Forward Natural Gas and Electricity Prices Discounted Versus Historical Prices

           US - Energy News

As we have now completed two thirds of the year we want to examine the current forward curves for natural gas and electricity versus the historical averages observed over the last nine years. This is just one of many methods of evaluating current forward prices and while no method is perfect, we do feel that nine years of historical data is a robust data set from which to compare forward prices to. While technology and efficiency improvements can be quite different going forward, we do feel that those factors are accounted for in the current forward curves for natural gas and electricity so we are comfortable using this approach.

The first eight months of 2015 can be noted for generally lower forward natural gas and electricity prices and also for the very low volatility of these markets. For natural gas the 12-month Chicago City Gate forward price declined 3.87% to $2.98 per mmbtu, the 24-month forward price fell 8.05% to $2.97 per mmbtu and the 36-month forward showed a decline of 10.45% and is currently at $3.00 per mmbtu. What is unusual about this year is that the forward curves are now in backwardation (meaning that further dated prices are lower than the nearby prices). This is not usually the case, as the risk premium attached to further dated prices usually causes those prices to be higher than nearby pricing.

The electricity market has been similar with mostly lower prices, lower volatility and a change in the 12, 24 and 36-price structure from contango (prices increasing thru time) to backwardation. The 12-month PJM/ ComEd forward price actually increased 2.86% over the first 8 months of the year to $31.32 per Mwh, the 24-month forward price declined .61% to $30.91 per Mwh and the 36-month forward price has fallen 2.25% to $30.85 per Mwh. What is noticeable is that the downward price movement has not been as exaggerated as with the natural gas market as PJM/Comed forward prices are trading just above the $29.46 average day-ahead price observed so far this year.

As stated earlier, when looking at the two charts comparing natural gas and electricity forward curves against historical averages it is important to think about the changes in the market that have occurred or may occur that make the market different from the past. In the case of natural gas, one example is the abundance of supply due to horizontal fracturing and specific to Chicago City gate, the building of pipeline infrastructure to deliver gas to the Northern Illinois area. For power, the forward curves reflect tepid demand growth and an increase in both energy efficiency and lower production costs for natural gas fired generation. However, it can be argued that these factors are already accounted for in current forward prices, leaving only unknown factors that may actually increase prices. What we do know is that both the natural gas and electricity markets are event-driven and unknown events are what usually cause high prices. In an environment where distribution and non-commodity costs are rising (see capacity article above) we feel that with these low prices, it is prudent for customers to fix their forward commodity costs to eliminate upside risk regarding energy cost budgeting.

Written By- David Mousseau
Sources- CME Group

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