Market Newsletter – February 2021February 28, 2021
Written by: Luke Nemes, Director, Energy Procurement & Market Intelligence
“The world as we have created it is a process of our thinking. It cannot be changed without changing our thinking.”
― Albert Einstein
Last month, I opined that a new era is upon us in the energy industry. If you missed it, here is the skinny: an over-supplied market cannibalizes itself until there are only a few meaty players left standing, at which point, enhanced conservation of financial resources and disciplined balance sheets become essential for survival. There is a litany of conditions that led to the imbalanced natural gas market that I will not belabor here, but it is important to understand that it is a combination of the gradual events of the past several years in tandem with the sudden events of the past few weeks that caused major market disruption in Texas and the Mid-continent. Furthermore, it is equally important to note that the rippling waves from such an historic systemic failure are still outwardly racing to shore – while regulators and legislators are now stepping in to investigate what went wrong and determine who or what is at fault, forward market implications have taken a backseat – we will investigate those shortly.
Before we go any further, there is an elephant in the room that requires addressing. The rolling blackouts in Texas were not simply caused by frozen wind-turbines. When properly winterized, wind-turbines are incredibly reliable in cold weather and we can look to the Nordics who rely heavily on wind-generation in much colder temperatures than what was witnessed in TX. The fact is that there is a multitude of culprits, and the rolling blackouts were really caused by everything being frozen (including grid-operators’ foresight and planning). Natural gas well-heads and equipment that pulls natural gas out of underground storage were frozen, limiting available natural gas supply. Natural gas pipelines required to deliver gas to homes and thermal generators (anything that uses heat to create electricity, like a natural gas-fired power plant) were subjected to temperatures that can cause gases with heavy carbon chains to liquify, limiting the ability to transport available gas. Emergency orders were issued (by The Railroad Commission of Texas, yes you read that right) that determined the prioritization of gas deliveries to human-needs first, and then to thermal generators serving residential communities before those serving industrial and commercial load. The thermal generators that could receive natural gas themselves were not equipped to operate in extreme cold (lack of weatherization), limiting output capabilities. Even one nuclear plant failed.
Also, yes – wind turbines froze, although it should be noted their expected output at this time of year is significantly diminished due to typical low winds and is otherwise dwarfed by natural gas generation. Around 29,000 megawatts of thermal energy — which is sourced from coal, gas and nuclear plants — were missing from the grid last Tuesday. Compare that with the roughly 5,000 megawatts missing from wind, and the claim that grid reliance on renewables is to blame becomes a statement trumpeted by the uninformed. It remains to be seen how ERCOT will emerge from this catastrophe, but the expectation is that they (like the rest of the country), need to reconsider the impacts of extreme weather events both in the summer and the winter. Furthermore, Texas’ insistence on self-reliance for the sake of preventing federal regulation is also likely to be reconsidered, which is what this essentially boils down to. Isolated grids are not structurally able to handle increased demand when supply is limited.
If demand on the grid significantly exceeds supply for even a few minutes, key infrastructure can fail entirely, a far more serious situation even than the one that actually occurred. In fact, had ERCOT not called for generators to shed load (disconnect from the grid), it is entirely possible that much of the state would still be without power – a truly dangerous and terrifying ponderance that makes one wonder if ERCOT really deserves the “R” in their moniker (it stands for Reliability). An enhanced emphasis on reliability moving forward is the most likely outcome, and that could mean breaking the isolation tank of Texas and ensuring interconnections to generating resources outside of the state can be utilized when demand exceeds available supply. Or, we could see mandatory winterization of the natural gas transmission and distribution networks, and of the generating facilities in-state, which at the moment, is merely a suggestion. ERCOT performs weatherization checks of some generating facilities, but it does not have the ability penalize units that are not taking measures to guard against the cold.
From a cost perspective, near-term, futures may continue sharply higher as risk models are updated with extremely high prices. In ERCOT, for example, February-to-date day-ahead on-peak prices have averaged a previously unthinkable $2,418/MWh. In the medium-to-longer term, the cost of grid hardening measures is likely to be passed through to end users via higher power prices. In PJM and the northeast ISOs, for example, winter-ready generators must either have firm gas supply, which is more costly than the interruptible delivery method that most ERCOT gas-fired generators utilize, or the ability to utilize backup fuel on-hand (distillate oil) – only a select few generators in TX have the capability to do either presently. Other tracks we could continue to see expand are increased energy storage for intermittent renewable generation, and enhanced demand response outside of the summer months.
As mentioned, none of this happened in a vacuum – the impacts were far and wide. Spot gas prices last week reached as high as $1,250/MMBtu in Oklahoma, $400/MMBtu at Houston Ship Channel, over$100/MMBtu at Chicago Citygates and SoCal Citygates, and exceeded $10/MMBtu at most key hubs across the country. National benchmark Henry Hub averaged $23.61/ MMBtu for delivery on February 18th—a new all-time record. The magnitude of the Arctic outbreak—and associated increases in weather-driven demand and reductions in production—sparked a 50¢/ MMbtu (19.2%) gain in March-June NYMEX contracts, 33¢/MMBtu (11.9%) for July-December 2021 contracts, 10¢/MMBtu (3.8%) for Cal 2022, and 2¢/MMBtu (0.7%) for Cal 2023. While noteworthy, these gains are insufficient to offset the rapidly tightening fundamental outlook—and further steep gains appear highly likely later this year. Yesterday, the EIA reported the second largest ever withdrawal from storage, flipping the 5-year storage comparison from a surplus to a deficit, which will only expand as we move closer to summer and injection season. The market is anticipated to be substantially undersupplied over the next 2-3 months, and in its continual quest for balance, may need to respond with rapid movement to the upside.