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Forex Flash: Europe- Back to the dark ages - BAML

FXstreet.com (Barcelona) - The Bank of America Merrill Lynch Commodity Research team believe that coal´s renaissance is Europe and Germany “dirty secret”.

They note that while coal use in power generation has grown out of fashion in the US, it is staging quite a comeback in Europe. They write, “Coal-fired power generation is growing at an annual rate of 5% and 22% in Germany and Spain, while generation from gas is falling by 15% and 23%, respectively. As running coal plants is more economic, gas lost 5% market share in Europe's power sector in 2012. On the back of that, CO2 emissions generated by the power sector in Germany perversely rose last year because of strong growth in lignite and coal generation.”

Additionally, they see that renewables and coal are crowding out gas. According to their analysis, German utilities currently stand to lose €5/MWh when burning gas during peak load while they can earn €10/MWh from burning coal during baseload in Cal14. In response to the price signal, they note that German utilities have opted to replace lost nuclear capacity with coal and lignite rather than cleaner burning natural gas. In addition, they add that gas is facing strong competition from renewables during peak demand. Solar capacity in Germany is now 33 GW and generation spikes during peak demand hours at mid-day. As a result, the gas load factor is firmly squeezed between renewables and coal, causing cash losses for operators. What's more, they see that German power demand is depressed because of subdued economic growth and efficiency savings, further reducing the demand for marginal gas plants. Many gas plants are now threatening to close.

Overall, they feel that German power prices have little upside and gas has therefore become irrelevent for German power prices. They write, “Combining our subdued outlook for coal and CO2 prices with the planned solar capacity build-out suggests that German power prices will fail to move significantly higher near-term. While marginal nuclear generation costs provide support at €35/MWh, CAL14 baseload power prices will unlikely trade above €45/MWh even if backloading of CO2 permits goes ahead. Given the lure of capacity payments, shutdowns of gas plants in Germany may take time, thereby pushing any power price recovery into the future. Finally, German power prices have decoupled from other central European markets, such as France, NL or Belgium, likely on the back of strong growth in solar capacity. We see a possibility of further decoupling.”

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