Since the beginning of August 2017 the prices on the electricity and commodity markets have been breaking one record after the other. Is it eventually time to pop the corks and finally ring in the end of the lean times? Or is it barely a temporary anomaly? To find an answer, we investigate the causes of the current price development.
While the electricity front-year base did not exceed the magical mark of 31.50 EUR/MWh between November 2016 and July 2017, it has been breached several times in July. At the beginning of August 2017 all dams burst, as an all-time high chases the other. At the end of October and at the beginning of November 2017 even contracts at prices over 37 EUR/MWh have been traded.
The future market prices for electricity are fundamentally linked to the commodity costs of power plants (hard coal, gas, CO2) and the availability of generating facilities. Political decisions also affect the price developments.
The coal market in a race
The coal market (API2), which is particularly relevant for the German electricity market, is currently characterized by a real race. Since spring 2016, the price of coal has increased almost continuously besides some short-term sideway movements. An increased demand for hard coal from China and India led to this expansion since the summer. Furthermore the exchange rate (EUR/USD) plays a crucial role for the European market, as hard coal is traded on the world market in USD. After a historic low in late 2016/ early 2017, the exchange rate expanded to its highest level since 2014[1]. This development lowered the price increase for hard coal for the European market.
The CO2 price fluctuates with each new message
Furthermore the carbon market does also display signs of awakening from its slumber. Since the summer of 2017, prices have increased to levels which have not been spotted since 2015, apart from short intermediate phases. While negative records of 4-5 EUR/t appeared almost normal, contracts were traded at prices of up to 8 EUR/t until the beginning of November. A broad number of significant factors enhance the pressure on market participants: discussions about the retention of British certificates after the final Brexit, the challenging negotiations in Brussels on the upcoming trading period, current discussions about minimum prices in several countries (including Germany, France, the Netherlands) and the present uncertainty regarding the availability of French nuclear power plants in the upcoming winter. Every new message, leads to a CO2-price movement – be it from France, Brussels or Berlin. Speculative traders do the rest[2].
What important role does the price of gas actually play?
The price of gas presents an important influence factor in assessing the actual price of the electricity, even though its influence is inferior to the one of coal. While gas prices reached their all-time lows in the beginning of 2016, the seemed to recuperate until the beginning of 2017. Until summer of 2017 however, prices dropped drastically with a price drop of just under three EUR/MWh (around 15 percent compared to the price peak of early 2017). As if the gas price wanted to emulate the price of coal, the price of gas ascended on time with falling temperatures in September 2017 by now two EUR/MWh again.
All of the fundamental factors which are relevant to the price of electricity – CO2 prices, coal and gas prices, power plant availability – underpin the continuing rise in prices.
Nevertheless is that enough to usher in the turnaround? When can a change in trend be recognised as one?
- What’s next in the coal market?
- What’s next with the CO2 prices?
- What’s next with the French nuclear power plants?
- What is happening on top of that?
The demand from Asia should not be underestimated
In particular market experts’ suspect that the current demand for hard coal from China and India will come to a natural end – at least as far as the current level is concerned. The increase in demand was mainly caused by empty winter stocks for power plant and coking coal in Asian countries. China increasingly closes inefficient coal mines in its own country and replaces the quantities with imported coal. However, China is increasingly relying less on hard coal in its current energy strategies. Therefore, demand from China will be lower in the long term.
Critical opinions on the correct amount of carbon prices
Developments in the carbon market are mainly dependent on decisions in Brussels, but also depend on national states (for national minimum prices). Amongst experts, it is almost uncontested that there must be a CO2 price that has to be well above the current price level to show a steering effect. Read our White Paper on carbon prices. Depending on the hard coal and gas price levels, the following price levels are discussed: 10 EUR/t (gas-fired power plants start to displace hard coal-fired power plants), 32 EUR/t (gas-fired power plants start to displace lignite-fired power plants) and 50 EUR/t (gas-fired power plants displaced lignite-fired power plants, hard coal-fired power plants start to displace lignite-fired power plants). Market participants see the associated effect on electricity prices as a major negative factor with regards to the consequences for industry. In particular, economies with energy-intensive industries or a high proportion of hard coal and lignite-fired power plants (such as Poland) are critical of a corresponding increase in CO2-prices. As a result, negotiations at EU level are extremely difficult. It is conceivable that an alliance of several nation states will agree on a minimum price for CO2. The current ongoing political discussions indicate this.
Developments in France: Nuclear energy to be scaled down
The French nuclear power plants are causing huge struggles for France already for several years. The nuclear power plant park is increasingly outdated and with an average age of around 30 years, 25 percent of the power plants have been on the grid for over 37 years. The flexible style of the power plants utilization leads to significantly faster wear compared to identical power plants in base load operation. In addition, the French government plans to reduce the share of nuclear power generation from 75 percent to 50 percent by 2025. In whichever way – the French power plant fleet will continue to occupy us.
Onshore wind energy: Possible gaps due to longer realisation time
In following years the nuclear phase-out is in full swing for Germany until end of 2022. As a result, the share of conventional generation units is increasingly diminishing. It is partly, albeit in a different structure, offset by the addition of renewable energies. The high proportion of citizen energy companies in the successful bidding in Germany’s renewable tenders creates a certain degree of uncertainty regarding the annual rates of onshore wind expansion. The longer realization time of 48 (+6) months instead of 24 (+6) months might induce an expansion gap in the coming years.
In addition to the ongoing nuclear phase-out also a coal exit by 2030 or later is being discussed. Depending on its design this could lead to a considerable reduction in capacity by 2020. This may increase the prices unless counteracted by other factors.
Sooner or later it is the CO2 price, which has a decisive impact on the electricity market. Nevertheless it is the policy that decides – we’re curious to see what happens next.
[1] Source: Montel
[2] The additional use of gas and coal power plants increases the need for certificates
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