Volatility, risk and risk premium in German and Continental power markets Stefan Judisch / Andree Stracke RWE Supply & Trading GmbH 22 nd January 2015 RWE Supply & Trading PAGE 0
Agenda 1. What are the market fundamentals telling us? 2. What can we observe in the traded market? 3. How will future developments impact merit order economics? 4. Summary and conclusions RWE Supply & Trading PAGE 1
Various fundamental factors influence power prices on the long-term forward market Fuel forward curves A CO 2 prices Gas prices Crude prices Coal prices Reservoir level Subsidies & technical progress Reservoir hydro plants Wind capacity growth PV capacity growth B Renewable power generation Marginal costs of thermal plants Thermal power generation Power price Available capacity Power plant new build Power plant closures Supply C Cross-border exchange balance E Seasonal temperature forecast Air conditioning / Electric heating Residential demand Comfort of living Weather impacts Industrial demand Energy efficiency Demand Macro cycle D RWE Supply & Trading PAGE 2
A B C D E Coal and gas prices collapsed whereas power declined less Relative development of German Power, API#2 Coal and TTF Gas for the front year (1 st Jan 2014 = 100%) RWE Supply & Trading PAGE 3
A B C D E German Power Supply (I): Renewables growth path: Less PV, but more wind Installed Capacity (Dec 14): - PV 37.9 GW - Wind 38.6 GW (thereof 1.3 GW offshore) > Solar installation growth was relatively low with only about 1.9 GW installed until Dec 2014. > Our 2015 capacity expansion forecast for PV is set at 1.8 GW. > On the other hand German onshore wind installations until Dec 2014 surprised to the upside, partly as producers accelerated their projects in anticipation of the EEG reform. In total more than 3.3 GW were installed from January to Dec 2014. > The onshore wind capacity growth forecast is set at 2.8 GW for 2015. RWE Supply & Trading PAGE 4
A B C D E German Power Supply (II): Fossil generation: capacity closures exceed new-builds Mothballed Newbuild > Taken into account recent updates, closures planned for 2014-2017 exceed new builds by 3.4 GW. > Grafenrheinfeld and Gundremmingen B will close in Apr 2015 and end 2017 according to the nuclear exit agreement. > Further gas and coal closures expected, if a capacity market will not be implemented. RWE Supply & Trading PAGE 5
A B Slowdown in German power demand less prominent > Energy-intensive industries are cutting production and consumers produce their own energy. Moreover, efficiency measures continue to weigh on power consumption, with the EU proposing an energy efficiency target of 30% until 2030. > As the German economy is gradually picking up in 2014, the demand slowdown has decelerated in 2014. 10% C D E Average Load YoY Change 5% 0% -5% -10% -15% Bank holiday effects -20% Dec 14 Sep 14 Jun 14 Mar 14 Dec 13 Sep 13 Jun 13 Mar 13 Dec 12 Sep 12 Jun 12 Mar 12 Dec 11 Sep 11 Jun 11 Mar 11 Dec 10 Sep 10 Jun 10 Mar 10 Dec 09 Sep 09 Jun 09 Mar 09 Dec 08 Source: Entso-E Power Consumption (preliminary hourly data) RWE Supply & Trading PAGE 6
A B C D E Cross-border flows: The introduction of flowbased market coupling will lead to more convergence of European power prices > Flow-based market coupling (FB) will lead to higher utilization of cross-border capacities than ATC market coupling. > Parallel runs show that German price will increase by 0.40 to 2.26 /MWh (depending on market tightness) and converge towards the higher price levels in Belgium and the Netherlands Results of parallel runs ATC vs. Flow-based (FB) market coupling for 2013 and 2014 Source: CASC CWE RWE Supply & Trading PAGE 7
Agenda 1. What are the market fundamentals telling us? 2. What can we observe in the traded market? 3. How will future developments impact merit order economics? 4. Summary and conclusions RWE Supply & Trading PAGE 8
The power price development over the last 14 years in Germany show 100 Forward versus spot prices (EUR/MWh) 90 Cal 02 Cal 03 Cal 07 Cal 08 Cal 12 Cal 13 80 70 Cal 04 Cal 05 Cal 06 Cal 09 Cal 10 Cal 11 Cal 14 Cal 15 Spot 1 60 50 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1 365d spot moving average RWE Supply & Trading PAGE 9
With plenty of generation capacity available, the market does no longer price in a risk premium Contango vanished again in the front of the curve Spread between implied versus front year (EUR/MWh) 1 Implied Year (FY0) 2 Front Year (FY1) Second Year (FY2) Risk premium (right scale) 1 German power baseload 2 Implied Cal as weighted average of spot settlements and balance-of-year forwards RWE Supply & Trading PAGE 10
The market expects renewable generation growth to force utilities into more plant closures Forward curve remains backwardated, but got significantly flatter. Spread between year 3 versus year 1 (EUR/MWh) Year 1 Year 2 Year 3 Risk premium (right scale) RWE Supply & Trading PAGE 11
European power prices decline as fuel prices collapse > French power prices were relatively less weak due to ARENH expectations. > German power forward prices have mostly decreased due to shut-in renewable feed-in *. > Belgian power prices decoupled when 3 GW of nuclear capacity was taken offline, but fell back now with 1 GW nuke capacity returning and easing winter fears. > Flow-based market coupling should lead to more price convergence again, but it was postponed to April 2015. Cal 16 Baseload Prices: UK: coal to gas switch, coal plant reliability very high this winter, all nukes back online BE: 2 GW nuke (Tihange and Doel 4) closed due to safety concerns and repairs. NL: gas dependent, hard coal plants finally commissioned. FR: ARENH decision postponed, expectations priced in. DE: renewables feed-in, fossil new-builds. NP: improved hydro balance * In times of high renewables generation, cross-border constraints limit exports. RWE Supply & Trading PAGE 12
