2. TABLE OF CONTENTS
EXECUTIVE OVERVIEW ...........................................................................................................1
The Sleeping Giant: When Energy Prices Awake ..........................................................................3
The Big Down Drivers from 2008-2012: Surging Gas Production, WEAK Economy,
and a Winter that Wasn’t.............................................................................................................3
Low Gas Prices Sent Gas vs. Coal Generating Competition Temporarily Into Turbo Mode .................4
What Comes Down FAST, Must Go back Up?............................................................................6
U.S. Shale Gas Effect.............................................................................................................................7
Coal-Fired Generation Retirements: Make Way for More Gas Generation ...........................................7
International Demands for US Natural Gas Emerge ..............................................................................8
Electric Generation Balances Demand at the Low End of the Natural gas price Range .......................8
But Most Shale Gas Producers Require a Higher Price Point ...............................................................9
Risks Inherent in the Close Connection Between Natural Gas and Electricity ......................................9
The Ill-Effects of the Extended Downturn on Corporate Risk Management ...............................10
Time for a more Proactive, multi-pronged approach to addressing both rate and Usage ................... 10
Energy Procurement Decisions: Managing deregulated contracts in a riskier Market................11
Consumption Controls: A New Emphasis on Energy Efficiency.................................................13
Conclusion: New Perspective on Energy Prices Requires Conscious Management..................16
3. PAGE 1 | WHEN ENERGY PRICES AWAKE
EXECUTIVE OVERVIEW
On the heels of the 2008 Global Economic Crisis, much of the country enjoyed falling prices for electricity
and natural gas. The low-cost energy anomaly was largely driven by very weak demand from a slow
economy, combined with dramatic growth in the domestic supply of natural shale gas. For many
companies, this offered a welcome spot of relief in their third- or fourth-largest business operating
expense.
After hitting decade lows in early 2012, spot and futures prices for both wholesale electricity and natural
gas have climbed steadily in all US regions as economic recovery and rising use of natural gas for electric
generation have begun to take up the slack. Through 2016, significant shifts in regional energy
fundamentals will drive new price dynamics that bear close attention.
After a long, steady decline, energy prices are once again trending up.
4. PAGE 2 | WHEN ENERGY PRICES AWAKE
As of mid-2013, the overall outlook for U.S. average retail electricity
price increases is a relatively mild 2% to 4% ($0.003 to $0.004/kWh
[kilowatt hour]) from 2012 to 2013, continuing into 2014. However, that
prognosis masks regional issues that will drive some sites to a year-
over-year increase of as much as $0.01 to $0.015 per kWh where
capacity prices, grid congestion, deregulated contracts or regulated
fuel cost pass-throughs allow retail prices to move more abruptly.
The natural gas retail markets will see even steeper hikes, with U.S.
average increases of 5% to 10% from 2012 to 2013 and continuing
into 2014. And, as with electricity costs, some sites will see much
steeper increases of as much as $1.00 to $1.25 per Dth (Dekatherm)
where regulations or contracting allow for quick pass-through of
commodity costs.
While natural gas typically accounts for only in the neighborhood of 20% of energy spend for commercial
users, this paper focuses significant attention on natural gas due to its expanding role as a primary price
driver in electric power generation.
In the following pages, we’ll explore the primary drivers that are shaping the short- and long-term energy
markets. We’ll drill down on the anticipated impact of these influences, and we’ll offer guidance on how
these trends affect energy procurement, pricing, and risk management.
Forward looking
companies with
significant energy
spend will need to
revise budget
expectations and
risk management
practices to
accommodate the
changing energy
price environment.
5. PAGE 3 | WHEN ENERGY PRICES AWAKE
THE SLEEPING GIANT: WHEN ENERGY PRICES AWAKE
THE BIG DOWN DRIVERS FROM 2008-2012: SURGING GAS
PRODUCTION, WEAK ECONOMY, AND A WINTER THAT WASN’T
Energy exploration and production is a dynamic business prone
to boom and bust cycles, and the past decade has proved no
exception. After natural gas prices spiked in 2005 through 2008,
a wave of investment in advanced drilling technologies moved
into the industry, driving natural gas production up by roughly
10% between 2008 and 2011, while consumption grew by only
5% owing to a slow economy.
