A Cool Summer Could Chill Energy Prices

 | Jul 14, 2014 | 5:00 PM EDT  | Comments
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This summer's energy demand may be lighter than expected. If forecasts are correct, less electric power, natural gas and coal will be consumed. Lower demand implies lower prices for basic fuels, including nuclear, wind, solar and energy efficiencies.

The issue is weather. The weather has been cooler than expected. Specifically, the drop in energy consumption is about declining "cooling degree days."

According to the National Oceanic and Atmospheric Administration, cooling degree days are based on the day's average temperature minus 65. For example, if the day's high temperature is 90 degrees Fahrenheit and the low temperature is 70 degrees, the day's average is 80 degrees. Subtracting 65 from 80 produces 15 cooling degree days.

Of course, the industry needs more detail. Utilities need more than simple averages. Their daily calculations are more complicated. They also track regional differences.

No matter how they are calculated, cooling degree days are important. Hotter weather means more cooling degree days. Hotter weather means consumers use more air conditioning. Hotter weather and higher cooling degree days also mean consumers will use more electricity in the summer season. And the summer season is when power producers expect the year's greatest demand.

Any change in expected cooling degree days is a big deal. It means energy producers will sell different amounts of their product at different price points.

This year, there could be a surprise. According to EnergyCAP, this summer's cooling degree days are expected to decline. Midwestern cities' cooling degree days are expected to be about 25% lower than last year. East Coast cities expect to be about 30% less than last year. New England cities could be as much as 40% lower.

If these forecasts are correct, independent power producers should see lower sales at lower average prices. This suggests that companies such as Exelon (EXC), NRG Energy (NRG), Entergy (ETR), First Energy (FE), PPL Corporation (PPL) and American Electric Power (AEP) could have disappointing third-quarter earnings from these markets.

Independent power producers are the tip of the spear. Lower sales and lower prices suggest disappointing earnings for upstream fuel companies such as Southwestern Energy (SWN), Chesapeake Energy (CHK), EQT (EQT), Range Resources (RRC) and others that have natural gas operations in the Marcellus and Utica regions. On a delayed basis, the falloff could also affect CONSOL Energy (CNX) and Peabody Energy (BTU).

Regulated companies are protected. Local distribution utilities that are owned by companies such as Consolidated Edison (ED), National Grid (NGG), Northeast Utilities (NU), CMS Energy (CMS) and DTE Energy (DTE) should be immune from slumping demand.

Watch Weather and Natural Gas

When it comes to weather, forecasting is fraught with uncertainty. Combining weather forecasting with guessing commodities futures is an order of magnitude more difficult.

The good news is that investors do not need to forecast the weather, commodity prices or anything else I order to profit. They just need to pay attention to weather as actual data are collected and reported. On average, if this summer is significantly cooler than previous years, then it is likely that energy companies' top-line revenue will be lower than many expect.

To validate this, watch the weekly reports of working gas in storage. The Energy Information Administration publishes storage data each week. You can see the Weekly Natural Gas Storage Report here. If storage numbers increase more than expected, the power grid's marginal gas-fired power plants were not used as expected.

Marginal gas-fired power plants are important because they are inefficient, they consume a lot of natural gas, and they are expensive to operate. Marginal gas-fired power plants are used only when prices are high enough to cover costs. If they are used, demand is high.

Finally, any significant reduction in energy consumed this summer could have an impact next winter. One example is natural gas. If gas inventories are restored, energy prices would fall. They would fall for heating consumers. They would also fall for power producers, and that would lower power prices for consumers.

In the end, consumers win. Industrial, commercial, government and residential consumers could see lower energy prices, and that would help stimulate the economy.

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