Expectations of falling electricity bills following the recent collapse in oil prices will require “careful management” to avoid a negative reaction from customers.
Keith Maclean, managing director of Providence Policy, said fixed costs now account for a significant proportion of expenditure in the power sector, meaning even if there was a knock-on effect on gas prices, the ultimate impact on electricity bills would be fairly limited.
“One issue to consider in the electricity sector is that consumer expectations following a fall in the oil price will be that this should flow through into power prices, as it did historically,” Maclean told Utility Week.
“However, the sector is now increasingly dominated by fixed price elements – transmission, distribution, metering, supply and policy costs. Even in generation, the increasingly dominant low carbon plant – nuclear and renewables – is also mostly fixed cost.
“Although the wholesale price may still be set by the marginal fossil fuel plant, Contracts for Difference will prevent this benefit accruing to consumers who will have to increasingly top-up payments to generators. This could be exacerbated even more if low demand further depresses wholesale electricity prices and increases the need for constraint payments.”
Maclean, who sits on Utility Week’s editorial board, said there would need to be “careful management and messaging” to avoid accusations that electricity companies are being unfairly protected and failing to pass on cost reductions “at a time when a more equal sharing of burdens is expected.”
He raised concerns that support mechanisms for low-carbon technologies may lose public support if additional investment is used to stimulate the economy following the crisis and consumers and taxpayers are left to foot the bill: “This, in turn, could create a viscous circle in which private investors demand ever higher rates of return to compensate for increased policy risk, increasing the costs to consumers and tax-payers and further losing popular support.”
Ben Wetherall, market development director for price reporting firm ICIS, said whilst gas prices were once linked to oil there is “no significant connection” anymore.
There are now very few gas contracts in North West Europe indexed against oil prices. They instead tend to be indexed against the gas prices on the NBP and NTF trading hubs in the UK and the Netherlands respectively. “If the oil prices collapses, there is no translatable direct impact on the gas price,” he explained.
Wetherall said the fall in oil prices could actually lead to some upward pressure on gas prices if they remain at low levels for an extended period. This could undermine the viability of some fields producing both oil and gas, curtailing supplies of both.
He said the gas market is currently being driven by a long-running oversupply which has only been exacerbated by the lockdown and the resulting reduction in demand. Before the pandemic emerged, the market was expected to return to equilibrium over the next few years but that is now unlikely to happen until the mid-2020s. Low oil prices could accelerate this rebalancing slightly.
Over the shorter term, Wetherall said gas prices are likely to continue falling from already historically low levels out to the third quarter of this year. Day-ahead and month-ahead contracts were trading for as little as 8.33 pence and 12.75 pence per therm this morning – prices not seen in well over a decade.
Although production is being curtailed somewhat in response, Wetherall said gas storage in Europe may be completely full by mid-summer, meaning prices would fall to extremely low levels: “The key thing the industry is asking is: What is the floor for European gas prices?”