ENERGY MARKET UPDATE October 9, 2014

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1 ENERGY MARKET UPDATE October 9, 2014 Winter is Right Around the Corner Are You Ready? Six months ago one of the most brutal winters on record in the US was winding down. Many energy consumers, who had unhedged price positions for their electricity and natural gas needs, saw their budgets shattered. Even those who had locked in a fixed price for supply needs experienced the pain through increased consumption and much higher prices for incremental consumption above historical norms. Fixed price electricity products, which for the most part protect consumers from imbalance costs on incremental usage, did insulate consumers from the wild swings in electricity prices. However, electricity consumers on index price-based product took big hits on overall costs especially in January through March (see graph below). $0.20 $0.18 ComEd Hourly Prices - Day Ahead Weekly Average - 6am to 10pm (Jan-14 thru Mar-14) Per kwhr $0.16 $0.14 $0.12 $0.10 $0.08 $0.06 $0.04 $0.02 On-Peak Off-Peak Fixed price natural gas products did protect consumers from the full brunt of near record prices. However, unlike fixed price electricity products, natural gas hedges are for specified contract volumes and consumers still have market price risk for incremental volumes above the volumes they have hedged. So it is impossible for consumers to fully protect themselves against high natural gas prices this past winter. Some consumers try to manage this risk by managing their own natural gas storage banks and owning the gas in storage. However, the cold hit early this past winter and many of those whom use this strategy found their natural gas storage reserves mostly depleted by the time January rolled around. The one year they really needed to rely on their storage, the reserves were not adequate to even come close to covering their needs.

2 But enough of reliving the doom and gloom of what was the winter of 2013/14. It s time to focus our attention on the upcoming winter. One important variable will be the US natural gas storage position heading into this winter. Back in April the industry was facing a record storage reserves deficit of 1008/bcf as compared to the 5-year average a 847/bcf deficit compared to the previous year. We pointed out in back in April that, among a number of variables that could impact energy prices in the upcoming year, replenishment of US natural gas reserves was right at the top. The biggest variable replenishing storage reserves would be summer temperatures. Well, the verdict is in. One of the more mild summers on record paved the way for a very robust in fact record storage injection season. Add in a nice assist from an inactive hurricane season with minimal supply interruptions in the Gulf. Add in a dose of increase natural gas production and we are sitting in a much better position as we wind down the storage injection season than anyone anticipated this past April. The main variable in our favor was our mild summer temperatures. Demand for natural gas for electricity generation during normal to hot summers can be significant. Remember the summer of 2006? Summer 2006 was the second warmest June-to-August period in the continental U.S. since records began in 1895, according to the NOAA National Climatic Data Center. During that summer, due to increased demand for natural gas from the generation sector, we actually had two weeks with net withdrawals not injections of natural gas from storage in July/August. Weekly storage injections in July/August 2006 averaged only 40/bcf compared to the 87/bcf we experienced during the same period this past summer. However, even with all this good news, the reality is we will still be entering the winter of 2014/15 with only our second natural gas storage deficit (as compared to the 5-year average) since the winter of 2000/01 when we entered the winter with a deficit of 237/bcf (see table below). Coincidently, that was the first winter we saw natural gas prices spike above $1/therm as the January 2001 NGI index hit $1.093/therm. But don t worry the storage deficit alone does not mean higher prices this winter. Where energy prices move this winter will come down to how cold it gets. What this storage deficit does mean is that we would anticipate natural gas and electricity prices would be more sensitive to the upside if we start off the winter with colder-than-normal temperatures.

