Tech&Creative Labs
Arbitrage in a Low Natural Gas Price Market
Gary L Hunt
“Natural Gas Prices Fall to New Lows!”
As consumers we like low prices. We believe low prices result from competition
between suppliers in the ruthless efficiency of the market place. In energy markets,
prices are subject to volatility that can create vulnerability at low prices as well as
high prices amidst uncertainty and the variability of regional markets, technologies,
and fuel.
There was a time not too long ago when the United States faced high natural gas prices out of fear of
the rapid depletion rates in Gulf of Mexico production fields combined with a booming economy with an
insatiable energy appetite. Those high natural gas prices created a market opening for imports of LNG
and put America on a competitive bidding collision course with Europe and Asia eager for supply.
Today, natural gas supply growth from domestic shale is driving down prices. Yet global oil prices are
going up from Middle East volatility and growing global energy demand. This decoupling of oil and gas
prices in North America creates more volatility because market fundamentals are disrupted.
Dealing with uncertainty is a continuous challenge in the boom and bust driven energy
marketplace. And so it is today even with natural gas prices at near historic low levels while world oil
prices are threatening returns to record high price levels at the next whiff of trouble in the Middle East.
How do low gas prices affect the arbitrage of fuel in your portfolio or your choice of power generation
technology? Chances are it is turning your conventional wisdom on its head.
Volatility turns portfolio strategy and risk on its head.
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Natural gas is the marginal fuel of choice in virtually every power market. We expect to see
more gas fired generation because gas has little technology risk, is easier to site, faster to permit
and is cheaper to build than other generation options.
Low natural gas prices undermine the economics of coal and nuclear generation. But should
e i est i e atural gas po er pla ts assu i g today s lo fuel pri es? Lo pri es reate
just as much vulnerability as high prices by upsetting the market equilibrium.
Growth in shale oil & gas production is rationalizing our energy infrastructure. For example,
pipelines once profitable moving product from offshore in the Gulf of Mexico onshore up into
the Midwest markets are being reversed to gather oil and gas liquids from the unconventional
shales for transport to the Gulf Coast for export.
Arbitrage in a Low Natural Gas Price Market
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Vulnerability upsets market equilibrium forcing tactical response.
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When domestic gas prices are low and global prices are high exports grow. E&P companies
are incented to shift production from natural gas to oil to keep margins up by converting
cheaper domestic gas into higher priced LNG for export sales in emerging markets in Asia. A
growth in US energy exports can be expected to set a floor on domestic gas prices almost
ertai ly higher tha today s histori lo gas pri es.
Volatility creates vulnerabilities by upsetting market equilibrium. Lower natural gas prices
from growing domestic US production undermines the economics not just for renewable energy
from wind and solar near term but also the long term economics of coal and nuclear.
Changes in oil & gas infrastructure may affect your hedging strategy. Domestic energy
production growth is rationalizing the pipeline and midstream infrastructure in North America.
This pressure for change means some pipelines are reversing flow to bring shale and Canadian
oil sands output to the Gulf coast refineries, storage and export facilities in search of higher
prices in overseas markets. So profound are these changes that the US is now a net exporter of
natural gas for the first time in decades and has overtaken Russia as a leading global producer.
Variability in rules, and regional supply & demand fundamentals makes
uncertainty a three dimensional threat.
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Tighter regional electricity reserve margins increase gas demand. Fuel demand for power
generation has largely displaced industrial demand as manufacturing moved offshore. But low
gas priced could encourage resurgent industrial demand especially if manufacturers win changes
in tax policy that allows repatriation of earnings or lowers corporate tax rates. Higher industrial
demand can be expected to increase natural gas prices.
States are reaching their renewable portfolio standard targets. Wind energy and solar
photovoltaic energy are becoming mainstream resources. All good news, you think? Not so
fast, i so e states like Califor ia all of those e re e a le e ergy resour es are ust take
resources meaning they are dispatched before lower cost natural gas generation in order to
comply with the renewable energy targets even if at above competitive market prices. That will
affect rates if you are a buyer of energy at retail and your dispatch order if you are a seller.
Renewable energy business models still depend upon subsidies to make the economics work.
Over the last year, we have seen 11 major renewable energy company bankruptcies in the US
and 16 in Germany. And Congress has, so far, failed to renew Wind energy production tax
credits, and solar energy fears the same fate creating uncertainty about future investment.
Natural gas is essential for renewable energy back-up given its intermittency. And natural gas is
the substitute for failed renewable energy project in every market. Volatility analysis requires
sophisticated models to assess uncertainty of all that renewable energy and how much natural
gas generation availability when we need it most.
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Arbitrage in a Low Natural Gas Price Market
Do ’t e o pla e t a out risk i a low atural gas pri e
arket.
Three dimensional risk exposures to volatility, vulnerability and regional variability require:
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A balanced approach to risk analytics combining the best available quantitative analytics to
model market fundamentals and portfolio value and risk.
The best available tools for scenario analysis to manage the three dimensional uncertainty
at ork a d play hat if a ross strategy a d risk para eters.
Integrated enterprise scale solution that provides a common data framework, consistent
assumptions and modeling methodologies across department to produce the best results for
managing strategic portfolio risk and rapidly adapting to change.
A recovering economy brings new challenges to your risk profile.
Low natural gas prices and the decoupling of traditional oil and gas price relationships are clear signals
that energy market fundamentals have been turned upside down. Where market equilibrium has been
disrupted volatility grows. While there can be substantial opportunity in volatile market conditions. The
increased volatility can also bring rapid swings in global or regional conditions for fuels, technology and
market fundamentals. If you are still managing your risk the way you always have---you might be in for
a big surprise. It is time to rethink how fuel risks are modeled in your portfolio and be prepared to act.
Volatility! Vulnerability! Variability!
It all happens! Sometimes volatility is good as when prices go down for the commodities you use most.
Sometimes it makes us more vulnerable like it does now as higher fuel prices ripple through the
economy. Managing uncertainty is a critical part of business strategy, but you cannot take it for
granted. Things change and modeling and risk analytics strategy must change to meet them. Prices may
go up and down, but understanding variable energy fundamentals, the implications of regulatory and
market changes in their global, national and regional context, and flexible modeling techniques that let
you play hat if will serve you well.
About Gary Hunt. Gary is president of Tech & Creative Labs, a Boston-based advanced predictive energy
analytics company leveraging disruptive innovation technologies to create fast-to-market, easy-to-use,
compelling B2B solutions in energy asset optimization, data visualization, and knowledge management. He has
thirty years of experience as a utility executive, public utility regulator and strategic energy consultant. Gary
served as global division president at Ventyx from 2000 to 2008. He served as VP-Global Analytics and Data at
IHS/CERA, and a Principal in Regional and Energy Economics at S&P. He can be reached at
[email protected].