One of the most common questions clients ask when purchasing electricity or natural gas is, “How much money am I going to save?” This is a reasonable question and for many years, savings could be realized because energy prices had been trending lower. Figure 1 shows how the NYMEX has settled over the last 31 years. This chart shows that natural gas hit its peak in 2006 in the wake of Hurricane Katrina and Rita where gas prices approached $14/Dth.
The expansion of horizontal drilling in the late 2000s provided access to vast quantities of onshore oil and natural gas reserves and resulted in an abundance of low-cost natural gas supplies as well. Domestic natural gas production flooded the market, placing downward pressure on prices and initiating a steady bear market that, with a couple of exceptions, has been in place since 2008.
Figure 1: Long-term Historical Wholesale Natural Gas Prices from cmegroup.com
In a bear market, when clients renewed their natural gas or electricity contracts, it was not uncommon for prices to be less expensive than on their existing agreement. This made it relatively easy to experience year-over-year savings. That bear market came to an end in March 2021. Since then, energy prices have been steadily rising in many parts of the country. There are no fundamental or technical factors to suggest that wholesale electricity prices will return to pre-pandemic levels. In this new market dynamic, price risk management and different electricity purchasing strategies are required.
Today, many believe that there is more room for electricity prices to continue to increase in the near-term. There are several reasons for this. First, there is fear in the market that the growth in the amount of electricity supply will not keep up with the growth in demand. Analysts believe that the rapid expansion of data centers and AI are pushing demand for electricity faster than new generating assets are coming online. The other factor is that while electricity prices have not followed natural gas prices down, many analysts think that a rebound in natural gas prices will push up electricity prices. Right now, natural gas prices are about as low as they have been in several years. This is mainly due to the large amounts of natural gas currently in storage. The red line in Figure 2 shows that current storage levels exceed the five-year average. High storage levels have resulted in a decrease in rig counts. Lower rig counts mean that the production rates and supplies of natural gas are likely to decrease in the near-term. Lower supplies coupled with higher demands for electricity are all bullish forces in power markets.
Figure 2: Chart by 5
With rising electricity prices, many clients are asking for advice on best practices for energy purchasing in this bull market. Looking to how one manages their 401(k) portfolio can offer some answers. The growth of a financial portfolio is dependent on how the stock market moves over time. Few investors take all their money and invest it all in one day unless the market is trading at record lows, which was the situation for natural gas and electricity before the pandemic. Most personal investors adopt a strategy based on dollar-cost averaging where an amount is invested across periodic purchases, regardless of the market price, to reduce the impact of price volatility on the overall purchase and maximize the return on the investment.
While it is impractical to make energy purchases with the same frequency as 401(k) investments, the same principles apply. The sticker shock that can be experienced when looking at renewal prices in a bull market can be alleviated by making measured and regular purchases over the duration of the contract rather than simply signing another fixed price contract. With this approach, clients of a certain size can fix a certain percentage of the electricity they need while keeping open or floating positions too. Those open or floating positions are then closed out (purchased) at opportune times when there are corrections or dips in the electricity market. Smaller clients can do something similar by making consistent shorter-term, fixed price purchases.
For many clients, this rise in energy prices brings about a necessary paradigm shift. The best approach to energy purchasing is to focus on price risk management rather than “savings.” Both electricity and natural gas are commodities whose prices are determined by market forces of supply and demand. These are also two of the most volatile commodities in the world. One reason for this volatility is that many buyers are limited in their ability to substitute other fuels in response to price signals and the fact that electricity cannot be stored in significant amounts. Other factors including weather, regulatory issues, storage levels (for natural gas), and transportation and delivery constraints have a material effect on energy prices and contribute to its price volatility. Savings are often a coincidental byproduct of a bear market and nearly impossible as market prices increase. Consequently, when market prices are low or falling, a simple long-term, fixed price purchasing strategy often makes sense. When market conditions change and prices rally, however, a different and more proactive buying strategy is required. Bull markets, like the current market we are experiencing, demand a paradigm shift and a move to focus on price risk management. But this mindset and strategy also requires expert-level help. Reach out to us for help in adopting best practices for purchasing electricity in this bull market for your business.