Pound slides to multi-year lows on Brexit concerns

Boris Johnson’s appointment as Prime Minister has seen a change in strategy regarding the UK’s negotiating stance with the European Union over its exit. The new PM has pledged to leave the EU by 31 October, deal or no deal. Furthermore, while his wish is very much for an agreed exit, Mr Johnson is taking a hard line with negotiators, refusing to meet with EU leaders until a new deal is offered, without the Irish backstop.

The heightened risk of leaving the Union without a withdrawal agreement has had a negative influence on the value of the pound. Sterling has fallen more than 2% against the Euro and 3% against the Dollar in the first week of the new PM’s premiership. The pound’s value against the Dollar is the lowest in nearly two and a half years, approaching the lows reached after Article 50 was triggered in March 2017.

Increased Costs

The weakness in the value of the pound will increase costs for consumers. British imports of energy from the Continent will require a price premium which covers the wholesale and shipping costs in delivery of supply. Weakness in the pound will make these imports even more expensive when the purchase price is converted from Euros. This would be a particular issue during periods of high demand, extreme weather or supply disruptions.

Impact on Supply

In previous blogs, we have explained how Brexit is very unlikely to mean the lights go out. The UK continues to strengthen Interconnector links with Continental Europe with the capacity for power links expected to double to over 8GW by 2022.

Britain is seeking to retain as free as possible access to the EU Internal Energy Market, post Brexit. Gas and power will still be able to flow between the EU and the UK but there is the potential for legislative issues, and trading could become less efficient while long-term security of supply is less clear.

It is a similar situation in the gas market, although the UK is much more reliant on imports, with more than half of the country’s natural gas being imported from countries in the European Economic Area – the vast majority from Norway. The UK can also import supplies of liquefied natural gas (LNG) shipped on tankers and pipeline flows from Belgium and the Netherlands.

Brexit is not expected to impact on the availability of this gas, even under no deal. However, less efficient trading, the possibility of new regulations, and heightened currency variations would all likely increase costs for consumers.

With the UK unable to meet demand with its own indigenous supply, the country is expected to become increasingly reliant on energy imports from foreign sellers, making these issues more prevalent in the day-to-day trading of energy.

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Weekly Energy Market Update for 29 July 2019

Gas

Balance of Summer gas prices continue to move lower. The September gas contract has moved to new lows in anticipation of low demand for the remainder of the summer. August gas prices fell 3% across the week but are finding support from expectations of heavy maintenance, which will reduce North Sea production next month. Weakness at the front of the curve reflected healthy supplies and low energy demand levels.

The UK experienced its hottest ever July day, but the extreme heat made little extra impact on gas demand. Overall gas consumption remained at its summer lows with weak domestic consumption and excess gas being injected into already very healthy gas storage sites.

UK gas storage stocks rose 15% last week, while total European gas reserves are fuller than ever before. This will reduce injection demand for the rest of the summer and limit the ability of storage to absorb excess production. This would risk further oversupply, pushing prices to lows that will encourage producers to reduce output, as the demand will not be there. Winter 19 prices followed the summer market lower but the rest of the curve saw little change.

Contracts from Summer 20 onwards spent the last week stabilising in the middle of their July range. The strong gains seen in the first half of July have been partly reversed after costs fell heavily early last week. Prices retreated after reaching levels that would have attracted spot LNG cargoes to Europe, an additional supply source that is not required. Any further losses on the curve are being capped by the continued strength in the carbon market. Carbon costs are holding around €29/tCO2e, close to all-time highs.

Gas Graph

Power

Power prices moved lower last week, in line with the weaker gas contracts. However, price movement was more gradual. Seasonal contracts remain above their early July lows, following the strong rally seen in the first half of the month. While prices have dropped back from their mid-month highs, the market remains elevated, supported by the continued strength in the carbon market and higher coal prices. The cost of carbon allowances remains close to record highs at €30/tCO2e, having risen nearly €25 over the last two years.

Peak electricity demand rose marginally last week, supported by low wind and demand for cooling as the UK experienced its hottest ever July day. However, demand levels only peaked around 34GW, within the summer range, heavily limited by the UK’s lack of air-conditioning infrastructure. Peak consumption is forecast to drop to new lows of 32GW this week. Gas dominates the fuel mix but the impact is muted by the low summer demand levels.

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An Insight into Gas Storage

Gas storage in the UK and on the Continent are both continuing to fill up fast and are much higher than normal levels for the time of year. With so little of the injection season having passed, for storage to be at these record high levels could pose problems later in the summer, when assets are even fuller and demand even lower.

UK

Medium Range Storage in the UK is 66% full, with considerably more gas in store for this time of year than at any point in the last six years.

The high inventories are partially boosted by Interconnector (IUK) maintenance happening in April as opposed to June. However this schedule change was to coincide with a time when the conduit was typically less active. With just 5TWh of working gas capacity left to fill, IUK exports will be key in using up any excess supply.

In September 2016, storage was at almost full capacity and the IUK was flowing at its maximum level. This pushed prompt prices as low as 20.6p/th. However, this situation is less likely now as the BBL pipeline, which currently only flows from the Netherlands, is undergoing maintenance to enable reverse flows (UK to the Continent). This will open up a route for a further 40 MCM/d of gas to flow away from the UK.

Europe

European storage reserves are 100 times bigger than the UK with a working gas capacity of 1087 TWh. This is currently 62% full. Having entered the injection season at the highest levels on record due to the additional LNG coming to Europe, injections have actually begun the season fairly strongly. Additions to gas storage are only marginally below last year’s levels when the injection season began with inventories at record low levels.

Injections across Europe through summer 2018 run at, on average, 3.3 TWh/d. However in June, July and August this moved to 4.0 TWh/d. If we run at that rate of injections this summer, then storage will be full by the middle of September.

However, as assets fill, due to increased pressure within the facility the rate of injection slows. At this rate, European assets will be 90% full by late August. Assuming the injection rate then halves, Europe will have to accommodate, or see a supply reduction, of 1TWh of gas per day throughout September, that would typically go into storage. This is over half of the UK’s total demand on a summer day.

This scenario is likely to tip the supply demand balance and could put very strong pressure on gas and power prices later this summer.

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Our Market Intelligence team keep a close eye on the energy markets and industry updates. For the most timely updates you can find us on Twitter and LinkedIn Follow us today.

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