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Energy Market Update
We Had Nothing to Fear but Fear Itself
October 2006
With crude oil retreating and natural gas prices crashing, it’s beginning to look as if markets are finally reverting to more supportable prices, trading on fundamental market factors rather than fear of the unknown. The post Katrina/Rita hangover is ending and the risk of catastrophe that was priced into the markets until very recently seems to be receding faster than a sub-freezing night in Houston. Energy markets are returning to the still elevated, yet more normal, trading levels seen in 2003 through the first half of 2005. Speculators such as hedge funds which had driven prices up appear to be getting creamed in some cases, with one fund recently announcing a 35% hit due to losses in natural gas trading.
An article of faith in the trading world has always been that prices, whether high or low, eventually revert to the longer term mean. Another axiom is that the cure for high prices is high prices. Both statements hold true over time, and what we’re witnessing now is the long-anticipated reversal of abnormally high prices. Oil and gas prices, already higher than historic levels last summer due to basic supply and demand factors both worldwide and nationally, shot up to previously unimaginable levels following Hurricanes Katrina and Rita. Refinery outages, pipeline damage, and platform destruction drove prices skyward and, coupled with Middle East tension, Venezuelan leadership comments and Nigerian rebel activity, prices were able to remain high long after the hurricane damage was essentially repaired. The 2006 hurricane forecast for above normal activity kept the climate of fear going and all but provided continued support to natural gas prices throughout this summer even while storage was being filled at record rates. Obviously, without significant hurricane activity becoming a reality, something had to give…and give it has!
We have all seen the retreat in oil and gasoline prices each time we fill up our tanks. We’re past the summer driving season, demand has slowed, refineries have been operating at close to capacity, and inventory levels are high, close to record levels, for this time of year. Worldwide tensions, while still strong, have eased a bit and crude oil prices have been dropping gradually to levels well off their highs of several months ago when Iran and the United States were lobbing verbal grenades in each other’s direction. Add in the very recent discovery of a potential “elephant” field in the Gulf of Mexico and the table was set for price softening. Crude peaked at almost $80 per barrel and now sits below $65. Filling up your SUV at current prices, although still painful by historic standards, almost gets one in the mood for a road-trip by comparison to where the cost was in June and July.
Still, natural gas is where the action has been. Storage has been at record levels all summer, storm activity has been non-existent to date in the Gulf of Mexico, NOAA has revised its forecast of hurricane activity downward twice in the past two months, and the heat of July has become a memory to most of us. Front month NYMEX prices kept falling as a result but the winter strip held up until early September when it became apparent that, absent a weather driven calamity in the Gulf, we would enter the winter heating season storage setting all time records, testing the theoretical limits of how much gas the nation’s storage fields could hold. A couple of weeks of surprisingly high storage fills finally forced those who were long to throw in the towel, and we’ve been on a downward path ever since. The winter strip, November–March, has dropped from well over $10/MMBtu to less than $8.00 in little more than a few weeks. This still compares unfavorably to $5.61, $5.28, and $6.88 for the winters of 02/03, 03/04, and 04/05 respectively, but is well below the $10.39 that we suffered through last winter. It looks very much like we have recovered from the “train wreck” of last winter and, with a little luck, we could be returning to levels of prior years.
This is not to say that all the risk has been driven out of the market and that we’re about to return to a golden age of low natural gas prices. Natural gas still trades somewhat in tandem with crude oil and crude, as we all know, is subject to international tensions well apart from the fundamental laws of supply and demand. The hurricane season, while reaching the peak period with nothing but calm waters in the Gulf of Mexico, could still erupt as it did last year with storms that cause platforms to be shut down and crews to be evacuated. Forecasts of worldwide demand for oil are coming down but the term “accurate forecast” remains an oxymoron.
Where to from here? Well…market fundamentals being what they are and market psychology being what it is, we wouldn’t be surprised to see a continued drift downward in oil prices, possibly hitting a low of $55 per barrel by January, and a continued drop in natural gas prices to a low of $4.50 before December. We wouldn’t bet the ranch on it but we might even see some short term gas prices fall below even that price as storage approaches the limit and pipeline line-pack builds. We’ve already seen some pipelines and LDCs begin to insist on balancing supply with demand. Drilling rig counts remain high even with the falling market and probably will remain high at least in the near term. We now have the beginning of an El Nino condition which may strengthen, suggesting to forecasters that a mild winter will result. All signs point to continued softening and who are we to argue? Keep in mind, however, that it would not take much for market psychology to reverse again and all of us need to be prepared to act quickly should things turn but, at least for the moment, fundamental market factors rule.
Compass Energy Gas Services, LLC is a leading provider of gas supply and management services for customers in Virginia, North Carolina, West Virginia, Ohio, and Pennsylvania. Compass Energy Services assists medium and large industrial and commercial customers with energy procurement and risk management strategies in both regulated and unregulated areas. Contact Compass for more information.
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