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Weather and Natural Gas - Impacts to Electric Pricing


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A glimpse into how weather and natural gas impact the price of electricity.

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Weather and Natural Gas - Impacts to Electric Pricing

  1. 1. MARCH 2014 What Does It Mean For Me? By Kevin Musicó This winter continues to produce record breaking cold temperatures across much of the U.S.. The Northeast, Midwest, and South have experienced several record breaking lows, with temperatures dipping well below zero in many places. So what does this mean for your energy spend? It is important for key decision makers to understand the broader picture and how climate and weather events and energy market behavior can impact your natural gas and electricity spend quite significantly, as the money spent on energy goes to the bottom line, dollar for dollar. The subject of energy markets is complex and for most translates in the form of an increase or decrease in your monthly electric or natural gas bills. But how are prices impacted and how can you mitigate your risk? Without getting too technical, we’ll keep it simple and illustrate this with a couple general events that drive pricing for electricity markets. Although there are many dynamics driving markets, at a high level, there are a couple factors that drive how pricing is set – Storage and Weather. So what do we mean by ‘storage’? Natural gas is among the top energy sources for electricity generation, accounting for approximately 30% of the total generation in the U.S. Coal remains the largest source accounting for 37% and nuclear sources trailing at 19%; this, according to the US Energy Information Administrationi. For purposes of this article, we will focus on our Natural Gas reserves (storage) and how electric generation and market pricing follow. (513) 792-0146 In general, electricity pricing follows the natural gas markets. For conversation sake, if the natural gas market is up, electricity pricing is up. This phenomenon is the result of supply and demand forces… much like when school lets out for the summer and families take to the road for vacations, the price of gasoline increases. If the amount of natural gas in storage (the supply) is depleted, and the use increases, natural gas prices will increase to slow demand. U.S. natural gas storage levels along with weather (more on that later) are among the indicators of what happens to natural gas prices. The spike in pricing in the chart was the result of the release of supply dataii. That is, it was reported that the storage level was less than desired, hence the market reacted.
  2. 2. pricing so heavily, after all, it’s just a little chilly, but you made it to work, and things around the office seem pretty normal… right? Electric generation bases their daily generation on a load forecast of power demand. This forecast is a model of the relationship between power demand (what the sum of all the users expect to use), the time of day (electric usage at 2am is far different than 2 pm because of hours of operation, and a host of other factors), season (with winter and summer having the most significant impact), and weather. The chart reflects natural gas levels as of February 28, 2014 in the lower 48 (U.S.). Focus on the blue line, which represents current storage (in billion cubic feet). Notice the steep slope of the line in late 2013 through current. This is among the steepest decline experienced in over a decade. So what is happening? Among the greatest impact to natural gas supply is weather. As a result of an early start, and a longer and colder winter season; natural gas reserves have been depleted at a faster rate and longer duration than the industry anticipated. When the burn rate of these resources exceeds the rate that reserves can be replenished, the result is an alarming decline in storage. Don’t panic, the U.S. is not running out of natural gas. But what is happening is our storage levels are dangerously low. As a result, pricing reflects the depleted levels in storage and the increased demand of natural gas to heat homes, and more importantly to generate electricity. Let’s think back to the earlier reference to economics, when supply is low, and/or demand increases; pricing jumps. What we have seen is a steady increase (with some dramatic spikes) in pricing of natural gas during this winter. To put this in perspective, around the same period in March 2012, pricing was around $2.30, today it is approximately $4.60 per Mmbtu. Let’s talk about weather. Each morning we are reminded just how cold it is. We roll out of bed, bundle the kids in winter wears, and hit the road. As we sit in traffic, we see how cold, snow, ice, heavy rain, and other weather related events impact our commute. At work, we can expect impacts to transportation (both for the movement of products as well as for staff to arrive to work and perform their duties). But why does cold weather impact (513) 792-0146 When it comes to weather, ambient temperatures, dewpoints temperatures, cloud coverage, precipitation, and winds impact the sensitivity in electric load. The weather patterns the U.S. is experiencing, particularly in the eastern half of the continental U.S. indicates we can expect a colder than normal forecast in the coming weeks. As the chart of the temperature probability outlook for March 12-18th suggests, the majority of the eastern U.S. has a very high probability of below normal temperaturesiii. With low temperatures, comes high demand. After all, we have to heat and power our homes and businesses, which contribute to a significant increase in power demand. The correlation of weather, temperature, and natural gas to electricity pricing can be best understood when you consider the mix (or type) of generation that exists, particularly in the region of the country you may have your business. Couple this with the types of heat sources that exist within homes and businesses and very quickly, you can see how our usage accelerates. Consider the mix of generation that exists nationally… 30% of the generation being from natural gas generators. But regionally, the mix of generation differs dramatically. For example, in PJM’s territory, the mix of coal vs natural gas generation is 74% vs 22%. You
  3. 3. might say 22% isn’t that significant. However, in the eastern portion of their territory, generation is heavy on natural gas whereby the western area is heavy on coal generation. As the map illustrates, pricing (a snap shot of March 7, 2014 at approximately 12:30PM) shows how pricing ranges from the low teens to more than $100 per unit dependent upon where in the region you may be located. We Can Help! What has been illustrated in this article represents only a small fraction of the complexity and moving parts that have to be considered when evaluating energy exposure. Energy risk management is often overlooked by most companies because it is often an area most are not aware of; it is grossly misunderstood; or misinformation about the ability to competitively shop energy. STEP Resources spends a great deal of time monitoring and evaluating the energy markets, weather, pricing, changes in the energy sector, regulatory issues, and supplier behaviors for your benefit. We have the resources and time to provide you with sound advice and guidance to make informed decisions. Contact us today to find out more about how we can help you mitigate your energy risk. There are several of these Regional Transmission Organizations (RTOs) across the U.S.iv that coordinate the movement of electricity around the country and within each region. Monitoring the activity within these regions along with several other sources such as National Oceanic and Atmospheric Administration (NOAA), and financial/commodity markets, you can gain insights into how your energy prices fluctuate. Contact Us: STEP Resources Consulting, LLC 8366 Princeton-Glendale Road, Suite B1 West Chester, Ohio 45069 P. (513) 792-0146 F. (513) 672-0584 E. Endnotes/Sources: i U.S. Energy Information Administration. Basis year 2012. ii March 7, 2014 So what does all this mean…? If the weather impacts demand and production… and the levels of natural gas and their prices impact the pricing of electricity, then what your business can expect is increasing electricity prices! (513) 792-0146 iii National Oceanic and Atmospheric Association, National Weather Service, Climate Prediction Center. iv Federal Energy Regulatory Commission (FERC).