Timera Energy

The value of flexible UK power assets (e.g. engines, batteries, CCGTS & DSR) is increasingly focused on margin capture from price shape and volatility close to delivery. 5 key challenges owners & investors are facing:

1. Prompt value: Quantifying & managing asset exposure to price shape & volatility.
2. Liquidity: Lack of liquid granular products to hedge shape & volatility.
3. Transaction costs: value erosion from execution of hedging & optimisation.
4. Risk adjustment: Appropriate discounting of uncertain extrinsic revenue streams.
5. Pricing options: Structured probabilistic framework to define, price & exercise asset optionality across Wholesale, BM, Ancillary & Embedded Benefit markets.

Two recent podcasts from Columbia Energy Exchange make for some very insightful summer listening:

• Shell’s transition to power: Shell Exec Maarten Wetselaar talks about how & why Shell is reorienting its business model towards power (e.g. recent acquisition of First Utility in UK). He also addresses Shell’s strategy for renewable technologies and the role of gas in response to evolving energy markets.
• Shifting energy landscape: Obama Administration US Energy Secretary Ernie Moniz talks about some key structural drivers transforming energy markets. Moniz sets out a very engaging perspective on the evolution of low carbon technology, the role of nuclear and the impact of climate policy and geopolitics.

Cheniere & CME Group are developing a physically settled LNG futures contract, delivering at Sabine Pass. This will add to existing SGX & ICE LNG futures contracts and some bilaterally traded derivatives. Liquidity is embryonic but starting to grow. 4 factors driving growth:

1. Spot liquidity: Derivatives require a liquid spot reference price. This is being facilitated by growth in spot cargo trade and maturing price markers.
2. Increasing flexibility: LNG portfolios are becoming more complex and flexible. E.g. US export contracts are rapidly boosting shorter term trading & optimisation of LNG supply.
3. Asian buyers: Structural imbalances & new supply in Asian LNG portfolios are seeing buyers expand commercial & risk management capabilities to support portfolio management.
4. Commodity traders: Intermediaries such as Vitol, Trafigura & Gunvor are rapidly expanding their LNG market presence. Their focus on shorter term arbitrage opportunities & risk management requirements are a catalyst for liquidity.

The majority of LNG portfolio hedging will continue to be done at key liquid hubs (TTF, NBP, HH). But growth in derivatives will facilitate greater flex to realise value from regional spot price liquidity & volatility.

UK thermal power assets are changing hands with the following portfolios in play:

UKPR, the UK gas engine & battery developer, has just been sold to Singaporean utility Sembcorp by private equity players Inflexion & Equistone for £216 million, after a complex & drawn out process.

Green Frog UKPR’s major competitor has had less luck with its parallel sales process with preferred bidder I-squared pulling out (8 £/kW capacity price unlikely to have helped).

Scottish Power has flagged the potential sale of UK gas-fired plants (timing to be confirmed) in stark contrast to its rival SSE who has just announced a £350m investment in a new CCGT (Keadby 2).

Calon is considering the sale of its portfolio of 3 UK CCGTs according to a recent FT article. This would follow Centrica & Engie’s sales of UK CCGT portfolios.

Centrica & EDF are both planning to sell stakes in existing UK nuclear assets, Centrica to exit & raise capital and EDF to sell down a 20-30% stake.

Price levels: Spot prices for delivery in Nth Asia are rapidly rising through 10 $/mmbtu. This has opened up a 2.5 $/mmbtu gap to TTF (exceeding variable transport costs).

China key: Chinese buyers are driving prices higher, given the ongoing policy push to gas, strong industrial demand and building of inventories ahead of winter. 

Other demand: Competition for spot cargoes is also coming from Japan & Korea (low storage balances after a cold winter) as well as India & Pakistan.

Supply constraints: Unplanned & maintenance outages are restricting supply over the summer (e.g. Gorgon, Sabine Pass, Sakhalin, Angola), with new Australian volumes unlikely to ramp up until Q3/Q4.

