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Holiday Energy Buying Strategies – December 23, 2014

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Natural gas and power prices, in addition to oil, gasoline, and other energy commodities, are all falling to levels not seen in years during this year’s holiday season.

What explains the falling natural gas and power prices and what should a business do about it?

Mild weather and prolific natural gas production, resulting in a shift in natural gas storage from deficit to surplus, are the primary reasons for the declines in gas and power prices. 

Shale gas production growth accelerated in the fall with domestic U.S. dry gas output exceeding 73 Bcf per day in December – a new record and increase of almost 8 Bcf per day compared to a year ago. November, if you recall, was cold, and gas production was offset by strong heating demand. Mid-November storms clobbered parts of the country (there were 88 inches of snow in Buffalo, New York) and frigid air affected most of the U.S. for most of the month.

Conversely, December has been a different story as temperatures have been above normal. Following a strong storage withdrawal for the week ending November 21 totaling 162 Bcf, withdrawals have dropped precipitously and so has the storage deficit – finally reverting to a year-over-year surplus as of December 12. This is a fundamental market change after storage deficits have been a dominant bullish factor since last winter’s polar vortex.

The result is near-term NYMEX closing at $3.19 December 22 - it hasn’t closed below $3.11 since 2012- down from $4.35 on November 26. Calendar strips are also at all-time lows. And the closest month over $4.00 is January 2017, andfor $5.00, it was January 2002. Even the risky Northeast U.S. energy prices are falling as on-peak power prices for January at Mass Hub, a hedging point for New England, have fallen from almost $200 per Megawatt hour on November 7 is just above $100 today.

Are falling prices a gift this holiday season? Or should we worry that the Grinch will steal it back?

More downside is possible if weather, production, and storage trends continue. But, how far will it go?

Of course, there are risks and here are a few:

  1. December 21 was the first official day of winter, so there is plenty of potential for cold weather. And recent forecasts for January and February are calling for cold weather. While NYMEX might stay low, spot gas and power prices remain vulnerable to spikes if sustained cold weather arrives. Pipeline and transmission constraints that caused spikes during the polar vortex have not gone away.
  2. While gas prices’ freefall could continue, the floor could be closer than you think. If the winter remains mild and the storage surplus becomes large, gas prices may need to fall to a level to encourage additional demand (via coal-to-gas switching in the generation stack) or discourage drilling to reduce supply. Remember that the economics are based on the sum of NYMEX plus basis. And in some markets the basis is already so weak that further gas downside is not necessary. Consider that natural gas prices for parts of Pennsylvania for next summer are already near $2.00, which is cheaper than coal on a per MMBtu basis.
  3. Power’s correlation with natural gas can break down if coal becomes the marginal source of supply. Gas declines may not necessarily lead to declines in power prices, especially in areas prone to transmission constraints.
  4. Finally, long-term bullish factors remain in place: exports via LNG and to Mexico, growing industrial demand, and EPA regulations. All of these factors are expected to have increased impact, especially in 2016 and beyond. And if near-term prices fall so low the producers reduce drilling activity, then supply could decline just as a new demand is growing. So, consider value in long-term prices.

These risks are by no means predictions of a rally - far from it, actually. But it is a reminder to consider that market dips are often brief and the upside risks exist even when prices are low. This is a good time to revisit your business’ energy buying strategy. And while we wouldn’t expect a change before the New Year, the market is always full of surprises. This recent decline sure is one!

If you have any questions regarding your energy buying strategy, please contact your Direct Energy Business Representative.

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Posted: December 23, 2014