Beware of emerging supply risks

Just a few weeks away from the official end of winter and the fundamental picture of European energy markets has barely reflected signs of the winter season. Demand destruction persisted, reaching 14% compared to the five-year average in countries like France, while gas inventories remained historically high amid weak withdrawals and, in some cases, net injections. This in turn depressed gas prices, incentivising coal-to-gas switching in the power sector. Hydro stocks and nuclear availability continued to decline, introducing upside risks to the summer.

European industrial demand remained underwhelming and well below long-term averages amid plunging but still high energy prices. Gas prices declined gradually during the month as a response to robust pipeline flows and LNG sendout. The weather contributed to this development with temperatures higher than normal in several countries, while markets pondered the extent of prolonged cold periods elsewhere. That being said, European gas inventories closed February 71% full and well above the 51% ten-year average. Coal prices also plummeted to multi-month low levels in early February before picking up again at the end of the month. Although both gas and coal prices dropped, the latter seemed to approach their cost-based anchors. This limited the possibility of Russian coal miners offering significant discounts to potential buyers and triggered some coal-to-gas fuel switching across European power markets.

Not all developments suggested a bearish mid-term fundamental outlook, however. Persistent dry weather conditions and falling hydro stocks, due to low rainfall and snowpack in the Alps, introduced a significant upside risk for the coming months. This is due to both potentially lower hydropower dispatch during the summer and the increased risk of production curtailments at nuclear power plants as a result of cooling water issues. Dry weather conditions could also render the waterborne delivery of coal supplies to Germany challenging, with low Rhine river levels similar to last summer. Meanwhile, French nuclear availability poses further risk premiums with contracts for next winter jumping up to 50% in recent days. This was driven predominantly by EDF’s disclosure of a new corrosion crack at its Penly 1 reactor, an issue which could be found across all 56 French reactors, according to the French nuclear safety authority.

Benign weather conditions for most of the winter and robust fuel supplies maintained coal and gas inventories at exceptionally high levels, reducing restocking pressure for the coming summer. But the question now is whether electricity markets will be able to absorb periods of tightness during the following months while being prepared for next winter. Demand destruction will certainly be among the most critical factors here.