From the consumers’ point of view, the last three years in the energy business have been unexpectedly benign. Electricity and natural gas prices have retreated from their high point in 2008. Some would say they have collapsed.
The causes for this are several, but generally obvious.
1. In mid-2008, the global financial crisis resulted in deep world wide economic downturn second only to the Great Depression of the 1930s. The downturn eliminated a lot of demand from the energy markets. As businesses closed or curtailed, less energy was consumed, so prices came down. The combination of a slack U.S. economy with more than 8% unemployment, looming European recession and a slow down of growth in Asia have given energy commodities no fundamental price support.
An additional impact of this financial crisis was an exodus of the non-commercial (i.e. speculative) traders from the natural gas commodities market. This has put downward pressure on natural gas and reduced price volatility. Natural prices are now closely following market fundamentals, i.e. supply and demand.
2. Electricity prices still closely track natural gas prices. Due to the nature of how electricity is priced in the wholesale market, both current and future prices closely correspond to where current and future natural gas prices are currently trading.
3. Dramatic increases in domestic supply of natural gas. The development of new drilling techniques to recover natural gas in deep land-based shale formations in the U.S. has dramatically boosted proven reserve and available supplies. Prior to 2008 natural gas prices closely tracked oil prices, both being set by the marginal price of imports. Now natural gas no longer does so and is trading at less than 40% of oil’s current price. Whatever the final results of New York State’s environmental rulemaking, market conditions will reflect drilling activity occurring in many states, such as nearby Pennsylvania, Ohio and West Virginia .
Looking into 2012, technical data for natural gas suggest that prices will remain soft. And again, because natural gas tends to control electricity markets, at least in New York, we expect electricity prices here to remain soft into mid-2012 at least.
Factors that could dramatically change this outlook include a significant improvement in the economy, increased use of natural gas to replace coal plants closed due to environmental regulations and an exogenous foreign event.
Consumers should bear in mind that energy markets today are awash in supplies and the economy is not running on all cylinders yet. As long as these conditions obtain, the fundamentals will tend to reduce volatility and keep prices low.
Beyond mid 2012, there is an increased chance that the U.S. economy’s recovery will gain momentum and increase demand for energy supplies. In addition, if the Europeans avoid a calamity between now and March, they may be considered to have muddled through the worst, and stability, if not growth, may resume. And if Europe stabilizes, the Asian economies may resume healthy growth. It should be borne in mind that Japan increasingly will be fueled with natural gas, as it decommissions its nuclear fleet, with the product delivered in liquid (LNG) form from North America. These forces could provide support to natural gas and electricity prices starting in late 2012.
Consumers in the coming weeks should consider their options carefully and look at securing fixed pricing for as long a term as they feel comfortable with. Today’s prices of natural gas and electricity are at historic lows. Of course they could retreat further, but historically they have been much higher. So the outlook here is for prices by the end of 2012 to justify a move today to fixed or hedged pricing that could provide long term price stability at very reasonable prices.
Saratoga Springs, NY
December 20, 2011