Energy Monitor December – Surprises in energy markets

by: Hans van Cleef

  • Shell consortium wins wind tender Borssele III and IV; possibly less subsidies necessary than expected
  • Non-OPEC countries agree production cut, Saudi-Arabia to do more if necessary
  • Upward potential oil prices seems to be limited for the moment
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Less subsidies for offshore-wind necessary?

Last week, Dutch Minister Kamp (Economic Affairs) announced that the tender for Borssele III and IV has been won by a consortium of Shell, Van Oord, Eneco and Mitsubishi/DGE. The consortium won the tender with an offer of EUR 5,449 cents/KWh (or EUR 54,49 MWh). This was remarkably lower than expected, and also significantly lower than the maximum allowed bid price for this tender of EUR 11,975 cents/KWh. It even beat the previous record low of EURc 7,27/KWh which was the winning bid for Borssele I and II, won by Dong Energy last summer. With this spectacular price decline, the target to reduce costs of offshore wind by 40% was reached easily. This also means that the subsidy needed to make this offshore wind park economically attractive will only likely be  seven or eight years. Therefore, the maximum amount of subsidy needed will not be the expected five billion euro’s, but somewhere around 300 million euro’s only, according to Minister Kamp. This estimate is based on the calculations for future power prices from the ‘Nationale Energieverkenning 2016’ of ECN. However, our expectation for future power prices is that they will remain low for longer. The persistent oversupply of electricity – which is needed for a smooth energy transition – will keep a constant pressure on electricity prices (Figure 1). In this case, the offshore wind subsidy for this tender will still be significantly lower than five billion, but also higher than the mentioned 300 million. In the summer of 2017 the Ministry will announce the next tender. This will be a tender for the ‘Innovative lot’ of 20MW near the Borssele wind park, and furthermore the first two lots of the offshore wind park Hollandse Kust Zuid.

The agreement of non-OPEC producers

In the weekend of 10-11 December, several oil producing countries which are not part of OPEC, met with OPEC producers. The intention of this meeting was to fill in the details of the announced non-OPEC production cut. During the OPEC meeting on the 1st of December, it was announced that non-OPEC producers will also cut oil production from January with 600 kb/d. This would come on top of the OPEC production cut of 1.2 mb/d. Non-OPEC oil producers agreed to cut production by 558 kb/d, short of the announced number. However, Saudi-Arabia’s oil Minister indicated that it would do more if necessary. Especially this remark was taken as a positive by the market, and provided support for oil prices. The market neglected the fact that an important part of the non-OPEC production cut will come from natural declines of production wells. This is remarkable.

The most important goal of these two agreements is bringing back a balance between supply and demand of oil. OPEC clearly indicated that its main focus is on the middle- and longer term policy. This is crucial as in the near term, the effects of this policy can be balanced out by extra crude production in the US (please see next paragraph). Besides that, OPEC just broke a record by increasing production to 34.2 mb/d in November. By lowering supply significantly from January, while demand continues to increase (IEA raised its demand forecast to 1.4 mb/d in 2017), expectations have risen that global stocks should decrease to offset a shortage of production. This is likely to balance the market earlier than with natural declines alone. As a result oil prices can rise further and investments will likely  become cost-effective again.

Only limited upside potential during the coming weeks

Nevertheless, several uncertainties could still cap the upside potential of oil prices. OPEC has the reputation that it does not meet its own agreements too often. Therefore it remains crucial that all countries involved continue to speak with one voice. As soon as one country deviates from its communication, uncertainty about the feasibility of this agreement is likely to return to the market. This could increase the downward pressure on oil prices. One OPEC member – Libya – already unexpectedly indicated that it is able, and willing, to increase its production. This will increase the pressure on the other OPEC members.

US shale oil production remains another uncertain factor. Markets fear that US oil production will increase rapidly as long as oil prices remain above USD 50/bbl for a longer period of time. Oil production can become financially viable again in many oil fields, especially in combination with the reduction of costs to prices and low costs of financing. Nevertheless, we don’t expect that a recovery will go as fast as feared, due to high inventories and risk awareness of investors. Still, it may even be a good development if the oil production in the US increases. After all, investments in the energy sector – outside OPEC and the US – are still under severe pressure, even with oil prices trading around USD 50/bbl. As a result, oil production outside OPEC and US can still remain under pressure for a longer period of time.

Furthermore, also the US dollar weakened the effects of the OPEC/non-OPEC agreements. After the rate hike by the Federal Reserve (+25bp) and the signals that more US rate hikes will follow in the coming years, the US dollar appreciated. Our expectation is that the dollar will gain against the euro to a level of EUR/USD 0.95 before weakening again in 2018. This could limit the upside potential of oil prices.

We are heading for the Holiday season. This means that a part of the speculative positions can be unwound. In recent weeks significant long positions have been built (speculation on price gains). Since we actually saw a strong rally of oil prices after the OPEC agreement, some investors may consider this as a perfect time to take some profit on recent gains before liquidity dries up during the Holidays. This can add further pressure on oil prices in the near term.