What’s Driving Energy Prices?

whats driving electricity pricesEvery morning I wake up and check the financial news to get a sense of what is driving the market. This week several stories caught my eye that I believe are notable, as we try to understand where the energy markets will go in the short-term, as well as over the next couple years. My forecast is pretty simple. There is a 100% chance that fear, uncertainty and doubt (FUD) will dominate the fourth quarter, and it will be December before we will see any chance of stabilization and the opportunity to make an informed assessment about the future.

The Gold Story

There has been intense debate as to whether we are headed for deflation, inflation, or hyper-inflation. Gold is often cited by analysts when making their case one way or another. Gold finally breached the $1300 an ounce mark, and many of the gold bears are finally changing their outlook. As the dollar weakens, and worldwide uncertainty around currency persists, gold appears to be building solid support on fear alone. Fear, uncertainty, and doubt (FUD) about monetary policy, and the ongoing disputes over currency manipulation has investors fleeing to gold, simply as a way to preserve value that may otherwise be eroded. It appears that the collective wisdom is that the dark clouds have no chance of parting anytime soon, which means gold really has no reason to decrease in value through at least 2012, except for periodic corrections. Adjusted for inflation, gold would need to break $2000 before it started to resemble a real bubble. To me, the important point is that FEAR has overtaken fundamentals, and technicals as the ptimary driver of investor decision making around owning precious metals including gold and silver.

Meredith Whitney Identifies Financial Crisis of the States

So Meredith Whitney became famous for predicting, with a great degree of accuracy, the banking crisis that brought the US financial system to the brink in 2008. She is a prominent advisor to hedge funds, banks, large institutions, and the like. Whitney just released a 600 page analysis that predicts the states (as in the states that comprise the United Sates of America) currently pose the biggest systemic threat to our economy. In a recent interview, Whitney said that her evaluation of the states reminded her “so much of the crisis with the banks”, and that she had “no doubt” about the seriousness of the threat.

In fact, Whitney felt so convicted about the situation that her boutique firm created this report, unsolicited. The report is appropriately labeled “The Tragedy of the Commons”, and provides the most in-depth analysis to date, of the 15 largest states in the country. Only Texas, Virginia, Washington and North Carolina received a favorable rating. As for the rest of the states profiled, California, Ohio, New Jersey, Michigan, Illinois, Florida, Georgia, and New York, the ratings were all negative. The good news for Texas, is that Whitney touted Texas as being in the best shape by far.

In a nutshell, things look very bad for most states. The massive gap in budgets versus projected tax revenues presents an imminent threat of default. The magnitude of the shortfall is estimated at close to $200 billion, and Whitney believes that those who fail to recognize the problem, and connect the dots, do so at their peril. It is housing that was the catalyst in the banking meltdown, and it is also the source of the problem for the states. The bottom line is that housing is just the first of many dominoes that lead to massive budget shortfalls. The cascade leads to higher unemployment as construction, and mortgage lending comes to a screeching halt, while foreclosures spike, and the death spiral continues. Something has got to give. It will be revealed in the next 12-18 months how this story plays out. Will it mean another multi-trillion dollar bailout by the federal government? Will we see municipalities default on their bonds? Will states be forced to cannibalize pensions, and other state funds? Stay tuned…

Politics as Usual

It looks like the congress will delay a vote on extending the Bush tax cuts until after the November elections. This ensures that the fear, uncertainty and doubt (FUD) impacting every decision that businesses make will persist until at least November. Without knowing the most basic rules of the game (tax rates), there can be no real recovery. The lame duck session will be very interesting, to say the least. With the expected purging of many current members of congress, there is no telling how the votes will go. Having lost re-election, many democratic lawmakers may choose to buck the party line. The problem is that it is really hard to tell what the party line is, and whether the outcome of the elections will encourage smart economic decisions to guide the votes, or if votes will be cast in a final blaze of glory along ideological lines.

What Does it Mean For Electricity and Natural Gas Prices?

Electricity and natural gas prices will likely trade sideways until we get past the elections, and we can begin to make better assessments about what our economic policies will look like. If the democrats maintain control, one might reasonably assume that FUD will persist as the pursuit of change continues. If a sufficient amount of democratic seats are won by republicans, or independents, it may create just enough gridlock to give businesses the certainty to make some decisions to get things moving again; putting capital to work, borrowing and hiring. If this is the case, it may very well serve as a turning point, where prices firm up in the natural gas market and we see an end to the multi-year bear market that has pushed prices to their lowest levels in the past 8 years.

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