As we draw an end to the first month of the UK lockdown, we have seen committed efforts by the government and regulatory bodies towards addressing the ongoing effects of COVID-19 in a pragmatic and supportive manner. While much of the response over the last month has been concerned with the short-term impact of COVID-19, the focus now appears to be moving more towards the mid-term outlook and potential impact of an economic downturn resulting from the pandemic.
In this regard, one of the most notable developments has been the approval by the EU of a €500 billion rescue package to support countries hit hard by the pandemic. Meanwhile, the UK Treasury has extended its overdraft facility with the Bank of England to deal with the increased financial strain on the economy as the nation prepares to extend its period in lockdown. The Treasury and the Bank of England have given assurances that this measure is solely for the purpose of providing the government with a short-term source of additional liquidity, if required, to support the markets during this period, and that the cost of COVID-19 would be financed through the government's normal debt management operations.
The falling energy demand driven by decreased industrial and commercial use, plus high solar and wind generation, has led electricity market prices to drop to their lowest in 10 years. Today, for example, the UK market experienced negative prices in day-ahead auctions, within-day prices were approximately -£45/MWh and there was a sustained period of negative system prices. Other European markets such as France and Germany have been similarly affected as operators take active steps to manage systems.
In its Summer Outlook report published last week, National Grid ESO (NGESO) estimated up to a 20% decrease in electricity demand this summer. As a result, the stack is currently close to just nuclear and renewables and NGESO expects to be managing periods where output exceeds demand more than usual. This also means that there will be very little inertia on the system, which in turn means that frequency excursions could be problematic. This may require existing balancing services to be used more often and for longer periods than in previous summers. In order to manage the continued low demand exacerbated by the COVID-19 crisis which could risk overloading the system, NGESO has warned it may take actions such as curtailing flexible wind farm output via the Balancing Mechanism or via direct trade, and trading to reduce interconnector imports.
Away from the effects of COVID-19, there is more positive news. The UK continues to make positive progress in its clean energy strategy – BEIS reported in its latest Energy Trend Report that energy output from bioenergy, waste, wind, solar and hydro stood at fifteen times higher than coal in 2019, with renewables' share of electricity generation hitting a record high at 36.9%.
In addition, following the government's announcement last month that "Pot 1" technologies could compete the next round of auctions for Contracts for Difference (CfD), Cornwall Insight has estimated that 13GW of projects are eligible to compete for CfDs next year, with onshore wind and solar projects contributing a substantial figure of over 5GW in this estimation.
Oil and gas
The much-anticipated meeting between OPEC and other oil-producing countries resulted in an agreement to cut around 10% of normal production levels in May and June (equating to approximately 10 million barrels a day). The meeting of the G20 oil ministers that took place on 10 April (following the OPEC+ meeting) did not firm up the agreement further, save as to provide its support for the efforts to stabilise the oil market. Despite the intervention, oil prices did not then recover as much as had been hoped as the markets had anticipated a bigger reduction in production to match the collapse in demand. Of course, the situation has today worsened significantly with US oil prices turning negative for the first time in history. More to come on this development.
The oil market report published by the International Energy Agency (IEA) for April 2020 predicts a further drop in oil demand in May, with a gradual recovery to start in June, although it notes that demand will still be lower than the same time last year (whether or not its predictions are revised in light of the latest developments remains to be seen). The IEA estimated that, despite the agreement to cut production, the implied stock build-up in the first half of the year will continue to test the logistics capacity of the sector to the limit. We have seen SSE taking the opportunity of decreased gas demand to auction gas storage capacity at its Atwick site in Yorkshire at a reserve price of 22.43 pence per therm – offering a total of 2.83 TWh of capacity for the 2020/21 storage year.
In the LNG space, low offtake continues to drive prices down, as sell tenders continue to flood the market with excess volumes and buyers look to defer cargo deliveries. Data from Reuters revealed the current average LNG price for June delivery into northeast Asia LNG-AS is almost half that for June last year. Inevitably, there will be those that find opportunities during times of crisis, particularly in Europe where LNG is heading towards historically low prices. Again, prices could well depreciate further following today's oil price crash.
The EUA price continued to recover over the last couple of weeks. The compliance deadline for the surrender of carbon allowances occurs at the end of this month, and therefore the market expects increased trading activity (which in turn will have a positive impact on the carbon price) over the coming days in line with previous reconciliation periods. However, this is being perceived as a short-term spike and once the deadline has passed, and demand falls again, so will the price in the medium-term.
The European Federation of Energy Traders (EFET) published its recommendations to attain a 2030 climate target plan, supporting the establishment of an architecture including the role of the energy sector to meet EU climate ambitions. Key policy priorities set out by the EFET include reform of the EU ETS by extending it to allow for greater consistency of carbon pricing, allowing the scheme to become the long term driver of decarbonisation across the EU economy, and utilising cost effective ways to harness Europe's energy markets to deliver 2030 and 2050 climate targets.
BEIS and the Construction Leadership Council (CLC)
Since the beginning of the lockdown, the UK government has been criticised for its lack of guidance to the construction industry about what work can continue.
However, BEIS has now released guidance in line with the Public Health England (PHE) social distancing guidelines, advising that construction work may continue in accordance with PHE guidelines wherever possible. This can be contrasted with the approach being taken by the Scottish Government, which has stated that construction work should not continue unless it is part of a Critical National Infrastructure sector.
