The Power Connection

Transcription

1 AMEREXENERGYUPDATE ELECTRICITY / NATURAL GAS / PETROLEUM / COAL JUNE 2008 / VOLUME 4, ISSUE 10 The Power Connection IN THIS ISSUE: TWO WHAT THE CURRENT FORWARD CURVES OFFER SIX Natural Gas Outlook Crude Outlook SEVEN Gas Storage Outlook Electricity & Coal Outlook EIGHT ERCOT Energy Prices Nothing has changed..

2 What the Current Forward Curves Offer... ENERGYUPDATE... The current volatility in the energy complex isn t unique in today s world of commodities. Price stress is found in food prices, metals, and foreign exchange as well. The root cause may be different in respect to supply/demand issues but there seems to be a common thread related to the strength of the U.S. Dollar. As an example, the price swing of Friday, June 6 th, for crude oil ($11) was attributed to a tightening of credit in Europe to counteract inflation fears (something that obviously got trader s attention). The movement in natural gas, on the other hand, was relatively muted (it was only up roughly 20 cents/mmbtu in the front months). Makes no sense? Actually, it s one of the first dramatic moves that has some rhyme and reason behind it (at least in this writer s mind). For the last several months, most of us have been in denial that there s an underlying force behind price movement past the excesses of hedge funds and other speculative pools of cash. The connection between crude oil and natural gas (see the chart on the front page) has maintained an 11 to 1 relationship (sort of). What we now think is that the momentum in the energy complex in general helped natural gas move to a reasonable arbitrage level for LNG. We aren t convinced that this was necessitated from a shortfall of supply, but what difference does it make? In a bull market, isn t it logical that the different sources of energy move to the high ebb? This should be as true for coal as it would be for natural gas, and that has proven to be the case. A side bar of this epiphany is that while we suspect the new trading range for domestic natural gas has move higher than the $6 to $10 that held heretofore, we don t believe new trading bands have been defined nor do we think that single digit natural gas is behind us forever. That said, we suspect that, barring some surprise such as a damaging hurricane or sustained incremental power demand, the highs for natural gas are within a reasonable timeline (i.e., the next several months, and our guess this is nothing else but a guess is that it ll be on the sooner rather than later side). Unfortunately, the price level that will cap the market is beyond our crystal ball. We have enough respect for what it might be that we ve locked most accounts at what is expensive insurance just in case our worst fears become reality. So what does one do? As said before, surviving summer is our number one priority. This is an energy market that no one has seen before and to make assumptions based on history is a questionable approach. The answer, we believe is to search for relative value and compromise a desire to capture the old level of pricing with the hope of avoiding accepting the new level, past the point that you secure what is immediately necessary for turning on the lights. Step 1: What does the Heat Rate forward curve offer? Whether it s South Zone (ERCOT), PJM NIHUB, MISO Ameren, or NYISO, Zone J, there s a value that is currently available. Is it a reasonable value? Should one expect better or worse values in the future and, if so, are these related to what natural gas prices are doing? The approach Amerex takes to making these decisions is a technical one, usually guided by price patterns as depicted in a chart. An example of this are the 2009, 2010, 2011 and 2012 ERCOT peak Heat Rates plotted below:

3 What the Current Forward Curves Offer cont... ENERGYUPDATE...

4 ENERGYUPDATE... What the Current Forward Curves Offer cont... The patterns for other jurisdictions vary slightly (but not significantly) over the 48/ month average. The 2009 numbers are better in PJM, for instance, and approach those offered in ERCOT s wind generation-rich West Zone. MISO is likewise attractive. The primary reason is that the feedstock mix in the northern jurisdictions is more efficient (they are no where near as dependent on natural gas). You will, after considering what the Heat rate multiplier is in the context of what you think natural gas will do, etc., make a call as to how long you want to lock this curve. Step 2: What does the forward curve of natural gas offer? This forward curve is much more visible (almost always the NYMEX value or a basis trade thereof) and it s the same curve regardless of jurisdiction. If we re managing a customer s facilities in multiple jurisdictions, having set individual Heat Rate values per the discussion above, the time to lock gas will be universal in almost every instance. When is this? As has become very apparent, when the front market becomes troublesome (an understatement if ever there was one), you do what you have to do to cover needs and avoid too much risk. If it comes as a surprise, it s all the more difficult. Such is the situation that began in the early part of Note the blue dashed line and the red dashed line (February 6, 2008 vs. June 6, 2008):

