Independent Energy Consultants would like to use this month's newsletter to recap the 2006 energy markets, look into 2007, and most importantly to say thank you to our clients, vendors and energy suppliers who make our efforts possible.

We began 2006 with most energy commodities trading at historical highs. The recovery efforts from hurricanes Katrina and Rita were in full gear as suppliers feverishly worked to restore supply, refining and distribution systems. January's record warm temperatures provided some welcome relief for natural gas and heating oil consumers as lower consumption helped offset the high prices. The mild temperatures also provided respite for suppliers attempting to maintain adequate inventories and avoid delivery curtailments.

As often happens with any market, the disruptions that occurred in the previous two storm seasons were fresh in people’s minds, and caused traders to keep natural gas futures' prices for winter above $10/MMBTU. It is difficult to quantify, but the impact of the "weather-media" and grossly inaccurate hurricane forecasts helped hype the fears of many. A number of financial funds also speculated heavily in energy commodities and drove the markets for much of the year. When the end of August and early September came without any trouble in the Gulf of Mexico, the bottom fell out of the market as storm-related fears turned out to be unwarranted. Hardest hurt were the investors in Amaranth Advisor's hedge fund when they reported losses of $6.5 billion in one month alone.

The spread between financial markets and physical markets gapped to well over $4/MMBTU (winter - summer). "Normal" winter/summer spreads are less than $1/MMBTU. This wide margin presented suppliers with an attractive "storage play" and drove inventories to all time highs. Annually, three trillion cubic feet of working gas in storage by November 1st has been the recent psychological number needed to get us through the winter. This year we achieved that level in September! In fact, cavern pressures were approaching operational limits and operators had to deny many requests to inject.

As we close out the year, the first two months of winter have been very mild and natural gas prices have dropped considerably. A mixed-bag of forecasts suggest that the picture could change in January, February, and March, but only time will tell. As we saw with the blown hurricane forecasts, speculators can move the markets, but eventually fundamentals will correct it.

Electricity prices have been closely correlated to natural gas prices because gas is a common fuel source to generate electricity. Similar to natural gas, electric prices shot up, then gave back some of the increase as the year went on. It is becoming common for utilities in deregulated states to set their default Standard Offer Service price via annual, semi-annual or quarterly auctions. While a proponent of deregulation and the use of Internet auctions, Independent Energy Consultants cautions its clients not to rely on default rates. We believe the process is flawed in several ways but most noticeably because it sets rates on a day selected well in advance. The chances of that day being one of the lowest-priced trading days of the year is very slim and price changes have been very dramatic. Accepting default rates is an example of customers letting rates control them, instead of them controlling rates with a well-thought-out strategy.

The 12-month strip for natural gas futures began 2006 trading at $10.80/MMBTU and at the time of this publication was trading at $7.43/MMBTU. This 32 percent decline brings us back closer to where the fundamentals suggest. If we can escape a bad hurricane season, or forecasts of a bad season, we could see further declines in natural gas and electric prices in 2007. The most recent forecast from the U.S. Energy Information Agency pegs the Henry Hub natural gas average spot price at $7.87/Mcf for 2007. The average wholesale spot price for 2006 is expected to end at $7.06/Mcf

Looking further out, most indicators point to a continued upward trend in energy prices. In the U.S. our production and refining capabilities continue to barely meet demand and the imports we rely on from Mexico and Canada are dropping fast. The Liquid Natural Gas (LNG) technology that shows promise is facing siting problems and has not kept up with predictions. It remains only a minor contributor in our supply portfolio. The demand for energy in the U.S. industrial sector has declined in the past decade, particularly in the past five years. The growth in China and India, however, has outpaced those loses. Furthermore, electric growth in the residential sector continues to push the demand for natural gas, as it remains the fuel of choice to generate electricity.

Politics aside, the shift of power in the House and Senate next January does not look good for our energy policy - if prior voting records mean anything. The new legislators are likely to exacerbate the already difficult process of exploring for energy, drilling, siting power plants, transmission lines, natural gas pipelines etc.. There is also already rumblings of more taxation and regulation on energy producers. We may, however, see tax incentives for energy conservation projects and alternate fuel technologies.

High inventories of crude oil should keep prices in the $55- $70/barrel range. Of all the energy commodities, crude is most susceptible to geo-political forces and tensions in the Mid-East can quickly drive up prices. For now, the OPEC ministers appear united and are able to maintain a price-floor for crude. Their 1.2- million-barrel cut in October and announced plans for another 500,000 barrel cut in February 2007 are the main reasons why crude prices and the distillates that come from it (jet fuel, gasoline, etc.) have not fallen further.

The record high inventories of natural gas and crude could cause a further dip in the markets, but the longer-term outlook remains bullish. Our advice this time last year was to ride the markets in 2006, as fundamentals and technical analysis pointed to falling prices. If the weather remains mild, 2007 could present a good opportunity to lock-in longer-term fixed prices.

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