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Buying strategies - October 25, 2013

Market Overview

Late October is the time for last-minute shopping for energy buyers.  Winter is around the corner and the new year is not too distant.  Whether you're looking to hedge the winter only or lock in prices for 2014, it is time to get moving if these purchases have not been made already.  Fortunately, wholesale gas and power prices are low (compared to historicals), providing one more opportunity to lock in prices before entering the volatile winter months.

There has been some price volatility this fall, but with little net change, as shown in the data below.  NYMEX Prompt Month natural gas futures bounced between $3.50 and $3.80 during most of September and into early October.  After a very mild start to October, forecasts calling for a cold snap pushed energy prices higher and set 4-month highs.  The rally was surprisingly strong and near-term prices posted their highest levels (on Oct. 14) since spring, with the Prompt Month settling at $3.82 and the 12-month Strip at $4.02.  Thereafter, prices retreated just a week before the beginning of “gas winter”, which is generally defined as November through March.

(all prices are in MMBtu) 10/24/2013 Change since 8/30/13
NYMEX Contract
Nov-13 $3.62 -10 cents
12-month Strip $3.81 -4 cents
Cal '14 $3.87 -6 cents
Cal '15 $4.05 -3 cents
Cal '16 $4.16 -10 cents

Market Fundamentals
Natural gas storage injections remain strong and continue to narrow the deficit versus a year ago.  As of Oct. 18, domestic gas storage inventories, as reported by the EIA., are at 3,741 Bcf.  This is 2.4% behind 2012, but 2.1% above the 5-year average.  Since last year’s levels set record highs, storage is in very good shape going into the winter, despite the slight deficit over last year.  Although minimal, there was an impact of the federal government shutdown, because the EIA was briefly closed, delaying one storage report for a few days.

Hurricane season, which runs through Nov. 30, has been very light—with only few storms impacting the U.S.  Tropical Storm Karen did shut in some gas production during October but the overall impact to the production area, as well as the eastern seaboard, has been minimal and hurricane season is winding down.  From a long-term strategy perspective, the share of U.S. gas supply represented by offshore Gulf of Mexico production has declined from 26% in 2005 to only 6% in 2013.  The worst-case impact of a storm the size of Katrina or Rita on the energy infrastructure has declined dramatically compared to a decade ago. 

On Oct. 15, the Supreme Court announced that it will hear a lawsuit challenging key aspects of efforts to regulate greenhouse gas emissions from power plants and other sources.  A ruling in this case will occur during the 2014 session. There wasn't any significant market reaction to this news and, at this point, it is unclear whether there would be any potential impacts to the EPA’s mercury rules, that go into effect in 2015.

Market Outlook
NYMEX gas futures have been mostly range-bound for all terms, since the spring of 2012.  As generator and producer economics continue to define this price range, that trend is expected to continue.  For the near-term, the range has been $3.20 to $3.80 since June.  Within that range, there has been movement, which is expected to increase during the winter.  Weather and resulting storage reports are primary triggers of volatility, and would offer the best chance for a break outside of the range, regardless of direction.  This is a key short-term risk to your energy purchasing decisions.

Long-term prices through 2016 have been in the $3.80 to $4.60 range since early 2012.  This is even stronger evidence of the economics of generation and production.  The premium for the long-term strips is justified by four primary bullish factors:

  • Gas demand for power generation continues to increase because of economics (i.e. low-priced natural gas) and the coal plant retirements related to impending EPA regulations. The impacts are immediate, with additional coal plant retirements expected as EPA regulations commence in 2015.
  • Industrial demand for natural gas is also increasing due to low prices that give U.S. industry an edge over international competition.
  • Natural gas exports to Mexico have also become more significant, growing from only 0.5 Bcf/day in 2000 to 2.0 Bcf/day in 2012, with potential growth to near 5.0 Bcf/day by 2015.  This is due to  pipeline expansions that are being built to meet the demand for generation and industrial demand in Northern Mexico.
  • Exports via LNG are expected to commence in 2016, with significant growth in 2018 and thereafter, based on four terminals (with a total export capacity of 6.3 Bcf/day) that have been approved for non-FTA nations.  However, only one terminal is being built thus far, with the earliest export capabilities still at least two years away.  This is a long-term factor, with only modest impacts expected before 2018.

