Gas, reserve margins boost electricity forwards: experts
By Mark Watson
March 8, 2013 - As natural gas futures for summer 2013 show year-over-year increases and electric generation reserves tighten, the outlook for power prices across the continental US have risen, experts say.
As of March 5, the June-July-August average on-peak forward prices for 10 geographically dispersed hubs around the US represent double-digit percentage increases from the forward prices for the same period of 2012 in late February 2012, according to Platts data.
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"Power traders expect power prices to turn around," said James Carson, CEO of Risquant, an electricity market consultant based in St. Paul, Minnesota. "Natural gas prices are 13.8% higher than one year ago. The forward power price response in the Eastern Interconnect is in line with what I would expect. In ERCOT and the Western Interconnect, power price increases are greater than I would expect."
In comparison with the actual day-ahead prices for June-August 2012, Platts data shows that on-peak forward electricity prices for 2013 are higher at every hub.
"The higher summer natural gas strip explains a large portion of the higher forward electricity prices," said Les Deman, a natural gas market consultant based in San Francisco. "But it is unlikely that temperatures will again be at record highs, so the market has taken that into consideration."
As of early March, full-market average forward prices for June-August 2013 for six geographically dispersed natural gas hubs range from 35.6% to 61.3% more than the average for the summer of 2012 as of a comparable date.
"Given the tighter natural gas supply and demand balance over the next six to 12 months, my belief is that the market is correctly pricing gas higher than 2012, so that the forward electricity prices should be up this summer, even with normal weather," Deman said.
Todd Hegwer, president of Denver-based Timber Canyon Energy Consulting, said, "I have seen some pockets of load growth across the country."
The highest forward percentage increases among the sample were at the SP15 hub, up 81.5%; NP15, up 60.9%; and Mass Hub, up 46.3%.
The continued outage at the San Onofre Nuclear Generation Station, near San Diego, is contributing to increased prices at California's SP15 and NP15 hubs, Deman said.
Michael Griswold, CEO and founder of Seattle, Washington-based Ansergy, an energy market analytic company, said, "Traders placed huge premiums on SONGS being offline, when in reality, the two nukes had a marginal impact."
In terms of heat rates, SP15 summer 2013 is trading at an 18% premium to summer 2012, Griswold said.
"Probably the biggest driver to the premium is the new carbon adder imposed by California," Griswold said. "From a forward fundamental perspective, California has much more robust water year in 2013 than 2012, but that will more than be offset by the diminished prospects for Mid-C."
One factor that may be boosting Mass Hub prices is a large increase in natural gas futures for June-July-August 2013 at the Algonquin Citygates. That three-month average was 61% higher than the summer 2012 average as of March 5, 2012, according to Platts data.
"Summer burn per degree on Algonquin has increased over the past five years," said Eason Jostad, an energy analyst at Bentek Energy, which, like Platts, is owned by McGraw-Hill Financial.
"I think what traders are pricing in this summer is partially this higher burn, and partially the lack of flows from the [Canadian] Maritimes," Jostad said. (See a related chart of Canadian Maritimes supply.)
However, these higher natural gas prices are likely to "edge out some of the coal-to-gas switching we saw last year," Jostad said.
"Due to the slightly lower power burn forecast, we think the market may have slightly overshot the true summer average," Jostad said. (See a related chart of Northeast power burn levels forecast.)
Other electricity hubs experiencing strong forward price increases include Mid-Columbia, up 44.3%; Palo Verde, up 38%; and ERCOT North, up 33.4%.
Ansergy's Griswold said that in terms of heat rate, "Summer Mid-C is actually trading at a 16% discount to 2012, whereas SP15 is trading at an 18% increase."
But in terms of fundamentals, Mid-C should be trading at a premium "as Mid-C is facing a more bullish summer in 2013 than 2012 due to diminished snow pack and increased load growth."
"In sum, Mid-C is probably underpriced and SP15 is probably overpriced," Griswold said. "Short the spread."
The Electric Reliability Council of Texas projects its reserve margin to dip below its 13.75% target to 13.2% this summer, which is strengthening power prices, Deman said.
"I'm relatively certain that dispatch models are showing that higher heat-rate units will be necessary to meet loads in Texas and the West Coast," Deman said.
Regarding ERCOT on-peak summer forwards increase, Clarence Johnson, former director of regulatory analysis at the Texas Office of Public Utility Counsel, noted that the Public Utility Commission of Texas has plans to raise the systemwide offer cap this summer from the current $4,500/MWh to $5,000/MWh on June 1.
"In addition, the PUC and ERCOT plan to change the deployment of operating reserves in a manner which is expected to put upward pressure on prices during peak periods," said Johnson, who now heads CJ Energy Consulting, based in Austin, Texas. "These actions, combined with the PUC's public statements regarding the narrow reserve margins and resource adequacy concerns, presumably affect expected increases in ERCOT prices in 2013."
Risquant's Carson said actual price performance this summer "depends entirely on what happens with natural gas prices and the weather."
"If natural gas prices stay where they are and temperatures are normal or higher, then power prices will be higher than last year," Carson said. "The National Weather Service is predicting a long, hot summer everywhere in the US." (See a related chart of Summer natural gas prices as of March 5 of each year.)
But Carson said he believes ERCOT prices are "far overpriced."
"In my opinion, for ERCOT, generators should sell 100% of their output in the forward market, load servers should be buying near the minimum of their hedging policy," Carson said.
The smallest on-peak forward percentage increases among the sample were Into Southern, up 21.1%; PJM West, up 21.3%; the Indiana Hub, up 24.6%; and New York Zone J, up 25.1%.
Deman said PJM West's place among hubs with slower price increases reflects "the large rise in Marcellus [shale gas] production," which results in "a glut of gas in the region, which depresses gas prices."
Among the six geographically disperses natural gas hubs sampled, Transco Zone 6, which is in the New York area, had the smallest average forward price increase, at 35.6%.
Southern Company spokesman Tim Leljedal said his company has historically generated about 70% of its power from coal and 11% from natural gas, but that mix in 2012 was 36% coal and 45% natural gas.
"While we do not speculate on future energy prices, the flexibility of our generation fleet enables Southern Company to deliver customer value by putting the lowest-cost fuel source to work for our customers," Leljedal said.
Natural gas supplies have been increasing, in comparison with previous decades, but prices in 2012 were stronger than in recent years.
"The market expects a smaller gas storage overhang this summer and tighter supply-demand balance," Deman said. "This seems to be based on the sharp decline in gas drilling over the past two years."
Also, Anoush Farhangi, principal of Trusmart Energy Holdings, said, "The increase in economic activity is certainly affecting the price of natural gas."
The following list shows the increases in average summer natural gas prices in a geographically dispersed set of hubs from 2012 to 2013, as of March 5 of each date:
**Northeast Algonquin Citygates, up 61.3%;
**Northwest Pipeline Sumas, up $53.1%;
**SoCal Gas, up 47.9%;
**Florida Zone 3, up 46.6%;
**Houston Ship Channel, up 42.8%; and
**Transco Zone 6, up 35.6%.
As of February 28, Bentek Energy projected the June-July-August Henry Hub price for 2013 to average $3.40/MMBtu, compared with Platts' forward assessment of $2.735/MMBtu for the summer 2012 package as of February 28, 2012. That represents an increase of 24.3%.
Chart: Canadian Maritimes supply