2011: The Year Energy Fundamentals Matter Again!

As we climb out of the deep funk caused by the great recession it is useful to remind ourselves of the most common forecasting mistake—taking today’s conditions or prices and projecting them forward.  Yet we see it happen over and over again.

Just this week oil prices climbed to near $90 per barrel and someone forecasts $5.00 per gallon gasoline prices.  Natural gas prices are low due to reduced demand and moderate weather and someone else says gas is a lousy business.  We build wind and solar energy projects because that is what the government is currently subsidizing and reports of the death of coal-fired generation reverberate across the trade press.

Even Al Gore is beginning to concede that maybe the global warming hype was overdone—even though he did make millions from it and got both an Oscar and a Nobel Prize exploiting it.

Life works in cycles.

Sometimes cycles are predictable because they are driven by science or the laws of supply and demand.  Sometimes they are driven by political correctness or policy-driven subsidies as in FiTs and RPSs that turn fundamentals upside down.  In the energy business things can often be turned upside down by policies and political correctness, but fundamentals still matter.


This was a slide I often used in my public presentations at Global Energy Decisions over the eight years I served as president of its Advisors division.  I used it with Boards of Directors and management teams to remind them to think long term and not just live in the current quarter.  I used it to remind investment bankers and rating agencies and politicians or regulators that there is an energy business cycle that is as sure and true as the rising and setting of the sun and they ignored it at their peril.

That business cycle is continuous from bust to recovery to build-up to boom and back to bust. The characteristics of each stage of the energy business cycle are predictable and when applied against the fundamentals of supply and demand in a given market can be forecast.  For eight years I made a good living reminding my clients of the inevitability of the laws of supply and demand and their impact on fundamentals.

Some like traders, dismissed fundamentals as too theoretical so they lived and died on the movement of NYMEX price strips often traded with poor liquidity or speculation as their quicksand foundation.  Others like utilities were driven by regulatory policies and the fear of making mistakes so they stuck to what worked in the past even though the analysis of the fundamentals suggested changes were needed.  That is why utilities had to be dragged kicking and screaming into embracing renewable energy and have been punished repeatedly for sticking with coal.

So what does this have to do with 2011?

The economic fundamentals tell us the recession is over.  While the recovery feels weak and feeble there are new green shoots of life in the economy that suggest we are turning from bust into recovery.

The difference between this economy and the last is that we now depend upon retail sales and services for our economic growth.  We outsourced much of our manufacturing base and buy much of our needs from China and other importers. Fuel demand for power generation is now a larger driver of the economy than industrial production—so when we mess with power generation we risk the entire economy.

Our services economy is now driven by consumer confidence. The combination of falling home prices and high unemployment create a vicious cycle that causes both business and individuals to reduce debt, hoard cash and hunker down.  But the only way out of the recession funk is consumer and business confidence which unlocks that spending.

Renewable Energy is Good but Not Sufficient for Equilibrium

For the past several years about the only energy supply additions we have been able to build are renewable energy projects driven by the combined biases of global warming antipathy toward fossil fuels especially coal, a lingering bias against nuclear because of thirty year old experiences despite stellar nuclear performance since, and the unabashed bias in favor of wind, solar and other renewable energy sources.

But it is low cost baseload power generation from coal and nuclear that kept electricity prices affordable.  Today and tomorrow our politicians and regulators are demanding that we rely on higher priced renewable energy and volatile natural gas fired generation as a larger share of our energy mix.

So here we sit entering 2011 with an energy portfolio that still has a solid foundation in coal and nuclear baseload generation but little new construction planned, plenty of renewable energy projects coming on line but the sum of all that plenty is insufficient to meet our energy needs when recovery brings demand back to historic load growth and accelerates into build-up.  And natural gas prices are low today but when the recovery turns to rebuild and demand for natural gas for power generation goes up so will our energy bills.

In short, we enter 2011, in my view, with a growing risk of energy shortages based on the same factors of supply and demand being set up as caused the last boom stage of the energy business cycle in the 1990’s.  Last time we met our energy challenges by building natural gas combined cycle generation. We sold off utility-owned coal and nuclear generation to merchant power producers who invested in making them more efficient.  Largely it worked.

And it seems as if the fundamentals are telling us we are increasingly likely to repeat it. Will we see another round of divestiture of older power plants so the new owners can fix them up again?  Unlikely in the face of an endangerment finding by US EPA.  Many of the old coal plants will be retired and torn down replaced by new gas fired generation because we will need it to back-up all the wind and solar energy we’ve built to assure reliability.

Energy fundamentals still matter.