5 What the Current Forward Curves Offer cont... ENERGYUPDATE... The normal mode of operation that Amerex follows in off-summer supply was to shift to the real time market unless either (a) natural gas was low enough to make such an assumption of open ended pricing (real time markets) unattractive, or (b) the assumption for real time market values when compared to fixing natural gas was such that it didn t offer an attractive advantage. This was effective until April (and even then, a one month anomaly isn t all that unusual). May s pricing continuing to be ugly, however, was the nail in the coffin and we took what action was available for each specific client. Taking the other instance, that is when you re searching for opportunities and not avoiding risk, you look at the same chart (above), but with a different agenda and perspective. The difference between the values in month 1 versus month 48 in the 2/6/08 curve is about $.85. The difference between the same months in the 6/6/08 curve is almost $3. Wait you say: the curve of 6/6/08 s 48 th month is $2 higher than the curve of 2/6/08. You re right of course, but it s the curve you have to deal with today. We suggest that the front months of a 48 month curve will more likely stay where they are or fall, but we re never certain. Accordingly, it might be advantageous to lock the Heat Rate and at the same time lock the last 12 months (the least expensive in the mix). You have hedged 25% of your portfolio, hoping that the market falls further and you can both (a) lock the open positions in the first 36 months at a better price and (b) lock lower net values beyond the 48 month period. The process just described is managing your energy procurement portfolio. The nuances you elect may vary, but the strategy should be fairly straight forward. It is, in our opinion, a better answer than either buying 48 months fixed or just buying 12 months out. The theory revolves around teeing up reasonable numbers in a Heat Rate and waiting out the oscillations of the feedstock piece (natural gas). Does this approach enable your objectives? Have you determined that such a strategy is suitable to your corporate parameters of risk? Most likely the answers will turn on both the level of fixed price alternatives and management s comfort level.

6 ENERGYUPDATE... High oil prices, low LNG imports, consumption growth, and a year-over-year decline in working inventories of 326 Bcf have all contributed to the recent strength in spot prices. Natural Gas Outlook Total natural gas consumption is expected to increase by 2.2 percent in 2008 and by 0.9 percent in Year-over-year increases in the residential, commercial and electric power sectors have been largely weatherdriven. In 2009, residential and commercial sector consumption is expected to be decline slightly while natural gas consumption for electricity generation is expected to increase by 2.5 percent. Growth in the industrial sector, which increased by 4.8 percent in the first quarter of 2008 compared with the corresponding period last year, seems to be tied to export strength and some resurgence in natural-gas-intensive industries, such as fertilizers. In annual terms, natural gas consumption in the industrial sector is expected to increase by 1.3 percent in 2008 and 0.4 percent in The Henry Hub spot price averaged $11.65 per Mcf in May, $1.16 per Mcf above the average spot price in April. High oil prices, low LNG imports, consumption growth, and a year -over-year decline in working inventories of 326 Bcf have all contributed to the recent strength in spot prices. These conditions are expected to continue and keep pressure on natural gas prices. On an annual basis, the Henry Hub spot price is expected to average a little over $11 per Mcf in 2008 and in 2009, an average increase of about $1.35 per Mcf from last month s forecast. WTI crude oil prices, which averaged $72 per barrel in 2007, are projected to average $122 per barrel in Crude Outlook In 2008, total domestic crude oil output is projected to average 5.1 million bbl/d, the same as in 2006 and Production growth in the lower-48 and Federal Gulf of Mexico regions is expected to offset declines in Alaskan production. In 2009, total production is projected to average 5.3 million bbl/d, up 210,000 bbl/d from Federal Gulf of Mexico output is expected to rise 270,000 bbl/d due mostly to the Thunder Horse platform coming on-stream in late 2008 and the Tahiti platform beginning production in 2009, but declines are projected for Alaska and the lower-48 States. This projection includes an estimated expectation of hurricane-induced outage of about 11 million barrels for the offshore region in Fuel ethanol production is projected to increase from an annual average of 420,000 bbl/d in 2007, to 580,000 bbl/d in 2008 and 640,000 bbl/d in Total petroleum consumption of liquid fuels and other petroleum products averaged 20.7 million bbl/d in 2007, similar to Based on prospects for a weak economy and record high crude oil and product prices extending into next year, consumption is projected to shrink by 290,000 bbl/d in 2008, a sharper drop than the nearly 200,000 bbl/d projected in the previous Outlook. In 2009, total consumption is projected to rise by 140,000 bbl/d, somewhat less than the nearly 200,000 bbl/d increase projected in the previous Outlook. WTI crude oil prices, which averaged $72 per barrel in 2007, are projected to average $122 per barrel in 2008, up about $12 per barrel from the projection in last month s Outlook; and $126 per barrel in 2009, up more than $20 per barrel from the previous Outlook.

