Energy Update | November 14th, 2018

Energy Update
November 14th, 2018

Winter 2018 Natural Gas Prices Have Exploded Due to Cooler Than Normal November, But Backwardation is Still in Place for 2019 Thru 2022!  

(My reports focus on Natural Gas as it is the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity are highly correlated.)

In my October 31^st Energy Report, I explained why Natural Gas backwardation over the next 3 years was unsustainable because low prices are a disincentive to increase production, while demand was expected to continue to increase resulting in structural imbalances leading to higher prices in 2019 and beyond.

In my September 19^th Energy Report, I warned although prices remained relatively stable since the beginning of the year with supplies at very low levels, it was not wise to become complacent and count on increased production handling demand this winter with supplies at the start of the winter heating season at the lowest level in 10 years.

In today’s report, I will update what has transpired since my last report and discuss how recent price increases have impacted consumers of Natural Gas and Electricity.

As you can see in the chart below, if you did not heed my September 19^th warning and have market based or variable rate pricing, a cooler than normal November triggered an explosive rally and you will be experiencing sharp increases in your Natural Gas and Electricity bills:

After my September 19^th Energy Report, Natural Gas prices increased from $2.95 per MMbtu to a high today of $4.93, an increase of approximately 67% in less than 2 months! The recent explosive increases in Natural Gas and Electricity prices have impacted rates in the forward markets though March 2019. Therefore, be very thankful if you already have an energy contract in place, you will avoid this winter’s sharp price increases.

The question is, what was the root cause of the explosive rally? The obvious answer is the rally was due to cooler than normal temperatures in November causing an already dire supply situation to continue to deteriorate and Natural Gas supplies are now projected to remain approximately 700 Bcf below the 5 Yr. Avg. by the end of November! The market is waking up to the reality supplies declined further below the 5 Yr. Avg. based on a cooler than normal November. We are not talking about Polar Vortex temperatures like the winter of 2013/14, we are talking about chilly weather in November!

But what do you think will happen to prices if we do experience a Polar Vortex this winter?

Therefore, it is not surprising as the market came to grips with this reality that Natural Gas and Electricity rates exploded thru March 2019, and you should be very thankful if you have an energy contract in place. But the good news is even if you don’t have a contract or your contract expires in the next few months, prices in the forward markets starting in April 2019 are little changed from the rates shown below in my Oct 31^st Energy Report, and the market phenomenon called “Backwardation” still allows you to secure rates far below present levels in the forward market.

As I explained in my Oct 31^st Energy Report, the above prices are not sustainable since E&P companies are not profitable when prices average below $3.00 per MMbtu. Therefore, I believe backwardation in the forward markets with prices from Apr 2019 thru Apr 2022 near $2.70 per MMbtu will likely lead to much higher prices in 2019 and beyond!

I believe the dramatic price increases over the last 2 months in winter 2019 prices are a harbinger of a new reality in which structural imbalances in supply/demand will periodically result in explosive price increases and I recommend securing long-term hedgers to protect yourself.

One last point to consider based on the empirical evidence contained in the chart below:

90% of the time over the last 20 years, Natural Gas prices have been higher than $2.70 per MMbtu, and since I believe prices below $3.00 per MMbtu will inevitably lead to structural supply/demand imbalances, and higher prices, I trust you can appreciate the wisdom of securing long-term hedges to protect yourself from the likelihood of higher prices in 2019 and beyond.

Conclusions:

The recent explosive 67% rally in Natural Gas since September 19^th was triggered by cooler than normal temperatures in November causing an already dire supply situation to further worsen with supplies now expected to remain 700 Bcf below the 5 Yr. Avg. by the end of November.

The concern is the recent rally was triggered by chilly weather in November, but how high would prices rise if we experience a Polar Vortex this winter! Therefore, given the fact that prices in the forward markets from April 2019 thru Apr 2022 are trading near levels in which over the last 20 years, they have been higher 90% of the time, and prices this low will likely lead to structural supply/demand imbalances, and higher prices in 2019 and beyond, it is wise for anyone with contracts expiring within the next 18-months to secure long-term hedges to protect themselves from the increasing risk of higher prices.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities now. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Energy Professionals
Senior Commodity Analyst