What the Polar Vortex Revealed About Energy Pricing

           US - Energy News

In regards to energy pricing, the “Polar Vortex” was the event causing the highest spot pricing for natural gas and electricity in a very long time after a few years of very low volatility. So what does it mean? At a very basic level, energy prices are driven by supply and demand and sudden or gradual changes to either or both can have big impacts on pricing both short-term and long-term. Since the financial crisis in 2008, the two largest long-term drivers of pricing have been the impact of the growing supply of shale gas and the slow growth of energy demand. The recent extreme weather can be classified as a short-term event. Energy curves for both gas and electricity confirm that the market is reacting to the short-term nature of weather while keeping longer-dated prices low based on the belief that shale gas will be abundant and long-term energy demand growth will be modest at best.

A proper risk management strategy examines whether the market is interpreting the future correctly. What we now know is the market is capable of incredibly high short-term pricing in an outlier “event” environment, a fact that seemed to have been forgotten in recent years. When you have such extreme pricing capabilities it can create a situation where the probabilities of such pricing start to be incorporated into the forward curves. Currently, this is not the case with longer-dated power curves (especially in the Midwest) as they continue to trade at a slight premium to production costs. A partial list of events that could change the longer-term outlook could be less shale gas than anticipated due to environmental issues/legislation, an increase in natural gas exports and a larger increase in natural gas demand due to chemical/industrial demand. On the power side it is worth noting that PJM/FERC suspended its generator price cap ($1000.00) during the crisis and they have a sliding scale set for an increase in demand side bids going to $2100.00 per Mwh on June 1, 2014 and $2700.00 per Mwh on June 1, 2015. It could be that now the upside risk is higher than potential downside benefits regarding the longer term outlook for Midwest forward electricity prices.

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