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The ‘Polar Vortex’ and Its Impact on Future Energy Prices

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It’s minus seven degrees in Pittsburgh and in other parts of the Northeastern U.S. today. Call me a wimp, but I paid extra to park in the basement lot to avoid walking outside and to make sure that my car would start for the drive home. When the day is over, it will most likely be the coldest day of the millennium. January 16, 2009 is the only competition. What does this mean for future energy prices?

Record heating demand is causing spot gas and power prices to spike all across the eastern half of the US. Natural gas deliveries for today to New York City (Transco Zone 6) averaged $56/ MMBtu. Texas Eastern M3, another key Northeast zone that has undergone huge price declines thanks to shale gas, rallied to more than $43 today. New England (via Algonquin and Tennessee) are only at $35, thanks to some help from LNG imports to Eastern Canada. The recent price spikes have made it profitable to send some LNG to the US, so it’s showing up.

Spot power prices are increasing along with gas prices. On-peak day-ahead prices for today to Zone J (New York) averaged $224/ MWh; MassHub (New England) is $228; PECO (Philadelphia) is $334; and ComEd (Chicago) is $205.

Clearly spot prices are way up, so beware if you’re buying an energy product tied to hourly or daily prices. You should be asking the following questions:

  • Are forward prices also way up?
  • How are pricings for the remainder of 2014 behaving if my contract expiration is imminent?
  • What is the status of longer-term prices?
  • Is the ‘Polar Vortex’ impacting prices for 2015 and 2016?

When examining the trend for NYMEX natural gas prices (the primary driver of retail gas and power prices across the US), the impact of weather 2014 prices is significant, but not nearly as much as spot prices. Meanwhile, longer-term prices have been mostly insulated from the cold snap, and here’s why.

At the time of this writing, February 2014 NYMEX is at $4.34/ MMBtu, which is relatively flat compared to a week ago. This is due to weather forecasts calling for drastic warm-ups over the next few days. The NYMEX 12-month strip is behaving similarly; $4.25 today versus $4.19 a week ago. While the polar vortex hasn’t driven up these prices, there have been significant increases due to the overall sustained cold weather since mid-November. February futures are up 25% and the 12-month strip is up 19% since lows of November 4, 2013. The reason: Unusually large natural gas withdrawals and the growing storage deficit.

Heading into winter, inventories were within 2% of last year and the 5-year averages for storage at that time of year. But after seven weeks of mostly colder-than-normal temps, there is now a deficit of 16% versus last year and 9% versus the 5-year average. This includes an all-time record withdrawal of 285 Bcf for the week of December 19th. And another record-breaking withdrawal is expected due to the current cold that will further expand the deficit. What does this mean? As storage levels fall, there are multiple effects:

  • less storage is available for the remainder of winter increasing need for flowing supply
  • increased demand to refill storage in the summer
  • a stronger likelihood that storage will not be full going into next winter

Each of these factors increases prices for the remainder of 2014.

But conversely, the storage inventory situation is expected to normalize by the end of next winter as higher prices incent both additional supply (shale) and reduced demand (possible gas-to-coal switching). And weather is generally expected to be normal over longer-term periods. Once storage is back to normal, the market’s focus returns to other fundamentals such as shale gas development, LNG exports, the impact of EPA regulations on the generation mix (gas versus coal), and growing industrial demand. News regarding these fundamental factors can drive prices in either direction, but over the last month, there has been little news outside of weather and storage. Long-term prices have been relatively stable.

The result has been a backwardated forward curve, which means that near-term prices (12-month strip at $4.25) are higher than long-term (2015 at $4.20, 2016 at $4.17, and 2017 at $4.20). The last time we saw sustained backwardation was during the 2008 commodity bubble.

How do all of these factors affect your energy buying strategy? Generally, buying during a rally is not recommended and this advice probably applies to 2014 except for those that are forced to buy – maybe due to an expiring contract or other business reasons. But the backwardated curves complicated the situation for the longer-term.

  • Is there value in 2015 or 2016 at a discount to 2014?
  • If weather moderates and 2014 falls, will 2015 and 2016 follow?
  • Or will news regarding LNG exports and Supreme Court rulings regarding EPA regulations push long-term prices higher?

There is no obvious answer, but it’s not as simple as watching the near-term NYMEX.

And of course, regional risks for the long-term vary greatly, especially when considering ongoing lack of sufficient pipeline infrastructure to meet winter gas demand in New England.

Whether you’re surviving the polar vortex or enjoying the subsequent warm-up, there’s a lot to consider for your energy buying strategy. Current price volatility should be a lesson to consider as you build your strategy for the future. They may or may not be repeated in the future.

And is the current backwardated forward curve an indication that 2014 prices are too high? Or is it an indication that long-term prices are a good value? You will only know with certainty when it’s too late to hedge your risk, so start working on your energy strategy now to proactively manage your costs and risks.

Posted: January 07, 2014