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Natural Gas Prices – Get Real

Previous articles on the topic of natural gas prices have looked at natural gas prices spanning the 179 month period of time running from January 1997 through November 2011 (click here, here, and here for more information). Here is a graph of the dataset.

Each time we have used this graph, we have noted that these natural gas prices are in “nominal” dollars, or dollars unadjusted for inflation. Readers have asked how natural gas prices have behaved on an inflation adjusted, or “real,” basis.

The blue line in the graph above shows natural gas prices in nominal dollars while the red line shows natural gas prices adjusted for inflation. Prices were adjusted using U.S. Bureau of Labor Statistics (BLS) Consumer Price Index (CPI) inflators. In other words, prices are presented on an apples-to-apples basis in constant year 2010 dollars.

In “real” dollars, natural gas prices, over the 14 year and 11 month period of time, averaged $5.56/mmBtu, reached nearly $15/mmBtu ($14.97/mmBtu) during October 2005, and dropped as low as $2.29/mmBtu during December 1998. During November 2011 (the latest month for which we have data) the monthly average spot natural gas price at the Henry Hub was $3.22/mmBtu.

The above graph shows natural gas prices over the study period ranked by price, from lowest to highest. The November 2011 price of $3.22/mmBtu is at the top of the bottom quintile, meaning that over the identified period, 80% of the time natural gas prices, in real dollars, have been higher than they are currently.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096, or email us at jmcdonnell@avalonenergy.us

Copyright 2011 by Avalon Energy® Services LLC

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Time to Convert

Like crude oil prices, fuel oil prices have risen dramatically (click here for more information).

The above graph shows the monthly average spot price history of #2 fuel oil delivered to New York Harbor. The prices shown date back to June 1986 and run through November 2011.

Fuel oil is a distillate of crude oil that is heavier than gasoline and similar to diesel. There are various grades of fuel oil (#1 through #6) but the most common is #2, which is used primarily for home heating and, occasionally, for electricity generation. As a home heating fuel, #2 fuel oil competes with natural gas, primarily in the Northeast US.

While crude oil and fuel oil prices have risen dramatically, natural gas prices have dropped precipitously (click here for more information). This has led to a large disparity in the cost of heating homes using fuel oil versus heating with natural gas.

The above graph shows the historical price relationship, on an energy equivalent basis, between fuel oil and natural gas, both delivered to New York City. Since 2006, the premium for fuel oil has increased at an increasing rate. For the month of November 2011, a million BTUs of fuel oil cost five and a half times the cost of a million BTUs of natural gas. This is a stunning difference in price for the same amount of energy. Home owners who heat with fuel oil and have the option to switch to natural gas should consider converting.

Many home owners who use fuel oil and would like to switch but do not have access to natural gas ask if they should convert to propane. Unfortunately, there is not much advantage in doing so. While propane is often produced in association with natural gas, propane prices track crude oil and fuel oil prices. This correlation with crude oil and fuel oil is true also with other natural gas liquids such as butane and ethane.

The above graph shows the historical price relationship, on an energy equivalent basis, of both fuel oil and propane compared to natural gas. Like fuel oil, since 2006, the premium for propane has increased dramatically. For the month of November 2011, a million BTUs of propane cost almost five times the cost of a million BTUs of natural gas.

Note: These prices are in nominal dollars and have not been adjusted for inflation.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096, or email us at jmcdonnell@avalonenergy.us

Copyright 2011 by Avalon Energy® Services LLC

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Crude Oil and Natural Gas Get a Divorce

As discussed previously on this blog, natural gas and electricity prices in the wholesale markets have declined precipitously (click here for more information). What is more obvious, certainly at the gasoline pump, is that crude oil prices, unlike natural gas prices, have been on an upward trend.

The above graphs show (i) the monthly average spot price history of natural gas at the Henry Hub in Southern Louisiana and (ii) crude oil prices, or more specifically, prices of West Texas Intermediate (WTI) at Cushing, Oklahoma. Prices are shown dating back to January 1986 and through October 2011. Natural gas prices and crude oil prices both hit a peak during the summer of 2008 and then dropped dramatically as the economy went into recession. Natural gas prices have remained low. Crude oil prices recovered.

Natural gas prices and crude oil prices have become decoupled. Historically, on an energy equivalent basis, crude oil used to trade at about a 50% premium to natural gas, reflecting crude oil’s greater energy density, portability, and flexibility. More recently, that premium has increased to more than 300% or more (see graph above). Thought of another way, natural gas is trading at a more than a 75% discount to crude oil.

As of this writing, natural gas is trading at $3.32 per thousand cubic feet (MCF) and crude oil at $99.41 per barrel; crude oil is trading at a 400% premium to natural gas on an energy equivalent basis.

