Natural Gas and Electricity prices

The purpose of this article is to help you view Natural Gas and Electricity prices from a cyclical and historical perspective. We discuss Natural Gas and Electricity together due to their high price correlation, but our analysis primarily focuses on Natural Gas since it is actively traded on commodity exchanges; therefore, we have access to large amount of historical data. Natural Gas’s cyclical pattern is primarily related to supply/demand factors. When prices are high, producers are motivated to increase production, while demand declines until prices collapse. Conversely, when prices are low, suppliers are motivated to decrease production while demand increases until prices spike higher. Price extremes are reached based on the market’s adjustment to supply/demand imbalances.

Over the last 4 years, production increased due to hydraulic fracking leading to lower prices, but lower prices along with the closure of coal fired plants has substantially increased demand, which is supportive to higher prices. The ongoing struggle between increased production and demand will invariably lead to increased volatility. This is primarily due to the limited storage capacity of natural gas, which will lead to wild swings in prices when either supply or demand gains the upper hand.

The chart below reflects high volatility of Natural Gas from 2000 thru 2009:

Prior to 2000, there was ample storage for Natural Gas to respond to changes in seasonal demand and prices were relatively stable, but as demand increased prices became increasing unstable from 2000 thru 2009. In 2012 prices collapsed due to the combination of increased production from fracking and low demand due a very warm winter. But demand for Natural Gas as previously mentioned has steadily increased and last winter when we experienced a colder than normal winter prices again surged.

It was cold last winter, but we have had cold winters before without experiencing the record breaking weekly drawdown of Natural Gas. The reason was simple. Demand for Natural Gas is much higher now than it was 10 years ago, but our working storage capacity has not kept pace, and increased pipe lines have not been sufficiently built to deliver Natural Gas to where it is needed. Over the next 10 years both production and demand for Natural Gas will continue to increase, and our structural limitations will lead to extremes in prices.

The chart below shows price extremes reached due to events affecting supply and demand since 2002.

Rates surged when we experienced a colder than normal winter in 2002, hurricane Katrina in 2005 and a hotter than normal summer in 2008. Conversely, prices collapsed when demand decreased to the financial collapse in 2009, warm winter of 2012 or this year’s milder than expected winter.

We are entering a volatile period in the energy markets in which determining where rates are from a cyclical and historical perspective will be vital to developing effective hedging strategies. This historical perspective should help you understand why, based on present cyclical and historical price patterns, the upside risks are substantial at this time. When your cost of Natural Gas or Electricity is not hedged you are short these markets. Over the last 13 years Natural Gas has been higher than present levels 

more than 90% of the time. Do you really want to be short when a market is at the lower end of its trading range? If your answer is, “No”, then you understand why we recommend hedging your cost of Natural Gas and Electricity near today’s low historical price levels.

Ray Franklin
Senior Commodity Analyst