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Recent Extreme Cold Snap and Its Impact on Energy Market Price Volatility

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The energy markets have shown significant strength so far in 2014 primarily driven by multiple extreme cold snaps. However, the price strength and volatility are focused in the spot/cash markets and the near-term contract months. Let’s take a quick look at where a few points are trading.

The NYMEX Henry Hub Feb 14 contract is currently trading close to $4.80 per MMBtu after a 25-cent gain on Wednesday to settle at $4.689/MMBtu. This was the highest close for a prompt month since June 2011. Early Thursday morning, the prompt month reached a high of $4.95, but was unable to reach the $5 level. The last time the prompt month contract closed above $5 was June 2010.

However, the market is currently in backwardation, which means that longer-term contracts are less expensive than nearer-term contracts. For example, Calendar years 2015, 2016, and 2017 are all trading between $4.10 and $4.20, versus the balance of 2014, which is trading around the $4.40 level. We are used to seeing the opposite, or a contango market, where the longer-dated contracts are trading higher than the nearer-term contracts.  A key question may be whether the shape of the forward curve indicates a premium for near-term prices or value in the long-term. The answer may be both because it may be risky to assume that the lack of long-term volatility will continue through 2014.

Meanwhile, the short-term volatility is magnified at the regional basis points for natural gas and electricity. Daily delivered gas has also traded at record levels with Transco Zone 6 dailies trading around $135. Algonquin traded in the $90s and TETCO M3 trading in the $70s in recent days. Day-ahead index power prices are also following gas prices with PJM West Hub trading around $400, Mass Hub around $390, and NY zone A around $280. We’re likely to see some of these prices cool off a little over the next few days, but we’re still expected to see very cold weather throughout the 10-day forecast.

The natural gas storage levels will also play a strong role in whether or not this price trend will continue. The EIA reported a 107 Bcf withdrawal from storage today, which was slightly larger than the expected 103 Bcf. Next week’s report will be more significant since it reflects this week’s cold weather inventories, which are currently 20% behind levels from a year ago at this time. This leaves less storage for the remainder of winter and increases summer gas demand to refill inventories. For this reason, a break in the weather may not necessarily lead to a collapse in prices.

For buyers of energy, short-term decision making is tough if you’re not already hedged. But long-term considerations are just as important. In some regions, there may be long-term value if prices haven’t risen. And this winter’s price volatility should also impact risk points when setting strategies for the future. While you may not want to buy long-term in the midst of the current value, you shouldn’t assume that more price strength and volatility is out of the question.

Posted: January 23, 2014