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Energy Market Update: April 29, 2020

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It was all over the news: oil briefly dropped to -$40/barrel this month. Presumably, this could lead to slashed production, which could in turn lead to production cutbacks in natural gas as well.
 
Direct Energy Strategist Tim Bigler shares his take on what this could mean for prices in this week’s Energy Market Update.

 
Markets were shocked earlier this month when the price of oil crashed, first to zero and then, almost inconceivably, into the negative. The good news today is that we’re out of the twilight zone; WTI crude is trading on the NYMEX at just over $10/barrel for a June 2020 contract, with prices rising for contracts over subsequent months. While these prices are above zero, they represent a drop from March’s prices, and a full-blown crash compared to $50+/barrel prices we saw a year ago. 

Currently, oil is following a “contango” pattern in which earlier contracts are discounted and later contracts are more expensive. One consequence of this pattern could be a significant drop in production. The EIA has already suggested that oil production has decreased by 900,000 barrels per day relative to a few weeks ago. If this reduction persists, it could impact associated natural gas production, and in turn cause price fluctuations in the natural gas markets.

Thus far, natural gas is less expensive, year-over-year, relative to summer of 2019. Prices are higher, however, once December 2020 hits, and going into summer and winter 2021, the demand shock associated with COVID-19 has driven prices above where they were a year before. Consequently, 2021 is something of a wild card at this point in terms of pricing, particularly for heat-load businesses who use significant amounts of natural gas during the winter months. A potential silver lining, however, is that prices appear to normalize following 2021, and (budget permitting) could represent an opportunity for savings in the long-term as the world waits for the effects of COVID to become clear.

Why is it important to watch natural gas prices so closely?
 
Take PJM, for example. If we observe calendar strips (which represent the average price of gas contracts over a given year) for PJM West Hub, it’s clear that natural gas in 2021 is getting pricier by the day. This makes sense given the aforementioned NYMEX price spike for 2021. Calendar strips for 2022, 2023, 2024, and 2025 are also on the rise over the last month or two, but looking at the big picture, these same strips were priced even higher just a year ago. In other words, the modest rise in prices for these strips still represents a year-over-year discount, all things considered.

ERCOT, on the other hand, was not enjoying the same discount as PJM over the last year due to the region’s tight reserve margins. Now, the same market effects are playing out there, but absent the price cushion enjoyed by other ISOs. The result, unfortunately, is that gas will continue to be expensive within ERCOT in the near-term.
 
The lesson, perhaps, is that while national storylines do affect the country as a whole, the specific outcome can vary drastically by region.
 

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Posted: April 29, 2020

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