Generation margin for hard coal plants is recovering reflecting plant closures in 2016/17 Expectations for clean dark spreads (EUR/MWh) > German clean dark spreads recovering while the backwardation is flattening. > Tightening supply/demand balance is getting priced into Cal 16 and even more into Cal 17. RWE Supply & Trading PAGE 13
The volatility in the German power market is shifting to the front of the curve Annualised volatility compared to 2001: Forward versus spot RWE Supply & Trading PAGE 14
and intraday market becomes more relevant to trade around actual solar and wind production Trading volumes on EPEX compared to 2010: Day-ahead versus intraday Day-ahead Intraday Market participants in 2010 Day-ahead trading: 94 Intraday trading: 89 Market participants in 2014 Day-ahead trading: 199 Intraday trading: 195 RWE Supply & Trading PAGE 15
A first blip of light at the end of the tunnel: More intraday spikes in tight situation Intraday vs Day-ahead: calendar weeks 48-50/2014 (EUR/MWh) RWE Supply & Trading PAGE 16
Agenda 1. What are the market fundamentals telling us? 2. What can we observe in the traded market? 3. How will future developments impact merit order economics? 4. Summary and conclusions RWE Supply & Trading PAGE 17
German merit order in 2014: prices and volatilities for different hours of the year Marginal cost (EUR/MWh) Renewables Nuclear 1 Lignite Coal Gas Oil Others A sunny hour with high intraday volatility A sunny and windy hour Capacity (GW) A average hour with low intraday volatility A cold winter hour with low intraday volatility A winter hour with high intraday volatility Announced for closure or closure candidates System services 1 Excluding nuclear fuel tax 1 Source: RWE RWE Supply & Trading PAGE 18
What will happen over the next five years? More renewables: merit order will shift further to the right > More fuel switch coal to lignite > Lower prices > Higher spot volatility Plant closures will accelerate > Capacity ranges for coal and gas in merit order will shrink > Gas will be running more often > Higher prices > More price spikes (spot/intraday) > Higher spot and then higher forward volatility > Re-appearance of risk-premium in forward prices Rise in gas and/or CO 2 prices > Higher prices Source: RWE > Higher forward volatility RWE Supply & Trading PAGE 19
Volatility and risk premium will spread from the very front end further along the forward curve. > Oversupply due to renewable penetration has moved volatility and risk in German and Continental power markets predominantly to the very front end of the curve. > This development led to backwardation of long-term contracts. > As a result generators react with initial mothballing of plants that are far out-ofthe-money. > Due to more plant closures to come (including nuclear closures), the tightening supply/demand balance already led to increasing clean dark spreads, especially for Cal 17 the dark spread backwardation compared to Cal 15 halved. > The tighter supply/demand balance with more renewables will lead to even more volatility in the prompt which should introduce more risk premium along the forward curve. RWE Supply & Trading PAGE 20
Agenda 1. What are the market fundamentals telling us? 2. What can we observe in the traded market? 3. How will future developments impact merit order economics? 4. Summary and conclusions RWE Supply & Trading PAGE 21
Summary & conclusion 1 What are the market fundamentals telling us? > Power prices are outperforming gas and coal prices > Despite reduction in subsidies, solar and wind generation will continue to grow in Germany > From 2015 onwards plant closures will reduce the current generous capacity margin > Electricity demand will drift sideways at best (assuming no major break-through on electric cars) 2 3 What can we observe in the traded market? How will future developments impact merit order economics? > The markets indicated that renewable generation capacity grew faster than thermal plants are being closed, low dark spreads triggered plant closures > Increasing fuel spreads on the back end of the forward curve are already increasing due to the tightening fundamental picture > More than 70 GW of renewable capacity in Germany push up intra-day volatility; sufficient flexibility in the system for the time being but more and more closures of conventional capacity will lead to spikiness in spot and intraday markets > Forward volatility is low right now as (1) coal plants are mostly price setting in average weather (assumption of forward market), (2) the volatility of coal is low > Spot/intraday volatility has gone up and is expected to rise further > Forward volatility likely to be pushed up if intraday price spikes become more frequent 4 Conclusions > Outright prices to drift sideways for a while before markets tighten. Fuel spreads on the back end of the forward curve are already increasing due to the tightening fundamental picture. > More short-term price spikes will induce rising forward volatilities and risk premium and a change in hedging behaviour of large power consumers RWE Supply & Trading PAGE 22