The following is a contributed article by Tim Comerford, senior vice president of Biggins Lacy Shapiro’s energy-services group and principal of Sugarloaf Associates and Joe Santo is a principal and director of business development at Premier Energy Group.
Because energy consumption is one of the largest operating expenses for a data center or manufacturing operation, it’s important that owners and operators understand the potential for price volatility here in the United States.
Natural gas and electric rates in the U.S. were stable for most of 2018, as higher demand for natural gas due to greater exports to Mexico and increased liquefied natural gas (LNG) shipments were offset by greater production of natural gas. As a result, supply and demand was kept in balance and prices remained in a tight band — that is, until November 2018, when prices spiked to a four-year high.
Despite the relative stability of pricing last year, owners and operators of data centers and manufacturing operations should continue to be prepared for additional periods of volatility and price spikes — both in the natural gas and electricity markets. This article explores why.
For most of 2018, energy prices were extremely range-bound as there was very little volatility. This can be seen in the graph below showing 12-month strip pricing for natural gas since 2012.
In a matter of a week in November 2018, the 12-month strip price for natural gas shot up by approximately 15%. Consequently, because of its function as an input fuel for a large percentage of U.S. electric generation, the natural gas price increase caused a similar rise in electricity prices.
What caused the sudden increase?
For a better idea of the late-2018 volatility, it’s worth examining U.S. storage levels. For most of 2018, natural gas storage levels were below average, and for the latter part of the year, they were below the five-year average.
In years past, these low storage levels would have pushed prices up significantly, but that did not occur for most of 2018 because natural gas production remained at record highs. The market became comfortable that any shortfall in storage would be made up by the increase in supply.
However, colder-than-normal temperatures in November temporarily disrupted that notion.
Greater demand for natural gas due to the weather caused the storage deficit to drop further. In addition, there was growing concern that the storage levels coming out of the winter would be extremely low and would require utilities to have to purchase excess supplies to make up for the shortfall. As a result, volatility increased, and prices moved up significantly.
These conditions, however, did not last too long. Temperatures and forecasts began to stabilize, and prices quickly recovered.
Pricing varies by U.S. region
Overall, prices do vary considerably from region to region.
In New England, prices run 25-30% above the least-expensive region, East North Central states, which include Illinois, Indiana, Michigan, Ohio and Wisconsin. Prior to the new shale gas discoveries, the lower prices were in regions that were closer to production or in areas served by major pipelines. This accounts for New England consistently having the highest prices, as there is no natural gas production and the interstate pipeline system is at capacity with little new development.
However, in regions such as the Mid-Atlantic (home to the Marcellus Shale) the price is near the lowest in the country. With such large variations in natural gas prices, large natural gas users may want to consider gas price a major factor in determining new plant locations.
Energy procurement strategy and opportunities
While electric and natural gas prices have been quite range-bound, owners and operators should not get a false sense of security.
With growing complexities, increased production and evolving demands, there will most likely be periods where supply and demand get out of balance thereby increasing volatility. In addition, as the U.S. continues to increase exports of liquefied natural gas to other countries, we will start to see natural gas shift from a domestic market to one that is international. This will bring forth a host of new factors that will influence pricing in the future.
At this point in time, pricing for contract terms of three to five years is attractive and should be given strong consideration. We recommend that high energy users take advantage of current market conditions and consider purchasing at least a portion or layer now to avoid large fluctuations in pricing.
Although there has been an evening out of energy prices since the late-2000s, the market is still subject to regional and seasonal demands. This was clearly on display in the later months of 2018.
That said, because of the United States’ sizable energy reserves and increased production, long term pricing should continue to be relatively stable.