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The End of History?

In 1992, an historian named Francis Fukuyama published a book titled The End of History and the Last Man. In the relatively peaceful, prosperous 1990's his book’s title became a meme for those who prophesied that the next century would see the end of radical ideologies and a reign of universal peace.

Boy, were they wrong.

I recently attended an energy conference in which several speakers vied to be the Fukuyama of commodities markets. Shale gas, they argued, had brought about such low prices that we were about to enter a long period of low to no volatility. Looking forward, they said, energy suppliers would have a hard time convincing consumers to lock in long term hedges of their energy costs.

Wrong again.

As with all commodities, energy markets are cyclical. Prices do not trend upward forever, any more than the stock market can gain consistently over time. There are periodic setbacks and downturns. Prices may trend downward for a time: Just look at crude oil prices after the 1991 Persian Gulf War, when the first defeat of Saddam Hussein after his invasion of Kuwait reduced concerns about a closing of the Persian Gulf to international oil shipments.

Recently we experienced a similar pricing trend in natural gas and electricity which is fueled largely by nat gas in the Northeast. After prices peaked in June 2008, they dropped in a sustained bear market through December 2013. Then in the first week of January 2014 the so-called “polar vortex” came down from Canada, driving nat gas to close to $100 per thousand cubic feet (up from about $5 per mcf) and electricity prices up to $.35/kWh, up from around $.10.

The price spike busted budgets. Some businesses on variable pricing paid as much in January and March 2014 as they would have paid in the entire prior year.

A low price environment is not synonymous with the “end of volatility.” Volatility measures the probability of price changes, NOT how high prices can go.

The volatility of electricity remains high because it is the only commodity that cannot, as a practical matter, be stored (except in the form of water behind a dam or in expensive batteries). Electricity is consumed the instant it is produced unlike most commodities that can be put in a warehouse or stored in underground caverns and pulled out when needed.

Many factors could lead to sudden increases in electricity prices: A nuclear power plant shut down or the unexpected outage of a major generator; sudden weather changes as with the polar vortex; war in the Mideast that leads to higher heating oil prices and, because of the absence of competition from competing fuels, higher natural gas prices; and a pipeline explosion or interruption that interrupts natural gas deliveries to power plants.

Last week’s shutdown of the Colonial Pipeline illustrates the impact on markets. Colonial carries gasoline from the Gulf to the New York area. Some 80% of the region’s gasoline is carried on Colonial; the balance comes from barges and trucks. A leak in Alabama led to a shutdown. Prices from the Southeast to the New York area jumped almost immediately. Even after the pipeline is repaired it will be weeks before prices settle back again.

The nation’s natural gas supply is likewise carried by pipelines. All pipelines are vulnerable to accidental explosion or intentional attack. A pipeline shutdown immediately curtails electricity generated from power plants fed by the pipeline.

Barring a huge investment in battery storage – beyond the capabilities of any utility – electricity will continue to be subject to sudden shifts in supply and demand. That, in turn, will mean continued volatility. Given that there is more upside to prices than downside, the probabilities continue to make sharply higher prices a question of “when,” not “if.”

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