Spring 2023 Energy Market Update: Getting Used to Volatility
What's happening in the energy markets – and what does it mean for consumers?
Paul Leanza, director of gas supply, and Joe Haugen, senior director of power supply, recently shared an update on what's affecting the markets. Here, we offer highlights from their update – including the reason why you should consider a long-term approach for your energy strategy.
A record year for volatility
You've heard it mentioned time and again: The energy markets have been incredibly volatile. But what exactly does that volatility look like?
Consider this: There are about 250 trading days in a year. In 2022, there were 46 days – nearly once every 5 trading days – during which the price changed by at least 7 percent, day-over-day. That makes 2022 the most volatile year for energy markets in recent history.
The reality is volatile energy markets might just be the new norm. But it's important to understand the short- and long-term factors that affect the markets – and prices.
Why we're experiencing volatility in the natural gas market
Let's consider the short-term and long-term factors affecting the natural gas market.
In the short-term bucket, we have, of course, weather. Another short-term factor? The implications of the COVID-19 pandemic, which affected other commodities markets, supply chains, and workforces. The energy industry, which laid off many workers due to historically low energy demand in 2020, was slow to rehire workers, as in many other industries.
The most notable long-term factor is energy storage. In the U.S., we've seen a massive uptick of natural gas production – nearly 40 percent in the last 6 years. Meanwhile, storage capacity hasn't increased in any meaningful way, leading to an increase in volatility as daily, monthly, and seasonal balancing options became limited.
As natural gas supply increased, gas-fired generation displaced coal as the leading generator in the power stack. As gas became more dominant in the power industry, its ability to leave the power stack to supply industries – such as heating or industrial demand – became more challenging, leading to various times of price inelasticity. In short, natural gas is being used by several different industries (including the power industry) and, unfortunately, during times of high demand, the price can become excessive especially in areas with limited supply options.
Another long-term factor is the fact that the U.S. energy market is increasingly driven by global energy demands. In recent years, U.S. exports of natural gas – notably liquefied natural gas (LNG) - have grown substantially. Since 2016, exports of LNG have increased from 0 BCF a day to more than 14 BCF per day. And currently, around 20 percent of the natural gas produced in the U.S. is exported to the LNG market and Mexico. We’re no longer only concerned with regional weather here in the U.S.; now, we have to worry about what’s happening across the globe, notably in Europe and Asia. Demand for LNG – and domestic producers' response – is a primary driver of price.
What natural gas volatility could mean for prices and hedging
The near-term conditions are typically the most volatile and hardest to predict with any certainty.
Prices will fluctuate based on supply and demand conditions due to weather, infrastructure issues, production outages, and economic conditions that can all be unforeseen. In the long term, as in the oil market, natural gas is becoming a global commodity. As the buildout of LNG continues, the price difference between the U.S. and global markets will compress. In turn, U.S. prices are likely to increase as global prices generally decrease. There will be times, however, when the world demand for seasonal LNG will decrease, pushing gas back into the U.S. and reducing prices temporarily.
Historically, consumers could lock in their prices for the year in September – and do the same the following year. But with so many longer-term volatility factors in play, it's important to take a longer-term approach. This means looking out three to five years when making your energy contract decisions.
The role of risk management in energy strategy
The source of electric generation is changing in the U.S. Currently, the power generation stack is in a transitioning period – from large fossil fuel plants to renewable energy production. As coal plants retire, natural gas generation is being used to provide reliability to the power grid. This shift, as noted above, impacts the gas market, directly impacting the price of power. (When natural gas prices go up, you will likely see an electricity price increase, too.)
Risk management is increasingly important, as more renewable energy generation creates a market structure with higher highs and lower lows.
Developing the right energy strategy for your business
In the years to come, we can expect greater volatility in both the electricity and natural gas markets, due to a variety of long-term factors.
If you're responsible for making energy decisions for your business, note that long-term energy prices are still relatively affordable, even despite the recent swings in the market.
For more from our energy supply experts, view this summary video.More Insight on Energy Markets