Energy Prices - Dramatic Increase
The Bigger Picture

A weakening U.S. economy has resulted in some alarming headlines in the past few months and we may be witnessing a financial version of musical chairs. We've all heard the story of Chicken Little and his claims that the sky is falling. While it's easy to dismiss the Chicken Littles of the world or The Boy Who Cried Wolf too often, we would have to put our head in the sand not to see a possible storm on the horizon. Consider the following stories making news.

U.S. Dollar continues to fall against foreign currencies

The Federal Reserve Chief reports mortgage crisis is likely to continue as we experience record number of foreclosures

$168 billion stimulus package needed to bailout people making bad economic decisions. Will this help or is this just another example of an election-year handout.

U.S. Triple-A credit rating is under threat

Gold approaches $1,000/ounce and many other commodities are rising fast

Crude oil reaches all-time highs topping and sustaining the $100/barrel mark

A popular financial TV talk show host predicts $14/MMBtu natural gas on the wholesale market

The DJIA continues a decline that began November 2007

Many think we are headed for a U.S. recession, others think it's already here and possibly worldwide.

Impact on Energy Commodities

Now that we have set the stage with some macroeconomics news, what does that mean to those taking the time to read this energy newsletter? In the past month a number of factors have come together to rapidly drive up natural gas costs and other energy related costs across the U.S. Whether or not this run- up is a short-term aberration or a reversal of declining prices over the past two years remains to be seen. As we see from the headlines above, one can easily make the case that natural gas is merely being swept up along with all the other commodities whether they be metals, grains, energy... The fundamentals of the natural gas market do not support these prices, but that is little consolation to those having to make buying decisions at this time. According to the U.S. Energy Information Agency and most industry experts, here are the reasons for the dramatic increase.

1. Crude oil prices influence the price of all other energy commodities and have a tremendous ripple effect throughout our economy. Crude oil is now trading at record highs and has broken through the $100/barrel barrier. That price impacts us at the gasoline pump, airline prices, electric rates, natural gas rates, diesel fuel rates, etc.

2. The winter has been consistently colder than forecasters have been predicting. That's eliminated the excellent surplus inventory we began the winter with, and market participants are already looking at how that could impact next winter's prices.

3. The environmental rules to limit airborne emissions that result from burning fossil fuels have continued to steer electric utilities to use clean burning natural gas as a fuel source to generate electricity. This trend started in the 1990's and has put a strain on the natural gas industry's ability to meet demand.

4. Imports of natural gas into the U.S. are down. Liquefied Natural Gas (LNG) which comes into the U.S. on cargo ships is now heading to Japan and Europe where prices are even higher than what we are experiencing. LNG technology is new and expanding. It has helped hold down prices the past two years but is another example of how risky it can be to depend on foreign sources of energy supply.

5. The output from new natural gas rigs is not keeping up with the depletion rate of output from aging rigs.

6. The continued weakening of the U.S. dollar relative to foreign currencies means we pay higher prices for the same goods.

7. Two recent Federal Reserve interest rate cuts and the federal government's stimulus package were measures taken to hopefully head off a recession. While noble objectives, the energy markets view this as sign of future increases in demand for their product and drove up prices.

What to do Now?

So with all this doom and gloom news what advice would we give a business? Our longer-term advice remains the same as always. If your energy bills are a top-5 spend category for your business, they should be integrated into your overall planning cycle and tracked as separate budget line items. You should have a procurement strategy in place with well-defined decision points as to when you will purchase natural gas, electricity, etc. Energy prices change constantly and opportunities come and go quickly. The time to set clearly defined goals and assign decision-making authority is before those opportunities arise. At Independent Energy Consultants we deal with many suppliers and have access to a great deal of market information and prognosticators. As painful as these prices currently are, we are not seeing anyone lock-in a long-term price now. The consensus has been and remains that this bubble has to burst as speculators and technical traders will eventually be overruled by market fundamentals. The long-term trend may be moving upward, but this meteoric rise in the past 6-weeks is likely to give back some of its gains, if winter subsides under normal conditions.

Times like this also point to the importance of entering a well constructed contract, where the terms and conditions can be as or more important than the pricing structure (see July 2007 newsletter). For residential and small-commercial customers, that means you want to be able to leave an energy agreement with little or no penalty. For larger commercial or industrial customers, it may mean the ability to hedge certain portions of your needs, or the ability to extend a contract term if prices are lower in the future months (backwardated market conditions).

Now a note about the emotionally charged aspects of paying utility bills. Assuming your energy purchase decisions were made with good information and you obtained the most competitive price at the time, we believe you should move on and not second-guess yourself. Airlines are filled with passengers who bought tickets at different times and for different prices. Cars travel our highways filled with gasoline purchased at various prices. Millions of people own the same publicly traded stocks, but bought at different prices. Were all the people who paid more lousy decision makers? Absolutely not! Just like gas tanks get empty at certain times, our energy contracts expire at discrete points in time. Will those contracts be renewed under the most favorable conditions? Maybe, maybe not. That's were a strategy comes into play and the decision makers must take a view of the market to determine what type of pricing to accept and how long to commit.

Now that we've discussed current market conditions, I think it is worthwhile to talk briefly about the longer term and what the future might hold. Most industry experts agree that reducing our consumption of energy is helpful and we have made tremendous progress in the past 30 years. Most also agree that unless and until our nation addresses fundamental supply-side issues and implements a serious national energy policy, consumers are likely to see increasing prices and be exposed to more rapid movements in prices. For those of you old enough to remember the energy crisis of 1973, this next fact alone should be cause for concern. In 1973 at the time of the Arab Oil Embargo the U.S. imported 26 percent of its energy. Today our dependence on foreign oil has more than doubled and we import about 60% of our needs!

The world is arguably more dangerous today and the U.S. appears to have fewer friends in oil producing regions. For example, the OPEC Ministers continue to manipulate oil supply output to prop prices up but keep them just low enough so the "pain" doesn't become so great that we take serious action to reduce our foreign oil dependency. According to the August 12, 2006 edition of The Economist, the top 13 companies with the world's largest oil and gas reserves control approximately 90% of the world's reserves. What makes this particularly alarming, is the fact that those are all national companies owned by the foreign governments in unstable regions of the world. When making energy purchases and trying to squeeze out every penny of savings, it is worth remembering this fact. Similar to financial investments, each energy purchase decision comes with its own risk vs. reward characteristics. Please contact Independent Energy Consultants if you would like help in identifying your risk tolerance, market trends and the development of a strategy that addresses both.

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