Heating Degree Days Show Winter Never Came

Posted by David on Jan 18, 2012 in Market Insights, Natural Gas, Power | 1 comment

In my previous article on natural gas prices, I stated eventually gas prices were going to come back up.   However, I carefully noted in the last sentence “when the winter weather comes”.   Based on the data so far, winter is not coming.  Below chart comes from the NOAA data showing the previous 30 years of December heating degree day (HDD).   As you can see from the chart, December 2011 was warm compared to the last four years.  It is almost a whole standard deviation from the average.

Looking at the weekly January HDD, January is trending even lower from normal weather.   This natural gas price capitulation could get much worse before it gets better; as the natural gas must be withdrawn in several areas else damage to the aquifers can occur.  There are contractual agreements requiring withdrawal of gas by the end of the heating season.

Once again it shows the most important variable to understand is DEMAND – which in this case is driven primarily by weather.   This statement is certainly true in power.  One can have all the knowledge in market relationships, but if your demand is off all bets are off.

In the longer run (6months+), gas at this price will put significant pressure on the utilities to curtail/retire their marginal coal plants.   As natural gas price falls, more coal plants are considered marginal.   I suspect some coal plants are running regardless of economics as the operator probably has contracted too much coal.  In this case, one would hope the public utility commission steps up and denies some of the fuel cost pass-thru for poor planning; else there will be no incentive to plan better next time.  In this low gas price environment, utilities should have weatherized their gas units to perform over the winter while also firming some transportation to their gas plants.  They should have adjusted their spot to coal contract ratio to be lower.  I know it is easier to quarterback after the fact, but last year showed several indicators that low gas prices are very likely.  This is not an after the fact quarterbacking session.  As the Managing Director Strategic Planning at AEP, I consistently championed the company to diversify to gas and believed in natural gas being the appropriate fuel in terms of managing capital and market risk.   Simple fundamental analysis even back in the 2005-2008 period showed gas prices were not going to rise and stay above $10/mmbtu for long.   Large LNG projects were lined up with the capability to supply the US markets for $7/mmbtu with a huge return on investment for those investors.   In addition, the free market should drive innovation as the price incentives rose from the $2/mmbtu enviroment to an ever growing price slope – as documented in my previous post.  Entrepreneurs who thought they could get gas out of shale for less than the market projections came and developed this shale gas revolution.

The big question to whether natural gas prices climb back above $4 will likely be answered by those who can predict the weather.   Will this summer be one of the hottest, coolest, or just normal?

I have been evaluating risk, developing scenarios, and forming hedging programs.  Please do keep All Energy Consulting in mind for your consulting needs. Let us write you a proposal.

Your Energy Consultant,

David K. Bellman