As gas production continued to surge into 2012 and minimal
demand for heating materialized during the 2011/12 “winter that
wasn’t,” markets reacted strongly to the record amount of gas
left in storage at the end of the heating withdrawal season, and
gas prices hit decade lows in April 2012.
US WORKING NATURAL GAS IN STORAGE
After a “perfect storm”
of global recession
and shale gas
expansion, a new wave
of environmental,
production, transport,
and international
demand drivers have
the energy market on a
bull run.
6. PAGE 4 | WHEN ENERGY PRICES AWAKE
US NATURAL GAS ELECTRIC POWER PRICE
LOW GAS PRICES SENT GAS VS. COAL GENERATING COMPETITION
TEMPORARILY INTO TURBO MODE
As gas prices slid below $3.75, natural gas generators, which would normally be cost-competitive only
during peak parts of the day, or seasonally when electric use was high, gained a much more even footing
with coal plant generating costs. The fight was on across the board as generators bid to supply energy
into the grid. The charts below illustrate the increasing competitiveness from 2010 on the left to 2012 on
the right. With more aggressive bidding and a burgeoning fleet of natural gas-fired generators, electric
prices in most areas fell by around $10.00 to their decade lows.
7. PAGE 5 | WHEN ENERGY PRICES AWAKE
SOUTHEAST HISTORICAL SUPPLY CURVE, SUMMER 2010-2012
SOUTHEAST HISTORICAL SUPPLY CURVE, SUMMER 2010-2012
8. PAGE 6 | WHEN ENERGY PRICES AWAKE
WHAT COMES DOWN FAST, MUST GO BACK UP?
From March 2012 through mid-2013,
generators continued to burn natural gas
at unprecedented levels, taking up enough
production slack that storage and gas
prices moved back up into the $4.00 to
$5.00 range. This, in turn, eased some of
the fierce competition between coal and
gas generators, allowing electric prices to
come back up as well.
NET GENERATION FOR ALL SECTORS, MONTHLY
Summary of Energy Upward Price Drivers
Most “Dry” natural gas basins have been
declining in production
Coal-fired generation retirements
Electric generation balances demand at
the low end of the price range
Most Shale gas producer require higher
price points
More international demands for natural gas
Risks inherent in the close connection
between natural gas and electricity.
9. PAGE 7 | WHEN ENERGY PRICES AWAKE
U.S. SHALE GAS EFFECT
Consider that at the turn of the century, shale gas accounted for only 1% of U.S. natural gas production.
By 2010, it surpassed 20%, and the EIA (Energy Information Administration) predicts that by 2035, 46%
of domestic natural gas supply will come from shale gas.
While the presence of massive North American shale gas fields has been known for well more than a
century, and the basic drilling techniques known for 20 to 30 years, directional drilling technologies have
only recently reached cost-points that meet commercial viability. Only within the last few years, increasing
experience with the technologies across many wells and shale basins and has resulted in increasing
confidence, which has tamped down “scarcity” concerns that likely contributed to the run up before 2008.
But, it is important to balance this against the reality that many of the large well-known conventional or
“dry” natural gas basins have been declining in production, even during periods of higher prices. Only a
few gas regions, most notably Marcellus, have been growing quickly enough to continue overall
production growth even during the last couple years of low prices.
Additional impetus for lower pricing has also been provided by higher prices for oil and natural gas liquids,
which are co-produced in a few regions. This has had the effect of providing a subsidy for natural gas
prices as drillers concentrate on the very best liquid rich regions, but the strategy is not widely
expandable beyond those top few regions.
COAL-FIRED GENERATION RETIREMENTS: MAKE WAY FOR MORE
GAS GENERATION
Because coal generating plants have such long life spans (often 30 to 75 years), decisions about capital
spending and competitive positions also happen on a long-term scale. A number of recent clean air
regulations require coal generators to comply with stricter emissions control levels. At the same time, they
see increasingly competitive positions of natural gas plants. Coal plants with weaker emissions controls
(often smaller, older units) are moving to retire rather than spend the capital for upgrades. Between 2011
and 2017, these planned retirements are expected to add up to approximately 40 GW (Gigawatts).
