Electricity prices & the solar eclipse

Electricity cannot be stored. When the sun hits a solar panel, or coal is burnt to turn a turbine and generate an electrical current, this energy is delivered to the distribution grid straight away.

Spot markets are where wholesale electricity producers and consumers go to balance their planned against their actual electricity needs. Those needs become clearer the closer we are to delivery, which is why electricity is often traded the day-ahead, or on the same day as delivery to the grid (intraday). This is particularly true for solar and wind power generators since the weather forecast becomes increasingly accurate from 24 hours out.

Solar eclipse

If you are a solar power farm what do you do if your energy source – the sun – goes offline? This is what happened last Friday morning, March 20th, in North-Western Europe. A solar eclipse, lasting around 75 minutes, during which the moon at least partially blocked the sun, had a big effect on solar electricity production.

Germany was particularly affected. Today it gets approximately seven-percent of its electricity from solar energy.

The celestial event affected French-German intraday spot prices between 9:00 and 11:00am. If you didn’t know better you might’ve thought the traders had pressed the wrong buttons on their keyboards! Bids as low as -975.00 euros and as high as 950.00 euros were tendered. To give you an idea prices are normally closer to 20.00 or 40.00 euros on the intraday market at the moment.

The final prices did eventually settle at 40.79 euros for 9:00-10:00am, and 66.37 euros for 10:00-11:00am, but varied a lot within the hour. Some 15min intervals settled at a negative price. This is not so unusual and has been seen before.[i] Nevertheless, the spot market demonstrated strong resilience to price volatility during the eclipse.

Negative electricity prices

When wind and solar generators have really good days electricity prices can drop below zero.[ii] The negative price means the market is oversupplied.  Everyone produced more electricity than expected and they don’t know what to do with it.

A negative price indicates you would actually pay someone else to use the excess electricity you produced. Why? It might be too late to decrease your production. Gas, coal and nuclear power plants need several hours to warm up (or down). Such facilities do not have simply on/off switches.

Avoiding blackouts

Those in charge of maintaining electrical grid stability, Grid Operators, can impose large fines if you exceed what you committed to delivering to the grid. Or if you do not produce as much as promised. Paying someone else to consume your excess electricity is probably a lesser loss than the fines imposed by Grid Operators.

The Grid Operators impose these rules because electrical currents need to be gently “ramped up” and “ramped down.”[iii] They have to plan ahead to ensure electricity flows safely and avoid blackouts.

What’s more consumers are fickle. You wouldn’t have been happy if your computer crashed, or you couldn’t make a cup of tea during your morning break because there wasn’t enough electricity – solar eclipse or not.

No one knew exactly how the solar eclipse would affect production, which explains traders’ erratic behavior. Somewhere else in Europe a more flexible electricity generator – probably a gas-fired power plant – had to quickly ramp up production to replace the eclipsed solar generation and meet consumer demand. Only the most modern and efficient power plants can react this quickly.

A test for Germany

The sudden drop in solar electricity production was an important test of grid stability. If Germany achieves its 2050 goal to produce 60% of its electricity from renewables, then cloudy days will have an affect on the grid as significant as last week’s solar eclipse.

The European Union also plans to increase the share of renewables in electricity production across the continent. In the future enormous swings in solar production could become commonplace.

[i] Take a look at all the prices here.

[ii] Sunny days tend to be windier then average, so solar and wind production peaks can coincide.

[iii] Imagine pulling your hairdryer out of the wall when it’s on full blast. Sparks fly! Multiply that effect by thousands and you can imagine the challenge for Grid Operators.

Oil trading 101

For those of us who never studied finance or economics, terms such as hedging, futures and long position are very mysterious.  Let’s look at a basic oil trading strategy: selling the futures spread, to understand some of these terms.[i]

First of all, what is a futures contract?

If I sell a contract, to deliver 1000 barrels of oil in December 2015, I have  sold an oil futures contract.

For example, I promise to supply a customer, let’s call him Harry Potter, with 1000 barrels of oil in December. Harry pays this December price to secure his supply and I lock in a comfortable price. Why would Harry do that? If the December futures price is currently $50 Harry probably believes that, come December, the real oil price will have changed. If it turns out to really be $70 (multiplied by 1000 barrels!) then Harry has won. He paid his supplier – me – much less then he would have paid if he had waited until December.

