Winter ends with relief, but new challenges arise

The end of March marked the close of a winter season characterised by above-normal temperatures, high wind power generation, and power and gas demand oscillating below 2020’s Covid low levels. Spot energy prices plummeted further through March, with risk premiums eroding towards the end of the season, showing once again that premiums are often overbuilt in the face of possible supply tightness. Strong energy demand destruction was seen both in the industrial and residential sectors, with the level of structural demand destruction remaining a key uncertainty. Meanwhile, coal and gas inventories remained at healthy levels. This was thanks not only to muted Asian demand and strong gas supply, but also a year of regulatory intervention which saw legally mandated gas storage levels and demand reduction targets, as well as the return of coal capacity.

Several developments through March continued to challenge European energy markets and supply outlook. Extensive strike actions in France over government plans to reform the country’s pension scheme heavily curtailed LNG imports. If continued in the coming months, these could limit Europe’s capacity to import LNG at a time of low pipeline supply and its highest dependence on LNG. Strikes also constrained the availability of hydro, fossil fuel, and nuclear plants for several weeks, while delaying the annual maintenance schedule of numerous nuclear reactors. Add to this EDF’s plan to check an even higher number of repaired welds in 2023 than originally planned, following the discovery of cracks at a corroded weld in the Penly 1 reactor, and it is easier to understand how the front winter contract Q1’24 jumped from 230 EUR/MWh to 430 EUR/MWh within the last month.

Unprecedented drought conditions and extremely low snowpack levels across Western Europe introduced another clear risk premium, supporting traded summer contracts through potential low hydro stocks, coal supply disruptions in Germany, and cooling water constraints at thermal power plants. Following the hot dry summer last year, market concerns arose about whether the inverted price seasonality seen across summer and winter last year will be repeated. Clearly the weather is evolving as an important risk factor in forward valuations during summer seasons. Decommissioning of Germany’s nuclear fleet in April comes as an expected supply constraint, but nevertheless will require stronger thermal power generation and increased exposure to fuel imports.

Meanwhile, last month the European Commission published its long awaited market reform proposal. This outlines new measures, such as the creation of virtual trading hubs, but retains the marginal pricing signal and supports power purchase agreements (PPAs) and contracts for differences (CfDs) for low carbon generation technologies. It will likely come into force in 2024, after its approval by the European Parliament and Council.