ArrowHead Solutions – Market Price and Issue Assessment

ArrowHead Solutions Help Clients Understand Key Market Issues and Their Impact on Future Market Prices

ArrowHead Solutions for Market Price and Issue Assessment

There is so much “noise,” so many unsupported opinions and judgments offered about oil price and markets, gas price and markets, power, environment, renewables, spark spreads, market heat rates, basis differentials, etc. Which viewpoint is right? Which is just plain fantasy? Companies cannot afford to rely on opinions or judgments; there is too much at stake. Companies need a definitive method that leads to the right answer for these prices and basis differentials, answers in which they are confident.

Most relevant issues are not simple, single issues. With varying probabilities, multiple events are likely to occur. What is needed, and what ArrowHead offers, is a way to understand the market impact of a wide variety of potential events by accurately reflecting the way the markets and market agents would react to the events collectively and/or individually.

ArrowHead Solutions for Fundamental Market Prices

Companies need a confident, correct projection of future commodity prices. There are statistical methods for projecting future prices (which have proven ineffectual over the time horizon for corporate decisions. For commodities that are illiquid, extrapolation doesn’t work because there is simply nothing to extrapolate). There are traded exchanges, which have been abysmal in their ability to predict prices. There are judgmental methods; bring in the experts! But without a model with a methodology that applies economic science and reflects market behavior, “experts” offer guesses at best. Companies need a correct forecast of price periodically as part of their planning, upstream budgeting, midstream budgeting, and strategy. The need for accuracy has grown; the risk is too high without it.

Examples of Market Price Issues:

What will natural gas prices be at key locations worldwide over the next 10 years? 25 years? (For more detail, click on additional natural gas industry questions).
What will the world oil prices be over the next 40 years? (For more detail, click on additional oil industry questions).
What will power prices, spark spreads, and market heat rates be at key locations worldwide over the next 40 years? (For more detail, click on additional power industry questions).
What is the price of a renewable energy credit (REC) going to be? What is the price of a RIN going to be? What will emissions allowance prices be? (For more detail on additional REC, RIN and emissions allowance questions, see ArrowHead Power and Environment Model).

How ArrowHead Solutions Help

ArrowHead consultants use the unique Arrowhead models to calculate probability distributions over prices and quantities for the key commodities of the analysis across the decision time frame clients need. Based on what our client prefers, we use our assumptions and probabilities, or their own. It is easy to quickly modify the models to reflect alternative assumptions and/or probabilities. In a single model run using probabilities for each of the uncertain market events, ArrowHead models calculate probability distributions over prices and quantities for the commodities needed. Not only does the model provide an accurate representation of market behavior under various assumptions, it also accurately applies the calculations for the various probabilities in an integrated fashion in a single run.

ArrowHead Solutions for Issue Assessment

Every event that occurs in a marketplace affects market prices, quantities, capacity additions, and retirements. Virtually all events carry a significant degree of uncertainty. Realistically, there are no “deterministic events” in markets to speak of. Companies “hedge” against uncertainties all the time (PPAs, oil index contracts, take or pay contracts, diversification of supply, etc.). Companies must predict and understand uncertainties and how they affect prices. They must use correct probability distributions over prices. Companies ask ArrowHead how particular events will affect the markets and the decisions they need to make. For example:

Will gas price continue to be indexed to oil? Should we continue to seek oil indexed provisions, or should we start to vie for gas indexing? Are gas markets likely to tighten, leaving us holding the bag if we are not long gas? Are markets going to loosen and decrease the need for oil indexing forever? Why have these markets been oil indexed in the first place and what held those indexes together? What if market area storage expands? Do we still need oil indexing? Should we renew expiring oil indexed gas contracts? Should we ramp down our exposure to oil indexing? If Russia expands pipe into Europe, does that imperil oil indexing? If China imports gas from Kazakhstan, does that imperil oil indexing?
Do we need a PPA to build a power plant? Can we build a particular power plant and “go naked” even in energy-only markets? Do we need our capacity wholly or partially guaranteed via PPA? How big a “haircut” will we take by signing a specific PPA? Is the haircut worth it to reduce volatility and risk, i.e., does the risk reduction justify the haircut? What is the true fair market value of our plant, and what do we gain or lose in a risk-return sense with a PPA?
If interest rates go up, where will oil price go as result? If the Fed and the EU continue liberal monetary policy and low real interest rates, what does that bode for oil price? Gas price? Economic growth? If the Fed or the EU tighten monetary policy and elevate real interest rates, what does that presage for oil price? Gas price? Where are interest rates likely to go? What is the probability they will go up? Down? Stay the same? What is the connection between interest rates and commodity prices?
If Iraqi crude output increases 2.5 mmbd, what source leaves the system and how much does price erode? Who, what, and where is the marginal source of supply vis-à-vis entry by Iraqi crude? Would it be Bakken? Eagle Ford liquids? Bay of Bengal conventional? Turkmenistan conventional? German/Polish border shale gas? LNG from Trinidad and Tobago? Who is the marginal source of supply in world crude markets? (The marginal source sets the price for everyone.) Is there any regional variation? Is there any crude quality variation?
If gas burn in the United States increases by 1, 2, 5, or 10 Bcfd, how much will that drive up North American gas prices region by region? How much will it affect intra-continental basis? Is there enough low cost domestic shale gas to keep prices at today’s levels for years to come notwithstanding demand increases? Alternatively, is shale a “sweet spot” business such that demand increases will be met with increased domestic supply cost and higher price? Will increased North American gas burn quell LNG exports? Will LNG exports be viable notwithstanding high domestic demand? Will increased North American gas burn reverse direction and catalyze LNG imports? Exactly how much gas price increase will accompany the various gas burn increases?
Does Russia have market power in Europe? Does Algeria have market power in Southern Europe? Can Algeria they control Italian price? What does market power mean? When Russia puts a new pipeline into Europe, are they de facto “competing with themselves,” driving down price? Or are they holding the line because they can sustain spare capacity and thwart other entry? If they cut deliveries, do they elevate the price in Europe? How much? Do they make or lose money by doing that? If storage in Germany or elsewhere is expanded, how does that affect Russian base load and peak gas prices and quantities?
Can Chinese shale gas thwart or suppress LNG imports? If Chinese shale gas produces large and increasing volume, how much depression in domestic price will occur? Will that eliminate oil price indexing in China? How much gas from Kazakhstan and elsewhere will be displaced? What are the prospects for LNG importation into China if supply of Chinese domestic shale gas were to grow?

How ArrowHead Solutions Help

ArrowHead consultants use the unique Arrowhead models to calculate probability distributions over key commodity prices and quantities across the decision time frame our clients need. Based on what our client prefers, we use our assumptions and probabilities, or their own. It is easy to adjust the models to reflect any of the conditions or events reflected in the types of issues presented above. Then in a single model run using probabilities for each of the market assumptions or issues that must be explored, the models calculate the probability distributions over prices and quantities needed to answer questions and issues posed here (or other issues and questions). Not only does the model provide an accurate representation of market behavior under the various assumptions, but it also accurately applies the calculations for the various probabilities in an integrated fashion in a single run.