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April 3, 2014 You paint a pretty gloomy picture for the Nabucco pipeline in your last Oil Market Report and yet still say it is Europe’s best hope for gas security. How so?
The March Oil Market Report certainly generated a fair bit of interest…
Nabucco certainly faces massive challenges, but still does hold a couple of “aces in the pack”. The first one is obviously the increasing EU determination to get the thing done. Yes of course we can all joke about EU bureaucracy, but where there is a political will, things do happen in the end – even in Brussels! So whilst it’s true that Nabucco has been severely hampered by a lack of political will over the last 5 years, we believe that events in Ukraine will bring an increasing focus to this project and we should expect accelerated activity on the Nabucco pipeline, as a result.
The second ace is Turkey and its booming economy – the fastest growing economy in the European area and expected to be the 3rd largest electricity and gas market in Europe by 2020. The country is planning to spend 100bn lira (£50bn) on energy projects over the next 10 years and the Nabucco line is expected to be the main supplier to many of these projects. So you can also expect a re-opening of EU accession negotiations with Turkey on the back of these developments, as Turkey is almost certainly going to become the key to Nabucco’s success.
We received this email from Helena in London
March 28, 2014 I am very interested in your latest article on our country. You seem to know a lot. We have nice summer house in Oblast-Siberia. I would like to invite you. We always interested in protecting people like you. Do not tell anyone of arrangements in case they worry. You may be some time.
That’s a kind offer Vladmir, but we will give it a miss. I will not look as good as you without my shirt.
This latest question/invitation relating to the March Oil Market Report came from Vladimir in Moscow.
March 17, 2014 I enjoyed January’s Oil Market Report on price predictions for 2014, but felt they only touched on the really big issues. Are there smaller, more technical issues that might affect prices this year?
Respect Jackie! You are certainly keen, although you should perhaps get out a bit more…
To answer your question, we see two factors that could shape oil prices in 2014 – both unlikely to grab too many headlines but both significant;
Firstly, the strength of the $ has always had a big impact on oil prices. Put simply, as the $ weakens against other currencies, it means that those currencies can afford to buy more things that are priced in $. For tourists, this might mean they can enjoy a cheaper holiday in the USA or fly to New York and stock up with cheap goods. But in commercial terms, this means that buyers of oil can buy a lot more oil for the same amount of money. Take the UK and today’s oil prices at $100 per barrel. With current exchange rates (circa $1.65 per £), a UK buyer could buy 1 barrel of oil for £61, but if the $ was to weaken versus the £ (say for example, we went up to an exchange rate of $1.90 per pound – roughly where it was in 2007), then that £61 would now buy circa 1.2 barrels of oil.
Such “value for money” might incentivise the UK buyer to take the opportunity and buy a whole lot more oil and if you then extend that concept across the whole world, then the impact on prices becomes apparent. In every country, we have the big strategic buyers (state stocking agencies, big plc’s, large transport infrastructures) increasing their purchases of oil because they can afford more through the weakness of the $. Result = oil prices go up!
Secondly, worldwide interest rates could also play a part in deciding oil prices. Over the last 5 years, interest rates across almost all the major economies have been at record-breaking low-levels. This has meant that a lot of financial funds (pension, hedge) have taken their money out of interest bearing schemes (safe but puny returns) and looked to invest them elsewhere. The elsewhere was often commodities with proven track records of returns, ie, oils, metals and agri-minerals and this has created a buying pressure that has undoubtedly pushed prices northwards. Arguably this is the worst type of speculative pressure, as it simply represents walls of money being invested in oil and simply because historically the oil price has risen and a bet is being made that, that trend will continue.
So central banks now have a very interesting role to play with regard interest rates and indirectly, oil prices. Keep interest rates low and the funds will continue to look at alternatives such as oil – thus keeping oil prices buoyant. Start increasing interest rates on the other hand (for example to encourage prudent savers, to combat inflation or to avoid property bubbles) and funds may come back to the safety of central banks, who can now offer more attractive returns. If and when this happens, you could see a great deal of money leaving the (oil) market and that should push prices downwards.
We had this question at the beginning of February 2014 from an anonymous sender – so we will call him / her Jackie Diesel…
December 19, 2013 Is LPG the same as normal mains gas? And is “normal” gas the same as LNG? Please help – there are too many names….!
No shame in being confused Margaret. Only today, I went to buy my wife some face-cream from our local Department Store….Never again.
First things first, LPG stands for Liquid Petroleum Gas and is not the same as “normal” mains gas. It is heavier than air and therefore sinks to the ground, whereas mains gas is lighter than air and rises upwards under normal atmospheric conditions (and therefore presents a much greater risk in terms of gas leaks). LPG is composed primarily of propane and butane, while natural gas is composed of the lighter methane and ethane. LPG has a higher calorific value than natural gas, which means it gives off more energy (heat) but also tends to mean that LPG is more expensive.
There is also a lot less LPG around. This is because LPG is derived from refining oil (hence Liquid Petroleum Gas), whereby the lightest and most flammable components of crude oil rise to the top of the Distillation Tower when heated (just imagine filling a massive kettle with crude oil and then boiling it). LPG is the first crude oil component to evaporate off, whilst petrol and kerosene (jet fuel) will also rise to the top of the mixture (but will not evaporate). At the same, heavier grades of fuel such as diesel and fuel oil will sink to bottom of the mixture.
