20081028 the impact of a volatile economy on energy markets
TRANSCRIPT
The Impact of a V l til EVolatile Economy on
Energy Marketsg
Robert McCullough, Managing PartnerMcCullough Research
NAESCO Annual MeetingNAESCO Annual MeetingOctober 28, 2008
Life on the Roller Coaster• I am unclear about the title of this presentation.
Should it be:Should it be:
– The Impact of a Volatile Economy on Energy Markets, or…
– The Impact of Energy Markets on a Volatile Economy
• I try to teach my assistants that it is really useful to see how we got here when figuring out where to go next
Economy Energy
Volatility is a significant cost to consumersconsumers• Long lead time projects like nuclear and coal now face
many significant risks:many significant risks:
– Massive fuel cost uncertainties
RTO markets are arbitrary and political– RTO markets are arbitrary and political
– Interest rates (and real financing costs) are difficult to estimate
• Short lead time projects now have a significant advantage
London Interbank Offer Rate and
$120 00
$140.00
$160.00
5.00%
6.00%
t
WTI Crude
$60.00
$80.00
$100.00
$120.00
2.00%
3.00%
4.00%
$/B
arre
l
ne
Yea
r In
tere
st
$-
$20.00
$40.00
0.00%
1.00%
On
1 Year LIBOR Rate WTI Crude
An environment not conducive to major energy investmentsinvestments
ABC News – August 3, 2006g ,
• MARK COLVIN: There was a dire warning today from one of the world's leading credit ratings agencies An oilone of the world s leading credit ratings agencies. An oil price shock could cause a major global recession, and financial markets aren't building in enough capacity to absorb risk.absorb risk.
David Wyss is the chief economist at Standard & Poor's.
He says that if there's a war centering on Iran that cuts off Middle East oil supplies, the price of crude could hit US$250 a barrel.
Yet after years of economic good times, global banks have been lulled into a false sense of security.
ABC News – August 3, 2006 (continued)(continued)• DAVID WYSS: The problem is financial markets just
don't believe that there is that much risk out there and Idon t believe that there is that much risk out there, and I think they could wake up to find a bigger hit than they expect and they've priced in. That's going to be very painful for investors.painful for investors.
STEPHEN LONG: We know there's a lot of hedge funds operating. We know that there's a lot of debt and p gleverage in the world, why do you think they're so sanguine? Why aren't they pricing in the risk?
DAVID WYSS: I'm not sure why they're not pricing in the risk. Partially, it's because the last few years, we're seeing abnormally low default rates.
ABC News – August 3, 2006 (continued)(continued)• Partially because they've sort of required this rather
touching faith in the central banks that the centraltouching faith in the central banks, that the central banks would be able to bail them out of any problem. But at some point, central banks can't print oil.
STEPHEN LONG: So the financial markets have been lulled into a false sense of security?
DAVID WYSS: I think there's an under-appreciation of risk out there. People just are a little too sanguine about the economy, about the possible shocks ticket, and I hope it doesn't happen, but they could get a nasty shock.
Slamming the homeownerg
• As oil and natural gas prices doubled and electricity prices climbed sharply the pressure on the blue collarprices climbed sharply, the pressure on the blue collar budget was a significant, but unappreciated effect
• Talking to “Sewage Trap Kevin”
• Home heating costs in Wisconsin are a sizeable proportion of rent in winter months
• Drawing down savings is only a temporary respite
Why are energy prices so volatile?volatile?• Shortage or lack of market surveillance?
