Eisenbach Consulting Market Update
Market Conditions – June 2012
The Energy Information Administration (EIA) Annual Energy Outlook Report released in January 2012 projects the production of natural gas will increase an estimated 3% from 2010 to 2035. It also projects renewable energy will rise an estimated 6% during that same period. Furthermore, the EIA expects electricity generation from coal to decline by 15% in 2012 while natural gas generation will increase 24% in 2012.
The EIA releases a weekly natural gas storage report every Thursday morning. Working gas in storage was 2,944 Bcf as of Friday, June 8th, 2012. This was a net increase of 67 Bcf from the previous week, 708 Bcf higher than this same time last year and 666 Bcf higher than the 5-year average, which equates to roughly 29% higher than last year and the 5 year average.
~Note that the shaded gray area indicates the range between the historical minimum and maximum values for the weekly series from 2007-2011.~
Abundance of domestic natural gas has contributed to continual low market price settlements. In 2012, we have already seen multiple market settlements at 10 year lows (see below for 2007-2012 pricing settlements).
Furthermore, the country’s high reserve levels of working underground natural gas storage have led growing pressure for the US to become a significant player in the exportation of liquefied natural gas (LNG). As first reported in spring 2012, The Federal Energy Regulation Commission approved Cheniere Energy, Inc (a Houston, TX based LNG-related business) to begin operations for major exportation of LNG at their Sabine Pass, Louisiana receiving terminal for the next 20 years.
The abundance of natural gas does not have strictly positive market influences. In spring 2012, Chesapeake Energy (the Number Two natural gas producer in the country and in the Barnett Shale in Texas) announced it will modestly reduce production until it can regain market value. This also carried troubling thoughts that the Oklahoma City-based company could see rough waters ahead in repayment terms of its $13 billion dollar long term debt.
The Environmental Protection Agency finalized a rule known as the Cross State Air Pollution Rule on July 6, 2011 that is directed to protect Americans by reducing energy emissions. The result of this new rule is a number of predominantly coal-fired power plants will be forced to either shut down operations entirely, or to renovate current operations to implement cleaner fuel sources such as natural gas and renewable energy sources. Reduction of energy supply, coupled with increasing demand can lead to possible energy shortages.
In Texas, the Electricity Reliability Council of Texas (ERCOT) that manages the electricity grid and distribution systems has projected energy reserves in the state to fall below target safety levels of 13.75% reserve margin by as early as 2013 and falling down to as low as 9.8% by 2014 due to the loss of coal-fired plant generation as mentioned above. This outlook is daunting when you consider that in August 2011 Texas set an all time US national record at 66,867 megawatts (MW) of electricity demand!
According to the National Oceanic and Atmospheric Administration (NOAA), March 2012 was the warmest March on record, breaking the 1895 record. Revised weather forecasts continue to call for above normal temperatures and a slightly less than normal hurricane season in 2012. This could potentially lead to more record setting highs of peak energy demand, similar levels to what the state of Texas incurred in summer of 2011.
It is important to note that falling natural gas prices do not necessarily correlate to lower electricity prices. Regional markets are seeing Heat Rates (the ratio of gas needed to burn to produce power) on the rise as well as a number of markets increasing market caps on electricity index prices. Again, specifically relating to the Texas Energy market, ERCOT has recently announced it is in process of approving cap increases on current market rates to encourage new production to meet growing demand. The result follows that in times of energy shortage, energy prices will be sold at high premiums to meet market need.
While natural gas storage remains abundant, reduced drilling/exploration and impending major exportation of LNG could have a substantial impact on reduction of storage ratios and create signs of stronger recovery in gas pricing. Despite abundant natural gas resources it is expected for prices to rise due to listed factors. Upward movement on the forward curve is currently limited by natural gas storage and generational capacity to meet current demand.
For consumers, the market sentiment continues to be bearish. Slow economic recovery, US entering the shoulder months (months when we turn off heating but not yet turning up AC), and abundant natural gas have kept the market at historic lows. While the 2013-2016 calendar strips have all fallen since March 2012, we see the forward projection of increased pricing.
*(prices in MMBtu)
May 2012 (prompt month): $1.95 on 4/18/12
Calendar 2013: $3.30 on 4/18/12
Calendar 2014 $3.76 on 4/18/12
Calendar 2015 $4.02 on 4/18/12
Calendar 2016 $4.25 on 4/18/12
The EIA currently projects increased electricity pricing through 2012, a slight decrease in 2013, and then future increases in 2014 and beyond. The EPA’s Cross State Air Pollution Rule was set to be implemented in April 2012, however federal court has currently delayed implementation and is expected to come after the summer months of 2012. The market is oversupplied at this time, so we expect a shift to balance the market supply versus demand.
Most regions are close to seeing fixed pricing hitting all time lows. Increasing heat rate, coupled with slightly reduced production, should balance the market going forward.
Premiums on long term contracts are higher, but appear to be minimal to the prompt months and worth heavy consideration due to market imbalance. Short term energy price spikes like we saw in 2011 can highlight the potential risk of a volatile energy market. Hedging now, before the upcoming summer months when we expect to see diminishing generation and increasing supply, mitigates not only short term, but also long term risk.
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