumes into a single supply contract therefore gaining the ability to secure a fully-flexible deal.
In 2009 suppliers tightened their credit-checking procedures. However the improvements in the economy may well see credit issues taking more of a back seat. Last year saw suppliers requesting increasingly onerous contract terms and, in some cases, refusing to quote for some consumers at all.
2009 has been extremely painful for many businesses, and unfortunately many of these negative factors are likely to persist into 2010. Consumers are facing an increasingly volatile and uncertain future in their energy contracting and therefore need to take steps to mitigate this risk. In an energy market dominated by environmental and political factors, where fundamental supply and demand may not be as prevalent a driver as in the past, this is no easy task.