Energy Market Overview for Newbies
The Federal Energy Regulatory Commission agency oversees the interstate transmission of electricity, natural gas, and oil. FERC also reviews proposals for liquefied natural gas terminals and interstate natural gas pipelines in addition to hydropower projects. For consumers and investors who are not familiar with the ins and outs of the energy sector but want to learn, FERC recently published a 140-page "Handbook of Energy Market Basics," which you can find here . I found this to be a great resource which discusses the topics of natural gas, wholesale electricity markets, oil, financial markets, and market manipulation.
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Natural gas
For the month of April, U.S. generation of electricity fueled by natural gas surpassed coal-fired generation for the first time ever. The average fuel share of natural gas in 2015 is expected to be 31%, up from 27% last year, while coal's annual share of U.S. generation is expected to average 36% in 2015, down from 39% in 2014. This illustrates the growing importance of natural gas in meeting the country's energy needs.
The table above depicts the percentage of U.S. electricity generation split by coal and natural gas from 2010 to 2016's projection.
The handbook delves into the importance of the shale revolution in increasing the supply of oil and natural gas. The major shale plays are pictured above. It discusses the infrastructure necessary to transport natural gas. The graphic below illustrates the "roughly 303,000 miles of wide-diameter, high pressure inter- and intrastate pipelines make up the mainline pipeline transportation network, run by more than 210 companies."
Multiple factors affect the cost of natural gas. FERC touches upon the mechanics of exploration and production, liquefaction, shipping, and storage, as well as factors that influence demand. The total cost of natural gas ranges from $2 to $4 per MMBtu (million metric British thermal units). The graphic below breaks down natural gas price by component.
Wholesale electricity markets
FERC's handbook discusses the supply and demand of individual electricity markets and touches upon the differences in geographic region. It starts with the basics of electricity generation for people new to the subject. It explains the different ways electricity is generated with natural gas power plants, steam boilers, gas turbines, nuclear plants, and renewable sources. The handbook then goes into specific policies and pricing mechanisms in each geographic region. The North American Electric Reliability Corporation is a not-for-profit international regulatory authority that is responsible for the reliability of the electric grid in North America. The picture below shows how North America's electric grid is divided by region.
U.S. crude oil markets and financial markets
FERC's handbook discusses the U.S. oil industry in an easy-to-digest manner by touching upon the production, refining, consumption, and transportation. Crude oil accounted for about a third of primary U.S. energy consumption in 2014. The sulphur content in crude oil determines the type of oil with sweet oil having less sulfur and sour oil having more sulfur. The table below shows the difference in sulfur content for the different types of crude oil.
Much of the oil produced in the U.S. is sweet crude. However, many U.S. refineries have equipment that is more suitable for refining sour crude. "During the 1990s when domestic U.S. crude oil production was declining, refineries along the Gulf Coast spent billions of dollars to reconfigure their equipment and operations to handle imports of heavy, sour crude oil from Mexico and Venezuela."
As a result, refineries along the U.S. Gulf Coast import sour crude. The graph below shows how light crude imports have steadily declined since 2009.
For the subject of financial markets, FERC explains how natural gas, electricity, and oil are traded on commodity exchanges like the New York Mercantile Exchange. It discusses market mechanisms and concepts like leverage, liquidity, open interest, clearing, settlement, and the financial instruments involved.
Parting thoughts
Earlier this year, I wrote a post where I researched my first coal company, Alliance Resource Partners (ARLP), and tried to determine if it was a potential investment opportunity. The company is a regional coal producer with most of its revenues derived from Illinois Basin Coal. The first questions I needed to answer were "Where was ARLP's average selling price for coal headed? Which direction was volume produced headed?" Those weren't straightforward questions to answer because the price of natural gas affects the price of coal and vice versa. The price of oil affects the transportation costs of coal. The electric markets which ARLP serve have unique power generation and logistical characteristics. All of these considerations affect demand for ARLP's product. Simply put, the energy market is complicated and there are many competing factors which make outcomes extremely difficult to forecast. As an investor, not knowing your blindspots is one of the biggest risks. FERC's handbook is a great introduction for anyone interested in the energy industry. You may be surprised at what you learn.
This article first appeared on GuruFocus.
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