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Energy Market Update: September 28, 2020

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After a months-long slowdown, demand for natural gas is back, and its effects are being felt in gas and electricity markets alike. Direct Energy Business Strategist Tim Bigler offers his perspective on these new market conditions in this week’s Energy Market Update.



Natural Gas in Backwardation

Simply put: volatility is back. Natural gas prices are experiencing drastic swings, as evidenced by NYMEX Henry Hub prices observed this month. At the daily level, the difference between high and low prices across a day vary greatly, particularly in the case of soon-to-expire contracts. Take October 2020’s contract, for instance, set to expire on September 28th: on September 22nd it traded at a low of $1.81/MMBtu and at a high of $2.13/MMBtu at different points throughout the day. This may indicate that large market positions from October are being rolled into the winter months. In addition, LNG exports and exports to Mexico are ramping up as global trade emerges from COVID-19-necessitated hibernation, which means that market wide demand is creeping steadily upward.

One piece of good news is that futures contracts toward the “back of the market” (and those expiring in the latter half of 2021 in particular) are experiencing less volatility. For the front of the market (i.e., contracts that are expiring sooner), the price at a given time on a given day may prove instrumental in the final price of your contract, which is an unfortunate consequence of present market volatility.

Looking at 2021 more closely, it’s possible that markets will follow patterns established in the latter half of 2020. The 2021 calendar strip price is certainly rising in lockstep with the 12-month strip running from October 2020 to September 2021. Again, renewed demand as the world adjusts to the pandemic is likely responsible for this dramatic late-year spike.

But just as was the case with monthly futures contracts, later calendar strips enjoy a discount. For example, calendar year 2021 is priced at $2.92/MMBtu, while 2022 is more than 25 cents cheaper, and the subsequent three years are 10 or 15 cents cheaper still. This is an example of backwardation, when earlier contracts are more expensive than later ones. Backwardation creates a benefit for buyers looking to plan long-term via fixed or managed products.

Electricity in Limbo

How is this volatility in the gas markets affecting the price of electricity? In PJM, the largest ISO in the country, backwardation is holding true. In the case of the JCPL (Jersey Central Power & Light) price point (corresponding to Zone 3 of the Tetco pipeline and Zone 6 of Transco), the fixed price decreases steadily over the 2021-’23 period, which counts as backwardation. When it comes to the ‘23-’25 period, however, the pattern reverses; earlier years are in fact more expensive than later years, which is not backwardation at all but rather a contango pattern. The price spread between these latter contango years, however, is not as dramatic as the one between the earlier backwardated years.

What does that mean? For starters, it means that term structures in natural gas and electricity, at least in PJM, are not carbon copies. While natural gas is in backwardation, electricity follows a “V” shape, implying backwardation at the front of the market and contango at the back of the market.

One reason for the disparity may be the Federal Energy Regulatory Commission’s (FERC) Minimum Offer Price Rule (MOPR) order from December 2019. In a nutshell, this order will make renewable energy sources more reflective of their actual cost, which could lead to an increase in energy cost. There are also rumors afoot of nuclear power plant retirements in PJM and the possibility that Pennsylvania will mandate that generators purchase carbon offsets, with costs presumably being passed on to consumers. Finally, PJM may price carbon into the energy markets, which would have ripple effects for producers and buyers alike.

All things considered, it’s clear that backwardation is in effect for NYMEX natural gas prices. This means that savings are available for those who can plan their buying ahead of time. In the electricity markets, PJM serves as an example of a market following a “high-low-high” or “V” pattern; here, buyers should examine prices year-by-year, to take advantage of savings where possible. Finally, a managed energy product may be the answer for many buyers, as the market is showing as many pitfalls as it is opportunities. Depending on the available timeframe, getting a plan together now could prove tremendously beneficial given the turbulence we’re seeing as this year enters its last quarter.

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Posted: September 28, 2020