Volatility, risk and risk premium in German and Continental power - - PowerPoint PPT Presentation

PAGE 0 RWE Supply & Trading

Volatility, risk and risk premium in German and Continental power markets

Stefan Judisch / Andree Stracke RWE Supply & Trading GmbH 22nd January 2015

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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

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Reservoir level Reservoir level Power plant new build Power plant new build Marginal costs of thermal plants Marginal costs of thermal plants Power plant closures Power plant closures Available capacity Available capacity Wind capacity growth Wind capacity growth Subsidies & technical progress Subsidies & technical progress Seasonal temperature forecast Seasonal temperature forecast Residential demand Residential demand Air conditioning / Electric heating Air conditioning / Electric heating Industrial demand Industrial demand Reservoir hydro plants Reservoir hydro plants

Supply Demand Power price

Cross-border exchange balance Cross-border exchange balance PV capacity growth PV capacity growth CO2 prices CO2 prices Gas prices Gas prices Crude prices Crude prices Coal prices Coal prices

Fuel forward curves Weather impacts

Thermal power generation Thermal power generation Comfort of living Comfort of living Energy efficiency Energy efficiency Macro cycle Macro cycle

Various fundamental factors influence power prices on the long-term forward market

Renewable power generation Renewable power generation

A B C D E

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A E B D C

Coal and gas prices collapsed whereas power declined less

Relative development of German Power, API#2 Coal and TTF Gas for the front year (1st Jan 2014 = 100%)

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> 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.

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)

B A E D C

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> 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.

German Power Supply (II): Fossil generation: capacity closures exceed new-builds

Mothballed Newbuild

C A B E D

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Slowdown in German power demand less prominent

Source: Entso-E Power Consumption (preliminary hourly data)

> 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.

• 20%
• 15%
• 10%
• 5%

0% 5% 10% Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14

Average Load YoY Change

Bank holiday effects

D A E B C

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Cross-border flows: The introduction of flow- based 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 E A B D C Results of parallel runs ATC vs. Flow-based (FB) market coupling for 2013 and 2014

Source: CASC CWE

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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

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10 20 30 40 50 60 70 80 90 100 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

The power price development over the last 14 years in Germany show…

Forward versus spot prices (EUR/MWh)

1 365d spot moving average

Cal 02 Cal 03 Cal 04 Cal 05 Cal 06 Cal 07 Cal 08 Cal 09 Cal 10 Cal 11 Cal 12 Cal 13 Cal 14 Cal 15 Spot1

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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

1 German power baseload 2 Implied Cal as weighted average of spot settlements and balance-of-year forwards

Implied Year (FY0)2 Front Year (FY1) Second Year (FY2) Risk premium (right scale)

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Year 1 Year 2 Year 3 Risk premium (right scale)

The market expects renewable generation growth to force utilities into more plant closures

Spread between year 3 versus year 1 (EUR/MWh)

Forward curve remains backwardated, but got significantly flatter.

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Cal 16 Baseload Prices:

European power prices decline as fuel prices collapse

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

> 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.

* In times of high renewables generation, cross-border constraints limit exports.

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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.

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The volatility in the German power market is shifting to the front of the curve…

Annualised volatility compared to 2001: Forward versus spot

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…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

Market participants in 2014

Day-ahead trading: 199 Intraday trading: 195 Day-ahead Intraday

Market participants in 2010

Day-ahead trading: 94 Intraday trading: 89

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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)

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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

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German merit order in 2014: prices and volatilities for different hours of the year

1 Excluding nuclear fuel tax 1 Source: RWE

A sunny and windy hour A sunny hour with high intraday volatility 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

• r closure candidates

Marginal cost (EUR/MWh)

Renewables Nuclear1 Lignite Coal Gas Oil Others

System services

Capacity (GW)

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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 CO2 prices > Higher prices > Higher forward volatility

Source: RWE

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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-of- the-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.

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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

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Summary & conclusion

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) > 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 > Outright prices to drift sideways for a while before markets tighten. Fuel spreads on the back end

• f 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 What can we

• bserve in the

traded market? How will future developments impact merit

• rder

economics? Conclusions

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