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E.ON Monthly Market ReportJuly 2016

Market summary for June 2016 Gas: Gas prices rise during market uncertainty.

Power: Power prices follow the cost of fuels.

Oil: Oil prices move sideways as bull run loses steam.

Carbon: European Carbon prices crashed over 20%.

Direction of commodity prices (June 2015 to June 2016)

Gas price

Power price

Oil price

Carbon price

Year

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Gas prices rise during market uncertainty

In June, wholesale natural gas prices rose, especially in the days before and after UK’s referendum on the EU membership. The month started with a continuation of the trend seen in May, where NBP prices were tracking oil. Usually, gas contracts are influenced by Brent oil prices, as a significant proportion of long-term supply contracts have a degree of oil-indexation. As oil prices continued to rise, gas followed suit with a moderate upward trend.

Prices became significantly more volatile in the second part of the month because of concerns regarding the outcome of the Brexit referendum. There was more pressure on the gas curve because LNG cargoes were pulled away from the UK by rising natural gas demand from established and emerging Asian markets. Volumes injected into the grid by LNG terminals decreased by 54% compared to the previous month. June 24 saw significant moves in gas, due to both the Brexit referendum result as well as an announcement from the Dutch government that it was proposing to further reduce a cap on production from its biggest gas field for the next five years. Finally, the sterling crashed after the result of the referendum was published, pushing gas prices higher. Overall, June was a month characterised by high volatility driven mainly by sentiment rather than fundamentals.

Power prices follow the cost of fuels

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Power prices mirrored the strength in the country’s NBP gas market. Short-term and intraday contracts were particularly volatile because of significant differences between renewables forecast and generation. This, and tighter summer supplies due to the closure of 6.5GW of coal-fired capacity since last winter, has

sustained the perception of a tight generation picture for winter 2016. Bullish movements in the coal market have also helped influence gains on the power curve, as coal power plants had largely moved to the margins of the UK’s generation mix in the recent months. Post Brexit referendum the power curve jumped higher, pushed by a weaker sterling. Until more information is provided regarding UK’s relationship model with EU, the NBP and power market will continue to operate under the same EU rules and regulations as all other members of the union. On the fundamental side, the 2GW IFA Interconnector, linking the UK and France, experienced intermittent maintenance for 10 days. Additionally, some nuclear power plants had their annual maintenances, with some of them expected to return online in July.

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European Carbon prices crashed over 20%

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Oil prices move sideways as bull run loses steam

Until the Brexit result was known, the carbon market had traded largely sideways. However European carbon prices tumbled in late June, on news that the UK will exit the EU. It jolted financial markets and left traders questioning the ability of remaining member states to reform the ETS. While the immediate bearish effects were linked to some degree of panic in the market, slower economic growth across EU could add further length to the already oversupplied market. In a further twist, the UK lawmaker responsible for steering post-2020 ETS reform legislation through the EU Parliament offered his resignation, raising uncertainty about the speed and commitment of MEPs to deliver price-lifting measures.

Oil prices moved sideways in June, eventually closing slightly lower as a result of a negative sentiment in the market following the UK’s EU referendum. At some point West Texas Intermediate, the US price benchmark, jumped above $50/barrel for the first time in 7 months after government data showed a significant drawdown in US crude inventories. Oil prices received some support following headlines of continued militant attacks on oil facilities in Nigeria, as the market feared that this could affect physical supplies for longer than expected. At the same time, wildfires raging in the Canadian province of Alberta forced oil-sands producers to evacuate and shut facilities, just as production was beginning to recover. Comments from Saudi Arabia seemed to be particularly bullish as the new oil minister announced that worst part of the oil glut was over, and that the kingdom would return to its historic role of a swing producer that would adjust output depending on demand. After the Brexit results were announced, oil plunged due to fears that UK’s exit from the EU could trigger an economic downturn, which in effect would affect demand.

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Things to watch out for in JulyGenerally, summer months are quieter than the rest of the year, but this time it will be different. The markets had significantly underestimated the chances of a vote for the UK to leave the EU, a decision that has left markets confused and volatile. It will take some time to find a new equilibrium point.

The stability of the UK politics will play a crucial factor in the direction of markets. As nothing is certain and will not be for some time, sentiment will be a factor to watch out for, especially due to its unpredictability. Also, the political situation in continental Europe will be very important, as the EU leaders will take a stance regarding UK’s decision probably at the beginning of July. A request to trigger Article 50 could put pressure on all parties, and limit the amount of time available to plan an exit strategy.

Another factor to watch out for in July will be the evolution of exchange rates. The strength of the pound has a direct impact on all imports, including gas and power prices. As sterling depreciates, natural gas in UK becomes cheaper for continental traders, which has an upward effect on price. The inverse happens when the national currency appreciates. As approximately 50% of the power generation in UK currently comes from gas, any change in the cost of fuel will translate in a similar effect in power markets.

On July 14, BoE will announce whether it will adjust interest rates, which is already at a historic low of 0.5%. Five days later, the Office for National Statistics will publish the CPI, which measures the rate of increase in prices for goods and services. The CPI is probably the single most important economic indicator available and usually moves both equity and commodities markets.

Jargon busterCCGT: Combined Cycle Gas Turbine LDZ: Local Distribution Zones LNG: Liquefied Natural Gas MCM: Million Cubic Meters NBP: National Balancing Point NTS: National Transmission System OFGEM: Office of Gas and Electricity Markets OPEC: Organization of the Petroleum Exporting Countries RO: Renewables Obligation CPI: Consumer Price Index ILO: International Labour Organisation UKCS: UK Continental Shelf IMF: International Monetary Fund IEA: International Energy Agency EUA: European Union Allowance BoE: Bank of England ETS: Emissions Trading Scheme

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