Where does this leave oil markets?
Author: Brynne Kelly 2/15/2021
Towards the end of last week, spot natural gas and electricity prices in the Midwest and Texas began to signal the upcoming cold weather event, now known as winter storm Uri , soon to be followed by winter storm Viola. For the first time in history, all of southeast Texas was set to be placed under a wind chill warning starting Sunday evening and lasting through Tuesday morning. "At this point, we really have no additional generation that we can add to the system to address the issues," said chair of the Public Utility Commission of Texas DeAnn Walker. "So therefore it comes from conservation and demand management."
The Electricity Reliability Council of Texas (ERCOT), which operates the Texas electricity grid, is asking consumers and businesses to reduce usage as much as possible from today through Tuesday. "We are experiencing record-breaking electric demand due to the extreme cold temperatures that have gripped Texas," said ERCOT President and CEO Bill Magness. "At the same time, we are dealing with higher-than-normal generation outages due to frozen wind turbines and limited natural gas supplies available to generating units. We are asking Texans to take some simple, safe steps to lower their energy use during this time."
By last Friday, spot natural gas prices at delivery locations in the southern and central US for the weekend soared to record levels.
As context, the maps below detail key natural gas delivery points (left) and electric power pools (right).
For some perspective on how historic this move in natural gas prices was, we observe spot prices over the last 3 years. Historically, the most constrained region in the US with regards to natural gas supply has been the Northeast due to pipeline capacity constraints.
Among the contiguous 48 states, Texas is the only state with a stand-alone electricity grid. Although there are four electricity grids that serve Texas, the state's main electricity grid is operated by the Electricity Reliability Council of Texas (ERCOT). The ERCOT grid serves about three-fourths of the state and is largely isolated from the other interconnected power systems serving the eastern and western contiguous United States. This isolation means the ERCOT grid is not subject to federal oversight and is, for the most part, dependent on its own resources to meet the state's electricity needs. The state's electricity supply has increased each year, but so has demand. Texas is the largest electricity consumer among the states. The largest share of its electricity retail sales go to the residential sector, followed by the commercial sector, and then the industrial sector. Three in five households in Texas use electricity as their primary source for home heating, but demand typically peaks during the hot summer months with the increased use of electricity for cooling
The cold weather sent wholesale electricity prices in Texas into the thousands of dollars per Megawatt hour for delivery the week of February 11-18 (green line below). Prior to that, daily real-time peak prices had averaged around $38.50 (orange line below). Prices for the balance of the month (February 19-28) moved up slightly, but closed at only $45/Mwh last Friday (blue line below).
Bottom line, suppliers and consumers are scrambling for physical delivery NOW.
Electricity markets represent one of the purest examples of event-driven backwardation since increases in demand must be met by instantaneous increases in supply. When the supply-side is constrained the market moves immediately to scarcity pricing due to the lack of storage resources to draw from. Price is typically an effective method of reducing demand but there is some electricity demand (like essential services) that simply does not or can not respond to price. In those cases the operators of the electric grid are tasked with allocating system resources to the most critical areas by cutting services to less essential services. This is not an exact science since the electric grid is a delicately balanced system that needs to operate at a safe frequency and voltage. Additions and subtractions to the grid affect this balance and capacity is needed to regulate them. Throw enough problems at the grid and maintaining stability across all resources can quickly become a nightmare as we saw today in ERCOT as well as SPP (Southwest Power Pool) and MISO (Midwest Independent System Operator).
As treacherous as the current situation is, it is not expected to exist in the same way in the future. This is highlighted by shift in the ERCOT North 345KV futures curve over the last two weeks. February futures spiked while the rest of the curve remained relatively unchanged.
Even commodities like oil and natural gas that have robust storage facilities can see sharp spikes in prices on any given day if those facilities are not accessible or are not located in the right place.
For a little perspective, the table below highlights how linked natural gas and power production have become since a majority of the electric generation in Texas comes from natural gas.
This bring us to crude oil markets, which might appear as a by-stander in all of this. Last Friday the scarcity pricing that rolled through natural gas and electricity markets began to work its way into oil markets. Both the outright price curve (below left) and the 1-Month calendar spread curve (below right) shifted up and closed out the week on their highs.
Why would the oil complex move higher on cold weather in Texas? This is a great question. Let's start with some energy facts.
Texas Energy Facts (per US EIA)
Texas has the nation's second-largest population and second-largest economy after California.
Texas uses more energy than any other state and accounts for almost one-seventh of the U.S. total consumption.
The state is sixth in the nation in per capita energy consumption and is the third-largest net energy supplier despite its high energy use.
The industrial sector, which includes the energy-intensive petroleum refining and chemical manufacturing industries, is the largest energy consuming end-use sector and accounts for half of the state's end-use energy consumption.
Transportation is the second-largest end user, in part because of the large number of registered motor vehicles in Texas, the great distances across the state, and the high number of vehicle miles traveled annually.
It's the fourth bullet point that supports a sympathy rally in the petroleum complex. The fear is that record cold temperatures are hitting in an area not well-equipped to deal with cold weather. For example, today ExxonMobil announced that it is initiating shutdown of its massive, 570,000 barrels per day, Baytown, Texas refinery near Houston, amid operating problems tied to a severe cold weather pattern blanketing the Gulf Coast.
The first thing that comes to mind when cold weather strikes in regards to the petroleum complex is heating oil. However, the 'South' accounts for only about 6% of heating oil demand (as of 2019 data, left chart below). Were this an abnormal cold weather event in the northeast we would expect to see more of a reaction.
Instead of demand pushing price higher, we may be dealing with supply disruptions providing support to the market as noted in the Exxon refinery issue above.
As of last Friday, 12-month backwardation in the crude oil, gasoline and heating oil (ULSD) markets were at or near recent highs (black, red and blue lines below). These markets were already reflecting the dynamic of OPEC+ supply cuts and the expectation that we have less supply online today than we will a year from now.
In fact, looking at calendar strips in both natural gas (left) and crude oil (right), it's the oil markets that have managed a larger recovery this year than natural gas. Thank you OPEC+.
Of the three commodities (oil/oil products, natural gas and electricity), oil storage is the least physically constrained and the most accessible. Oil doesn't require the type of pressurization that natural gas does and also has a lower freeze point (aka freeze-offs). Electricity storage as it exists today is significantly under-developed.
Yet, backwardation in oil continues to rise. We have entered spread territory not often seen in history without a bullish demand picture.
Bottom line, there are some serious short-term issues impacting all energy markets. There needs to be proof of concept to propel term markets higher. In oil and gas this will come from storage draws and whether or not the market believes these storage draws can be recouped as severe weather conditions subside.
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EIA Inventory Statistics Recap
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 4.30 million barrels for the week ending February 5, 2021.
YTD Changes
Year-to-date total inventory changes for 2021 stand at 1.40 million barrels, with crude oil inventory now down 16.40 million barrels for the year.
Inventory Levels
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years continue to show signs of recovery.
