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 Supply & Trading GmbH

RWE Supply & Trading PAGE 1

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

Supply Demand Power price

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

Fuel forward curves Weather impacts

Thermal power generation Comfort of living Energy efficiency Macro cycle

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

Renewable power generation

A B C D

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2012 2013 2012 2013 2012 2013 2012 2013 TTF Sum2014 (EUR/MWh) Coal Cal2014 (USD/t) CO2 2014 (EUR/EUA) German Power Cal2014 (EUR/MWh) (coal at the margin)

With the exception of coal, energy prices moved mostly sideways over the last two years

A B C D

As of March 2014

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Recent energy price developments continue to move sideways

A B C D

As of August 2014 2012 2013 2014 2012 2013 2014 2012 2013 2014 2012 2013 2014 TTF Sum2014 (EUR/MWh) Coal Cal2014 (USD/t) CO2 2014 (EUR/EUA) German Power Cal2014 (EUR/MWh) (coal at the margin)

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German photovoltaic and wind installations account for 46% of installed capacity and 19% of generated power in 2013

German power supply – renewable capacities continue to grow

Expected capacity growth (GW) Total capacity installed (GW)

Solar Max Solar Min Wind Offshore Wind Onshore

A B C D

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For a number of thermal plants the energy only market is no longer viable

> Based on current announcements Germany will loose more than 4 GW of ‘dependable’ generation between now an 2018 > From 2015

• nwards

announced plant closures will tighten the capacity

• utlook

Plant additions and closures in Germany (MW)1

1 According to BNetzA (July 2014)

Closure announcements are cause for concern

A B C D

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1 IED - Industrial Emissions Directive 1 Source: BNetzA (July 2014) without newly announced RWE closures

While there is sufficient capacity right now, additional plant closure announcements will eventually tilt the system

> The BNetzA’s view on security of supply has been assessed starting from 2013 figures and adding known capacity changes (net capacity development is negative to 2018) > To ensure security of supply TSO’s will require 5 GW capacity margin above expected load for every hour > In this assessment mothballed capacity is assumed to contribute to security of supply as it can be reactivated when necessary > Without any additional decommissioning, security of supply will not be seen as endangered (much) before 2018 > Assuming that the regulator wants to maintain 5 GW capacity margin to cover forecast errors additional 3-5 GW plant decommissioning would intensify the discussion on security of supply MW Mothballed plants Nuclear capacity to be decommissioned until 2023 2013 Until 2018 2023 Remaining capacity incl. capacity from abroad (AT, LU) IED-related decommissioning1 Decommissioning according to BNetzA

A B C D

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E.ON announced early nuclear shutdown

A B C D

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Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114

German power demand – power consumption remains weak

Low load in May (-12%) not representative due to higher number of bank holidays

Energy-intensive industries are cutting production and consumers produce their own energy

Average change of weekday load compared to previous year

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

A B C D

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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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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

The power price development over the last twelve 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 Spot1

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…that the risk premium has been mainly in forward parts of the price curve (spike risk)

Spread between forward and spot prices (EUR/MWh)

Cal 02 Cal 03 Cal 04 Cal 05 Cal 06 Risk premium (right scale) Cal 07 Cal 08 Cal 09 Cal 10 Cal 11 Cal 12 Cal 13 Cal 14 Spot1

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

1 365d spot moving average

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2012 2013

With plenty of generation capacity available, the market does no longer price in a risk premium

Contango has been reinstated 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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The market expects that renewable generation is growing faster than utilities will close their plants

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

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

2012 2013

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2009 2010 2011 2012 2013

2013 forward 2014 forward 2015 forward

Trading year 2012 Trading year 2013 Trading year 2014

The market expects also that German dark spreads will follow the decline of spark spreads

Average clean dark and spark spreads (EUR/MWh)1 Expectations for dark spreads (EUR/MWh)

Something has got to give!

1 RWE Supply & Trading, prices until 25 February 2014

CDS Cal 2013 – 15 Base load (€/MWh) (assumed thermal efficiency: 36%) Average CDS Cal 2013 – 15 CSS Cal 2013 – 15 Peak load (€/MWh) (assumed thermal efficiency: 49%) Average CSS Cal 2013 – 15

• 16
• 12
• 8
• 4

4 8 12 16 Year 1 Year 2 Year 3

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Germany’s oversupply is dragging adjacent markets lower as long as there is sufficient border capacity

> European power price convergence until 2012 > Since then prices diverged > In the Netherlands and UK gas-fired power plants mostly set prices; whereas in Germany, France and Poland cheaper coal-fired plants are price setting > Renewable additions exceed the extension of cross-border capacities > Germany is increasingly no longer able to export its surplus renewable power production European power prices (EUR/MWh)

Capacity constraint Capacity constraint

10 20 30 40 50 60 70 80 90 2009 2010 2011 2012 2013

Germany Netherlands UK Poland France

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

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

Annualised volatility compared to 2001: Forward versus spot

Forward1 Spot2

1 Front year baseload 2 Day-ahead baseload

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2010 2013 2012 2011

…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 2013

Day-ahead trading: 208 Intraday trading: 198 Day-ahead Intraday

Market participants in 2010

Day-ahead trading: 94 Intraday trading: 89

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07 July 10 July 09 July 08 July 11 July 13 July 12 July

A first blip of light at the end of the tunnel

Intraday vs Day-ahead: This year’s calendar week 28 (EUR/MWh)

Intraday high / low Day-ahead Intraday

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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 2013: 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, risk and risk premium is moving along the curve in the course of time

> Volatility and risk in German and Continental power markets have moved to the very front end of the curve > This development led to backwardation of long-term contracts > During the last decade seasonal patterns became more pronounced: As a result generators react with seasonal mothballing > Such cycles can also be observed in other markets

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2008 2009 2010 2011 2012 2013 2007 2006

Experiences from other markets prove as well that risk premiums fluctuate

USA: Back and forth shifting of the risk premium in PJM power market

1 Rolling front calendar year for that day 2 365d spot moving average

Spread between forward and spot prices (USD/MWh)

Result of the bull market in fuels... The reduction of risk premium was also a supply glut due to rising shale production ...and corresponding correction of prices Forward1 Spot2 Risk premium (right scale)

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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? > Prices for fuel commodities and CO2 are drifting sideways > 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 assume that renewable generation capacity will grow faster than thermal plants are being closed > Lower dark spreads would signal to plant operators that their capacity is no longer required > 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 > Price to drift sideways for a while before markets tighten > 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

1 2 3 4