Is the market “broken”? What can we expect now?

For weeks, COVID19 has monopolized the titles, news, articles, blogs, opinions and comments. We are not going to talk about what the arrival of this virus has meant, but it is necessary to reflect on the scenario in which energy markets are now, on which we have to make decisions (now and in the coming years).

We get up and go to sleep with data about the pandemic and throughout the day there is speculation about scenarios, measures, and more. Today, more than ever, expectations and reality are further apart.

In energy terms, we see how the daily markets (spot) transmit with concern a clear oversupply situation as demand sinks. Oil, Gas, emission rights, Coal … they all seem to have no floor and some of them have even traded at negative values. Something never seen before. Values ​​that make all market players uncomfortable and worry (governments, regulators, generators, investors, utilities …).

On the other hand, we have the forward markets that show is giving some timid signs of recovery. These move with the expectations. Right now with the hope that the current situation is conjunctural and won’t last much longer.

In any case, we have never had such sharp differences between the spot market and the forward market. Markets, on the other hand, in which any company of the sector must take its decisions.

Sometimes we read (or listen), with a certain amazement, how the fundamentals of both markets are confused and there is a tendency to simplify the conclusions with clear objectives of individual interest.

What is clear is that they must be analysed on different perspectives and variables since their decoupling is more evident than ever.

Daily markets (the reality)

If we start from the global reference for energy markets, oil is the one that transmits the sentiment to all markets. Both on the supply side (disagreement between Saudi Arabia and Russia) and on the demand side (slowing down of activity due to COVID19) has created a great problem of oversupply. In these charts we can see how we have been overproducing oil in recent months:

Situation that has led the market to moments of panic, where the price of crude oil (WTI reference) has come to quote with negative values of up to $ 40 / bbl. The European benchmark (Brent) is not going through its best moment either:

Just after oil situation we found the Gas markets: These were already coming from a last quarter 2019 of low prices due to slowdown signs of the in the Asian market. The markets are under great stress due to oversupply and especially the pressure of global LNG. The world is running out of storage if we are not able to stop this trend. The signals from the European and American markets are clear:

 

The result has been not only the fall in prices of the main markets, but the rapprochement of prices in the main regions (USA, ASIA and EUROPE).

The scenario in local electricity markets is not different. And if we take the Spanish market as a representation of the Europeans, we see that the demand for electricity in April closes with 17.3% less than the corresponding in 2019. A value that adds to the 5.9% registered in the month of March according to data from Spanish System Operator. Situation that has completely displaced traditional thermal generation and has given way to renewable energy that has produced almost 48% of the total energy consumed in Spain. Again, this is a punctual reality and we cannot link to the forward market behaviour.

As a result, we are living the collapse of prices to levels never seen before:

These price levels are redefining the “normality” of our markets. Right now, many portfolios are in losses, defaults are soaring and companies with less economic solvency are going through their worst moments. A period of great activity in M&A (Merger and Acquisitions). Investments are on hold as fear has gripped the capital.

Forward markets (expectations)

In contrast, forward markets have slowed their losses and seems to have reached new resistance values. Coinciding with the beginning of the deconfinement phases in most developed countries. These markets move based on expectations. Expectations that, on the other hand, are being revised day by day as well.

In this line, we have that the reference oil market Brent quotes the M + 1 product above $ 20 / bbl, while the forward market draws an upward curve to values above $ 40 / bbl.

The benchmark Gas market in Europe (TTF) continues at daily values below € 6 / MWh while annual products are trading at values above € 12 / MWh.

The same thing happens in electricity markets. Daily prices in the Spanish electricity market are struggling to stay above € 20 / MWh while futures markets (calendar products) seem to want to resist their falls below € 40 / MWh:

Conclusions

Oil and gas companies are facing the collapse of their profits and margins. Countries whose economies depend on oil revenues are going to have to balance their budgets with urgent measures.

The consequences of this crisis will reside not so much in the fall in prices but in the time that they remain at these levels. Recovery in “U”, “V”, “W” or even “Y” are terms that we will have to familiarize ourselves with in order to establish future scenarios. The longer the period of price depression lasts, the greater impact they will have on the functioning of the market and the capital flows it needs as we know it.

This crisis has brought great uncertainties and will surely erase some companies from the map. Despite this, many already see new opportunities.

The coronavirus is likely to foster a greener way of thinking globally. Investments will be adjusted in line with decarbonisation and market diversification trends. Further enhancing that transition in which so much hope has been placed.

This could be a considered opportunity for governments to impose a “green” program that companies must adhere in order to obtain government financial support.

Ultimately, this is a time to reconsider strategies and have long-term goals rather than the immediate one. From Magnus we always help our clients to position themselves in the medium-long term strategies, without forgetting the risks and opportunities of the short term. And it is not just about spot vs forward. Is about defining the role your company wants to take within this revolution. What decisions have you made or are you going to make?

Alejandro De Roca | Energy Consultant