3 It looks like we ll start off this winter with a storage deficit (to the 5-year average) of between 250 and 300/bcf. Natural Gas Storage Imbalance Heading into Winter Date Storage Inventory - 1st Week November 5-year average Variance from 5-year average Percent 11/06/09 3,813 3, % 11/05/10 3,840 3, % 11/04/11 3,831 3, % 11/02/12 3,929 3, % 11/01/13 3,814 3, % 11/07/14 3,548 3, % Winter Weather Projections While National Oceanic and Atmospheric Administration's (NOAA) official three-month outlook for the coming winter months isn't due out until around mid-october, we do have the Farmer s Almanac outlook projecting another record breaking cold winter. The 2015 edition of the Farmers' Almanac which hit shelves Aug. 25, projects this winter will see "below-normal temperatures for about three-quarters of the nation. The Almanac also predicts that the Northern Plains and the Great Lakes regions of the U.S. will be hardest hit. But the predictions included in the Farmers' Almanac are just that: predictions. And early indications are the NOAA forecast, due out next week, will conflict with the Farmer s Almanac. The Farmer s Almanac did get it right this past winter 2013/14 when they projected a cold, frosty, wet winter for most of the United States. The reality is that it is very difficult to project weather and other conditions that might impact energy prices out 2-3 months with a high level of accuracy. So let s talk about what we can be more certain of the current week and the next month. Currently Going on in the Energy Markets The past week the Energy Information Administration (EIA) reported a very large natural gas storage injection of 112/Bcf. The 112 Bcf injection reported by the EIA caught a number of traders by surprise. Not surprisingly, natural gas futures prices moved lower since the report was released. Inventories now stand at 3,100 Bcf and are 373 Bcf less than last year and 399 Bcf below the five-year average. The large injection was largely due to reduced power burn with the cooler temperatures which lead to the lowest demand for natural gas since the June 27 storage week. Analysts are thinking this might be as good as it gets and that last weeks report will likely mark the high point for injections during the second half of the season given the increase in weather-related load expected as we progress into October.

4 Weather-wise, the current NOAA projections call for temperatures to average above normal for most of the country in their day forecast. This is also helping prices slide lower this week. However, with the deficit in natural gas storage, the markets may be hard-pressed to allow price to move significantly lower. Since late July, natural gas futures for the heart of the upcoming winter (Dec-Feb) have traded in a range of $4.00 to $4.30/Mmbtu. Prior to last week s storage report, the market was trading at the top of that range. We are right back at the bottom of our recent trading range. This could present a hedging opportunity to those currently looking at locking in a price for the upcoming winter or for $44 Price Trend for 2015 Retail Power - Price per Mwh Actual price will be load profile specific $0.57 $0.55 Natural Gas - Forward 12-Month Fixed Price Estimate for Illinois (August 2013 to September 2014) $42 $0.53 $0.51 $40 $0.49 $0.47 $38 $0.45 $36 $0.43 $0.41 $34 $0.39 $0.37 $32 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 $0.35 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 You may note in the graphs above that electricity prices have actually trended higher since late July versus the up and down trading range we ve seen with natural gas forward prices. The reason is that heat rates moved higher from late July into late August. Heat rate is a term of measure of how efficiently a power plant converts its fuel source in this case, natural gas into electricity. The simple formula is electricity price = heat rate multiplier x gas price. A change in the heat rates across a geographic area impacts power prices. Heat rates in our PJM region moved higher which, combined with a slight upward trend in gas prices, moved electricity prices higher. The good news is that, overall, both natural gas and electricity prices are still currently trading in the lower quadrant of their 10 year price curve. Looking Forward For budget conscious customers, if there was a winter to make sure your energy price exposure was limited through financial hedges, this would be the winter. This absolutely does not mean we are projecting a winter similar to what we had this past year in term of both temperatures and prices. What we are saying is that with the price volatility of this past winter still in the recent the memory of energy traders and with our expected natural gas storage deficit entering the winter, energy prices should be more sensitive to the upside should we start out with a cold winter versus to the downside should the winter start out mild.

5 And unless we assume last winter was an aberration, the graph below showing the NGI Chicago-citygate index cost for natural gas since 2000 shows we ve had five major price spikes in natural gas prices (and electricity prices) just since Add in moderate price spikes in 2005, 2007, and 2009 and the only real question is not if but when the next price spike will occur. NATURAL GAS PRICE HISTORY ILLINOIS AS MEASURED BY THE NGI CHICAGO CITY GATE INDEX $1.40 $1.20 $1.00 $0.80 $0.60 $0.40 $0.20 $0.00 With this in mind, we suggest the following: If you have a natural gas or electricity agreement ending at the end of 2014, you should be looking at extending your agreement now. The risks of waiting too late in the year outweigh any potential benefits. Those who have energy agreements expiring in the spring should also be looking now at pricing for an extension. You might be surprised and see a current opportunity to lock in a new energy supply agreement at a lower energy price. Plus, if we have another frigid winter we could see our highest prices of the year coming out of the winter, just as we did this past year. If you are on an index/spot product for either natural gas or electricity, make sure you are aware of the risks to your budget. We can assist you in quantifying the risks and evaluating alternative strategies. Price layering strategies out multiple years are becoming increasingly popular. If this interests you or you want to hear more about this type of strategy, give us a call. Please give us a call if you have any questions or if you have any questions inquiry@centuryenergysolutions.com

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