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Energy Buying Strategies in a Volatile Market

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Energy Market Update, I have provided some in-depth energy buying strategies in the current volatile market. Briefly, a month ago NYMEX futures broke out of their range and exceeded $3.60 per MMBtu for the first time in four months.  A month later prompt month gas futures are $4.20 for the first time since July 2011. Why, you ask? The primary reason: March was COLD. Heating demand depleted storage inventories to levels not seen since the last time gas was over $4.10. But the long-term picture is not as grim. Gas futures for 2014 are up significantly less than the near-term, and 2015 and 2016 are down. The bottom line is that the rally is being driven by near-term fundamentals while long –term prices have stabilized, thanks to shale reserves resulting in a much flatter forward curve.

The details are in the numbers below
                                             Prices as of 4/12/13         Change since 3/7/13
Prompt month natural gas    4.22                                  +0.64
12-Month Strip                      4.37                                  +0.52
Calendar 2014                      4.26                                  +0.15
Calendar 2015                      4.27                                   -0.03
Calendar 2016                      4.36                                   -0.09
($ per MMBtu)

In addition to impacts of trends in the NYMEX, both regional gas basis and regional power issues are driving power prices.

  • New England: Winter gas basis volatility remains a hot topic with forward prices remaining elevated as supply challenges due to pipeline constraints and reduced LNG imports and is expected to continue for the next several years
  • New York: Gas basis will get some relief thanks to pipeline expansions
  • PJM: This market has seen the least volatility due to impacts of Marcellus shale, but capacity prices are changing significantly and are much higher for some parts of the ISO
  • ERCOT: Summer is around the corner and so are concerns about adequate reserves and risk of hitting the higher price caps. Summer prices and heat rates are high.
  • California: Cap & Trade regulations have changed the market and uncertainty regarding generation from the San Onofre Nuclear Generating Station (SONGS) have ended the California run of consistently low prices

Market Outlook
A repeat of the spring 2012 dip is very unlikely. The change in storage inventories from surplus to deficit is enough to prevent any such market crash. Beyond storage, the market is “smarter” this year by knowing the price points that require changes in supply and demand. Power generator and gas producers behaviors have limited upside and downside in the market. This limits upside risk and this is apparent as long-term prices have stabilized, but also reduces chances for a big dip. The result has been an end to the seemingly never-ending prices declines from 2008 through 2012 and a flat price curve.

What will trigger price spikes or buying opportunities? Weather is critical as always, so watch out for the impact of summer heat and hurricanes. It will be interesting to see whether producer activity picks up due to rising near-term prices. Consumer demand from the industrial sectors has increased due to the US’s low natural gas prices compared to abroad. The net effect is apparent in storage activity. And keep an eye on regional gas and power fundamentals and heat rates – watching the NYMEX alone is risky.

For the long-term, key drivers of the shape of the forward curve encompass EPA regulations, LNG exports, Natural Gas Vehicles and the US economy.

Fixed Price Customer Considerations

  • It is very difficult to buy in a rally and many customers are certainly frustrated as they have been waiting for the “inevitabledip that the spring would bring.
  • Higher prices are inevitable for most. It is possible that a dip is forthcoming, but targets from a month ago must be revised upward because any downward move before will be limited by the storage deficit. Summer brings potential risk and reward – so have a strategy to deal with both.
  • Budgets that require year-over-year rate declines may be unrealistic depending on the timing of your previous contract and can result in undue risk by setting targets that are unlikely to occur.
  • Short-term contracts are a strategy to buy time, but do not recognize the possibility that current prices levels will be sustained or could move higher.
  • Long-term prices may still present a good value because they have risen much slower than the near-term.  And the flat forward curve provides opportunity for stable prices.

Managed Product Customer Considerations (Portfolio Product, Heat Rate & PowerFit)

  • Although they do not provide an escape from higher prices, products that allow layering have significant advantages during periods of price strength by allowing initial layers to be utilized to mitigate risk with subsequent layers being utilized to take advantage of market dips.
  • Hedging strategies will depend on market fundamentals and customer risk tolerance.
  • Be careful of using prices from 2012 to form price targets except for final layers.
  • Even customers with a high risk tolerance should consider hedges for upcoming summer months.
  • Initial layers should be considered if not already in place for 2014.
  • Recognize that the flat forward curve may provide significant value for layers into 2015.
  • Utilize seasonal layers to address regional concerns such as winter gas basis spikes in New England and summer price spikes in ERCOT.

Posted: April 17, 2013

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