Why the divergence? Crude oil prices are driven by influences in the world energy market, the largest being growing demand in developing countries. US natural gas prices are driven by factors specific to the integrated North American natural gas markets.

Note: These prices are in nominal dollars and have not been adjusted for inflation.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us

Copyright 2011 by Avalon Energy® Services LLC

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“Energy Prices Always Go Up”

There is a common perception that energy prices have been, and continue to be, on a one way path upwards. Is this the case? No.

The graph above provides a historical view of natural gas prices. Plotted are the monthly average spot prices of natural gas at Henry Hub (a trading hub in Southern Louisiana) going back to 1997. During November 1997, natural gas prices averaged $3.08/mmBtu. One hundred and sixty-eight months later, during November 2011, prices averaged $3.28/mmBtu.

Between November 1997 and November 2011, the monthly average natural gas price has traded in the following range (values given are in $/mmBtu):

Maximum 13.42
Average 4.92
Minimum 1.72

While natural gas prices are volatile, they do not “always go up.” In fact, they have declined. The prices presented above are in nominal dollars. If they are adjusted for inflation, today’s prices are significantly lower in terms of real dollars.

The natural gas “winter strip” represents the average futures price for natural gas over the five month period of November through March. As seen on the above graph, for this 2011/2012 winter, the winter strip closed below $4/mmBtu, which is a 10 year low. The two big drivers of declining natural gas prices are increased supply, in the form of new shale gas reserves, and decreased demand, resulting from the weak economy.

What does this mean for electricity? In the Mid-Atlantic, natural gas prices and electricity prices are highly correlated. Commercial businesses in many locations are now seeing electricity supply (generation and transmission) prices below 8 cents per kilowatt-hour.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us

Copyright 2011 by Avalon Energy® Services LLC

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Earthquake!

Wholesale electricity prices are volatile. Because electricity cannot be stored in any meaningful quantity, electricity load (demand) and supply must be matched in real-time. Matching load and demand is the challenging job of grid operators. To give you an idea of how volatile prices can be, take a look at the graph below (source: pjm.com).

Unlike a few weeks ago, weather this week in the Mid-Atlantic has been mild. Mild weather generally leads to low and stable electricity prices. Prior to 2 PM yesterday, 8/23, wholesale prices in PJM were below $40 per megawatt-hour. Then came the earthquake. Very quickly, as a precautionary measure, a number of nuclear power plants were immediately taken offline. In some areas, spot prices in the wholesale market jumped to $140 per megawatt-hour. That is a 250% increase. Within approximately 20 minutes, however, spot prices were back to $40 per megawatt-hour as the grid operator was able to bring online other resources or implement demand response measures.

As volatile as these prices seem, during the summer heat wave, spot prices in the PJM wholesale market at times exceeded $600 per megawatt-hour. For short periods of time, spot prices in the ERCOT (Texas) market have reached $3,000 per megawatt-hour.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us

Copyright 2011 by Avalon Energy® Services LLC

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Trade Association Buying Groups – Who Benefits?

Do businesses benefit by purchasing energy through trade association buying groups?  In many cases “no.”  How can that be?

First, some background.  The term “load profile” refers to the variation of an electricity user’s electrical load versus time.  Load profiles vary by customer categories (residential, commercial and industrial) and by individual customer within those categories.  Customer’s individual load profiles are used to estimate their electric supply requirements and determine their individual pricing.  The two main drivers of pricing are demand charges and energy charges.  Demand charges are based on a customer’s peak load as measured in kilowatts (kW).  This is the customer’s highest rate of electricity usage during a given time period.  Energy charges are a function of how much actual electricity a customer uses over a given time period (month, year), measured in kilowatt-hours (kWh).

When customers with individual load profiles are aggregated, an economic benefit to the overall group may result.  Whether or not an economic benefit results depends largely on whether or not the aggregated group of customers have non-coincident peaks.  When combined, customers who have variation in their individual peaks may have a more attractive overall load profile and this can lead to improved pricing for the group.  Where does the benefit go?

The value of any economic benefit resulting from forming an aggregation group can be shared with the customers, kept by the supplier, or a combination of the two.  Customers will rarely ever know if there is a benefit and what comes of it.  The only way customers could possibly tell is to have the supplier price each load individually, price the group as a whole and then compare the two sets of prices.

There are also costs associated with participating in trade association buying groups, many of which are hidden.  Such costs include:

Open Offers

When making offers, many trade associations and their supplier will keep the offer price open for a period of time.  This may be a few days, a week or even longer.  Holding a price open is risky for suppliers.  If, during the offer period, customers sign up and, at the same time, the wholesale market for electricity rises, the supplier can lose margin or even end up “upside down” having to purchase supply at a price that is higher than the price they have held open and committed to sell at to customers.  In order to protect themselves from this possibility, suppliers will add a risk premium to their offer price.  This can be expensive and drives up the offer price.  [Alternatively, suppliers may “pre-purchase” supply in anticipation of making an offer.  In this case, the risk works in reverse.  If during the offer period the wholesale markets decline, customers who sign up will pay an above market price for their electricity.]

