Falling sterling following Brexit to buoy energy contracts
Yesterday morning Mark Carney announced the first measures the Bank of England would be taking to calm markets in the wake of the Brexit vote. The announcements were made at the launch of the financial stability report where he ordered banks to cease from building a reserve margin — which banks should hold as a buffer for when things turn bad — in order to release up to £150bn in potential loans to boost liquidity in the market.
The Bank of England had already announced it may loosen monetary policy in the near term to bolster the economy. Many believe this could come in the form of an interest cut to 0.25% in August following the publication of the quarterly inflation report — depending on the findings of the report. Others think a rate cut could come as early as this month. The Bank of England is also expected to employ further quantitative easing measures.
Sterling could fall further
This is likely to add further pressure on the pound which had already fallen to 1.304 against the dollar yesterday — its lowest since referendum result and since 1985 — despite no actual confirmation of further easing from the Bank yet. Some believe employing such measures could push sterling to 1.2 against the dollar and around 1.08 against the euro, down from 1.17 yesterday — its lowest since 2013.
How would this impact energy prices?
As mentioned in previous posts, an outage at the Rough gas storage facility — the UK’s only large, seasonal storage facility — could mean the facility isn’t filled by the beginning of the winter. This poses a threat to security of supply and could mean the UK needs to meet stronger demand in the event of cold weather by importing more gas from the continent through the Interconnector pipeline. This gas will need to be bought at European hubs exposing the price to the potentially weaker pound against the euro.
The significant upside risk for the power market comes from the cost of coal-fired generation which has been a key driver for pricing this winter as the UK will need to bring on coal-fired plants to keep the system in balance as demand ramps up during the period. This exposes the UK power market to the sterling-dollar rate while the cost of carbon — which is relatively high for coal firing — will be influenced by the sterling-euro rate.
All other things being equal, if sterling fell to 1.2 to the dollar and 1.08 to the euro this could add approximately £2/MWh — or 4% — to the winter power price.