National - Energy Market Update

By Special Contributor, Andrew Weissman, Publisher, Energy Business Watch

Commercial and industrial customers dodged a bullet this winter. Three months ago, when the winter heating season began, energy prices still were at tolerable levels. While electricity prices were higher than September lows, the spot market price at most trading hubs and the price of the 2010 calendar year strip were lower than they had been in January of 2009. Prices at Henry Hub still were hovering near $ 4.00/mmBtu. The 2010 calendar year strip traded in the mid-to-high $ 5.00/mmBtu range.

This apparent moderation in prices was more fragile than it seemed. In recent years, since natural gas-fired generation is the marginal source of supply for the electricity market, natural gas price spikes frequently have been sharp run-ups in the wholesale market price for electricity. During much of 2009 the natural gas market was severely over-supplied, due to a sharp decline in U.S. demand for natural gas and U.S. production near its all-time high. Weather conditions in most months also were close to historical norms. As a result, the amount of natural gas in underground storage grew rapidly. By late August, more than 3,300 Bcf of gas was in storage – more than 400 Bcf above historical norms. To absorb enough of the available gas to prevent storage from overflowing, the spot market price briefly fell below $ 3.00/mmBtu. This decline occurred in order to induce sufficient displacement of coal by natural gas to soak up the excess gas available to the market. This massive displacement of coal by natural gas also put significant downward pressure on coal prices, especially since, on a weather-adjusted basis, U.S. demand for electricity was far below the levels expected in recent years – further reducing demand for coal. As a result, electricity prices in most regions declined at the same time. Early in the fall, prices for both natural gas and electricity reached historical lows in many parts of the country.

During the fall, despite this plunge in the price of natural gas, the amount of gas in storage continued to increase, reaching 3,837 Bcf just after Thanksgiving – a new all-time high. By early December, the amount of gas in storage exceeded the 5-year average by 513 Bcf, providing the market with more than a half a Trillion Cubic Feet cushion against a natural gas price spike even in a very cold winter. Not surprisingly, therefore, most market analysts concluded that prices for natural gas and electricity were likely to remain moderate all winter.

In assessing the natural gas and electricity market, however, weather conditions always are critical. The continued build-up in storage during November was due to exceptionally mild weather – negating the much colder-than-normal conditions in October. Even though the year-over-year surplus in the natural gas market had continued to grow, however, the supply/demand balance in the natural gas was starting to tighten significantly.

By early December, some observers were contending that the market had tightened by as much as 4 Bcf/day. Starting with the storage week that ended on December 11th, the amount of natural gas in storage began to plummet – exceeding the 5-year average for six straight weeks. As a result, the huge storage deficit in early December was eliminated entirely by mid-January, falling 6 Bcf blow the 5-year average during the week ended January 15th, a unprecedented 519 Bcf swing in less than 1 ½ months (a decline of 12.5 Bcf/day relative to the 5-year average). This decline resulted in a sharp jump in the spot market price and in the price of the remaining winter month futures contracts. At the peak, prices at Henry Hub for a day reached $ 7.50/mmBtu per day, almost twice the levels of just a few weeks earlier.

This steep increase was due primarily to extreme cold weather beginning during the second week in December. Over this period, the number of Heating Degree Days was more than 58 HDDs above the 30 year norm. Even after adjusting for deviations from normal weather, however, withdrawals were significantly larger than last winter. This suggests that either: (i) U.S. production has started to rapidly decline; or (ii) industrial demand has started to revive significantly: or (iii) both

Even in early to mid-January, the February 2010 NYMEX natural gas futures contract and the 2010 calendar strip only briefly touched $ 6.00/mmBtu. Electricity prices also remained moderate. However, the underlying market fundamentals had changed considerably since the winter heating season began. The huge storage cushion that existed when the winter began was now gone, and the supply/demand balance in the U.S. market appeared still to be tightening. Further, the amount of gas in storage was adequate to meet market needs. If temperatures during the remainder of the winter were in the normal range, with at least some margin to spare, in early January, every major weather forecaster warned that weather conditions in the 2nd half of January and February (often the coldest days of the winter) were likely on average to be colder than normal, with the potential for sustained far below normal conditions and only brief periods when temperatures were more moderate.

