The natural gas and electricity markets in 2016 were characterized by some sharp price moves both lower and higher as there were some fundamental changes occurring just below the market surface. Additionally, the election of Donald Trump as President on November 8th will certainly impact the energy markets over the coming years, though it may take a little while to discern just what exactly that impact will be and we will watch for coming developments.
From a price perspective, the first three months of the year could be characterized as bearish, continuing the deflationary environment from 2015. The nearby Henry Hub futures contract set a 17-year low as the March 2016 contract closed at $1.71 per MMbtu. Very mild winter weather and the moribund natural gas market forced PJM/ ComEd day-ahead spot prices to the lowest levels seen since PJM adopted a Locational Marginal Pricing (LMP) system in 2006. The first quarter average day ahead price of $23.35 was 3.53% lower than the 2015 fourth quarter, which had been the lowest quarter since 2006. At that juncture, the market was extremely bearish in price and sentiment and as is often the case in commodities, this set the stage for a meaningful rebound for the balance of the year. This price rebound was stronger in the nearby part of the forward curves for natural gas and electricity than in the further dated sections as the market has become increasingly backwardated (lower prices as you move out along forward curve).
While the spot markets for both natural gas and electricity did rebound some after the first quarter, it is important to note that on an annual basis, the spot prices for natural gas and electricity were lower year on year and were at multi-year low levels. For electricity, The PJM/ComEd day-ahead average for 2016 was $26.47 per Mwh, lower by 5.83% from the 2015 price of $28.11 per Mwh. The PJM/ ComEd 12-month rolling forward increased 6.20% year to year to finish at $30.83 per Mwh, the 24-month rolling forward added 1.29% to close the year at $29.85 Per Mwh and the 36-month rolling forward was -1.23% to $28.94 per Mwh. For natural gas, the Chicago City Gate (CCG) daily average price for 2016 was $2.4826 per MMbtu, down 8.35% from $2.7088 per MMbtu in 2015. The CCG 12-month rolling forward increased an impressive 43.25 % on the year to close at $3.609 per MMbtu, the 24-month forward rose 27.74% to $3.31 per MMbtu and the 36-month forward added 16.58% to end the year at $3.12 per MMbtu
While certainly these numbers show the backwardation (prices lower the further out the curve one goes), looking just at calendar prices for both commodities shows even more backwardation and does a better job of highlighting what the market expectations are as we enter a new year. For PJM/ComEd electricity the 2017 forward electricity price increased 7.47% Y on Y to $30.95 per Mwh, the 2018 price rose 2.26% to $28.96 per Mwh and the 2019 forward price was unchanged on the year at $28.41 per Mwh. For CCG natural gas, the 2017 calendar price rose 11.16% to $3.685 per MMbtu, the 2018 calendar rose 3.34% to $3.068 per MMbtu and the 2019 calendar price declined 1.82% to $2.755 per MMbtu.
The backwardation is a clear sign that the market believes that the higher spot markets (especially natural gas) the last 9 months of the year are temporary and that prices will be lower once again. For example, the 25.26 % discount between the CCG 2019 calendar price of $2.755 per MMbtu and the 2017 calendar price of $3.685 per MMBtu is not normal in commodity markets and even when there is backwardation, this type of discount is highly unusual. There is much less backwardation in the electricity markets and that is more because the forward and current spot rates are trading very close to each other. The spot price in PJM/ComEd is quite close to the current overall price of production so from our perspective, the downside potential for electricity pricing is limited. When we evaluate natural gas the question is whether the spot price for natural gas (remembering that all forward prices are expectations of future spot prices) will average $2.75 per MMBtu when 2019 is finished.