Europe impact: The Asian spot vs TTF price differential will see flexible LNG supply diverted to Asia, with cargo reloads coming back into the money.  This will support summer prices at NBP/TTF.

Sale of regas terminal stakes (e.g. Dunkerque, Dragon, Adriatic) as well as possible new terminals (e.g. Germany, Croatia) are drawing in new investors.  5 value drivers to consider:

1. Contract position: many facilities have LT contracts in place de-risking front year margin – buying time for utilisation recovery
2. Utilisation: Declining domestic production in Europe key to utilisation recovery over time. Understanding potential utilisation profiles key to value.
3. Option value: Regas capacity is a ‘put option’ allowing cargo sale into European hubs. Merchant value linked to utilisation + premium. ST capacity prices capped at regulated tariffs / LTC capacity prices (~0.2-0.3 $/mmbtu).
4. Portfolio value: Regas capacity value can significantly increase when considered as part of portfolio (e.g. unlocking constraints within portfolio, adding additional physical optionality). Important for Asian buyers, LNG portfolio players, producers.
5. Competitive position: Important considerations (i) relative variable costs (including transport), (ii) access to liquid hubs (iii) commercial flexibility (e.g. TPA vs tariff).

What will be the annual range in wind & solar output be in 2030?  The chart shows the projected distribution of annual volume range from low (5^th percentile) to high (95^th percentile) wind & solar output in 2020 vs 2030. Analysis assumes 25GW solar and 35GW wind installed by 2030. Fluctuations in wind and solar output are set to become increasingly important drivers of power price shape & volatility in the 2020s. The ability to capture margin from shape & volatility will underpin the value of flexible assets (engines, batteries, DSR & CCGTs).

We extend last week’s analysis of wind & solar output distributions out to 2030 in the chart. Two key factors are combining to drive up intraday price shape and volatility. Firstly engines, GTs, batteries & DSR are replacing retiring coal & CCGT units with lower variable cost. This is lifting prices in periods of high demand & low wind/solar output.  Secondly increasing levels of wind and solar capacity are acting to pull down prices in periods of low demand & high wind/solar output. Wind/solar output distributions are rapidly becoming a major factor driving power asset risk/return dynamics.

UK price dynamics are increasingly being influenced by variations in wind/solar output. The chart shows the % of time that different technologies set UK power prices, based on a projected distribution of wind & solar output. CCGTs dominate price setting, underpinning a strong linkage between gas & power prices. Coal units remain important for setting peak prices, but engines/GTs start to pull up super peak prices (e.g. Block 5). Offpeak prices are starting to be structurally eroded by increasing wind & solar output.

2017 saw the reversal of two trends in the coal market. Global consumption increased for the first time since 2013, lead by growth in India & China. The production declines in China and the US that have dominated 2014-16 reversed sharply with a 3.2% rise in global output as prices increased. China is playing a pivotal price management role as it attempts to reform its domestic coal sector.  Policy driven closure of Chinese mines (2015-16) in parallel with stronger economic growth supported global price recovery in 2017. China has responded by taking a more supportive approach towards domestic supply.

The ability to reload cargoes at LNG terminals has become an important source of additional supply chain flex over the last few years. But reloads still only account for a fraction of global trade (2.6 MT vs global trade 290MT i.e. < 1 %).  The chart shows a breakdown of 2017 reloads. Activity has historically focused on Europe (57% share in 2017), as a means of getting around destination clauses and access Asian price premiums. But reloads are increasingly occurring in Asia & Lat America and are being used to optimise shipping logistics as well as destination clauses.

UK wholesale power prices have risen across 2018 pulled up by increases in fuel & carbon prices. After a weaker winter for gas plant margins, forward clean spark spreads (CSS) have started to recover across H1 2018, with Win 18-19 CSS now around 4.50 £/MWh.  However a divergence is opening up between Win 18-19 and Sum 19-20.  Coal units are important for setting UK winter peak power prices. Rising coal & carbon prices are pulling up the Win 18-19 power contract and lifting gas plant generation margins.