Utility Week

UTILITY Week 6th November 2015

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Page 26 of 31

Markets & Trading UTILITY WEEK | 6TH - 12TH NOVEMBER 2015 | 27 Analysis I n 2008, the oil price soared to $147 per barrel. Now, the price for Brent Crude is around $50 – and gas prices have tended to track oil price trends, although the corre- lation has been less pronounced of late. The great uncertainty is whether lower US shale-driven oil and gas prices are a short-term phenomenon or whether they will endure long term; much will depend on Saudi Arabia's oil production policy. We could be at the forefront of a new paradigm of low energy costs, or prices might return to their 2008 peak. For utilities, the gamble either way holds very different outcomes. On the one hand, cheaper gas prices could boost large user demand and the profitability of gas-fired generation. At the same time, increasing effi- ciency could undermine any demand gains while earnings and profit losses might undo a boost to generation margins. Theoretically, far lower oil and gas prices should stimulate UK fossil fuel generation investment. Aer all, if gas input prices are cheaper – they account for a large propor- tion of a combined cycle gas turbine (CCGT) plant's operating costs – the investment case should be more attractive. But in the UK, electricity generation operates in a far from perfect market; in fact, most UK generation investment is subsidy-driven. Even so, a combination of depressed gas prices, minimal UK plant margins, as updated recently by National Grid, and his- torically low interest rates would seem to be an ideal scenario for a second 'dash for gas'. The reality, though, is that virtually no base-load plant is under construction, although SSE's depreciated 735MW Keadby plant will reopen this week. The new-build exception is Carlton Power's planned CCGT plant at Trafford in Manchester, which crucially has still to achieve financial close. Prior to the general election, the lack of base-load investment was partly attributable to political uncertainties. With the election of a majority government, it was hoped that investment in new plant would rise. Despite progress in advancing the Hinkley Point C project, these hopes have not been realised. CCGT plants have not delivered decent financial returns for some years. In 2013 and 2014, Centrica reported losses on its CCGT plants of £120 million or more. Against such a background, it is not surprising that CCGT investment languishes in the doldrums. Instead, the big six are more keen to reduce their excessive net debt levels than to respond to lower gas prices by building new base-load plants. On the supply front, margins in the UK have generally been thin. Lower fuel input costs are unlikely to have a major effect on overall financial returns. However, utili- ties do stand to gain if enduring low energy prices boost demand. In recent times, energy growth levels have lagged below the long-established two-thirds of GDP growth rule of thumb ratio; part of this trend is due to the current emphasis on energy saving. Furthermore, the advent of smart meters should depress demand. However, if domestic electricity and gas prices continue falling on the back of lower raw material prices, this could drive up energy use. But it will be some time before the full effect passes though the system, given that utilities book most of their gas supply requirements years ahead. By the time their core contracts have unwound, the oil price might have returned to nearer 2008 levels. More specifically, the sharp decline in the energy prices has severely affected Centrica's results. In the first six months of 2015, and despite almost identical output levels, Cen- trica's gas production profits were decimated when compared with the same period in 2014: £48 million compared with £465 mil- lion. Its full-year gas production returns are unlikely to make pretty reading for investors. For consumers, falling energy costs can only be beneficial. Aer all, since 2005, domestic electricity and gas prices have risen sharply. But, if the low oil price is main- tained, there is every likelihood that this upward trend will be reversed. Hence, UK utility chiefs would be well advised to watch Saudi Arabian oil developments like a hawk. Nigel Hawkins, director, Nigel Hawkins Associates Keep an eye on Saudi Arabia Lower oil and gas prices could lead to greater demand from large users and falling energy costs for consumers, but much depends on Saudi Arabia's oil production policy. Nigel Hawkins reports. Clean spark spread Lower oil and gas prices have helped boost the profitability of gas-fired power generators. Market experts at Icis have noted a 72 per cent increase in the value of a tradable product known as a clean spark spread, which measures the price of gas generation minus the cost of gas and carbon. At the start of Q2, the clean spark spread for UK power delivered this winter was valued around £2.50/MWh. At the end of Q3, this had risen to around £4.30/MWh, having peaked at around £4.70/MWh a fortnight earlier. 4.5 4 3.5 3 2.5 2 WINTER 2015 UK CLEAN SPARK Jan 2015 Feb 2015 Mar 2015 Apr 2015 May 2015 Jun 2015 Jul 2015 Aug 2015 Sep 2015

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