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Forward power price bull run takes a breather

The bull run of 2007-2008 came to a halt mid-July as the forward power curve responded to falling oil and coal prices. Also down was CO2, dipping below Euro25/EU Allowance from early July highs of Euro29.70/EUA.

Finally, several traders observed the usual pre-summer holiday settling of positions and a reluctance to open new ones in power ahead of the break, further serving to dampen prices.

For Europe's price-setting power market, Germany, the focus has been on a rush by speculators to exit coal.

For Europe's price-setting power market, Germany, the focus has been on a rush by speculators to exit coal (Listen to podcast: European power markets analyzed).

The CIF ARA 2009 coal contract (See chart: CIF ARA 90-day forward coal price) on July 23 was heard as low as $169/metric ton during the morning session, down from a midpoint assessment of $211/mt on July 11, as bearish sentiment fuelled by weakness in the crude oil futures market continued to apply downward pressure.

Sources said that despite tightness in long-term supply/demand balance, there was little in the near term to offer support to spot prices.

One trader said that with workers at Drummond's Pribbenow coal mine in northern Colombia returning to work, there were "no prominent fundamental issues shoring up prices at the moment."

Traders said that speculative players were giving up long positions in the coal paper market had contributed to the drop. "Technically the market looks oversold, it's hard to gauge how much speculative money has come out," said a utility trader.

German year-ahead power closed July 23 (See chart: Platts Year Ahead Base Power Assessment) at Euro76.75/MWh, the French Cal 09 base at Euro80.75/MWh, having hit all-time highs on July 1, closing at Euro90.10/MWh and Euro93/MWh respectively.

Gas prices, meanwhile, have eased this month. On July 1, Platts assessed Winter 2008 UK gas at Euro44.47-44.56/MWh, Summer 09 at Euro40.38-40.46 and Winter 09 at Euro47.36-47.45/MWh.

On July 23 Winter 2008 was down over Euro4.00/MWh to Euro40.10/MWh, with similar or great dips for Summer 09 (Euro35.70) and Winter 09 (Euro42.50).

Dutch TTF midpoint assessments on July 1, meanwhile, stood as follows: Q4-08 Euro39.50/MWh, gas year 2008 Euro40.70/MWh, and Cal 2009 at Euro41.95/MWh. On July 23, the contracts were assessed at: Q4-08 Euro36.10; gas year 2008 Euro36.30; and Cal 2009 at Euro36.55/MWh.

With coal historically high, gas easing, and the LCPD forcing some generators to ramp back on non-retrofit coal plant, gas units are being sweated a little harder than coal units in markets where fuel switching is an option.

Indicated month-ahead profits for coal-fired generation in Germany have switched to negative since the start of July, while in the UK gas-fired generation has looked more profitable than coal-fired since the middle of June.

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The UK month-ahead 50% spark spread -- the difference between the cost of gas and the price of power for a combined cycle unit with an efficiency of 50% -- was almost Euro20/MWh below the equivalent spread for coal (the dark spread) at the start of the summer, April 1. But that difference has narrowed to just Euro3.4/MWh as of July 15.

When the cost of carbon (See chart: December 2009 Carbon) emissions is taken into account, the spread between the spark and dark spreads reverses to favor gas, as coal-fired generation produces about twice as much carbon dioxide as gas-fired. The UK month-ahead clean spark spread was Euro38.75/MWh July 15, compared with a clean dark spread of only Euro25.82/MWh.

In Germany, the same process has resulted in the month-ahead clean dark spread moving into negative territory as of July 1, when it was minus Euro9.92/MWh. At that time the clean spark spread was Euro6.15/MWh.

In theory the reversal of the spreads would prompt generators to favor gas-fired generation over coal-fired generation, but in practice only the UK has the flexibility to switch to any extent.

German gas-fired generation is relatively minor at around 11.7% of total capacity, although other forms of generation are available, namely nuclear and renewables.

If those forms of power can meet demand then German producers have a strong incentive to ramp down coal output, sell fuel and EUAs, and buy wholesale power.

The ability to switch to gas in Germany is, of course, growing now that a minor dash-for-CCGTs is underway. Indeed fuel switching across northwest continental Europe will be greatly extended by the present drive to install gas-fired units in the Netherlands, Belgium and France.

It would be wrong to read too much into these near-term price movements, however. The present popularity of gas-fired investment has more to do with capital costs, lead times, flexibility and a reluctance to commit to coal and nuclear under short-term EU ETS signals.

And while the near curve shows gas-fired generation favored over coal, forward prices show a marked advantage for the latter. Forward spreads indicate that EUA prices would have to rise to around Euro45/EUA to encourage a shift to gas.

Next page: Bearish two weeks blunt 2008 gains

Created: July 30, 2008

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