The polar vortex and natural gas prices

002 - DE NYC Polar VortexIf you keep tabs on natural gas and electricity prices, then you’ve probably been shocked by the market’s volatility and strength this winter.

NYMEX natural gas futures reached 5-year highs. Spot gas prices posted new all-time highs at more than $50 per MMBtu in parts of the Northeast US. And spot power prices were sustained above $100 for days and even weeks from parts of the Midwest all the way up to New England. We can place most of the blame on the Polar Vortex and its impact on natural gas and power demand, as well as on natural gas storage inventories. But when will it end?

Will prices fall when the weather warms? Yes, no, and maybe so. My apologies for the vague response, but give me a chance to explain.

YES: Spot prices fall as demand falls and temperatures rise, but not without risk and volatility, of course. But day-to-day and hour-to-hour prices should be lower in the spring compared to the peaks of January.

Also, if you watch the NYMEX for the prompt month (the nearest month that is traded), it should fall, because the nearest month will change from a winter month (March) to a spring month (April).

NO: But from the perspective of an end-user who shops for gas or power every six,12, or 18 months, then none of that really matters. What really matters is the price for the remainder of 2014 or for 2015 and beyond. How will a price for those terms change as winter ends? There is a very different answer to this question.

Unfortunately, the Polar Vortex’s impact on the market will be sustained through 2014 and will provide resistance to price declines.

  1. Natural gas storage. Record gas demand has resulted in record withdrawals of natural gas from storage, resulting in a huge storage deficit compared to historical levels (40% below last year at this time of year and 33% below the 5-year average). To prepare for next winter, more gas must be injected from April to October to refill storage to historical levels, thereby eliminating the storage deficit.

    How much more natural gas needs to be injected? More than 3.5 Bcf per day above the typical pace.

    Where will this additional supply come from?
    Possibly from shale gas, but this could absorb all shale growth, which was a key driver of previously low prices. But higher prices than 2012 and 2013 could provide an extra incentive for producers to bring more supply to market. Similarly, high prices can discourage demand such as some gas generation that may be replaced by cheaper coal. But in each case, prices higher than a year ago may be needed. April – October NYMEX is currently trading near $4.50 compared to finishing at $3.78 during 2013.

    Risk. This year’s unforeseen market strength and volatility will also change the assessment of future risk by market participants in a way that may sustain higher prices. This premium may be narrowly focused on certain regions (especially the Northeast) and seasons (winter). Consecutive winter price spikes in Massachusetts will likely support prices for next winter in that region. And this same risk from a New England winter can translate to an ERCOT summer. Even if the NYMEX would fall, there may be terms and locations that resist such a decline and maintain a risk premium that reflects the new perceived market upside from this winter.

MAYBE: This doesn’t mean that prices can’t fall. Weather could be mild. Producer output could exceed supply expectations. But the end of winter itself will not erase the impact of the Polar Vortex on prices for the remainder of 2014.

What about 2015 and beyond? Long-term prices have moved only modestly during this winter. Why? Storage is expected to normalize over time, so the current deficit has limited impact on long-term prices. But since near-term fundamentals did not push long-term prices higher, then another change in near-term fundamentals as winter ends should not cause a decline either.

REMEMBER: Current market prices reflect information currently available. We all know that winter will end, and will not be the only driver to change prices beyond the near-term. Putting near-term price volatility aside, which can be very unpredictable and sometimes unexplained, it will take new information to push prices lower. But new information could just as easily push prices higher. Prices bottomed in April 2012, but rose through April 2013.

Make sure you’re being realistic with any buying strategies for 2014 that considers potential market support due to the storage deficit. And don’t assume that high near-term prices prevent consideration of long-term prices, which may present a discount and a value for 2015 and beyond!

And keep your focus beyond tomorrow to avoid exposure to the next market surprise.

GUEST BLOG: Provided by TEPA member, Direct Energy