Where Are Energy Prices Headed?
October 2, 2009
This time of year always has consumers – residential and industrial – wondering about where prices will be headed as we approach winter. Even the most seasoned prognosticators are not certain. A friend who is a buyer for a mid-sized manufacturing firm said this when describing the future of natural gas prices: “Storage is strong. Demand is weak. Weather is unpredictable. The market is volatile.” Additional research has found his analysis to be right on the mark. Since energy costs are a significant input to the cost structure of thermal-processing companies, we will consider how these four factors impact future prices.
Storage is Strong
The recession has had an impact on oil. As the WSJ recently reported, “the world’s storage terminals have been overwhelmed with unwanted oil and fuel for months.” Recent data has indicated that this glut is “even bigger and more persistent than many had anticipated. Distillates inventories are at the highest weekly level since 1982.” In spite of this, oil prices have more than doubled since January.
Natural gas prices have fallen by 45% since January as supplies have soared in the U.S. this summer. As of late August, stockpiles continued to grow to a level nearly 20% above the five-year average. This is at least partially due to the recession’s impact. In addition to these stockpiles, the U.S. sits on natural gas reservoirs “containing more energy than all the oil in Saudi Arabia.”
Another piece of good news is the recent discovery, by BP, of a Gulf of Mexico oil source that may contain 3 billion barrels. This is equivalent to about a year’s total output from Saudi Arabia and closely matches the entire proven reserves of the U.K.
Demand is Weak
As mentioned in the first point, the ongoing economic downturn has created a demand reduction. As factories are slowed, their energy usage is reduced. Also affecting reduced demand is actually the next factor – weather. The unusually cold summer has reduced demand for electricity, which reduces natural gas usage.
If you are a consumer, this is great news. If you are a producer, however, the news is not so good. In fact, recent reports indicate about 63% fewer gas rigs were working across Canada compared to the same time period in 2008. The WSJ also reported that the slack demand for electricity across the country is leading to some of the sharpest price reductions in recent years. Daily market prices for electricity are down by 40% as a result of this lack of demand.
Weather is Unpredictable
As mentioned earlier, our cooler-than-usual season (what happened to the global warming predictions?) has impacted demand for both natural gas and electricity. The natural gas trackers are saying weather is playing a smaller role than it once did, however, because of the investor factor. Investors are seeking to buy natural gas futures at the currently depressed price, which is sustaining pricing a bit.
Meteorologists (not metallurgists) are predicting a moderate autumn, which could further reduce prices of heating oil and natural gas. Because of the expected El Nino this winter, most forecasters are also predicting a mild winter. The newly released 2010 Farmer’s Almanac, however, is predicting a frigid winter for much of the country. Weather is unpredictable.
The Market is Volatile
This statement is true because of the other three factors and in spite of them. One of the factors making the market more volatile is commodity trading. This can be a good as well as a bad thing. Our government is seeing this free-market activity as only a bad thing and is considering regulation. It is believed that traders influenced the run-up in oil prices last year. Clearly, governmental restrictions on exploration and new drilling had a big impact then and continue to affect pricing and our dependence on foreign oil.
Natural gas producers believe that long-term hedging by the free market is helping to keep prices from a free fall, which is buoying employment in the sector. Producers warn, “a poorly thought out rush to lock the doors to energy speculation could diminish the depth of the market, hinder the ability to secure the best price and deprive producers of the ‘cash-flow certainty’ that funds drilling, creating new supply.”
Combining all of the above, your guess is as good as mine. Indications are, however, that prices of natural gas and electricity will be favorable in the short- and mid-term future. This is good news for us as private and commercial consumers. We hope that any governmental restriction of free-market behavior is well thought out and will not adversely hurt producers, which will end up hurting the consumer. IH