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Articles Archive
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June 2004
Yep, Still Risky
By MATTHEW FRYE
Prices of crude oil and natural gas, the No.1 and No.2 energy commodities consumed in the United States, have skyrocketed over the last 14 to 18 months. Crude prices - subject to world markets - have been and will continue to be impacted by tighter supplies and increased demand worldwide, particularly from China.
Natural gas prices are basically a North American supply-demand imbalance phenomenon that has seen its share of swings and increasing monthly averages. Inherent in both commodities' price escalation and volatility is the need for increased risk management in a variety of areas: price, volume, credit and operations.
Ever since December 1998, when crude reached an historic low of just over $11 per barrel for West Texas Intermediate, the price has gradually increased. In recent years, OPEC (Organization of Petroleum Exporting Countries) has learned how to regulate production to increase prices. Consequently, crude prices have risen to the $20 and high-$30 per barrel range.
GAS PRICE VOLATILITY
At the same time, natural gas prices have continued to fluctuate dramatically due to increased demand and the perception of supply shortages. While the deregulation of natural gas transactions within interstate markets began in earnest in the early 1990s, gas prices have floated between more than $l/MMBtu to slightly more than $3/MMBtu before heading to much higher levels in late 2000.
Prior to 2000, volatility meant an occasional spike to over $3/MMBtu. But from late 2000 to early 2001 natural gas prices jumped to a monthly average of more than $8/MMBtu for Gulf Coast wholesale gas, according to Jofree Energy Consultants. Eventually, a new pricing paradigm began in late 2002 after prices had decreased from the highs of 2000-2001, and gas prices leveled off at $5/MMBtu.
Despite reaching monthly average highs of $7 to $8 in early 2003, the current outlook calls for about $5/MMBtu as the new low range for gas prices. The one-time low of approximately $2 is an historic relic, and exploration for new gas resources in unproven fields and the need for increased imports of LNG to match U.S. demand can only lead to higher natural gas prices.
TIGHT GAS SUPPLIES
In a recent presentation to the National Petrochemical and Refiners Association's annual meeting in San Antonio, the administrator of the U.S. Energy Information Administration (EIA), Guy F. Caruso, forecast that both natural gas and crude oil prices would remain high. With regard to natural gas prices he said, "The U.S. doesn't have enough LNG terminals or regasification capacity to help ease prices or supplies in the near term."
It is well known in commodity trading - or any market for that matter - that increased price volatility means increased risk. Under the old market dynamics for natural gas, daily price fluctuations were generally in the range of pennies. Today, with higher prices, movement can be close to a dollar and can have a far more significant impact on cash flow and solvency.
The energy trading meltdown that began in late 2001 has been difficult to overcome even as new companies, traditional and financial-based, fill the wholesale energy-trading void. High-profile trading failures have marked the industry with significantly higher and more volatile prices, increasing risk for remaining players. Further, the lack of counterparties, the huge credit crisis and meltdown of the over-the-counter markets have reduced liquidity and increased price spreads.
ENTER PHYSICAL TRADERS
A fair share of trading has shifted to physical players. The asset-management and back-office activities once outsourced by many of these pipe and wire companies now are being brought back in house, adding new levels of complexity to these organizations' IT requirements. Since their focus has widened beyond supporting the logistics of moving and accounting for product, they now require software to manage price exposure. From trade capture to risk management, settlement, logistics and even accounting, the need is now greater than ever for straight-through-processing (STP) software to properly control and manage risk.
Sarbanes-Oxley compliance issues also must be dealt with. Patchwork solutions that require significant manual input or integration must be improved or replaced to deal with these new business dynamics. Investment in a robust, STP software solution links the numerous commodity merchant activities of today's advanced physical energy companies into a single processing environment that allows stringent control over risk, regardless of its source.
Matthew Frye is Managing Director of OpenLink's Houston division. He has 20 years of experience in energy markets, including trading, risk management and operations software.
Copyright © 2004 Hart Energy Publishing. All rights reserved.
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