Ohio Power Market Spotlight
Last year, 15 percent of Ohio’s coal-fired power plant capacity retired due to the Environmental Protection Agency’s (EPA) Mercury and Air Toxics Standards (MATS). Data from the Energy Information Administration (EIA) states that Ohio has one of the largest coal fleets in the nation. Fossil fuel accounted for over 67 percent of the state’s power generation in 2014. Given the importance of coal-fired power plants to the Ohio power market, the large number of generation retirements in recent years would appear to be bullish for power prices in the region. However, a closer examination of Ohio power price trends tells a different story.
From January through September of this year, day-ahead (spot market) power prices at the AEP-Dayton Hub have fallen by 18 percent year-over-year due to a sharp decline in fuel prices. Natural gas prices fell to multi-year lows earlier this year amid a lingering supply glut. Coal prices also declined due to an uptick in natural gas use in the power sector that lowered demand for coal. The National Oceanic and Atmospheric Administration (NOAA) ranked June through August as the fifth hottest period on record. However, hourly power prices in Ohio still declined by three percent compared to the mild summer of 2015. Despite the highest summer load levels since 2013, the lack of price volatility this year suggests that coal unit retirements have had a minimal impact on prices in Ohio.
Forward power prices also remain near multi-year lows in spite of the evolving generation mix in Ohio. In late-February of this year, wholesale power prices for 2017-2020 delivery at the AEP-Dayton Hub fell to all-time contract lows, meaning that fixed* energy prices for these forward contract years have never been lower. During the spring through mid-summer period, Ohio power prices increased by about 11 percent as power demand increased and natural gas prices recovered from multi-year lows. Yet in July, forward prices in Ohio once again began to pull back. This eventually resulted in new all-time lows for 2017-2020 forward prices in early August. Although forward power prices for 2017 have recently increased by about five percent ahead of winter, 2018-2020 calendar strip prices remain within one percent of all-time contract lows as of early November.
Another trend of note in the Ohio power market is that forward prices have been backward-dated since June 2016. In a backward-dated market, forward prices for longer-dated contract terms trade at a discount to near-term prices. In this case, power prices in the Ohio market for 2018 and 2019 contract terms are trading lower than 2017 prices. This backwardation in the forward market implies a belief that spot power prices in Ohio may decrease over time. It also presents a unique chance for energy buyers to procure power at a lower average cost by contracting for extended terms.
So what explains the fact that spot and forward power prices in Ohio continue to trade near historical lows given the large amount of coal-fired generation that has shuttered in the state?
One likely reason is that Ohio sits above a rich supply of natural gas from the Utica and Marcellus shale plays. In fact, natural gas production in Ohio grew at the second fastest rate in the nation from 2014 to 2015, trailing only behind Pennsylvania. This source of low-cost fuel has created a major incentive for generators to build new natural gas-fired power plants within the state.
According to the EIA’s generator database, Ohio will add 4.4 GW of new baseload natural gas-fired generation to its power supply stack between 2016 and 2020. This will be in addition to the 1.4 GW that came online in 2012. Of the 25 GW of baseload natural gas-fired generation likely to be built in PJM through 2020, nearly 25 percent of the new capacity will be located in Ohio. At the same time, coal unit retirements are projected to taper off after the end of 2016.
Coal-fired generation has fallen from 83 percent of Ohio’s power supply mix in 2010 to only 61 percent last year. Natural gas-fired generation has increased from five to 23 percent of supply over the same period. This trend should continue as more natural gas-fired power plants are expected to be added through 2020, though the incentives to build new generation could change if the parent companies of Ohio utilities are successful in their efforts to re-regulate the generation units owned by utility affiliates. Without adding new gas-fired generation to replace outgoing coal plants, Ohio would need to rely on more costly generation units to meet its power demand. The new baseload generation being built in Ohio is cheaper to run at current fuel prices. It is also more efficient than retiring the aging coal units. This could result in downward pressure on power prices in coming years.
The evolving fuel mix in the state’s power sector also results in changing risks for energy buyers. Natural gas power plants make up a larger share of generation. This link between power and natural gas prices is likely to increase going forward. This means that any increase in natural gas prices will translate into higher power prices as well. As we learned from the Polar Vortex during the winter of 2013 to 2014, natural gas prices can be very volatile as generators and heating load compete for fuel supply. Energy buyers may need to rethink their risk management strategies to ensure that their budgets are protected against price spikes in both the summer and winter months.
Putting It All Together
There are many factors that energy buyers may want to consider when developing an energy procurement strategy. Some of these factors include the evolving generation landscape, quickly changing market fundamentals and regulatory vagueness in Ohio. With this in mind, here are a few things to consider when taking advantage of the long-term value in the Ohio power market.
- Avoid Trying to Pick the Market Bottom
Rather than trying to time your purchase to hit the bottom of the market, take advantage of prices when they meet your budget objectives. Waiting for an extra 25-cent decrease could result in a $1 move in the wrong direction. This is particularly true for buyers who do not pay close attention to the market.
- Layered Product Solutions
Given the long-term decline in prices, many energy buyers have begun to explore product solutions that allow them to layer in energy purchases over time rather than purchase 100 percent of their energy at a single point in time. Through this approach, customers have the ability to protect their budget with fixed* prices, but also have the flexibility to take advantage of further market declines.
- Budget Protection in Winter and Summer Months
As natural gas becomes a larger share of the power generation mix in Ohio, the potential for energy market volatility during the winter months could become a greater concern for energy buyers. Layering in fixed* prices for a portion of summer and winter usage is a key building block of a comprehensive energy risk management plan.
- Extended Contract Terms
With the recent increase in short-term natural gas and power prices, many energy buyers are adopting a longer-term approach to energy procurement. Backwardation in forward prices may provide customers a chance to reduce their average energy cost by extending contract terms into outer years where prices are still trading very close to all-time contract lows.
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*Product availability varies by state and customer class.