Energy, Oil and Gas trends of 2015

Last year saw a shift from old style power generation to renewables. Aided by extreme weather conditions, the output from renewable generation reached new heights, especially at the end of the year when storms arrived one after another.

The move away from high carbon generation is becoming noticeable both in the politics and customers’ bills, where the costs of delivering the changes ultimately end up. The costs of supporting this transition has clearly been on the government’s mind as it has sought to control the impact of high capital cost renewables in a low priced commodity environment. Does anybody remember 2008 when the brightest city analysts predicted $200/bbl oil?

Energy Price

2015 saw a continuation of the decline in wholesale energy prices. Oil, gas, coal, freight… the super cycle is well and truly over (until the next time).

However, the rate of decline and levels are unprecedented, with even geopolitics failing to stymie price falls. Looking at a simple chart of front month price change over the year, there is a consistent pattern of price decline across oil, gas and power. For electricity and gas, it is notable that the end of the year gradient was steeper than at the beginning. As the final months of the year represent the onset of winter and increase in demand, it is unheard of for these prices to be below the ‘warm’ part of the year.

In the final quarter, the combined impact of global commodity events, and delayed onset of winter led to sharp price decreases. Gas storage remained almost full, LNG cargoes unloaded; and future prices were impacted. The effect of the weather has been phenomenal in the final quarter, with both temperature and wind speed edging towards the limits of what could be expected.

Wind production smashed all records, with National Grid reporting 11 per cent of electricity was generated by wind in 2015, and 17 per cent in December. This helped push prices lower as demand for gas generation was reduced, on top of the warmer weather.

Future Energy Price

Last year saw the start of Electricity Market Reform, although no generation is yet being produced under its mechanisms. Unlike other low carbon subsidies, the cost per unit produced is fixed each year, irrespective of wholesale cost movements. Generators receive a top-up to energy prices when they are low and pay back when they are high For suppliers this introduces a new risk to manage which will gain complexity over the coming years as the number of assets under the scheme grows.

The development of the Hinkley Point C project has been implemented under the new Contracts for Difference, initiated by Electricity Market Reform. Although this looks expensive compared to today’s energy cost, £92.50/MWh compared to around £36/MWh for 2016 at the time of writing, only our children will know if it was a good decision.

Non-Energy Price

As energy prices fall, the rise of non-energy costs continues. For electricity customers these now make up over 40 per cent of the delivered price – and have influenced the fall in end user prices in response to wholesale price falls. Recent years have seen a rapid increase in the costs of low carbon generation in the form of Renewable Obligation (RO) and Feed-In-Tariff (FiT). The increase in these costs has provided a major headache as they are not linked to any market index.

The RO has supported growth in low carbon generation, but with the obligation on suppliers quadrupling between 2011 and 2016, keeping pace with this has been somewhat challenging, and created difficulties in keeping customers informed of what’s driving their prices.

FiT costs have risen rapidly beyond the initial forecast (see below). This has created challenges for suppliers to understand and recover the correct amount from customers; and for government as the costs have far exceeded the amount expected under the Levy Control Framework (LCF). As shown below, in 2015 (year 5) the costs were dramatically above the amount nominally set-aside for suppliers to recover in order to pay for the scheme.

Source: Ofgem Feed-in-tariff annual report 2014/15

As a result of the costs, the government has reduced the rate at which new FiT installations get paid, and introduced a cap on the rate of growth at £100 million/year. From an energy supplier perspective, this will make it easier to forecast the future cost, although there is still the matter of levels of sunshine and wind to worry about in understanding the final cost to customers. Solar subsidies have been particularly hard hit, with domestic rooftop installations initially being targeted with an 84 per cent reduction in income, and ending with 64 per cent. As the arguments about when solar will reach grid parity continue, it looks likely that the growing impact of solar on the overall energy mix is destined to grow further.

What has 2015 taught us?

Energy prices have fallen, and can go down even as events across the globe continue to dominate the headlines. Non energy prices are set to continue to rise and get more complicated. Although, the most prominent message is probably that the impact of weather is now stronger than ever – not only does it impact customer demand, but also the price of energy as there is so much weather dependent generation capacity.