European steelmakers don’t expect new energy contracts yet, despite oil slump

European steelmakers don’t expect any immediate renegotiations of their energy supply contracts, even though oil prices have tumbled 45% since the start of the year and energy prices are at multi-year lows in markets overshadowed by coronavirus, industry associations said.

European steelmakers’ association Eurofer pointed out that oil is not a central component in steelmaking and that currently EU producers are making deliveries regardless of the coronavirus outbreak.

Andres Barcelo, general director of Spain’s steel industry group Unesid, said: “We don’t see any short-term renegotiations … since most (energy supply) contracts are index-linked to market benchmarks. The few contracts that are at a fixed price are more difficult to renegotiate and have characteristics similar to an underwriting agreement.”

Still, lower oil prices should filter through in time to lower operating costs in metals and bulk commodities markets, BMO Capital Markets analyst Colin Hamilton said. “Extraction of metals is naturally an energy-intensive process, and lower oil prices tend to feed through to reported costs, with a few months of lag,” he said.

Forward power contracts across much of Europe remain close to multi-year lows, dragged down by a mix of cheap gas, plentiful wind and weak demand.

European forward power contracts (Italian Q2, French front-month, German year-ahead) fell 4%-7% early Monday in response to that day’s collapse in the oil price and recovered losses mid-week only to dip again Thursday and Friday, with the benchmark contract German Cal 21 seen at Eur39.80/MWh Friday afternoon.

In Spain, where energy costs have been problematic for years, the decline in power prices will only partially offset the disappearance of other mechanisms that the steel sector previously used to reduce its energy costs, such as interruptible contracts, according to Barcelo. These have been gradually scaled back in terms of both quantity and price, to the point that the H1 2020 awards mean only around a Eur1/MWh saving on the energy cost for large consumers, according to S&P Global Platts’ estimates. Power demand from metal companies – Spain’s largest single consuming sector – has dropped around 15% in the last year.

Gas price decline gives some relief

The recent decline in gas prices has meanwhile turned out to be quite a relief, turning out better than steelmakers and metals producers expected.

Data published this week by gas grid operator Enagas showed a 7% year-on-year increase in gas demand from metal producers, spurred by multi-year low gas prices. The increase in February compares to an underlying increase in demand of 0.3% for the trailing 12 months, and is a sharp contrast to a 7% decline in January, meaning that activity may be picking up again spurred by the lower energy costs.

Still, market sources said that a sustained drop in power prices could threaten the current drive towards the use of long-term power purchase agreements, since forward prices are now quoting below the level at which most Power Purchase Agreements (PPAs) have been agreed in Spain.

Structurally, this is an issue, because the government wants large consumers to forward purchase much of their energy via renewable-backed PPAs and is drawing up legislation specifically with that aim.

Market sources have reported that standard Spanish PPAs are usually agreed for 10 years for a fixed amount per year (in GWh) and at a price that has been around Eur42/MWh.

At present, balance of year prices are below this level, making it more economical for large consumers, such as metal groups, to purchase power in the wholesale market. Cal 21 is still at a premium for the moment, at Eur43.50/MWh on the OMIP Exchange.

Moreover, in the longer term, low oil prices could curb investment in the oil and gas sectors, reducing their steel requirement. “The drop in oil prices is a symptom of an economic slowdown … additional to the uncertainty generated by the coronavirus pandemic,” Unesid’s Barcelo said.

Maxim Khudalov, senior director at Moscow-based analytical credit ratings agency ACRA, sees that additional market pressure may spur further European steel capacity cuts. “Closures.. may also become essential in developed markets, in dollar and euro zones, and take place as soon as H2 2020-H1 2021 provided the situation does not improve,” he said in an interview. “In the EU, the only source of additional income could become those CO2 border taxes, currently in contemplation, provided their proceeds are distributed among domestic mills. Therefore, we may expect EU steelmakers to make policymakers speed up their introduction.”
Source: Platts