Predicting Electricity Price Trends

Guest Blogger: Kathy Kiernan
Senior Vice President & Managing Partner, APPI Energy

Retail electricity prices are largely driven by natural gas prices. Even though your system operator (PJM, ERCOT, MISO, NEPOOL) is procuring power from a variety of sources—hydroelectric, wind, solar, nuclear, coal, gas—the way system operators pay generating plants is based on the last fuel used to meet demand, which is almost always natural gas. Therefore, the amount you pay per kWh is determined primarily by the current price of natural gas in your region. 

Retail electricity prices tend to follow trends in natural gas prices. Gas prices, however, are significantly more volatile than electricity prices. For example, when we see gas prices fluctuate by as much as 70% in a single month, corresponding electricity prices will generally move in the same direction, but by only around 10%. The change in electricity prices will also typically lag behind gas prices by a couple of weeks.

In the financial sector, the “volatility index” of a stock, commodity, or asset is a statistical measure of the uncertainty or risk associated with rapid and/or dramatic changes in the security’s value or price. Over the past 12 months (Feb 2016 – Feb 2017) the volatility index for NYMEX natural gas futures was 5.7%, and 7.0% for Henry Hub spot prices. The volatility index for the national average benchmark price of retail electricity during this same timeframe was only 1.4%.

What does this mean? The use of gas prices in short-term forecasting often overestimates the extent of change in electricity prices. Gas prices are therefore a better indicator of longer-term electricity price trends than they are predictors of short-term price shifts. Rule of thumb, for a 10% shift in gas prices anticipate electricity prices will move in the same direction by only 2-3%.

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