Volatility….What Price Electricity?

The energy business has always been wild and dangerous and often dirty. Think “wildcatter” and “roughneck”. It can be risky for investors, not a place for widows and orphans. As for dirt and danger, most of us have no desire to be coal miners. In addition to common industrial workplace hazard, extraction has often been from places of violence, an environment more akin to a battlefield, not pastoral peace and quiet.

Wars are fought over oil. This is the story today in Sudan, and the world waits nervously for resolution of a standoff with Iran over it’s nuclear development activities. There’s fear of a cut in the oil supply from the Middle East.

There are stories of violence and treachery at a personal level too. The 2007 movie “There Will Be Blood” is a gripping tale of oil wealth that is not always an unqualified blessing.

The energy industry has been, and is, immensely profitable. Consider the wealth of John D. Rockefeller in the early 20th century. In relative terms the value of his holdings in the oil industry may have exceeded that of any individual before or since. Rockefeller’s power was diluted by intervention of the Federal Government. The U.S. Supreme Court ruled that Standard Oil, the company he founded and his source of wealth, had violated the anti-monopoly Sherman Act and ordered it broken up.

Today one of the fragments from Rockefeller’s empire exists as what is the largest or second largest publicly traded corporation in the world, Exxon-Mobil. One clue as to the profitability of this company is the compensation reported for it’s retiring CEO, Lee Raymond in 2005. As required by securities law, this is public information. Total compensation for his retirement year was $140 Million, much of that performance based, i.e. he was entitled to a piece of an extraordinarily large profits stream. On top of the final year paycheck, Raymond took home $298 Million in retirement benefits.

It hasn’t always been a winning game, however. Louisiana suffered economic hardship in the 1980s as a glut drove oil and natural gas prices to collapse following shortages and price run-ups in the 1970s. More recently, imagine the pain of speculators in petroleum (the ones who were long the market) in 2008 when crude dropped from over $145/bbl in July to a little over $30 in December. At the beginning of June 2012 traders worry about a possible repeat event.

Natural gas isn’t immune to wild price swings. The price escalation of 2008 took gas (the Henry Hub Spot Price) from $4.60/MMBtu in November 2004 to a peak of $13.07 in June 2008. Then it promptly fell to $3.06 in September 2009. There’s more to come, though. In June 2011 the price had recovered to $4.69. From there, another collapse, hitting $1.90 on April 19, 2012. That price is the equivalent of about $10 a barrel for oil. No surprise that by the beginning of June there was a bounce back to over $2.40.

Obviously there’s financial danger and opportunity here, on a grand scale. And lest we forget, there’s still real physical hazard for workers in this business too. Remember the Big Branch mine accident and Deep Water Horizon.

Few readers of this commentary will subject themselves to the physical danger. On the other hand, everyone takes a piece of the financial risk, and pays some premium for every activity that uses energy–practically everything.

All things being equal, low energy prices are a good thing. (note: among the “all things,” include carbon footprint) Every aspect of our modern existence requires consumption of lots of energy, so lowering its cost returns a large dividend usable for other things. We are fortunate today to have falling electricity prices because natural gas for power generation is cheap. (in Florida, electricity production is now over 50% from natural gas–good for us!)

A word of caution. Don’t count on cheap electricity for very long. In April when natural gas was auctioned at $2/MMBtu in the U.S., it sold for $11 in Europe and $16 in Japan and Korea. Petroleum on a unit of energy basis was priced at 5 to 10 times the price of gas in the U.S. One final data point. A historical trend line that would take out some of the price volatility suggests today’s price should be $5 or $6 here in the States. Granted, widespread use of fracking and horizontal drilling is bringing on new supplies and may be bending the long term price trend downward a bit, but price discrepancies of this magnitude don’t persist. They won’t this time. Enjoy the cheap electricity but better count on it being more expensive in the future.


About wattnextblog

I'm Bill Ferree, a chief officer of WattNext, Inc.
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