$70 – the actual price of oil in December – is called the December “spot” price.

On the other hand, if it turns out the December spot price falls to $45 then the supplier made the better deal. I wait until December to buy 1000 barrels of oil at $45 each. I supply these barrels to grumpy Harry who already paid me $5 more per barrel and rather thought he had made a good deal back in March.

Oil future prices emerge because different players have different expectations about how oil prices will evolve.

Current market conditions

The oil futures market  is currently in deep contango. What does this mean? Contango means traders expect the price of a barrel of oil to be higher in the future than it is today. Deep contango means this price will be a lot higher. Yet, as we just saw above, when delivery day arrives the spot market might tell another story.

As a trader I need to make a prediction about what will happen over the next few months

For example:

  • Oil storage facilities are near capacity in Europe and essentially full in the US. Storage is becoming inaccessible.
  • Today’s spot prices are at a historic low. I might think they are likely to drop further, since producers cannot store oil to sell later and will be forced to dump their supplies somewhere.
  • Many producers are becoming unprofitable. Investment in new oil production projects is being put on hold because prices around $40-$50/barrel are not enough to cover production costs.
  • If there are few new projects to replace current production then oil supplies will eventually tighten and prices will increase. But not for at least a year or two. Identifying this lag is crucial.

This means the contango will deepen.

Based on the above predictions, I would expect the futures spread to widen. That is, the difference between the spot and future price of oil will get much bigger.[ii] Why?

To reiterate: spot prices will decrease as we have a situation of oversupply that is likely worsen when oil storage facilities run out. Then the oil futures price will increase, relative to spot, since the market is not expected to tighten for one or two years. This pattern should hold for some months.

My trading strategy, based on these expectations, is to sell the futures spread.[iii]

Selling the futures spread means I sell a futures contract for a near month  and buy a futures contract a far month. This will be profitable if I am right about the contango spread increasing.

For example:

It is March 2015.


  • Sell April oil futures contract @ $48.13
  • Buy May oil futures contract @ $49.13
  • The spread is -$1 per contract.

It is now April 2015 and I need to offset my position.


  • Buy April WTI spot contract @ $47.13
  • Sell May WTI futures contract @ $51.13
  • The spread is now -$4 per contract.

Intuitively -4.00 < -1.00

So I sold something at a higher price than I bought it back for. Profit!

My total profit is: (-1) – (-4) = $3 x 1000 contracts = $3000

A helpful guideline:

Which trading strategy to use?   Contango time spread (normal market) Backwardated time spread  (inverted market)
Expect the spread to widen Sell spread Buy spread
Expect the spread to narrow Buy spread Sell spread

Selling the spread:  short the near futures position and long the far futures position.

Buying the spread: long the near futures position and short the far futures position.

[i] Please be aware that this example is pure fiction and the author takes no responsibility for losses or gains made by anyone trading oil futures based on the above-described strategy.

[ii] It does not really matter what the price level is per se. So it’s not helpful to say “prices will go up.” Relative to what?

[iii] Short = sell, long = buy. These terms do not have anything to do with time-frames!

Canada’s tar sands: unburnable carbon

Canada’s tar sands contain some of the biggest proven oil reserves in the world. They are mainly found in Alberta. But mining these tar sands, to produce ‘synthetic’ crude oil, is expensive. The process also releases more greenhouse gases than conventional oil production does. If we are serious about arresting climate change then these reserves need to stay in the ground.

What are tar sands?

Tar or oil sands are unconventional natural crude oil sources that have a viscous, tar-like consistency. A mixture of sand, clay, water and bitumen, the sands are really a bio-degraded form of crude oil: “Old oil, [it’s] kind of like old wine that’s past its peak.”[i]

The bitumen part must be separated out and then upgraded into a synthetic crude oil (syncrude) before it can be further refined into petroleum products like gasoline and diesel.

Two different production processes can be used to extract the bitumen from tar sands: open-pit mining, used when oil-sands deposits are close to the surface; and in-situ mining, used when oil deposits are deeper underground.

Open-pit mining accounts for around half of all production. The process is destructive. First, forests must be cleared away. Then the tar sands are dug out, using enormous shovels, and they are then transported to processing facilities in trucks several storeys high.