• Clinton signed into law the second of the Enron loopholes in 2000
Eight years have passed without repeal of either of the• Eight years have passed without repeal of either of the Enron loopholes
• Despite of many “valuable” insights from the pundits, we p y g p ,have no idea why oil prices spiked on July 3, 2008
– Chinese and Indian demand was as predicted
– Exchange rates had not changed
– Production was higher than predicted
Dow Jones Industrials and WTI
12000
14000
16000
120
140
160
als
Crude
6000
8000
10000
12000
60
80
100
120
Jon
es I
ndu
stri
a
olla
rs P
er B
arre
l
0
2000
4000
0
20
40
Dow
Do
hi k d h
WTI Sweet Crude Dow Lines Industrials
Chicken and the Egg
The pundits knew that flight from equity fueled oil prices until July and they now know that recessionsprices until July and they now know that recessions lower oil prices
RTO and Non-RTO Electric Prices
$95.00
$105.00
$115.00
Wh
$65.00
$75.00
$85.00D
olla
rs P
er M
W
$45.00
$55.00
$n-
98 l-98
n-99 l-99
n-00 l-00
n-01 l-01
n-02 l-02
n-03 l-03
n-04 l-04
n-05 l-05
n-06 l-06
n-07 l-07
n-08
Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
Ju Jan
RTO States Open Market States
Linear (RTO States) Linear (Open Market States)
Bad news for consumers in RTO states; not all that good for
everyone elseeveryone else.
U.S. LNG Imports
100,000
120,000
p
60,000
80,000 M
MC
F
-
20,000
40,000
h i l l i hi h
-
Jan-
2001
May
-200
1Se
p-20
01Ja
n-20
02M
ay-2
002
Sep-
2002
Jan-
2003
May
-200
3Se
p-20
03Ja
n-20
04M
ay-2
004
Sep-
2004
Jan-
2005
May
-200
5Se
p-20
05Ja
n-20
06M
ay-2
006
Sep-
2006
Jan-
2007
May
-200
7Se
p-20
07Ja
n-20
08M
ay-2
008
Even the simple relationships have become mysterious
LNG imports have dropped steadily – export permits for LNG are
increasing.
Natural Gas and Crude
12
14
16
120
140
160
BTU
rrel
Katrina
4
6
8
10
40
60
80
100
Dol
lars
Per
MM
B
Dol
lars
per
Bar Enron/El Paso
Ike
0
2
4
0
20
40 D
Weekly Cushing, OK WTI Spot Price FOB (Dollars per Barrel) Natural Gas
Natural gas prices have roughly followed oil this year and now are
leading oil downwardsleading oil downwards
Hurricane Ike -- WTI Spot Prices and
$120.00
$140.00
1,200,000
1,400,000
y
pShut in Oil Production
Source: EIA and MMS Daily Updates
$60.00
$80.00
$100.00
$
600,000
800,000
1,000,000
, ,
lars
Per
Bar
rel
ls o
f O
il P
er D
a y
He
$-
$20.00
$40.00
-
200,000
400,000 20
08
2008
2008
2008
2008
2008
2008
2008
2008
2008
2008
2008
2008
2008
Dol
l
Bar
re
earing
8/28
/2
8/30
/2
9/1/
2
9/3/
2
9/5/
2
9/7/
2
9/9/
2
9/11
/2
9/13
/2
9/15
/2
9/17
/2
9/19
/2
9/21
/2
9/23
/2
Shut In Production $/ Barrel
Confounding the pundits , hurricanes do seem to lower pricesto lower prices
EIA October 2007 Forecast and
$120 00
$130.00
$140.00
Market Actuals
$90.00
$100.00
$110.00
$120.00 ol
lars
per
Bar
rel
$60.00
$70.00
$80.00 Do
EIA Short term Forecast Actual Average Monthly Prices
Careful forecasting always guarantees good resultsresults
How is this impacting energy companies?companies?• Constellation
– Has announced a “stealth” bankruptcy
– Acquisition by Buffett
• Reliant
– Has put itself up for sale
– Blaming problems on Merrill Lynch
• Risk management is proving far too risky
How viable are high capital resources in this environment?resources in this environment?• Financial analysis requires a clear statement of future
fuel pricesfuel prices
• Interest rates are also volatile
Without rate base treatment or taxing authority high• Without rate base treatment or taxing authority, high fixed costs will be impossible to finance in RTO areas
• The risk of a high emission allowance cost adds to the grisk of traditional coal units
X
XX
X
X
XX
X
X
What is left?
• Renewables
• Energy efficiency
• Government-backed baseload
