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European emissions prices to encourage US LNG exports

02 Feb 2017 13:36 GMT
European emissions prices to encourage US LNG exports

London, 2 February (Argus) — The profitability of US LNG into Europe could largely be determined by emissions prices, while coal is the main driver of gas markets on both sides of the Atlantic.

If European gas prices stay at, or above, levels that are competitive with coal, there would be an incentive for US LNG exports — barring a collapse in emissions prices.

Henry hub prices have mostly held around levels that would leave gas-fired generation competitive with coal since early 2015, except for some brief periods.

Only in late October and early November, when storage was almost completely full and mild weather curbed demand, have Henry hub day-ahead prices dropped far below this fuel-switching price — assuming a 55pc-efficient gas-fired plant and 38pc-efficient coal-fired unit.

US power-sector gas consumption has risen in recent years, as it has become more competitive with coal. In August it reached the highest since at January 1973, although coal-fired generation was also strong.

European gas prices driven by coal

The correlation between European prompt gas and coal prices was shorter-lived, and has partly broken down this year.

TTF prompt prices have held at the fuel-switching price — using the same plant efficiencies but including ETS emissions prices — in August-December.

Record high European stocks combined with strong imports from Russia boosted supply, pushing continental gas prices low enough to displace some coal-fired generation.

But cold weather this winter and strong power sector gas demand has left inventories below average, lifting TTF near curve prices to just above fuel-switching prices, leaving gas uncompetitive with coal.

European fuel-switching prices are higher than US equivalents largely because of emissions pricing, although differences between coal prices in the two regions as well as exchange rates are a factor.

European ETS emissions prices add less than $0.50/mn Btu to the European fuel-switching price.

US coal lags API 2

While the US also has emissions prices in California and the RGGI states, these do not apply to most of the country. And Henry Hub prompt markets have largely held at levels that would be competitive in states without emissions prices, with US domestic coal prices lower than international equivalents.

TTF prompt prices have held at a premium to the Henry Hub in recent weeks, which has widened as European gas has become less competitive with coal.

The connection also briefly broke down in October-November, when Henry Hub prompt prices slipped with high stocks and mild weather curbing heating demand before reverting back to close to the fuel-switching price.

But TTF-Henry Hub prompt basis markets have not held exactly in line with the emissions component of the relative fuel-switching prices, even when excluding the brief collapse in Henry Hub prices.

US coal prices have also typically been slightly lower than their European equivalents. As a major swing supplier to international markets, US coal prices often follow API 2 but tend to respond with a slight lag.

And there is a substantial domestic demand component that can cause the spread between US and international coal prices to change.

US coal prices' discount to API 2 combined with ETS prices is usually enough to put European fuel-switching prices substantially above the US equivalents.

NBP premium to encourage LNG exports

European gas prices will be at a wider premium to the Henry Hub — offering more incentive for US LNG exports — when the NBP is the main driver rather than the TTF.

UK fuel-switching prices are higher than on the continent because of the £18/t CO2e carbon price floor, which adds about £4.93/MWh to the fuel-switching price, equivalent to $1.80/mn Btu at today's exchange rate.

The TTF has been the main driver of European prompt and near curve prices, which held close to continental fuel-switching levels, at least in the fourth quarter. NBP prompt prices have been in a range just above the TTF with the UK having strong demand for imports this winter.

But the NBP has led moves in European gas prices for delivery after this winter, and along with the TTF has remained tightly correlated with the corresponding API 2 swaps. The NBP first-quarter 2018 contract has held at levels that would keep gas and coal in competition in the UK generating mix, with the TTF at a slight discount.

NBP and TTF forward contracts close to UK fuel-switching prices are at a wider premium to the Henry Hub.

Continental European gas prices may remain uncompetitive with coal if stocks are below average heading into next winter. Inventories are lower than in recent years following the brisk stockdraw this winter.

But if Europe has ample supply heading into the next heating season, prices could slip and find support in the range that would encourage gas to displace coal in the Netherlands and Germany.

And Henry and European gas prices may not remain driven by coal markets in the medium-term, which could result in emissions and coal prices playing a smaller role in the profitability of LNG deliveries into Europe.

LNG deliveries to Europe

NBP contracts delivering next winter staying at UK fuel-switching prices would be at enough of a premium to the Henry Hub to cover variable costs of LNG deliveries to Europe from US terminals, assuming gas at the Henry Hub also remains competitive with coal.

European prices need to be at a premium of around $1.45/mn Btu to cover variable costs. The carbon price floor alone — before adding ETS prices — adds enough to UK fuel-switching prices to cover this.

And European hub prices slipping to levels that would offer an incentive for burning gas ahead of coal in the Netherlands and Germany could still encourage US LNG exports, barring US and European coal prices converging.

The trans-Atlantic arbitrage would only be too tight to cover variable costs if Henry Hub prices rise to levels that are uncompetitive with coal or the TTF slides below fuel-switching prices.

Europe's power sector could absorb a substantial volume of supply — as it has this winter — before TTF prices would drop below fuel-switching levels.

UK's winter premium

The premium of NBP forward contracts to the Henry Hub equivalents is widest in the winter, especially the first quarters of each year. This could result in most incentive for US exports to Europe during the heating season, although global premium markets such as northeast Asia may also take more cargoes in this period leaving less for delivery to Europe.

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US coal prices closely correlated with global markets $/MWh

Components of UK 1Q18 fuel-switching price $/mn Btu

Coal makes up most of Dutch fuel-switching price €/MWh

TTF day-ahead finds support at fuel-switching price €/MWh

NBP 1Q18 keeps UK gas in competition with coal p/th