A version of this Spotlight from S&P Global Platts Analytics was first published Oct. 5.
The risk premium on Chicago's winter 2021-22 basis is has been increasing over the past month, and it is now trading above the strips of the following two winters. This may be due to market concerns that in the current price range power demand, which in "normal" times can ramp up and down in response to price to help balance Chicago, may be inelastic to price. This could make Chicago vulnerable to more frequent and severe price blowouts than in other years.
--Note – This article will talk about Chicago's winter strip basis pricing in terms of "risk premium." This refers to the fact if Chicago's winter basis strip is trading at a 20-cent premium to Henry Hub, the market likely doesn't actually expect Chicago to trade this high for the vast majority of winter. For instance, leading up to last February's cold snap and price blowouts, Chicago basis averaged minus $0.12/MMBtu. But then in February there were several days when Chicago traded more than $120.00/MMBtu in excess of Henry Hub. So, the market likely knows that Chicago will largely trade at a discount to Henry, but it prices in a risk premium to account for the possibility of massive blowouts.
As the "Chicago futures basis" graph shows, basis for the upcoming winter is now pricing considerably higher than the following two winters. The graph also shows how this separation really began in late August. The timing of this is likely because late August is when Chicago's outright price for this coming winter began to push into the $5.00/MMBtu and higher range, as shown in the "Chicago winter 21-22 strips" graph. Notice how since late August, movements in Chicago's outright winter 21-22 strip price are being closely mimicked by movements in winter strip basis. As Chicago's outright price increases, so does its basis risk premium, and vice versa.
This may be because the higher Chicago's outright price, the less gas-to-coal switching possibility there is. When Chicago moves from $2.00 to $3.00, there is plenty of gas-to-coal switching available to help lower power demand in periods of supply scarcity. However, from $5.00-$6.00 and beyond, most gas plants that can turn off and be replaced by coal likely already switched at a lower price point. We can see this if we look at Gas/share of thermal loads (calculated as: [(Gas Gen)/(Gas Gen + Coal Gen)] in MISO, which is really not declining very much despite a substantial increase in Chicago cash prices.
The first, "Chicago Futures" graph shows how the basis strips for the winter of 2022-23 and 2023-24 are not seeing their risk premiums rise like this for this upcoming winter, and this is likely because with Chicago at $4.30 and $3.80, respectively, the power market should be more able to balance Chicago, so less risk premium is needed.
In sum, expect Chicago's basis price for this coming winter to continue to rise and fall with the outright price as long as Chicago is this strong.
Check out the corresponding Canadian Weekly Feature spotlight "Chicago's winter strip separating from Dawn and MichCon" that discusses how Chicago's basis increasing is causing it to separate from Dawn and other Midwest hubs.