7 Gas Storage Outlook ENERGYUPDATE... Working gas in storage was 1,886 Bcf as of Friday, June 6, 2008, according to EIA estimates. This represents a net increase of 80 Bcf from the previous week. Stocks were 343 Bcf less than last year at this time and 19 Bcf below the 5- year average of 1,905 Bcf. In the East Region, stocks were 6 Bcf below the 5-year average following net injections of 54 Bcf. Stocks in the Producing Region were 11 Bcf above the 5-year average of 649 Bcf a net injection of 10 Bcf. Stocks in the West Region were 23 Bcf below the 5-year average after a net addition of 16 Bcf. At 1,886 Bcf, total working gas is within the 5-year historical range. Working Gas in Underground Storage Compared with 5-Year Range Note: The shaded area indicates the range between the historical minimum and maximum values for the weekly series from 2003 through Source: Form EIA-912, "Weekly Underground Natural Gas Storage Report." The dashed vertical lines indicate current and year-ago weekly periods. Electricity & Coal Outlook Three of the five warmest summers since 1975 in terms of cooling degree-days occurred in 2005, 2006 and NOAA projects temperatures this summer will fall back to near-normal levels, thus limiting annual growth in electricity consumption to 0.6 percent for Three of the five warmest summers since 1975 in terms of cooling degree -days occurred in 2005, 2006, and NOAA projects temperatures this summer will fall back to near-normal levels, thus limiting annual growth in electricity consumption to 0.6 percent for Consumption is expected to grow at a higher rate of 1.6 percent in The cost of most fuels used in generating electricity has risen significantly since the beginning of the year. How soon these higher generation costs are passed through to consumers depends on a number of factors such as the terms of utilities fuel purchase contracts and the regulatory structure within a given State. Average U.S. residential electricity prices are expected to increase by about 3.7 percent in 2008 and by 3.6 percent in Electricpower-sector coal consumption grew by 1.9 percent in Slow growth in total electricity consumption is expected to limit growth in electric-power-sector coal consumption to 0.9 percent in Projected increases from other generation sources (nuclear, natural gas, hydroelectric, and wind) in 2009 will continue to dampen electric-powersector coal consumption growth, projected to be 0.6 percent in 2009.

8 ERCOT Energy Prices YEAR (Peak - 5X16; All - 7X24) 5X16 7X24 5X16 7X24 5X16 7X24 5X16 7X24 5X16 7X24 ERCOT Heat Rate X Gas Strip* Heat Rate 9.10X X X X X X X X X X7.68 NAT GAS STRIP DATE 6/9/2008 *Heat Rate X Gas Strip - Provided as an indication of price levels only; Calculated using median of STP HR Bid/Offer This data consists of purely indicative bid/offer market prices, and calculated heat rates where noted, and no warranty that the data represents or indicates prices at which transactions may be or were affected at any time is given by Amerex. Any opinion expressed or assumption made in association with the data is a reflection of the judgment of Amerex or any person who supplies all or part of the data to Amerex at the time of compiling the data and is subject to change without notice. Amerex Energy Services One Sugar Creek Center Blvd. Suite 700 Sugar Land, Texas (t) (f) (toll free) info@amerexenergy.com Notice of Proprietary Rights The information contained in this document is provided as a courtesy by Amerex Brokers LLC ( Amerex ). As a condition of receiving this information, you and any other recipient are deemed by Amerex to have acknowledged and agreed that (a) Amerex has exclusive and valuable property rights in this information, (b) Amerex is making this information available to a restricted group of recipients including certain of its employees, customers and business partners, and you may not distribute it in any form to any other person or entity without the express written consent of Amerex, and (c) you may make use of this information only for your internal business purposes and not for the benefit of any third party. Amerex does not make any representations or warranties, express or implied, with respect to any information contained herein, including without limitation any representation or warranty that the data set forth herein is accurate, complete or timely. Amerex reserves the right to terminate the distribution of this information at any time at its sole discretion.