Greenhouse gas emissions

‘Well-to-wheels’ life-cycle methodologies calculate the GHG emissions released in producing a petroleum product and getting it to the petrol pump. They don’t calculate emissions once you start driving. According to IHS CERA an Albertan tar-sands project releases between five and 15 per cent more GHG emissions from ‘well-to-wheels’ than does conventional oil production.

The extra emissions come from two main sources: fuel input and ‘fugitive’ emissions. Fuels used in open mining projects include diesel, electricity and natural gas – for trucking and steam production, and for upgrading the oil to create syncrude. (Syncrude then has to be refined again to obtain the final-use fuel.) Around 20 per cent of all Canadian natural gas produced serves the tar-sands industry.

Fugitive emissions are another problem. They stem from natural gas leakage, venting or flaring during mining. Venting is a process that releases any associated natural gas into the atmosphere; flaring burns off this unwanted by-product – because it’s not profitable to get it to a pipeline. 

Overall, the Canadian oil-sands industry generates emissions equivalent to Portugal’s – as a country. Portugal is ranked 56 out of 142 GHG-emitting countries worldwide.[ii] Open-pit mining also has the added effect of destroying Albertan boreal forest – a net carbon sink. All this makes Canadian tar sands development a significant net contributor to global climate change.

Who is the consumer?

Despite the emissions released during production, final-fuel combustion is ultimately more troubling. Emissions weigh heavily in the consumption phase, contributing 70 to 80 per cent of overall lifecycle emissions.

The US is Canada’s primary export market for syncrude. It is transported by pipeline to specialised refineries mostly in America’s Midwest. Around three-quarters then becomes gasoline and a quarter is turned into diesel, feeding domestic markets.

The controversy surrounding the Canadian-US Keystone XL pipeline project stems from US environmentalists’ opposition to production from the tar sands, since it is a particularly emissions-intensive source of crude oil. Yet, Albertan syncrude can still be imported by train, with or without Keystone XL, and transport by train has historically caused more leaks and accidents

Unburnable carbon

If all known oil reserves worldwide were extracted, produced and then used, climate change would occur on a dramatic, irreversible and dangerous scale. We have a lot of ‘unburnable carbon’. So we need to choose which sources, if any, we are going to develop. ‘Unburnable carbon’ refers to fossil fuels that can’t be burnt if the world it to limit carbon emissions so as not to trigger serious climate change.

Most oil that is easily and commercially producible around the world therefore needs to remain in the ground.

Tar-sands projects are among the world’s most expensive and marginal oil production projects – meaning that the cost of production is significantly higher than for conventional oil. In addition, tar-sands oil is only profitable when international oil prices are close to $100 per barrel. Canadian producers are already taking a hit. The International Energy Agency has estimated that a new Canadian oil sands project will cost up to 10 times that of a conventional project in the Middle East.

The economic cost

Research by the Canadian government and the Pembina Institute shows that Canada’s manufacturing slowdown is partly the result of the Canadian dollar appreciating. This has risen over the past decade as exports, mostly of crude oil, have risen. Essentially, the development of Alberta’s oil sands is hampering the manufacturing growth.

Continued reliance on commodity exports will divert investment away from the transition to a low-carbon economy. Being endowed with diverse natural resources, and having advanced manufacturing, service and innovation sectors, Canada has alternatives. Progress within more innovative and value-additive sectors is being overlooked, locking Canada into a high carbon-intensity development path.

The impact of tar-sands development on global climate change, though alarming, is not the only reason to discourage such development. They are not only of questionable benefit to the Canadian economy overall but are unlikely to remain profitable in a low oil-price climate.

Finally, as a significant GHG emitter, if Canadian politicians were to take a lead on climate change issues they could have a real political impact worldwide. Perhaps, the Canadian government and people could leave these particular hydrocarbons in the ground.

[i] The U.S Oil and Gas Boom, Ifri 2012

[ii] S. Dyer, M. Dow, J. Grant, M. Huot & N. Lemphers, Beneath the Surface : a review of the key facts in the oil sands debate, The Pembina Institute, 2013

Note: where unquoted statistics can be credited to the Pembina Institute.

What the frack?

