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

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.
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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.
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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
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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
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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. info@STEPresources.com
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www.LinkedIn.com/company/step-resources
Endnotes/Sources:
i
U.S. Energy Information Administration. Basis year 2012.
http://www.eia.gov/tools/faqs/faq.cfm?id=427&t=3
ii
www.investing.com/commodities/natural-gas. 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!
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iii
National Oceanic and Atmospheric Association, National
Weather Service, Climate Prediction Center.
http://www.cpc.ncep.noaa.gov/products/predictions/814day/
iv
Federal Energy Regulatory Commission (FERC).
http://www.ferc.gov/industries/electric/indus-act/rto.asp
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