These four bullish long-term factors are offsetting ongoing prolific shale gas production growth, especially in the Marcellus regions.  There is no slowdown in sight for this trend.

If you have electricity purchases to make, it's important to remember not to solely focus on the NYMEX as a gauge for your purchasing strategy and timing—it is critical to consider regional power prices.  In fact, while NYMEX prices have been range-bound, power prices have exhibited both significant opportunities and risk.

Here are a few highlights of key regional issues that should be considered in your electricity purchasing plan:

PJM – Wholesale prices are especially low, even lower than historical day-ahead prices in some cases, but consider significant capacity rate changes to be effective in June 2014, with ongoing fluctuations that vary across PJM for upcoming capacity years (June-May).

New York   Like PJM, NY power prices have benefitted from shale production despite the statewide ban on fracking.  Two pipeline expansions to New York City (Spectra in Nov ‘13 and Transco in Nov ‘14) have suppressed regional gas basis and power prices.  Be aware of capacity market changes in the Lower Hudson Valley Region that could offset the benefits of the declining wholesale rates.

New England   For New England, the story continues to be the same.  Ongoing pipeline constraints and lack of LNG imports can cause short-term winter volatility for both gas and power prices.  This risk has provided forward price support— especially for the winter.

ERCOT – In Texas, long-term resource adequacy and rising offer caps, with the corresponding risk of summer price spikes, remain critical.  In addition, ERCOT is in the process of establishing a new initiative, the Operating Reserve Demand Curve (ORDC), which could trigger automatic $9,000 interval prices if peak demand is within 2,000 MW of available capacity.  This mechanism would work on top of the already established systemwide offer cap, which is $7,000/MW, beginning June 1, 2014.

California – The California market has been relatively quiet and forward prices are down, while index prices are up $14/MWh compared to 2012—primarily due to  cap and trade.

Strategy Considerations
With prices for most terms and regions relatively low or extremely low, based on historicals, there are good buying opportunities now.  As always, it is tough to predict the market’s direction from here.  A significant consideration will by the length of the term being evaluated, regardless of product, as well as your risk appetite.  If you aren't currently hedged and do not want to be exposed to winter prices, any delay in purchasing is basically speculation on short-term weather, since it is likely to be the primary driver of the market.  Consider the current low prices for most markets.

If near-term risk is not a concern, winter may afford buying opportunities if the weather is mild.  Waiting could be an option for buyers that (1) are comfortable with short-term price volatility, (2) are on a managed product, such as PowerPortfolio, with some hedge coverage in place, or (3) are looking at longer-term buying decisions and do not have urgency.  In each case, buyers should have a strategy in place in case prices rally.

If your business is focused on long-term strategies, your approach can be different but will still depend on product and risk philosophy.  If you consider bullish long-term fundamentals, the range-bound nature of the market and the fact that prices are near the bottom of the range, this could be a buying opportunity.   As noted above, winter dips are worth watching if they occur.  This is especially true if you're on a product with layering capability, because you may already be looking at prices for 2015 and even 2016, depending on your company’s buying procedures and goals.  At the same time, any test of the upside of the price range is less of a concern, as long as the range is expected to hold.

Three final thoughts are as follows:

  1. Consider both the NYMEX and regional gas/power fundamentals.
  2. Have a strategy to deal with market movements in either direction.
  3. Be nimble (i.e. make sure yhave the capability to move quickly to take advantage of buying opportunities, which are often brief.

As always, consider your budget and/or year-on-year comparison and consult with your Portfolio Strategist regarding the appropriate strategy for you.