New Fuel Budget Risks of Sustained Low Natural Gas Prices
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- Jul 27, 2020 4:15 pm GMTJul 27, 2020 2:04 pm GMT
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New Fuel Budget Risks of Sustained Low Nat Gas Prices
The socioeconomic impact of the Covid-19 pandemic is unlike any other in modern history.
But the impact to the energy industry is only just beginning.
Sustained low natural gas prices introduce new risks and uncertainty to an industry already grappling with a widening disconnect between technology & market design.
During the next six months, three risks will need to be reconsidered in your portfolio.
- Price Risk
- Volume Risk
- Public Policy Risk
Risk refers to situations in which the probabilities of occurrence can be identified for possible outcomes and can be quantified.
Uncertainty refers to epistemic situations involving imperfect or unknown information.
The era of Covid-19 introduces significant risks and uncertainties to your forecasted fuel budget.
During the past twenty years, quarterly historical volatility of natural gas has ranged from a low of 12% to a high of 80%
Nat gas has a long history of punishing long or short players who overstay their welcome.
So, what is new here?
Once the global economy completely shut down, drillers needed to suddenly slam the brakes and “the great shale shut-in” began. The unprecedented speed and scale of the shut-ins certainly cut production way back, but it also introduces a question as to whether some damage occurred by doing so.
In other words, we are in unchartered territory. Physics will be at play as much as economics regarding the resumption of drilling in the future.
Contrary to perception, turning a well on and off is not the same as flipping a light switch.
If the global economy recovers quicker than expected, prices could rise over 100% from current levels. According to a recent Goldman Sachs forecast, Nat gas will leap to $3.50 this winter and average $3.25 for all of 2021.
However, the uncertainty of any forecast is exceptionally high.
Both the supply and demand variables for natural gas forecasts own new and unique risks and uncertainties.
Volume risk refers to the fact that a participant in the natural gas market has uncertain sources of consumption or sourcing.
While we know the sourcing uncertainties, the consumption incertitude is not as clear to many.
As natural gas prices go lower, the consumption goes higher.
As natural gas gains market share, coal generation recedes. The economics of gas versus coal is accelerating coal retirements.
In the southeastern United States, many utilities have seen their energy derived from natural gas generation increase from 30% to 50% during the past five years.
On the surface, $1.60 natural gas prices would seem like a financial boon to a fuel budget. And many utilities have abandoned hedging programs in the past five years to fully capture the steep decline in prices.
But will it be wise to remain unhedged in the next five years?
A 60% increase in your natural gas volumes significantly raises your portfolio risks to potential price spikes. It also raises your delivery risks on your pipeline.
Especially if everybody else is doing the same thing.
Speaking of pipelines…….
Public Policy Risk
Not so long ago, environmentalists embraced the fracking revolution since it replaced coal and played a major role in the greenhouse gas reduction for the past decade.
That honeymoon has come to an end.
The recent cancellation of the Atlantic Coast Pipeline in addition to the shut down of the Dakota Access & Keystone XL sent a clear and loud signal for the future.
But will the policy shift end there?
Could fracking be banned in the future? Likely not right away.
Could production be limited & regulated more? Yes, it could.
The November election in the United States will answer many questions regarding future public policy towards natural gas production, transportation, and consumption.
If the energy industry begins to believe that natural gas generation will be gone in the next decade, how will that impact long term planning decisions considered today? Will maintenance and safety be compromised?
Capital has a funny tendency to flow to where it feels most welcome.
Considering the increased reliance on natural gas to replace coal today and help balance solar generation swings in the future, the public policy risks represent real concerns to utility portfolio managers.
The Covid-19 pandemic did not cause low natural gas prices.
Long before the COVID-19 outbreak, fracking firms in the Permian Basin were experiencing a downturn.
Associated gas from oil drilling arguably makes the cost of that gas to be zero.
But the pandemic has done what many black swan crisis events seem want to do.
It has accelerated previous trends and introduced substantial risks to utility portfolio managers regarding price, volume, and public policy.
What does the future hold?
Perhaps the better question is when will a vaccine be ready?
At some point, the global recovery will begin to heal from the biggest economic crisis since the Great Depression.
But nobody really knows when and how fast.
Uncertainty to heightened risks is clearly not an excuse for inaction for portfolio managers. Some decisions need to be evaluated:
- Should I begin to hedge my price risk?
- How can I accurately forecast the volume of gas that would need to be hedged?
- Do I own adequate and reliable pipeline capacity to handle these volumes?
- How do potential public policy changes impact the risk to my portfolio?
Of course, many more questions need to be considered.
The Covid 19 pandemic has introduced unprecedented risks and uncertainties to the utility portfolio manager.
In a period of historic economic uncertainty and budget challenges for public power entities, addressing these risks today may well define how competitive you remain in the future.
Finally- There is an old saying in Houston that might provide a glimpse of light and wisdom in today’s uncertainty.
“The cure for low prices is low prices.”