Oct. 1—Wholesale power prices typically track with natural gas—the dominant fuel source for marginal power supply. While correlated, the wholesale power market analysis can be misleading due to other factors such as capacity, transmission, losses, and a variety of ancillary services. Regional differences further complicate the analysis, and the lack of a single market index, which the NYMEX provides for natural gas, creates additional ambiguity.

For the first time in the modern era, power demand fell for two consecutive years, in 2008 and 2009 (down 4.7 percent). The fall coincided with record added wind generation capacity, increased participation in demand response programs, and 6,500 megawatts (MW) of new coal-fired generation. In 2010, demand recovery has been stronger than predicted. Obviously, much of 2010 power demand which is up 4.7 percent has been weather driven. Most estimates put 2010 power demand growth from factors other than weather at roughly 1.8 to 2.2 percent. It is clear that the regions most heavily affected by the recession are gaining the most in the recovery based on improved industrial production, including the Southeast, Gulf and Midwest. But, with two years of decline, it will likely take several years to recoup the demand loss without the aid of weather.

Interestingly, power prices have not moved commensurately with the industrial demand improvement that has been obscured by the weather (and the parallel drop in natural gas prices). That suggests the impact of added generation capacity which grew in 2008 and 2009, and continues to grow. One could argue forward power prices do not support the build-out of new generation facilities…period. Regardless, 2010 will see almost 5,000 MW of extra coal-fired and 4,000 MW of additional wind generation capacity.

Forward power prices are still dominated by changes in natural gas prices and have fallen despite increased industrial and weather-related demand. The capacity increases imply an additional layer of weakness. Even with unanticipated, substantial gains in demand going forward, the power market is unlikely to tighten for several years. Efforts to retire significant volumes of coal-fired generation are meaningful, but also not expected for several years. Therefore, we anticipate that power prices will continue to track with natural gas—with both remaining low through calendar year 2011 and perhaps into 2012.