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Energy Market Update: November 19, 2020

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2020, tumultuous though it has been, will soon be in the rearview. What’s the outlook for 2021?
 
Direct Energy Strategist Tim Bigler talks California, natural gas and market conditions in this week’s Energy Market Update.

 

 

The good news: in California, natural gas and electricity prices may look better moving into 2021 than they do now. Basis prices -- which refer to the price available at a specific geography, relative to the Henry Hub price -- at SoCal Citygate and PG&E Citygate have been elevated recently, and 2021-2025 calendar strips have been climbing steadily during the second half of 2020. However, there is one exception. 2021 prices, after spiking at the beginning of November, have begun to dip. Furthermore, the market is in backwardation, meaning that contracts expiring later are priced lower. This may represent a buying opportunity, either via fixed or managed product, for customers in California who have yet to lock in a strategy for 2021 or beyond.

Zooming out, the NYMEX tells a similar story. The 2021 calendar strip, after spiking to an all-time-high in early November, has fallen slightly, and the market overall is also in backwardation, with ‘22, ‘23, ‘24, and ‘25 prices sequentially lower. While price dips also present a buying opportunity here, it’s possible that NYMEX prices could rise significantly at the same time that basis prices drop, leaving buyers’ net fixed cost somewhere in between. For this reason, a managed product may be optimal for some buyers looking to control risk going into 2021.

How are power prices responding to these shifts in the gas market? When it comes to SoCal and PG&E CNP15 ATC prices, backwardation is present in the power market, with later contracts trading at a discount. This is worth keeping in mind as the year draws to a close. While price dips could be coming in the short term, the most significant savings exist between calendar years, with ‘24 and ‘25 strips, for example, trading at $34/MWh while ‘21 hovers above $40.

The key to understanding the relationship between natural gas and power in California is to look at supply during peak periods. On August 17, 2020, for instance, natural gas was the most significant contributor to power supply across the entire day, with renewables coming in at a distant second (and fading over the course of the day). On that same day, the next-day price for natural gas at SoCal Citygate spiked to $14/MMBtu. Likewise, power reached a peak of $650/MWh on August 17 on the CAISO SP15 Next-day peak marketplace. Events like these indicate a strong relationship between gas and power markets, but they also affect the markets. In other words, when traders see volatile days like August 17, they factor in the risk of such a day happening again, which can drive prices higher.

In terms of production, natural gas has experienced a turbulent year. In the western region (which includes the Northwest, Southwest, and Rocky Mountain sub-regions), production remains lower, year-over-year, relative to 2019. Note that while it is forecasted to increase, this will perhaps not happen for some time based on forward prices for gas and crude oil. 

At the same time, natural gas exports are up, thanks mostly to an increased appetite for Liquefied Natural Gas (LNG) exports. Exports to Mexico have also increased (albeit modestly) this year and look to be sustained by increased demand for power generation within Mexico, especially next summer. 

California gets gas from the Rockies and Texas so if demand for exports continues to climb, then prices in California could be affected. It’s also worth noting that higher oil production could bring on an increase in “associated” natural gas production. With crude oil prices currently low, production is below potential; if oil prices were to rally -- which, given the sensitivity of oil prices to geopolitical events, is always a risk -- then we could see associated natural gas production, or even gas prices themselves, rise as well. 

In summary: as the year winds down, fixed natural gas prices are lower than their recent highs. Moreover, the farther you go out on the calendar, the lower gas prices go -- with 2025 prices at a significant discount relative to 2021. Currently, natural gas and electricity prices are highly correlated; buyers can look to fixed or managed products to take advantage of market shifts, though emerging technologies may disrupt this correlation in the future. Finally, as gas-on-gas competition heats up due to climbing demand (for both domestic and export), price dips may not swing as low as they have in the past. This is because the marketplace has yet to adapt to the new supply/demand natural gas paradigm. 
 

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Posted: November 19, 2020

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