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EXPERT ADVISES ON RISKS OF "TIMING" WHOLESALE ENERGY MARKETS
September 01, 2006
Just as unsophisticated investors try to “time” the stock market to make the best investment decisions, there are those without the knowledge base who try to time the wholesale energy markets, specifically the price of natural gas, to secure the best electricity prices for their business.
Not surprisingly, financial advisors and energy management professionals alike will openly state neither approach tends to yield favorable results. In fact, while a business waits to time the renewal of its electricity usage agreement with price dips in the natural gas markets, it inevitably will pay a far more costly month-to-month rate and in the end, defeat the purpose of shopping its electricity usage in the first place.
The fact is, even with the most sophisticated data, the savviest energy management professional who watches the wholesale markets day in and day out cannot predict the volatility of natural gas, the energy source that fuels a majority of the nation’s power generation plants.
Natural gas is a commodity. Therefore, its price fluctuates according to a host of factors – none of which can be controlled by an individual energy user and certainly none of which can be predicted.
What are the key factors that contribute to the fluctuating price of natural gas?
Production. Natural gas prices have skyrocketed in the past several years, simply because the production of new natural gas supplies have not kept pace with increasing demand. Even though new, gas-fired power plants have come on line, demand continues to outpace production.
Weather. A colder than expected winter will drive up prices simply because businesses will likely use more energy than they did the previous year. Conversely, a hotter summer will create more "peak" cooling demand. As last summer's hurricane season demonstrated, sudden weather events can cause major disruption of natural gas production in the Gulf of Mexico. In the case of Hurricane Katrina, the storm was responsible for reducing natural gas supplies by an estimated 8.8 billion cubic feet per day.
Storage. A colder than normal winter, particularly early in the heating season, can lead to the accelerated decline of natural gas storage levels. As storage declines, natural gas prices and hence, the price of electricity, climbs.
Oil Prices. Historically speaking, political instability and wars in oil-producing countries of the Middle East had little impact on U.S. natural gas prices. In fact, many large industrial users who could switch between natural gas and oil frequently sought lower-priced oil, thereby relieving demands on the natural gas market. But as oil prices have climbed, many of these users have reconsidered their energy strategies and switched back to natural gas - a trend which has further increased demand.
The Economy. A strong economy creates more demand for natural gas to fuel the country's growth. More usage equals less supply which leads to higher prices.
Instead of trying to predict these and other economic and political events, not to mention Mother Nature, business decision makers would be well served to forego the short-term approach associated with purchasing power by timing the market. Energy management decisions for a business, regardless of its size, should be made with a long-term thought process in mind.
A more effective energy management solution starts by determining the risk appetite of a business. Work with a qualified energy management consultant to determine if it is in the best interest of the business to operate with a fixed-price contract or if it is in a position to assume more risk with electricity priced according to the fluctuations in the wholesale markets.
Evaluate how the business has changed since its energy management contract was last negotiated. Has it expanded or are expansion plans under consideration? Has new equipment been purchased? Will new locations be added? Should billing inefficiencies be addressed? Assessing the business, its energy budgets and its future power needs will go a long way toward signing an energy management contract that's right for the business today - and tomorrow.
Business owners agree – never before has electricity been such a key component of the cost of goods sold. With this in mind, create a long-term energy management plan based on the future of the business, not on the low predictability of timing market factors out of one's control.
Collin Coker, collin.coker@gexaenergy, is Senior Director, Commercial Sales for Houston-based Gexa Energy. He has more than seven years experience in wholesale and retail electricity.
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