So what do we think will happen in 2017? A good starting point is to recognize that nobody knows where electricity and natural gas prices are going to trade with any type of certainty. What we try to do is use historical pricing information in combination with fundamental analysis to make decisions about possible direction.
We are not traders, we are risk managers who endeavor to help our clients beat their energy budgets and reduce the exposure to the upside risk that is inherent in energy markets (see chart 1 below).
From a fundamental perspective, there were some significant developments this year that need to be understood when evaluating pricing. In the electric market, we did experience a very warm summer and for the most part we did not observe any real scarcity pricing. Electricity pricing can go much higher when generators can command very high prices for even as few hours as 20 or 30 hours a year since those hours can really lift the overall average. The higher cash natural gas prices the 2nd half of the year probably lifted electricity baseload prices since natural gas generators are often on the margin when it comes to setting spot electricity prices. Concurrent with that, in the Midwest, coal-based electricity can replace natural gas generation as the fuel on margin, setting a partial ceiling to prices. For natural gas the story in 2016 was that demand increased noticeably as natural gas exports to Mexico jumped, LNG exports to Latin American from Sabine Pass began in earnest, increased industrial demand and even greater demand for natural gas from the natural gas electricity generating sector all contributed to higher demand. On the production side, we did see decreased natural gas production for the first time since the fracturing revolution started in earnest in 2012. This tightening in the supply/demand equation explains the price rise in 2016. Going forward, as explained above, the natural gas market seems to be of the belief that the upside in prices is limited because the United States seems to have an abundant supply of cheap shale gas at its disposal and that there is a global glut of natural gas. The important fact to remember though is the market is already pricing in a 25.6% decline from 2017 to 2019. Our belief is that natural gas will be the fossil fuel of choice globally over the next decade and that demand will continue to grow, and while there is a large supply of natural gas, there is an inherent event risk that is always present in the energy markets. Therefore, when it is possible to lock forward energy at 20% discounts to spot prices, it makes sense to do so. We will continue to monitor the market as we move through 2017.
Analyst – David Mousseau
Information Sources – Reuters, CME, and Energy Information Administration (EIA)
