Markets reverting to traditional price anchors

European energy markets maintained their bearish sentiment over the course of January amid persistent demand destruction, continued ample fuel supply and solid coal and gas inventories. Some energy prices plunged to ten-month lows. Unseasonably warm weather during the first half of January was among the key bearish drivers, heavily reducing the call on thermal power generation, while, multi-year high fuel inventories provided supply flexibility. This proved pivotal in limiting the upside from the subsequent short-lived cold spell, with price increases proving mere volatility spikes within the prevailing downward trend. 

On the fuels side, demand destruction in residential, commercial, and industrial gas use sectors continued to reduce consumption. Meanwhile, robust LNG volumes and strong pipeline imports from Norway enabled inventories to reach around 87pc of capacity, the highest on record for the time of year. Confidence grew that Europe is able to offset the lower gas supply from Russia, moving gas prices closer to the fuel switching range. Coal markets closely tracked gas market developments. Combining with the support of fundamental drivers including robust supply, high stockpiles in ARA terminals and China’s muted demand amid rising Covid cases, this pushed the front-quarter contract to around January 2022 levels.

Improving nuclear availability in France has been another important bearish factor, ramping up significantly as several reactors went back online. This propelled nuclear production to its highest level this winter, in stark contrast to previous months when availability was 10 GW lower than usual and insufficient to counterbalance falling Russian gas volumes. Meanwhile, Germany’s Emsland reactor returned to service before its final closure in April and, together with Slovakia’s Mochovce 3 reactor, offset the closure of Belgium’s Tihange-2 reactor at the end of January. Meanwhile, the Belgian government is considering extending the operating lives of three nuclear reactors to 2027.

Although the above-mentioned drivers maintained the bearish market sentiment over the course of January, the decisive factor that could reverse or at least slow down the ongoing return to traditional price anchors is energy demand. Should lower wholesale prices trigger recovering demand levels, particularly after the recently improved global economic growth forecasts, Europe risks pricing out essential LNG supplies and paying a hefty premium to fill its gas reserves. This would be further exacerbated if combined with a prolonged cold spell or the final shutdown of Russian gas supplies via Ukraine. Meanwhile, the European Commission has launched a public consultation on reforms to the EU power market structure. This is an attempt to harmonise all ad hoc policy measures adopted across the continent, de-risk renewable energy investments and ensure market stability. The outcome of this process could significantly influence the way power markets trade in the future, and will therefore be another important factor in price formation over the coming months.