10. PAGE 8 | WHEN ENERGY PRICES AWAKE
The expected retirements of coal-fired electricity plants will accumulate to around 40 GW by 2017—a gap that will
largely be filled by, natural gas-fired plants.
Using recent history as a guide (left chart above) much of the capacity will be taken up by adding natural
gas plants, or running existing gas plants for more hours and/or higher outputs. But, while the
accelerating coal retirements have made headlines, the significance of the impact on price has largely
been left to the imagination. We estimate that the gas required to replace the retiring plants would be
around 3 to 5 Bcf/day by 2017. In the context of overall natural gas demand across all uses, the effect
would contribute around 1% to 2% to annual gas demand growth. That is not hair-raising by itself, but as
we will see below, more demands continue to emerge.
INTERNATIONAL DEMANDS FOR US NATURAL GAS EMERGE
The FERC (Federal Energy Regulatory Commission) has approved at least one company, Cheniere
Energy Partners, to export LNG beginning in 2015. Around 20 other companies are in the process of
making similar requests, with around a dozen approvals totaling LNG export capacity of 5% to 10% of the
total U.S. production expected over the next few years. Additionally, several pipeline projects are slated
for completion in the 2014 timeframe that will increase capacity for export to Mexico from around 3.5
Bcf/day (only about 50% of which is in use currently) to around 7 Bcf/day, allowing ample spare capacity
for future export growth.
ELECTRIC GENERATION BALANCES DEMAND AT THE LOW END OF
THE NATURAL GAS PRICE RANGE
The overall net impression we have is that if gas prices fall much below $3.75, electric generation
demand for gas can increase by as much as 6 Bcf/day, as it did in 2012. And, as prices approach $4.00,
electric generation demand slackens, as it did in early 2013.
11. PAGE 9 | WHEN ENERGY PRICES AWAKE
BUT MOST SHALE GAS PRODUCERS REQUIRE A HIGHER
PRICE POINT
We believe that prices below $4.00 do not allow sufficient return to maintain interest in drilling and well
completion capital costs necessary to support supply growth. At this price level, producers will continue to
drift toward oil and liquids-centric opportunities, and away from gas production. A range of $4.50 to $5.50
is needed to stimulate drilling enough to support continued production growth in the near term. That price
requirement will rise over time as locations offering the best return on investment, such as the currently
popular liquids-rich plays, become saturated.
RISKS INHERENT IN THE CLOSE CONNECTION BETWEEN NATURAL
GAS AND ELECTRICITY
Natural gas prices are volatile. Even when they are within a relatively low range, they jump around
significantly, so it is important to remember that level of volatility when looking at a smooth EIA projection
or futures curve.
HENRY HUB NATURAL GAS PRICE
EIA’s range is
good guidance,
but remember to
plan for volatility
along the way.
12. PAGE 10 | WHEN ENERGY PRICES AWAKE
And, it is especially important to remember and communicate the potential for volatility to energy price risk
stakeholders when so much of the current media hype cycle on shale gas declares it a “Boom” or a
“Revolution.” Seemingly, the U.S. will soon be an energy independent net exporter, with 100 years of
natural gas supply and new prosperity. While each of these statements is potentially true in isolation, at
some point it is easy to begin to double count benefits, or assume that potential benefits are highly
certain. Ultimately, this tends to lead to a perceived “bust” or a “bubble pop” cycle that may focus on
imminent scarcity. Sentiments move markets in unpredictable ways that can defy underlying
fundamentals. This volatility risk is increasingly important to bear in mind as wholesale, and ultimately
retail, electricity prices become more tied to gas through fuel cost adjustments.
Overall, we are now in a period of recovering wholesale energy prices, as opposed to the market drops
that dominated the past few years. We can expect the emerging demands for natural gas, and varying
price-needs of natural gas market participants, to leave significant room for volatility.
Next, we’ll discuss how businesses can prepare for an anticipated increase in energy pricing by
communicating the risks associated with the status quo, mitigating that risk, and gaining control of costs
through decreased consumption.
THE ILL-EFFECTS OF THE EXTENDED DOWNTURN
ON CORPORATE RISK MANAGEMENT
From late 2008 until late 2012, almost any short-term approach to either fix energy prices or ride the spot
market would have resulted in decreased costs year-over-year. As a result, traditional risks associated
with purchasing electricity and natural gas were hidden, and conversations about potential to miss budget
on overall cost were pretty rare. A general feeling of complacency around risks crept in among energy
buyers and budget stakeholders.
