If you don’t know where you’re going, any road’ll take you there.
We’ve all heard a version of this old adage. It reminds us why a reliable guide can help us get from point A to point B assuming we know where we want to go in the first place.
Recent volatility in natural gas markets has left some organizations a bit lost somewhere between Cost Certainty and Market Opportunity. Two of Schneider Electric’s market experts – Brian Burgin, Risk Manager, and Melanie Hale-Zanetti, Regional Market Manager – provide some guidance on natural gas market dynamics in the U.S. and abroad, including key recommendations to define success and get there without making wrong turns.
Where Are We?
Well, we knew it was coming and 2018 did not disappoint: volatility returned. Heading into Q4 last year, European gas prices had jumped to multi-year highs, before reversing course with a major shift in crude prices to finish up the year
Figure 1: Major EU and US benchmark gas prices, January 2018-Present.
In U.S. we saw the highest gas prices on record since that really severe winter in 2014, and promptly followed that up with some record selling pressure in December. Overall, the net result for most global gas benchmarks was some considerably higher year-on-year prices in 2018, and some renewed focus on upside risk in the year ahead.
This period follows a couple years of relative calm in the markets. That lull, unfortunately, led some organizations to fall into a sort of complacency. And, many of those same organizations are now faced with the prospect of significant inflation and uncertainty.
One of the recurring themes we cautioned against was sidelining one of the key risk strategy drivers – longer-term budget certainty – in favor of an approach that’s too focused on short-term market dynamics.
How’d We Get Here?
The biggest reason we are where we are is that market fundamentals shifted. And continue to shift. A few that come to mind that are really doing their part to disrupt markets and create that volatility that Brian mentioned:
- Exports to Mexico and LNG growth
- Increased coal retirements
- Growth in natural gas-fired power generation
- Growth in renewables
- Growth in production
- Pipeline infrastructure growth
From the basis/transportation side, there are pockets of volatility driven by pipeline constraints across the U.S. One recent example is the October 9, 2018 explosion on the Enbridge’s BC West Coast pipeline, which halted gas flow from BC into the Pacific Northwest. This caused extreme volatility in multiple markets as supply was re-routed from other areas. Low storage levels exacerbated the issue, as well.
The reality is, tremendous growth in pipeline infrastructure (with more to come) has created truly interconnected markets. As a result, capacity holders often become “price chasers” and this inevitably creates volatility.
And just to add a bit more context, the recent weather trends, structural growth in all demand sectors (power generation, exports, industrial) have helped to accelerate the global economy. This has led to strong demand growth in emerging markets and fundamentals have tightened over the past 18-24 months.
Looking back a bit further, we saw prices make a bullish run between 2012-2014 when crude passed $120 a barrel and US natural gas crossed $6. This was followed by a period of strong supply growth, particularly in the US. That lead to oversupplied markets for coal, crude and natural gas. This period of low volatility and low prices left organizations “upside down” if they opted to “panic” buy natural gas in 2014 and 2015 during the first and second polar vortex.
Figure 2: Note the sudden winter spikes in late 2013 into Winter 2014, then again in Winter 2015. We’ve seen similar spikes over the last few months.
Where Are We Going?
The good news is we have avoided significant market premiums, at least in deferred terms. Markets still believe long-term supply growth is sufficient to keep fundamental balance. U.S. export capacity growth over the next two years provides a link for global market connectivity. That said, global disruptions will still be felt in all regions, and price volatility could be more pronounced, particularly during primary winter months in the Northern Hemisphere.
Are We There Yet?
Not quite, and that’s a good thing. To prepare for future market movement, organizations can take action in two areas to help create internal alignment:
- Define and set clear objectives in these areas:
- Cost-certainty focus vs. market-opportunity focus
- Time horizon for hedging
- Hedging physically, financially or both
- Get buy-in, communicate and be transparent
- Enlist the right stakeholders
- Maintain regular communication with tactical energy team
- Report periodically to oversight/strategy team
- Document risk tolerance and risk-strategy “playbook”
If you’re unsure how to arrive at success using your current natural gas sourcing strategy, we can help. Our market experts can work with you to define where you want to go and the best way to get there. Let us know how we can help.