A consistent approach to the BEIS guidance has now been adopted by the CLC with the issue of a third edition of the Site Operating Procedures (SOPs) last week. Having amended the SOPs three times in three weeks, the message now appears to be clear – there is no limit on the type of work being carried out in the construction sector to ensure continuity of work, but site operators remain ultimately responsible for the safety of their workers and the detailed guidance now in place is designed to achieve this.
The CLC also issued a statement expressing its concern over the management of payments in the supply chain as the industry continues to feel the impact of the pandemic. Its statement highlights a concern and disapproval of parties seeking to invoke contractual clauses to delay payment or extend credit terms on a unilateral basis to the detriment of other firms. The CLC has called for solidarity to 'sustain the industry' during this uncertain time, instructing businesses to abide by agreed contractual terms relating to payment to ensure liquidity in the sector in order to aid their calls to the government for support measures.
Ofgem has set out guidance on what connection works are to be prioritised to deal with the escalating impact of COVID-19, and what works and services may be temporarily deprioritised and suspended without regulatory enforcement consequences. The threshold for High Priority Works and Services has been set high and include critical response and repair work to ensure the continuity and security of supply for customers, and essential connections work as part of the response to fighting COVID-19 (for example, hospitals, food shops, sites of critical national infrastructure).
This period of regulatory flexibility adopted by Ofgem will remain in place until 30 June 2020 to be further reviewed by Ofgem nearer the deadline in consideration of circumstances then prevailing.
We note that the guidance seems to focus on supply connections. There have been calls from industry for Ofgem/BEIS to provide greater clarity on what connections for generators will be deemed essential.
In addition, Ofgem has updated its information for energy licensees noting that its current focus remains on the most time-critical work being carried out so as not to impede its response to the COVID-19 crisis. Of the list of work areas being prioritised by Ofgem until 30 June, notable items include the consultation on the Capacity Market Rules policy, managing ongoing OFTO tenders, all obligated licensing activities, and monitoring the wholesale energy market with a special focus on market liquidity.
Low Carbon Contracts Company (LCCC)
LCCC, the government-owned counterparty to contracts awarded in Contracts for Difference (CfD) auctions, has confirmed that COVID-19 is capable of constituting a force majeure event under the CfD. The message from LCCC is that it plans to work with CfD projects to assess the impact of COVID-19, whether that materialises in the immediate or longer term, in a 'reasonable and pragmatic' manner. Generators have also been reminded of their contractual obligations to mitigate the effects of force majeure and satisfy the elements of a force majeure claim if seeking such relief. This will generally be welcomed by generators because the LCCC has, in the past, taken a hard line on force majeure claims (such as the attempted termination of the Neart na Gaoithe offshore wind farm' CfD, which was ultimately decided in favour of the generator following legal proceedings).
Investment and business outlook – a shifting paradigm?
Policymakers and climate strategists have been stressing, over the past few weeks, the need to utilise the current pandemic as an opportunity to accelerate the global transition to clean energy. The International Renewable Energy Agency has stressed that the strain of COVID-19 on communities and economies will require far-reaching strategies including public policies and investment decisions containing the vision of a sustainable future.
Investors are no strangers to a recognition that sustainable investments must remain in their long-term strategies. Market players such as MUFG, Barclays and Bank of America have shared views supporting the role that COVID-19 must take in shaping ESG investment going forward and of public policy support being offered to companies. MUFG made the notable decision last year not to finance new coal fired projects, and SMBC Group followed suit at the end of last week with the same decision, as increasing numbers of investors shift their focus to clean energy and infrastructure projects to maintain their reputation in the market and utilise the current crisis to address ESG risks.
Businesses are also beginning to focus on the role they play in the fight against climate change, shifted in part by what the market and society expects of them. Oil and gas majors such as Shell and BP have made ambitious pledges to become net-zero companies by 2050 (in line with the goals of the Paris Agreement). Taking Shell as an example, its plans revealed last week include net-zero on emissions from the manufacture of its products, as well as seeking to serve businesses and sectors that are net zero emissions.
As the nation settles in for at least another three weeks of lockdown, the government continues to consider longer term strategies to support the economy through the crisis. Regulatory bodies are working through the upcoming issues affecting the energy sector while the sector itself pulls together and tries to carry on with business as usual, as much as is realistically possible.
An apparent commitment towards continuity of business by the majority of the energy sector should hopefully help ensure that it is better placed than others to weather the storm. Despite the immediate liquidity concerns being faced by some suppliers, prompting whispers of bailouts and other government intervention, there is a feeling that businesses are starting to gear up for the recovery period – with one eye on normal operations resuming and another on new opportunities that may arise as a result of the crisis. Indeed, news from prominent market players is symbolic of this approach - such as I Squared and Blackrock announcing new energy and infrastructure funds in the last few weeks.
The global focus will once again turn to the US oil price crisis, the consequences for producers and other players in the oil industry, the speed and means of recovery and from a UK perspective, how this will impact the UK market.
A final word goes to the former talk of the town…Brexit. While daily parliamentary efforts have been focused on responding to COVID-19, the clock continues to tick on the UK's transition period set to expire at the end of this year. The chief negotiators of the UK and the European Commission held a meeting last week to assess the status of negotiations, including identifying key sticking points. Concerns have been raised about whether meaningful negotiations can take place before the end of the year between the EU and the UK, including by the IMF who appealed for a delay to Brexit. With Boris Johnson now on the road to recovery from COVID-19, the government has rejected the suggestion of an extension to Brexit stating that that it remained in the interests of the UK economy to continue negotiations in line with the agreed timeline to enable economic autonomy to deal with the effects of the crisis. A bold statement of intent!