On the other hand, Natural Gas is gas that is extracted directly from underground rock formations. Like crude oil, it is formed when layers of buried plants and animals have been crushed by extreme geological pressures over thousands of years. Often, natural gas sits on top of coal deposits and sometimes can also sit on top of existing oil reservoirs. Before it can be used as a fuel, natural gas must be purified and once this is done, it is typically pumped into the gas main (hence “mains” gas).
Transporting mains gas is extremely cost effective (once the pipelines have been constructed), which is why Western European Countries invested in huge gas networks in the 60’s and 70’s. However, the beauty of LPG is that it can be used where no mains gas networks exist – so in the UK it tends to be a central heating fuel in rural areas and in the developing world, it is used as a heating fuel for both hot water and cooking. LPG is also a much more diverse and useful product than natural gas, in that its uses range from camping gas stoves to aerosol propellants (where it has replaced o-zone depleting CFC’s) and of course in cars as Autogas.
Finally, answering your question on LNG; this is the same as natural gas, but it is gas that has been cooled and liquefied for transportation purposes (hence Liquefied Natural Gas). So whereas, natural gas extracted in the North Sea is simply pumped into a pipeline under the sea and then transported by that pipeline into the UK’s gas grid, natural gas in (say) Qatar is extracted and then liquefied, before being pumped onto a ship and sent to an import facility in (eg) the UK, where it is pumped into the mains gas grid.
As central heating systems across the UK started to go into overtime, we had this question from Margaret in Sutton.
October 14, 2013 The news commentators and politicians keep on referring to the California black-outs as a reason that fixed prices are not workable. What was the situation there and when was it?
Another good question, although we would say the link between Ed Milliband’s energy proposals and the California black-outs has been over-played. The California energy crisis took place in 2000 – 2001 and was caused by questionable / fraudulent activity on the part of Enron, who were selling electricity to the Californian utility companies. However, the latter had not hedged their exposure, so that when Enron pushed prices up by a factor of 10 (by physically restricting the market), the utility companies could not pass these increases on to the consumer. The reason they could not pass the costs on – and here is the link with Milliband’s proposals – is that the utility companies were limited by the Californian State as to what prices they could charge. The result was that costs for the utility companies rocketed and with no ability to charge consumers for the higher prices, they simply stopped supplying electricity – leading to wide scale black-outs and power failures.
However, if the electricity companies had hedged in the first place, the rise in costs from Enron would have mattered less (or not at all) because then the hedge would have paid out on any cost increases. So in theory this situation should not occur in the UK, as long as companies hedge correctly. But then again – on the basis that the Government could not force the utility companies to hedge – the risk of this happening in the UK might be remote, but would still be a possibility.
October 4, 2013 I realise that gas and electricity are not your main areas of expertise, but what chance of Labour's 'energy price freezing'
Not our main areas of expertise as you say Simon, but we still fancy our chances against the policy makers! Our guess is that this idea will never see the light of day (even if Labour win the election in 2015), largely because of its radical nature, the significant opposition from vested interests and the legacy of previous government interventions in business activity.
However, if the question is whether the policy is ‘doable’ (rather than ‘will it be done?’), then we don’t see that it is very difficult to achieve at all. Let’s look at a few key facts:
– The process of Price Hedging in order to fix prices is ubiquitous across all energy sectors and the key players partake all the time
– Forward contract “strips” of 12 months are very common, positions of 3 years + are not unusual, and the Futures Markets even allows positions up to 9 years forward to be taken
– Most utilities trade wholesale gas and oil on the wholesale markets and then use derivatives (futures, swaps & options) as insurance against price volatility
– At any given time, all utility companies will have hedged at least some of their forward consumption and / or sales
– How much they have hedged is a function of how pro-risk (or risk averse) they are, ie, do they hedge 100% and lock in all profits / costs or do they hedge a smaller portion, leaving them free to speculate on market movements?
So all of the above tells us that the mechanisms are in place to achieve Ed Milliband’s goal and that there is no practical reason why the utility companies cannot provide a fixed energy price to UK consumers. Forward derivative contracts would be taken out (be they on electricity, gas, coal or oil) for the 18 month period proposed and for the volume that is supplied to UK customers. Then the energy companies would decide how much margin they want to add for UK sales and away they go.
The idea that infrastructure investment in the UK will cease as a result of fixed prices seems bogus, although it might be based on the fact that a fixed margin on UK sales may not generate enough profit versus the current method of generating income based on speculative activity. This is a moot point of course, but it is worth reiterating that selling energy on a fixed price basis does not lose the energy company money (as long as they have a forward hedge in place), but it might not make them as much money as speculative trading, the (increased) profits from which could be then used to reinvest in infrastructure. That being said, as hedging providers ourselves (on fuel), we would have thought that one of the energy companies would see this ‘fixed price’ debate as a great opportunity to present themselves as the ‘honest’ party by offering fixed prices to consumers before it becomes mandatory (or not) and increasing their customer base in the process.
Finally though, a cautionary point before anyone gets too carried away with the idea of fixed prices. Hedging the price of gas or electricity does not bring prices down per se and nor does it fix prices in perpetuity. A fixed price simply holds costs steady for a certain defined period (eg, Milliband’s 18 months) and removes price volatility. At the end of the fixed price period, a new fixed price has to be set and if wholesale markets have gone up in the meantime, that new fixed price will obviously be higher than the previous one.
This question came from Simon in London (Oct 2013).
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