The US shale revolution is a hot topic these days. It’s one reason  America recovered faster than Europe following the 2008 global financial crisis. But what is shale gas and shale oil? And what’s all the controversy about?

Fracking 101

Hydraulic fracturing, abbreviated to “fracking,” technology is not new. It’s been around since at least the 1920s. It simply got cheaper and easier to do in the last ten years. Basically, instead of drilling multiple wells to extract gas or oil from underground rock formations, water or a mix of chemical lubricants is injected into the ground at very high pressure to shatter or “frack” the surrounding rock and increase yield from the well. This can be done several times at different intervals along the well shaft. The gas then travels up the well shaft and is collected at the surface.

Fracking can also be carried out horizontally as sketched in the diagram below. Rather than drilling several vertical wells down into the same shale rock layer, the well turns a corner and follows the hydrocarbon producing rock.


Shale gas is the same organic compound we refer to when we say natural gas – primarily methane. Shale actually refers to the porous rock within which gas is trapped. Generally shale, but sometimes sandstone. It’s like a solid sponge which shatters under the high-pressure injections of water and releases gas.

The most profitable shale “plays” (industry-speak for a geological area containing underground shale gas reserves) are described as “wet” because they also contain crude oil. This liquid hydrocarbon is called shale oil or light, tight oil being trapped in the porous rock and very high quality crude.  [i]

The shale gas revolution

Small and medium-sized producers began fracking in the United States several years ago. Enormous shale plays were discovered in Pennsylvania (Marcellus), Texas (Eagle Ford), and North Dakota, Montana (Bakken). All very profitable whilst international oil prices were high. Since the US gas pipeline network is so well developed it was easy to market the associated natural gas.

The gas market was flooded with diverse new supplies – decreasing gas prices at physical trading hubs substantially. This was a huge boon for industry. Cheaper energy has made US exporters more competitive whilst Europe continues to struggle with higher gas prices and economic recession.

It was heralded as a golden age of gas. This was good news for US greenhouse gas emissions too. Emissions have decreased since gas became more competitive with cheap, but polluting coal in the electricity sector. Additionally, some fuel-switching has occurred with natural gas replacing petrol in a limited number of cases in the transportation sector. This is no small achievement. The US transportation sector is overwhelmingly the greatest source of greenhouse gas emissions in the world.

Could the shale gas revolution happen in Europe?

Two factors allowed US production to take off the way it did. Firstly, in the United States mineral wealth is privately owned. Meaning whatever you dig up and find in the subsoil beneath your property belongs to you. This is why we have the stereotype of a Texan oil baron. A lucky farmer that strikes oil on his ranch keeps one hundred percent of the profits. (Best practice is to hide your find from your neighbours for as long as possible, lest they get digging as well).

In Europe governments retain mineral and mining rights. There is much less incentive for small-time producers to drill for hydrocarbons outside of the United States. Despite your capital investment, the profitability of the project is unpredictable.

Second, the industry was almost completely unregulated when it got started. The wells were already pumping gas and turning a profit before proper regulatory oversight came into play.

Fracking companies have been targeted with accusations of poisoning aquifers. Aquifers are a subsoil layer that must be drilled through to reach shale rock formations below. This is also referred to as groundwater – frequently a natural source of water for rural and urban communities.

There have been cases of the chemicals used during fracking processes leaking into the groundwater in parts of America. Very toxic lubricants were used to make the wells more productive in the early days. Nowadays shale gas producers are willingly reporting the chemicals they are using, (previously considered a commercial secret,) to try and regain the American public’s confidence. And a properly reinforced well should not be leaking into an aquifer for any reason. It’s eventually been made harder for frackers to get the right permits to go ahead with new projects.

Proper geological imaging to ensure wells are drilled far from sensitive fault lines, as small earth tremors have been linked to fracking processes, and regulations regarding water use in drought-prone areas have emerged too.

There are shale basins in Europe, notably in France, Poland and the UK, quite close to dense population centres. If proper regulation oversees the production process chemical leakage and earth tremors are totally avoidable. Nevertheless, the conditions that shaped a shale gas revolution in America are still unlikely materialise in Europe.

[i] This should not be confused with oil shale, which is kerogen. Kerogen rock needs to be heated up to extract crude oil. This is a very different and more expensive industrial process.