Cool down

Published at 21:15 23 Jul 2019 by . Last edited 11:18 22 Aug 2019.

Overview

This summer has brought heat and humidity but not high prices, at least so far. Our forecast is slightly above market forwards in PJM and New York, though renewed declines have narrowed that gap of late. New England term prices are higher than our expectations, meanwhile, as demand has disappointed and renewables will continue to grow.

The record heat has missed Texas so far this year, and that continues to weigh on near-term and forward prices, ameliorating concern about tight reserve margins. After the coolest June in more than a decade, temperatures have failed to reach the triple-digit level often enough in July to test the ability of the current generating stack to meet peak air-conditioning load. Early August is typically when demand peaks in ERCOT, but near-term outlooks do not promise hot-enough weather to put risk premiums back in the market, which is the key to forward market heat rates and prices climbing toward our forecasted level.

Forward prices in the eastern markets will struggle to move significantly higher without signs of real-time market volatility, quick implementation of planned market rule changes or a dramatic increase in coal retirement plans. There are no signs of any of these factors on the near-term horizon. Our view on forward markets in PJM is now above current marks following the dramatic sell-off that finally abated in early July. Cal-20 on-peak prices at PJM Western hub dropped by 20% from mid-April to late June before recovering modestly early this month. Continued below-normal degree-days, the plunge in prices of both natural gas as well as that of coal, and the resulting lack of market volatility contributed to the decline. The return of cooling load this month renewed some buying interest at both the front and back ends of the forward curve, though prices remain sharply below levels seen at the end of winter.

Despite a hotter-than-normal first two-thirds of July, all the eastern markets (PJM, NYISO and ISO-NE) have seen lower power prices at similar load levels compared to July 2018. We do remain modestly constructive on heat rates compared to the forward curve for 2020 and 2021, though. The upcoming PJM capacity auction—barring approval of long-pending new rules the ISO submitted to FERC in 2018—should clear lower y/y and push some excess coal generating capacity out of the stack. However, further changes to coal and nuclear capacity are taking longer to develop than the low energy market margins would indicate.

Energy market rule changes pending at FERC, which drove forward market gains in PJM from late 2017 through last winter, are also taking longer to materialise than some had expected. Fast-start reforms were due to be filed at the end of this month and implemented before winter, but both timelines are now in doubt. More substantive reserve pricing rule changes were submitted to regulators earlier this year, but the debate that prevented a majority from backing the proposal within PJM is now being aired out at FERC, raising questions over whether and when those will be approved.

Nevertheless, private equity has shown continued interest in picking up older coal units in PJM at a fraction of the cost of new gas-fired capacity, and the remaining utility owners are evolving their fleet, but at a very slow pace. AEP set a target this month to retire one of its two massive, 1.3 GW Rockport (Indiana) coal units, but not until 2028. The transition to renewables and lower-emitting generation will continue but take longer than developers and states in the Northeast would like, keeping reserve margins high and limiting the potential for scarcity events.

In New England, the second wave of offshore wind development is underway, but already hitting some of the same roadblocks the aborted first wave hit nearly a decade ago, when Cape Wind was under contract but not able to get under construction. As Vineyard Wind hits its first two setbacks, New York and New Jersey have awarded even bigger offshore contracts, though all this new capacity is not likely to generate electricity until the mid-2020s at soonest.

Fig 1: PJM heat rates, mmbtu/MWh Fig 2: PJM Western hub power on-peak, $/MWh
Source: Bloomberg, Energy Aspects Source: Bloomberg, Energy Aspects

 

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