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Gaze Into the Crystal Ball of Power Prices and You Won’t See Much But Cracked Glass

May 15, 2018

As we move into the second half of the year, forecasters are looking into their crystal balls to get some idea as to where electricity prices might be headed. Good luck with that.

Although the U.S. Energy Information Administration forecast in May that residential rates will be down overall in 2018 from their 2017 level (10.52 per kWh vs. 10.92/kWh), month-by-month estimates for the rest of 2018 tell a slightly different story. EIA projected rates will rise from $13.11 this month, peak at $13.59 in September, then fall back to $12.96 in December.

For commercial customers, the agency projected rates in 2018 would average $7.90, up slightly from the $7.87 figure of 2017.

End of discussion, right? Well, not exactly. Because when you look to the future, what you see depends on what pieces of the price puzzle you’re using, and how you assemble them. And this particular puzzle has a lot of pieces.

The monthly bill depends on multiple variables, some that can be controlled (consumption) and some that can’t (weather). But a key component is fuel source. And right now, with all apologies to coal, natural gas is king.

EIA projected that the share of utility-scale electricity generation from gas-fired plants will rise to 34 percent in both 2018 and 2019, up from last year’s 32 percent level. Share from coal, meanwhile, was expected to average 29 percent both years, a decline from 30 percent in 2017. What’s more, the agency predicts that 21 gigawatts of gas-fired generation will come online this year, making up a significant portion of the 32 GW in total new capacity expected to be added by year-end.

On top of that, natural gas production is expected to hit a record 80.5 billion cubic feet per day in 2018 and reach 83.3 Bcf/d next year. Coal output, meanwhile, is projected to drop by 3 percent nationally, and its use in power production is seen dropping as well.

Which brings us to natural gas prices.

EIA estimates that Henry Hub spot prices will average $3.01 per million Btu this year, rising to $3.11 in 2019. That’s up from the $2.74 figure on May 7, and would suggest that – since more gas is being used to produce power – there could be a corresponding increase in prices.

But, but, but: Raymond James & Associates said in a note earlier this month that prices for 2018 will average $2.75 per million Btu, and lowered its forecast for 2019 from $2.75 down to $2.25.

Keep in mind, too, that the Raymond James assessment came before President Trump’s announced decision to withdraw from the Iranian nuclear deal. And while everyone is reading the tea leaves as to how that will affect oil prices, it’s also likely to have a collateral effect on gas prices.

Here’s why (and forgive the momentary digression):

There has been an increasing trend of oil prices becoming “divorced” from gas prices. In other words, when oil prices spike, gas prices tend to decline. “U.S. natural gas prices have effectively become inversely related to oil prices,” analysts from Raymond James said.

The reason? Most rigs produce both oil and gas, and rising output from booming U.S. shale plays puts more gas – and less expensive gas – on the market. And as long as prices keep rising, and they have been, drillers are going to keep drilling. Which explains why EIA now says U.S. crude production will rise even more than previously estimated, lifting its estimate for this year to 10.72 million barrels per day and 11.86 million bpd next year.

To summarize: More oil, more natural gas; higher oil prices, lower natural gas prices. Now, back to the Iran deal.

Depending on which expert is talking, tearing up the agreement will have a major or not-so-major impact on global oil supply. Barclays said Iranian crude production may not be affected at all. UBS said exports could drop 200,000 to 500,000 barrels per day in the coming months. Analysts generally agree that the country’s exports will fall by between 200,000 and 1 million bpd, depending on how many countries back the U.S. effort.

In any event, if global supply tightens, oil prices that are already rising will rise even more. Goldman Sachs said withdrawal from the Iran deal – coupled with plummeting Venezuelan output and rising tensions in the Middle East – could push the price of Brent crude to $82.50 per barrel by summer. Bank of America said they could hit $100 next year.

If the trend continues, and oil prices keep going up, then it follows that gas prices will go in the other direction; Tudor Pickering forecast that gas traded on the New York Mercantile Exchange could decline to $2.25 to $2.50 per million Btu by the third quarter of this year, and even went so far as to say that gas prices in West Texas – from the Permian Basin – could actually drop to zero on some days.

“(Gas is) getting incredibly cheap again versus oil and refined products,” another analyst, John Kilduff at Again Capital LLC, told Bloomberg. Producers, he added, “are just going to try to give it away.”

While we seriously doubt that producers are going to freely surrender their product, you don’t need to be a market genius to see that the confluence of rising oil prices, a global shortage of crude, increasing gas supplies, and geopolitical concerns could translate to lower gas prices.

Except just last week, EIA reported that injections into natural gas stocks were a bit lower than expected, creating what Bespoke Weather Services termed a “slightly bullish” climate for gas. Indeed, June contracts rose by roughly 3 cents to $2.785 right after the announcement, and then to $2.795 a half hour later.

Bespoke, an energy market forecasting firm, also said that prices could get some additional support from cooling demand provided that current above-normal temperatures stretch through May and into June, potentially hitting between $2.80 and $2.82.

Now, back to the question at hand: What does all this mean for power prices in the coming months?

Basic economic theory suggests that if the cost of raw materials is low, the cost of the products that use those materials will drop. Given that virtually every indicator signals that the environment is right for lower natural gas prices, we could logically expect to see some downward pressure – however marginal – on bills.

And yet grid operators from across the country are issuing warnings about record-breaking prices, for reasons that range from insufficient infrastructure, to high peak demand in a summer expected to be hot and dry, to shrinking reserve margins. All of which, no doubt, have the very real potential to mitigate any declines from low-cost gas. 

So while your crystal ball is probably as good as ours, they both have be thing in common: Look into either, and you’re going to see a lot of cracks, and more cloudiness than clarity. Which reminds us of the quote by Nils Bohr, the famed Nobel laureate in physics:

“Prediction is very difficult, especially if it’s about the future.”