Sitting on the Fence: Effective Strategy or Uncomfortable Position?

2010 was a nice year for energy consumers in Texas, and early 2011 seems to be continuing the trend.  The combination of moderate economic conditions, ample supplies of natural gas and adequate generation inventories resulted in much lower energy prices than recent years.  The lower prices have lulled many energy buyers into a wait and see, or sitting on the fence position, in hopes of catching even lower energy rates before making a decision on their next energy purchase.

The good news, future energy prices could go lower, and if your company intends to operate in future years, you will be able to take advantage of lower rates if and when they materialize.   The more important news?   Your company already has an open price and volume position if it intends to keep operating in future years, and near term energy prices are near historical lows.   If you have not already considered purchasing energy for a future period, say 2011-2014, now is a good time to make that decision.   Why?

The ample supplies of natural gas, moderating demand from the slow economy, and ample generation supplies have resulted in retail power prices that are very attractive from a historical perspective.  If you are a numbers person, look at it from this perspective – retail prices for 2011-2014 are above the 85th percentile, meaning that less than 15% of the time since 2004 have power prices been lower than those available today, or more than 85% of the time prices have been higher.   From a probability standpoint, now is a great time to consider your next contract.

In Texas, our ample supply of generation and natural gas allowed us to accommodate a very warm Summer without major price spikes.  Combine the ample inventory with a mild hurricane season and you have lower energy prices.   Generation values in Texas remain weak and as the generation companies look to the maintenance season and evaluate this past Summer, many have lowered their expectation for future value – the result is lower generation costs embedded in future retail pricing.

While the generation picture and natural gas supplies are supportive of lower prices, some aspects of the market suggest we may see higher prices.   The weaker dollar and social unrest in the Middle East is driving crude oil prices higher and is making USA sourced coal more attractive for international buyers.   Coal and Natural Gas are the major fuel for electric generation in the USA, so if coal prices escalate, we could see a higher floor for natural gas prices, and higher natural gas demand.   In addition, the introduction of the nodal market in Texas will bring better price transparency to power generators, which could lead to many generators retiring the less efficient power stations, especially since the future value of generation in Texas has dropped during 2010.   If these units are retired, we could experience relatively higher generation costs in the coming years.

If you contract for the 2011 to 2014 period now and prices continue lower in the coming year, you can always contract for additional term next year, or consider blend and extends.   Keeping the entire future period open is a large risk – contracting some portion now moderates the open volume and price risk.  With less than 10% of the prices since 2004 being lower than now, it seems a good time to finalize your approach for the next power purchase.