Expensive Embedded Option

Some trade associations promote that their contracts call for no penalties to be paid by the customer if the customer breaks their contract because they sell their property before the end of the contract term.  This is an option and options have value.  In exchange for including this feature in a contract, suppliers add a premium to protect themselves in case customers exercise this option and break their contracts because of the sale of a property.  The customer pays this option premium whether they exercise the option or not.  And what is the customer paying for?  This option is only of value to the customer when two conditions are simultaneously true; (1) they sell their property during the contract term, and (2) prices in the wholesale market are lower at the time the contract is broken compared to when the contract was entered into.  Most customers do not expect to sell their properties during the term of their electricity supply contracts.  And, what is the likelihood that prices will fall further below today’s already low levels?  In summary, customers end up paying for an option feature that has little chance of being of value to them.

Trade Association Fees

In order to entice a trade organization to promote the supplier’s offer to the trade association’s members, suppliers often will agree to make payments to the association itself.  These payments are rolled into the price they offer the trade association members and they can be substantial.  You may really like your trade association and may be happy they can make a buck or two, but you should be aware that they are being paid and that you are footing the bill.

No Competition

Suppliers seek trade association relationships because it is a way to exclude competition.  By gaining the trade association’s endorsement, the supplier no longer has to compete with other suppliers.  While the trade associations may conduct some sort of due diligence during a selection process, what matters is the pricing the suppler offers the trade association’s members during the offer period.  And, by this point, there is no competition.

Winner and Losers

When forming an aggregation group, there are times when some members of the group will benefit and others will not.  As an extreme example, imagine an aggregation group consisting of a large hospital and several small sandwich stores.  The hospital, with its attractive load profile, may end up with a slightly higher price.  The sandwich stores, with their much less attractive load profiles, would each most certainly benefit immensely.  Sometimes some members of an aggregation group are subsidizing other members of the group.

So, what can be done?

If you are considering participating in an aggregation group, it is to your benefit to seek other quotes.  You cannot lose.  Either you will confirm that the aggregation group is economically better for you or you will elsewhere find better pricing, terms and conditions.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us.

Copyright 2011 by Avalon Energy Services, LLC.

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Is the Shale Gas Revolution for Real?

Some have described the proliferation of shale gas plays as a “quiet revolution.”  But, the revolution is not so quiet.  Stories now appear regularly on the front page of the Philadelphia Inquirer, the New York Times, and many other newspapers far from the oil patch.  What are the facts?

US natural gas production is higher than it has been over the last 30 years.  On a twelve month rolling basis, US natural gas withdraws as of July, 2006, were 23.1 trillion cubic feet (TCF) (see note below).  Current annual US natural gas withdraws are 26.5 TCF, a 15% increase in less than five years.

Examination of the data from the last five years on a month-over-month basis highlights the steady upward progression of natural gas production in the US.

The increase in US natural gas production has been driven largely by increases in shale gas production.  US shale gas production has increased dramatically as shown in the table below:

    Increase
Year TCF   TCF %
2007 1.3
2008 2.2 0.9 69%
2009 3.3 1.1 50%
2010 4.9 1.6 48%

By contrast, annual US crude oil production has declined significantly since peaking at 3.6 billion barrels in 1971.  Currently, US crude oil is being produced at a rate of about 2 billion barrels per year.  This is a 44% decline from the 1971 peak.

The stark divergence in the trends of natural gas and crude oil production in the US stands out even more when the production levels of the two forms of energy are converted to a common energy unit.  The graph below presents US natural gas and crude oil production in millions of mmBtus.  A mmBtu is a million Btus.  Conversion factors of 1,025 Btus per cubic feet of natural gas and 5.8 mmBtu per barrel for crude oil were used.

The discussion above has focused on natural gas production.  Natural gas reserves have increased even more dramatically.  The DOE Energy Information Administration recently estimated US recoverable unproved shale gas reserves at 827 TCF, 474 TCF more than their estimate last year.

So, what could derail the natural gas revolution, “quiet” or otherwise?  The short answer is public sentiment related to two environmental concerns; (i) potential groundwater contamination, and (ii) the disposal of drilling and fracking fluids.

The failure of a well’s casing can lead to drilling or fracking fluids seeping into fresh water aquifers.  Generally, fresh water aquifers are encountered in the first few hundred feet of a well while shale gas reserves exist thousands of feet below.  This is not an environmental risk to be ignored.  However, over many decades there exists a successful track record of keeping ground water aquifers isolated from formation fluids (natural gas, crude oil, natural gas liquids and formation water).  The same techniques and technologies can be applied to keeping groundwater aquifers isolated from fracking fluids.

