Lack of buyers weighs on German 2020 power contract
A lack of buying interest for long-term contracts has pulled the German 2020 base-load contract and corresponding clean dark spreads to record high discounts over the 2019 delivery year.
Market participants are eyeing a higher unhedged ratio of expected power production two years ahead compared with recent years which could provide future downside for the power contract, although the market has seemingly shrug off the potential for a fundamentally tighter German power system by 2020.
The German 2020 base-load contract ended yesterday' session at €40.85/MWh which was its highest close since assessments started in 2016, but at a contract-high discount to the 2019 contract which closed at €42.40/MWh, based on Argus assessments.
Clean dark spreads for base-load delivery in 2020 ended yesterday near an all-time low at €0.89/MWh for a 40pc-efficient coal-fired power plant which was €1/MWh below clean dark spreads for the 2019 delivery year. And while 2020 clean spark spreads for highly efficient 59pc gas-fired units are well above clean dark spreads for older coal plants, ending yesterday at €1.65/MWh, they have fallen from levels above €3/MWh as recently as 1 May.
Sellers
The 2020 outright power contract and corresponding clean dark spreads had held a premium to the 2019 delivery year in the fourth quarter of last year when German Chancellor Angela Merkel's CDU-CSU during the so–called Jamaica coalition talks with the FDP and the Green Party had offered to close up to 7GW of mostly lignite-fired capacity by 2020 in a concession to the latter. But the 2020 contract lost ground following the collapse of the talks which resulted in Merkel restoring her coalition with the SPD. The backwardation between the German 2020 and 2019 power contracts started to exceed the discount for equivalent products in the API 2 coal swaps markets in the first quarter against a backdrop of less active utility selling.
German utilities RWE, Uniper, and EnBW, as well as domestic nuclear generator PreussenElektra and Austria's Verbund all reported lower hedge ratios for their expected power generation two years ahead, now 2020, as of the end of the first quarter.
Depressed base-load clean dark and just clean spark spreads, with the latter only in positive territory for highly efficient units, is likely to continue to weigh on the appetite to sell 2020 power this quarter even as outright prices have continued to rise. RWE has adopted an implicit fuel hedge strategy for its German nuclear and lignite generation which means that the utility sells fuel rather than outright power, converting a long power position to a long spread position. The decline in clean dark spreads this quarter and RWE's expectations that 2020 clean dark spreads will eventually recover means the utility is keeping open position on the 2020 power contract, it said earlier this week.
Buyers
The absence of strong selling appetite from power generators has failed to support the German 2020 base-load contract. Buyers securing power for self-consumption or their large industrial consumers might hold back in locking in large volumes for 2020 as they expect outright prices to fall once utility hedging activity for their expected power generation steps up. And some might have bought 2020 power in the fourth quarter last year when the Jamaica talks had resulted in much larger gains for the 2020 contract compared with the 2019 delivery year even as there had been no details on whether the up to 7GW of lignite capacity offered to the Green Party would shut down entirely at the start of the decade or whether some closures could be implemented in 2019.
As of yet unhedged power on the buyer's side could prove to be a risky strategy. The German-Austrian day-ahead auction on the Paris-based Epex Spot exchange had settled at a discount to the average close of the calendar year during trading in the forward market the prior year in 2012 through to 2016. This encouraged market participants to buy their power needs closer to delivery given that short-term prices had delivered below the forward market. But the trend reversed in 2017 when the average German-Austrian base-load day-ahead settlement was €34.20/MWh, which was at a €7.60/MWh premium over the average close of the 2017 forward contract when it had been the year ahead in 2016.
The 2018 base-load contract last year closed at an average of €32.39/MWh, Argus data show. The German-Austrian day-ahead auction has settled at an average of €34.26/MWh so far this year and, taking into account yesterday's OTC market close for contracts delivering the remainder of this year, the market currently expects prices to average €39.63/MWh throughout 2018.
Rising costs for German coal and gas-fired generation have supported the upside in delivery so far this year compared with the year-ahead close in 2017. And buyers having yet to secure all of their power needs face exposure not only to the potential of continued strength in fuels and in the EU ETS market but also to a tightening German power system which could increase price volatility and increase the risk of buying larger volumes short term.
Standard deviation in the German intra-day market, also operated by Epex Spot, so far this year is just below last year's four-year high, based on the weighted average of concluded transactions for hourly products, and is above the average so far this decade, ahead of the second winter quarter of the year. Price volatility tends to be highest in the demand-intensive winter months.
Tighter market
German conventional capacity could be around 4-5GW lower in 2020 compared with 2019 based on current plant start-up and closure schedules. A total of 3.2GW of conventional capacity is to drop out of the wholesale power market in 2020. This includes the permanent legally-mandated closure of the 1.4GW Philippsburg 2 nuclear plant by 31 December 2019 under the German nuclear phase-out law while 757MW of capacity will join the German lignite reserve in October this year. The first delivery period of the 2GW capacity reserve is now set for October 2019-September 2021. Conventional power plants and demand-side management providers meeting the as of yet to be confirmed pre-qualification criteria will be allowed to participate in the German capacity reserve tender. The auction has the potential to take another 2GW of conventional plant capacity permanently out of the power market.
Other closures in 2019 are for commercial reason and most retirements are scheduled for the end of the first quarter.
There is limited potential for currently mothballed conventional power plants to return to the market in 2020. Two of the biggest units which are currently unavailable to the wholesale power market are the highly efficient Irsching unit 4 and 5 combined-cycle gas turbine (CCGT) power plants with a total capacity of 1.4GW . German utility Uniper has re-applied to mothball the units, which are part of the German grid reserve, from May 2019 and the CCGTs are likely to be again declared system relevant. System-relevant plants remain in the grid reserve for two years at a time.
This leaves Uniper's 1.1GW Datteln 4 coal-fired plant as the only conventional power plant scheduled to be commissioned in 2020. Uniper currently expects the plant to come on line in summer that year following lengthy delays.
Renewable generation capacity is expected to continue to rise in Germany but exports could step higher with the commissioning of new interconnectors. The 1GW Alegro interconnector between Germany and Belgium is scheduled to be commissioned in 2020. The Belgium 2020 base-load contract last changed hands in the over-the-counter (OTC) market on 16 May at around €43.60/MWh which was at a €3.35/MWh premium over its German equivalent, according to Argus data. This suggests that power flows would be mostly in the direction of Germany to Belgium. The 1.4GW Nordlink interconnector between Germany and Norway is expected to begin commercial operations in 2020, which could see stronger German imports from the Nordic region generally but is likely to limit downside on days with strong intermittent wind and solar power generation.
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