To paraphrase a quotation attributed to Mark Twain (aka Samuel Clemens), everybody talks about the weather, but nobody seems to agree about the forecasts. Will El Nino warm up the Northeast and cool off the South and wreak havoc on utility and natural gas earnings? Will the Pacific Northwest have less rain this winter? And, most important, will the snow stop long enough in the Northeast to shovel the walkways clear for a day?
Weather forecasts in the past few days may have left some to wonder what tomorrow really will bring. Last Monday, financial analysts with The Williams Capital Group LLC warned that the (so far downplayed) El Nino phenomenon is growing and “likely” will turn the Northeast warmer this winter and play havoc with utility and natural gas companies’ earnings by the first quarter of 2003. Mid-week, weather forecaster WSI Corp. issued an updated short-term forecast predicting cooler-than-normal temperatures for the eastern third of the country, and El Nino probably coming into play toward the end of the heating season. Friday, well known weather analysts Jon B. Davis and Mark Russo of Salomon Smith Barney (SSB) offered up their short-term winter outlook, predicting that the current winter weather will evolve after the next few days into near-to-slightly-above-normal temperatures through the end of December.
Taking a little bit from this one and a little bit from that one, it’s perfectly clear: winter is here and it may be bad or it may not be. Just like all the other years. All of the scientific models still provide at best short-term weather predictions. Overall, here’s what the latest forecasts portend — at least in the short term:
At SSB, Davis and Russo reviewed the week through December 4, and found that heating demands in the “key energy usage quadrant from new York to Chicago are running significantly above normal,” by 5-10%, and “well above the levels of a year ago,” or 30-50% above this time last year. For instance, in Chicago, demand is 6% above normal and 34% above last year. In Dallas, demand is 12% above normal and 64% above 2001. Denver’s demand is 12% above normal and 31% above last year.
However, along the West Coast, SSB found that comparisons are “much different.” In San Francisco, current heating demand levels are 17% below normal and 4% lower than a year ago. In Seattle, demand is 3% below normal and 5% below last year. Calgary’s demand is 14% below normal.
“The pattern since the third week of November has featured strong troughing over the eastern portion of North America and strong ridging over the western portion of the continent,” said the SSB analysts. “This pattern has been very persistent due to jet stream stability over the remainder of the Northern Hemisphere. It has been a classic high amplitude pattern which implies that the regions that are warm are very warm (western U.S.) while the regions that are cold are very cold (eastern U.S.).”
What this means, they said, is that the western United States will continue to show a warm bias while the East “continues to be unseasonably cold during the next five-six days.” However, by the middle of the month, the pattern “is going to lose amplitude and become more zonal (west to east jet stream flow).
“There will be some weak troughing in the eastern U.S. and some weak ridging in the western U.S., but these features will not be nearly as strong as they have been since the middle of November. As a result, we will lose the temperature extremes of late and switch into an environment that will feature near-to-slightly-above normal temps across most of the country.” In fact, the analysts predicted that “temps are going to revert to the mundane as most areas of the country experience near-to-slightly-above-normal readings.”
As to how long and how much, Davis and Russo said, “we feel that the pattern that will evolve next week [beginning Dec. 9] will remain in place through the end of the month. We would term this an extended period of time.” From a longer-term standpoint, they said they would be “watching for the development of further MJO wet cycles during the remainder of the winter,” and if that occurs, “and we emphasize if, then the central and eastern U.S. would potentially get into a colder pattern sometime in January.”
In contrast, WSI’s three-month winter forecast calls for cooler-than-normal temperatures now and into February in the eastern third of the United States, as well as in the southern and central Plains (e.g., Phoenix, Denver, Dallas, Houston, Little Rock, Kansas City, Chicago, Detroit, Cincinnati, Atlanta, Miami, Boston, New York, Washington, DC and Philadelphia).
WSI sees warmer-than-normal temperatures in the West Coast states and northern Plains (e.g., Seattle, Portland, San Francisco, Sacramento, Los Angeles, Billings, Bismarck and Minneapolis).
A higher heating demand for most of the winter “will increase regional power loads and natural gas demand, thus pushing prices up, in the Midwest, Plains, Northeast and Mid-Atlantic,” according to WSI.
WSI’s latest winter forecast failed to mention El Nino, which other forecasters, including the National Oceanic and Atmospheric Administration, predict will cause warmer-than-normal temperatures in the Northeast and Plains, and cooler-than-normal temperatures in the Southeast. However, WSI seasonal forecaster Todd Crawford said that El Nino will play a role in winter weather, especially cooler Southeast temperatures, but WSI is “less confident” in the warm northern tier prediction because of El Nino’s relatively weak magnitude.
Crawford said that El Nino will play a part in the forecasts, but does not expect that to begin to occur before the end of December. Crawford noted that if the Energy Security Analysis Inc.’s forecast of $5-plus per MMBtu gas prices at Northeast gas hubs (Algonquin, Transco Zone 6 and Tetco M-3) holds, “heavy fuel oil-fired steam turbines could become competitive with combined-cycle gas turbines and limit power price spikes in PJM, New England and New York.” Above-normal temperatures in the West “should keep regional electric power loads and gas demand moderate.”
WSI, a subsidiary of Landmark Communications, expects the following monthly trends:
WSI’s Energycast seasonal forecasts are now being issued using the trailing 10-year (1992-2001) average temperature as “normal,” reflecting a sentiment in the energy trading industry that the last 10 years are more representative of future weather than the U.S. government standard 30-year fixed (1971-2000) averages. The next WSI seasonal forecast, which will cover the period January-March, will be issued on Dec. 17.