The improper disposal of drilling and fracking fluids poses a serious threat to surface ecosystems as such fluids can contain toxic materials.  Effective regulation and enforcement of the handling and disposal of these fluids is imperative.  Recently, the development of fracking fluids using chemicals “sourced entirely from the food industry” has been announced.  In any case, the disclosure of detailed information about the chemicals used in its fracking fluids is critical.

Note:  Natural gas and crude oil production and reserve data was obtained from the US Department of Energy, Energy Information Administration website.

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us.

Copyright 2011 by Avalon Energy Services, LLC.

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Fixed Price versus Variable Price Energy Supply Contracts

When purchasing energy, there is a price/risk continuum between fixed price contracts and variable price contracts.

Fixed price contracts allow you to minimize your exposure to price risk by transferring this risk to a supplier.

With a variable price contract, you are accepting the risk associated with changes in the market price of electricity. This is not an insignificant risk as electricity prices are highly volatile. And, electricity price risk is asymmetric, meaning there is much greater potential for upward movement than there is for downward movement (prices are bound by zero on the downside but are not bound on the upside). With variable price contracts, suppliers transfer electricity price risk to you. In exchange, pricing to you should be at a discount.

Most variable price contracts will base changes in the contract price to changes in an index. Here in the Mid-Atlantic, the grid operator, PJM, tracks hourly prices by zone. These hourly prices are referred to as “LMP” which stands for “locational marginal price.” These LMP prices are a transparent index, meaning PJM makes them available.

Most suppliers who sell variable price contracts will price them as “LMP plus a fixed adder” and they will tell you their “adder”. LMP is passed through to you dollar-for-dollar and the “adder” is their margin on top of LMP. With the same LMP as a basis, you can then compare what “adders” different suppliers are offering. This approach is transparent.

Some suppliers who sell variable price contracts base their prices on indices that are proprietary and vague. There is no place you can go to see the index. Further, they often don’t disclose what their margin is on top of the index and they don’t commit to keeping the margin fixed. This allows them great flexibility in what they charge you each month. You are left vulnerable and there are no checks and balances.

If your are currently purchasing from a suppler under a variable price contract that does not have a transparent index and does not have a fixed “adder” we recommend that you review your contract and examine all of the suppliers monthly invoices to see if you have been getting the benefit of an “index” product.

Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us

Copyright 2010 by Avalon Energy Services, LLC.

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Is There a Shortage of Energy?

I was recently asked to review a draft of a book in which there was reference to “…rising energy demand, global climate change and limited energy supplies…”  Are energy supplies limited?  The short answer is “no.”  There is no shortage of energy in the universe and energy supplies are not limited.  This is more than a technicality.  There may be a shortage of socially desirable energy supplies currently available, but as an absolute statement, there is no shortage of energy supplies.  The author of the book asked me to explain.  Here is my response: 

 

Concerning the needs of the human race, there is no shortage of energy in the universe and there never will be.  The amount of energy that exists is incomprehensibly beyond what we could ever use. 

 

Some forms of energy are currently more easily accessible and economical than others, such as coal, oil, natural gas, hydro and nuclear.  Other forms of energy are currently less accessible and economical, like solar, wind, ultra-deep geothermal, shale oil and tidal energy. 

 

While some forms of energy are currently easily accessible and economical, they may be less socially desirable.  Coal, for example, when combusted, emits soot, mercury and CO2.  Because of concerns over the impact of these emissions (along with other issues), coal has become less socially desirable.  Oil, natural gas, hydro and nuclear each have their own set of trade-offs, some of which are more socially undesirable than others.  We are learning some of the socially undesirable second order implications of wind energy, like bird kills, intermittency, energy sprawl and its negative impact on landscape aesthetics. 

 

So, there is no shortage of energy available.  Each form of energy comes with trade-offs and has its own balance sheet of socially desirable and undesirable attributes.  How we rate the trade-offs changes over time.  But at any point in time, some forms of energy are more or less socially desirable than others. 

 

The Avalon Advantage – Visit our website at www.avalonenergy.us, call us at 888-484-8096 or email us at jmcdonnell@avalonenergy.us.    

 

Copyright 2010 by Avalon Energy Services, LLC.    

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Constellation Electric Offer (continued)

Both of our last two blog entries have generated a great deal of interest.  Jay Hancock of the Baltimore Sun picked up on our write-up on Constellation Electric’s offer to customers in Pepco’s territory.  Below is a link to his article: 

http://weblogs.baltimoresun.com/business/hancock/blog/2010/08/avalon_energy_constellation_of.html

You can scroll down to our original article or access it by going to:
https://avalonenergy.us/2010/11/constellation-electric-offer/