UK energy utilities face hedging strategy re-think
Henry Evans
12-Aug-2016
Long-term hedging strategies adopted by the UK’s largest six utilities are likely to change following the publication of recent results indicating reduced profits in power generation despite an improvement in spark spreads over the last 12 months.
Despite a sustained recovery in spark spreads – the crude profit margin for gas-fired generation – since the end of 2015, length built up on the forward curve has prevented utilities from profiting from the relatively recent upturn. This because their hedging strategies often meant locking in forward costs and income before the increase in sparks occurred.
Utilities including Centrica and RWE have recently reported reduced profits in generation, despite combined-cycle gas turbines (CCGTs) now being the dominant plant in their thermal portfolio.
Clean spark spreads, which include the additional cost of carbon paid by UK fossil-fuel generators through the carbon price support (CPS), have widened on average in the first half of the year (see graph).
Day-ahead dirty spark settlements during the most recent Q2 were also higher compared with the equivalent period in 2014 and 2015, according to ICIS data (see EDEM 27 June 2016). And these bullish numbers helped inject value into spreads further out on the curve, sources said at the time.
A continued fall in gas prices in the 18 months preceding this April and the closure of coal-fired capacity have improved the economics for UK CCGTs.
‘A new hedging strategy’
“Utilities, if they want to maximise returns, will have to develop a new hedging strategy which is more prompt and near-curve focused as the volatility is there to drive greater profitability as more and more intermittent generation connects to the grid,” said Inspired Energy risk manager Nick Campbell.
“The need to develop a new hedging strategy is becoming more important given utilities’ margins are being squeezed across the vertical market as higher policy charges impact both retail and generation profitability,” he added.
RWE reported a 7% drop in profit margins from its power generation business in half-yearly results published on Thursday. The company stated that profit margins in gas-fired generation had also dropped.
“The most recent developments on the market had very little impact on revenue from electricity generation in the reporting period,” RWE said.
Utilities have traditionally hedged the majority of their forward generation on the far curve in order to lock in profit margins and insulate themselves against potential declines in wholesale prices, as well as against general uncertainty and volatility, nearer delivery.
Centrica also recently reported reduced profits of 59% during the first half of the year in its power generation arm, which is predominantly based around gas-fired generation (see EDEM 28 July 2016). Higher output from the UK’s nuclear fleet, in which they have a 20% stake, and their CCGTs was offset by the impact of lower baseload power prices, the company said.
Centrica has two major CCGTs that continue to operate in the wholesale market – the 895MW Langage facility and the 1.25GW South Humber Bank power station that is currently selling a reduced output of 540MW into the market.
“I guess as the hedges roll off into next year, the profitability will improve,” Jefferies’ utilities equity analyst Oliver Salvesen said.
However, the strategy of the business is already directed towards profiting more from short-term markets following the establishment of a new distributed energy business and its acquisition of Danish energy trading company NEAS, Salvesen added.
henry.evans@icis.com
Global News + ICIS Chemical Business (ICB)
See the full picture, with unlimited access to ICIS chemicals news across all markets and regions, plus ICB, the industry-leading magazine for the chemicals industry.
Contact us
Partnering with ICIS unlocks a vision of a future you can trust and achieve. We leverage our unrivalled network of industry experts to deliver a comprehensive market view based on independent and reliable data, insight and analytics.
Contact us to learn how we can support you as you transact today and plan for tomorrow.
READ MORE
![](https://cjp-rbi-icis.s3.eu-west-1.amazonaws.com/wp-content/uploads/sites/7/2024/01/16170556/ContactUs_Services.jpg)