TIME FOR A MORE PROACTIVE, MULTI-PRONGED APPROACH TO
ADDRESSING BOTH RATE AND USAGE
With a high-level understanding of how energy market dynamics have shifted, energy cost stakeholders
are better positioned to take an appropriate perspective on energy costs moving forward, and able to
value procurement, budgeting, and energy consumption cost and risk reduction strategies more fully.
Companies that tackle the challenge aggressively, via multiple paths, will have the greatest success.
Below, we offer some suggestions for several areas of focus.
13. PAGE 11 | WHEN ENERGY PRICES AWAKE
ENERGY PROCUREMENT DECISIONS: MANAGING
DEREGULATED CONTRACTS IN A RISKIER MARKET
Assessment of exposure to the risk of riding spot pricing should take into account the impact of price
volatility that differs between regions. This must be done with careful consideration of the physical
footprint and consumption of sites within those regions. The decision to ride spot pricing in Texas, the
North East, or New England, for instance, could result in the one-day loss of an entire month’s energy
budget. On the other hand, contracting for a substantial double-digit fixed rate increase for the upcoming
season could be hard for stakeholders to swallow. Thus, we suggest energy managers ramp up the
communication of what’s coming and lead an ongoing conversation on what to do about it. For instance:
Share energy market price intelligence widely. Finance, C-Level, and Field Operations engineers
all benefit from common understanding of the trends.
Include intelligence on both national and regional trends.
Recalculate and maintain current estimates of the organization’s VaR (value at risk), the
measurement of the risk of loss at various probable future price levels on the energy contract
portfolio.
As energy market intelligence is understood and these discussions become more commonplace,
revise documents guiding acceptable levels of risk with key stakeholders.
14. PAGE 12 | WHEN ENERGY PRICES AWAKE
Managing for Energy Budget Risk - Recommended Actions
Work with budget stakeholders to review deregulated contracting style impacts on budget
certainty. The same contracting styles that lead to consistently beating budget over the last
few years, will likely become a liability as markets reverse. A reassessment of VaR might
lead to the determination that the organization should set limits on the amount of variability
within the current budget year.
Review variance and reforecast budgets more frequently to quickly identify regions or sites
where rates are changing, and clarify quickly whether the changes are temporary or will last
throughout the rest of the budget period .
Recalculate price impacts on capital budget cases for efficiency projects. As the cost per unit
increases, the ROI on capital cases also increases. In particular, give renewed attention to
reviewing capital cases for efficiency projects in congestion-prone, market-driven, and active
regulatory regions.
While a complex exercise that requires skill and commitment, properly preparing for energy market
volatility and rising energy costs is a wise use of time and resources. For some businesses, the
application of market expertise to procurement and contract decisions can have substantial impact on
budgets in the near term. That said, while rate and contract negotiations are the starting point of the
energy management continuum, energy efficiency programs create impressive and long-lasting
opportunities to mitigate the risks of increasing energy costs.
15. PAGE 13 | WHEN ENERGY PRICES AWAKE
CONSUMPTION CONTROLS: A NEW EMPHASIS ON
ENERGY EFFICIENCY
While the terms green, sustainability, and energy efficiency conjure up
altruistic thoughts, they also pave the way toward clearly defined and
substantial financial benefits—you don’t pay for energy you don’t use.
Therefore, energy consumption reduction will undoubtedly take on new
relevance as energy prices climb. In a business environment where
investment decisions are made almost exclusively on the promise of
ROI, low- and no-cost opportunities to save energy, water, and waste
costs via sustainability initiatives present businesses with a significant
opportunity for measurable savings. Some of these steps to combat the
inevitably rising energy costs we’ve discussed here are sufficiently
simple that they rarely require capital resources beyond that which is
already budgeted. For example:
The installation of programmable thermostats. When temperature settings are adjusted
appropriately for just 8 hours a day, a business facility can save as much as 10% on its annual
heating and cooling bills. Remotely programmable thermostats, which have dropped considerably
in price, add operational efficiency gains to the ROI equation. With a network connection and a
password, a single energy manager can program and control hundreds—even thousands—of
thermostats across a distributed enterprise, maximizing energy savings while minimizing facilities-
level human intervention.
