I had the recent pleasure of speaking on evaluating risks in uncertain energy and commodity markets, at the ZE sponsored Argus Americas Coal Summit in Miami last week. In today’s global market environment every event has a multitude of interrelated risks, which act like a ripple effect spreading out from that single event. Just like waves, as multiple events occur, each event’s wave pattern will impact the others. This superposition will cause some waves to completely cancel out and others to double in amplitude. Such as it is with risks. Global events impact one another either by escalating particular risks or mitigating them.
An event to have dramatically impacted the coal industry is the boom in shale gas, particularly in North America. The emergence of this cheap and abundant fuel supply has affected energy markets around the globe. Coal, which had already been under pressure from new emissions reduction programs, has been particularly affected. The increase in supply of four dollar natural gas plus pressure on coal from environmental standards has caused demand to decrease dramatically as can be seen in Average US Coal Prices vs Henry Hub Gas, where the price of coal correlates highly with the price of natural gas.
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Figure 1: ICE Henry Hub Gas Price vs. EIA Coal Price – data collected, analyzed and graph produced on ZEMA |
An interesting counterpoint to the decline of coal prices is the resiliency of crude prices which rebounded after their decline in 2008. With oil production inside the US continuing to rise and limited pipeline capacity available to get the crude to market, a gap has opened between West Texas Intermediate and Brent Crude oil (see Average US Coal Prices vs WTI and Brent).
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Figure 2: EIA Coal Price vs WTI and Brent Crude prices – data collected, analyzed and graph produced on ZEMA |
Another event which has the potential to affect commodity markets in an unpredictable manner is the persistent drought conditions across the US. Conditions in many parts of the central US are suffering from exceptional, long term drought conditions according to the US Drought Monitor. Along with these conditions, food prices have increased dramatically over the last 10 years and are expected to continue to rise sharply unless conditions improve. This could lead to civil unrest and overall more risk to markets.
The continued emergence of China as the single largest net energy importer will further add risk as global markets become tied to the policies and purchasing habits of a single importer. While many in North America are chasing the Chinese market it is important to remember that despite having a natural long position they have one of the largest shale gas deposits and access to markets in Russia, Africa, South America and Europe.
Aside from these market drivers, risks often derive from unpredictable crisis and that has been consistent for centuries. Whether it is war, terrorism, financial meltdown, or bursting bubbles, crisis is a consistent phenomenon.
So what does all of this mean? With everyone building infrastructure in the rush to get shale gas to market, does this mean that it will be a buyers markets for many years to come? Will North America get access to Asian and European markets and how will sub four dollar gas impact economies around the globe? The only certainty is that there are multiple outcomes and all of our future views, curves and outlooks must reflect this. So while the technical task of tracking risks rippling out from an event may keep your boat afloat, hang on to your seat, the fundamental waters look pretty choppy.