Meanwhile, analysts with Williams Capital believe that the next El Nino, which has been strengthening in the past few months, could “severely” impact first-quarter earnings of electric and natural gas utilities, pipelines and marketers.
In fact, the 16-page review found that on a few utilities in southern and southwestern U.S. states are “likely” to avoid the adverse effects on natural gas demand that the coming El Nino is expected to produce this winter.
According to the 16-page report by analysts Christopher Ellinghaus and Ida Fiumefreddo, the National Oceanographic and Atmospheric Administration (NOAA) expects an El Nino this winter, even though so far “one could not tell by the weather.” El Nino would bring warmer-than-normal winter temperatures to the Northeast, Midwest, northern Rockies and Pacific Northwest.
“We do not believe that management guidance or Street estimates, for nearly two-thirds of the [power and natural gas] universe, reflect the potential havoc El Nino could play on earnings in 2003,” said the analysts. “Lower potential earnings would affect liquidity and cash flow in an already constrained environment,” and “extreme uncertainty” in 2003 earnings could lead some stocks to “react badly to the additional strain of earnings further reduced by El Nino.”
The Williams Capital analysts believe that the media has not yet “capitalized” on the anxiety that El Nino produces, noting that the cold Northeast temperatures make it “hard to imagine that the U.S. is likely in for an abnormally warm winter. Yet, another El Nino event is on the way and most people are not yet aware of the developing surprise.” NOAA, they said, has been tracking El Nino’s development since last spring and is “warning” that the system is strengthening.
Now considered unlikely to match the El Nino of 1997-1998, NOAA has described the current El Nino as moderate but gaining strength. It also has been “very unpredictable” in the past, the analysts said. “Only one fact is certain…the vast majority of scientific and government authorities are expecting a significant weather disturbance this winter in the United States.”
El Nino’s primary influence, they said, is on surface temperatures. In this case, NOAA is forecasting warmer-than-normal temperatures throughout the Pacific Northwest, Plains, Midwest and Northeast. The middle continent is expected to have normal temperatures, while portions of the deep South, including parts of Texas, Louisiana, Mississippi, Alabama, Georgia, South Carolina and Florida, will have normal to below-normal temperatures.
Also affected by El Nino are precipitation patterns. The NOAA is forecasting that parts of the Pacific Northwest, including parts of Washington, Oregon, Idaho, Wyoming and Montana, and most of the Rust Belt states in the Midwest will have below-normal precipitation. The deep South, southern California, southern Nevada, New Mexico, Arizona, Oklahoma, Texas and parts of Arkansas, Missouri, Nebraska and Kansas will have “abnormally” high precipitation. The rest of the states are forecasted to have normal precipitation, with below normal trends in Hawaii.
“Unfortunately, most of the effects of El Ninos [in the past] have a deleterious impact on energy company earnings,” said the Williams Capital analysts. “The effects of the previous El Nino were felt from the fourth quarter of 1997 through the fourth quarter of 1998. The first and fourth quarter earnings for electric utilities can be significantly reduced, particularly in the northern states.”
Those expected to be “punished” by the warmer weather will be natural gas utilities and pipelines in the largest domestic gas consuming regions. In the first quarter of 1998, analysts noted that natural gas consumption by residential consumers declined over 15%; many electric and gas utilities showed an average decline in year-to-year earnings per share of 6-7%. Gas local distribution companies also experienced a 7-8% average decline. Utilities also showed 10-20% declines in operating earnings.
However, the cooler southern temperatures gave gas and electric utilities in those regions an average increase in earnings for the first quarter of 1998 of about 7% over the previous year’s first quarter.
Although they believe it is “safe to assume” that this El Nino will not be as significant as the last one, “the anecdotal evidence certainly suggests to us that El Nino has arrived,” said Ellinghaus and Fiumefreddo. “The potential storm damage, lower energy demand and lower commodity prices likely associated with the current El Nino should have an adverse effect on energy company earnings that are incremental to the issues currently plaguing the sector. The likelihood of negative comparisons at this time of extreme earnings uncertainty for our distressed sector is unfortunate.”
In 1998, said the analysts, “utilities had advance warning El Nino was coming and far more capacity to manage earnings than they do today,” adding, “we fear that negative surprises await.”
The Williams Capital report assumes that heating degree days this winter will be down 5-10% from the norm. Natural gas consumption “is very difficult to forecast…but we suggest that gas demand could fall two [to]three times the decline in heating degree days, or perhaps 15-30% if the El Nino’s effects prove moderate.”
On natural gas prices, the analysts expect a “late winter drop” to $3.50/Mcf or less as the full effects of El Nino’s warming materialize. However, as the economy “presumably recovers” next year, prices will rebound.
For electricity prices, there will be a “commensurate” decline with the gas price fall, “at least temporarily.” Also, the higher temperatures in some northern states “should also produce a decrease in electricity demand in some regions” like the Pacific Northwest, where electricity is used for heating.
Finally, the U.S. energy infrastructure also is likely to see adverse effects from El Nino, said analysts, with storm surges, mudslides and flooding in California and the Gulf states affecting transmission and distribution assets.
“Unfortunately,” they said, “very few electric utilities, natural gas distributors, energy marketers or natural gas pipelines will likely escape unscathed from the developing El Nino.” The “only conceivable beneficiaries” will be power and gas utilities in the South, Gulf Coast and Southwest.
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