The replacement of standard fluorescent and incandescent light bulbs with next-generation CFL
(compact fluorescent), LED (light emitting diode) and improved halogen bulbs. Depending on the
size and scope of the business, according to energystar.gov, more than 35% of commercial
electricity expenses go toward lighting; CFL bulbs are up to 75% more energy efficient than
traditional incandescent lighting, and lighting incentives are among the most lucrative
opportunities. Upgrades to facility lighting systems often deliver 25% to 35% reductions in lighting
energy, with a simple payback of two-three years.
Some steps to
reducing energy
consumption are
sufficiently
simple that they
rarely require
capital resources
beyond that
which is already
budgeted.
16. PAGE 14 | WHEN ENERGY PRICES AWAKE
As is common in retail, a great percentage of energy is being consumed on lighting and HVAC. With this
in mind, some no cost/low cost lighting initiatives might include:
Use of occupancy sensors in areas of low activity
Verification of optimum start and stop settings
Perform a dark store lighting check
Some no cost/low cost HVAC system initiatives might include:
Maintaining temperature set points
Verification of optimum Start and Stop Programming
Other steps, such as outlier investigation, energy intelligence and benchmarking solutions, metering and
utilities-based rebate programs are slightly more complex. However, taken as part of a holistic energy and
sustainability management program, they will yield compelling results. Fortunately, for many of these
energy efficiency measures, there are energy rebate programs available through utilities, which
companies may take advantage of to help subsidize the cost of capital improvements. Read more about
the keystones of TESM (total energy and sustainability management) here.
While the end value of taking these initial steps is industry specific and market dependent, most
businesses can expect total utility savings of 20% to 30% from intelligent TESM investments. When
applied to areas with rising and volatile prices, those savings go a long way to reducing energy cost risk.
ELECTRIC CONSUMPTION (kWh)
Sample: Small Retail
Sample breakdown for a small box retailer’s energy consumption mix
17. PAGE 15 | WHEN ENERGY PRICES AWAKE
Best Practices to Achieving Expected ROI
with an Energy Management System
Monitor and Manage Human Interaction
Standardize on Proper Alarm Management
Minimize Access to Systems
Document Standard Configurations and Sequences of Operation
Pinpoint Sensor Location for Powerful Tracking Results
Implement Variance/Change Management Program
Back-up Configuration and Program Files
Re-Commission Energy Management Systems
Apply a System Monitoring Program
Read Ecova’s Best Practices for Maximizing ROI of Energy Management Systems
White paper that details methods to counter the challenges above.
18. PAGE 16 | WHEN ENERGY PRICES AWAKE
CONCLUSION: NEW PERSPECTIVE ON ENERGY
PRICES REQUIRES CONSCIOUS MANAGEMENT
The long-term lull in energy prices we’ve enjoyed in recent years will cause many business energy
stakeholders to be caught off guard as the influences we’ve discussed above cause prices and volatility
to increase.
Specifically, as natural gas increasingly becomes the primary driver of electricity generation costs, energy
price risk will shift into a higher gear. Deregulated markets and regulated regions that allow fuel cost
pass-throughs will see the cost impacts first, while more heavily regulated markets, will tend to lag but
ultimately will see similar rate increases smoothed over a longer period.
Responsible businesses will take heed of the changing influences and risks impacting their energy costs
and take action on multiple fronts: Procuring, budgeting, and reducing usage more proactively.
Learn more about minimizing your organization’s energy costs and energy consumption:
The Ecova Blueprint, your guide to developing a proactive, strategic and actionable Total Energy &
Sustainability Management (TESM) plan.
Big Data Look at Energy Trends: 2008–2012, leverage Ecova’s big data insights to help your organization
see more savings.
How to Capitalize on Billions in Available Energy Incentives: Four Types of Qualifying Energy Efficiency
Investments. (Whitepaper)
Best Practices for Maximizing ROI of Energy Management Systems, (Whitepaper)
Inside Energy webinar series — Stay informed on energy trends with Ecova Webinars, subscribe to
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