2020 has been a very challenging year for power producers. In mid-2020, power was almost free, which creates challenges not only for utilities but also for their owners, some of which rely on the ‘steady’ income streams that come from utility ownership. One might be tempted to blame the COVID-19 pandemic for the price decline. But, in fact, the pandemic only plays a minor role in this context. Instead, the weather is the main culprit. While we expect future power prices to trend upwards, large price fluctuations are also expected. Events like 2020 may occur with increasing frequency, creating uncertainty around the dividends available to owners, many of which are local municipalities or the state.
Record low power prices in 2020
The power price has been at a record low in 2020. While the average power price in 2019 was almost 40 EUR/MWh, the 2020 average will likely be around 13 EUR/MWh. That would be the lowest level we have experienced at any time since 2000 (inclusive), see Figure 1.
The current situation is very challenging for Nordic utilities and their owners (largely comprising the state and municipalities), which rely on steady incomes from power generation.
Don’t blame the Corona virus
One might be tempted to blame it all on the COVID-19 pandemic. That would be a mistake however. While the pandemic did lower demand for power and gas across Europe – albeit to a lesser extent in the Nordics – the main culprit is the weather. The start of 2020 was wet, windy and warm. In the second quarter, the water inflow and snow available to hydropower reservoirs could supply 35 TWh more electrical energy than in a normal year (equivalent to about 25 percent of Norwegian annual demand). On top of that, windy weather added considerable wind generation, while mild temperatures reduced demand by significant amounts.
When looking at daily Elspot prices since December 2019 (Figure 2), the beginning of the COVID-19 lock-down cannot even be identified from the curve.
Weather creates considerable uncertainty
In other words, this time, the weather is to blame (see also Insight 2016-04). Historical developments reveal that considerable price fluctuations have always occurred. While long-term fundamental trends (like increasing demand or rising CO2-prices) determine the general power price outlook, there are significant short-term movements around these trends. This is nothing new. In dry years, power prices tend to be high; in wet years, power prices tend to be low. What is new, though, is the extent of the price decline, which has contributed to unprecedented low prices.
We might see the 2020 price development again
The question is whether 2020 was an exceptional year, or whether similar price collapses may be expected in the future. Will such price swings become the new normal?
In a special analysis in our Autumn 2020 market outlook, we have analysed weather risk in detail, modelling market developments in future years using historical weather conditions from 1981 to 2016.
Based on this analysis, 2020 does not look so special after all. Wet, warm and windy conditions often coincide. An illustration is given in Figure 3, showing the relationship between annual hydro generation and annual wind generation. A similar pattern can be seen for demand; wet years tend to coincide with low demand.
While we estimate an increasing trend in future power prices, there is tremendous price risk in the market. This is because the Nordic power market already exhibits a substantial energy surplus even in normal weather years. For example, the annual normal surplus in 2022 is estimated to around 40 TWh. Thus, even in a dry year with 30 TWh less inflow than normal, the Nordic region is still exporting power. However, in a wet year with 30 TWh more inflow than normal, the surplus increases to a staggering 70 TWh, which is equal to half of Norway’s normal power production.
New interconnectors help somewhat in managing this risk, but a substantial price risk remains. In fact, while we estimate a mean and median price above 30 EUR/MWh for the year 2022, in 20 percent of the weather simulations conducted, power prices fall below 20 EUR/MWh. In 5 percent of the simulations, the annual average falls below 10 EUR/MWh.
Significant implications for the value of Norwegian resources
For the owners of Nordic power resources, this may not be good news. For example, looking at total Norwegian wind and hydro generation capacity in 2022, total annual gross revenues can swing from between around 975 mill EUR to 5.750 mill EUR. These estimates take into account the fact that higher hydro and wind volumes partly compensate for lower prices.
If one wants to avoid the implied revenue swings, one would need to hedge one’s portfolio. Current trading in the forward market for the Nordic system price is very low, however. In our opinion, the current forward market is undervalued: the expected price outcome over all the weather years we simulated is above current forward price levels. However, forward markets may be biased in the sense that they don’t reflect expected values so much as certain worst-case outcomes. In addition, liquidity in forward markets is challengingly low, with some doubting the representativeness of the forward market.
In short: While we expect power prices to go up, be prepared for a roller coaster ride!