To a greater extent than the market appears to have recognized at the time, this put the price trajectory for natural gas and electricity in significantly greater doubt. The amount of gas in underground storage was adequate for the market to tolerate a significant amount of relatively cold weather. But potential clearly existed for continued much colder-than-normal weather, extending into February and possibly March, with only a few one-to-two day swings in a milder direction. If the forecasts issued by several major forecasters during this period had verified, our model showed that the amount of working gas in storage was likely to fall to no more than 1,200 to 1,250 Bcf by the end of the injection – i.e., 200 Bcf or more below the 5-year average, with the potential in some plausible scenarios for the amount of gas in storage to drop to as little as 1,000 to 1,100 Bcf.

If this occurred, it would not have been surprising in the spot market price for natural gas traded in the $ 7.00 to 7.50/mmBtu for sustained periods, with even more severe price spikes when temperatures were especially low. Further, if the amount of gas in storage fell to the 1,200 to 1,250 that these forecasts suggested was plausible – and perhaps even likely – the natural gas would have been vulnerable to even larger storage deficits this spring or early this summer, with the potential to storage to drop 300 Bcf or more below the 5-year average. This might have put further upward pressure on the cash market price and forward delivery curve for natural gas, and almost certainly would have had a major impact on electricity prices.

As it turned out, however, these forecasts for much colder-than-normal weather turned out to be far off the mark. Weather conditions over much of the country were much colder-than-normal during early December, and the deviation from normal temperatures was even more extreme during the first two weeks in January. This resulted in successive draws of 266 Bcf and 245 Bcf – more than ½ of a Trillion Cubic Feet in just two weeks.


Top 10 Storage Withdrawals (Bcf/week)

However, contrary to many forecasts, extreme cold weather in December and January was strictly limited to these periods. Further, the pattern change many meteorologists predicted for mid-January never occurred. Instead, temperatures during the second half of January were, on average, far milder-than-normal, during what ordinarily should be the coldest period of the winter – offsetting much of the effect of extremely cold weather during early December and the first half of January.

Many forecasters still predict colder-than-normal weather in February, in part because a great deal of cold air is still bottled up in Canada, which could still move into U.S.:


Source: Commodity Weather Group (www.commiditywx.com)

The risk of energy prices escalating sharply this winter or pushing up the forward price delivery curve later this year is now largely over. Current forecasts for colder weather in February are not nearly as cold as severe as they were just two weeks ago. Further, the heart of the winter heating season is rapidly drawing to a close. The historical norm for Heating Degree Days starts to drop sharply by mid-February. Colder-than-normal weather in late February or March, therefore, still would be relatively mild compared to conditions earlier in the winter. Our storage projections indicate that even if temperatures in February are as cold as the weather map above suggests, end-of-season storage still will be at least 1,525 to 1,550 Bcf, 25 to 50 Bcf higher than the 5-year norm. Further the experience this winter (and in several other recent winters) suggests that periods of much colder-than-normal will often take longer to develop and be less severe than initially forecast. There is a significant possibility, therefore, that weather conditions will be milder and end-of-season storage even higher.

This is a critical issue. Even if this forecast verifies, the forward delivery price curve for natural gas is unlike to move significantly higher and could decline. U.S. production has remained stubbornly high. There is little evidence to date that production has started to rapidly decline. Global LNG production capability is expected to increase rapidly again this year, as projects started several years ago come on line. As a result, by no later than the 3rd quarter of this year, the amount of LNG flowing into the U.S. market is likely to increase significantly, further increasing the supplies available to the U.S. market. On the demand side, unless the spot market price falls to the $ 3.50 to $4.00/mmBtu level, use of natural gas-fired generation to displace coal is likely to fall dramatically as compared to 2009, eliminating up to 800 Bcf of demand compared to last year. Even if weather conditions are significantly colder-than-normal, therefore, the price of natural gas is likely to come under pressure, creating renewed downward pressure on natural gas, which is likely to spill over into the electricity market.

If temperatures during the remainder of the winter are more moderate, however, end-of-season storage could be as high as 1,750 to 1,800 Bcf. If this occurs, the decline in prices could be steep.