Natural gas prices key to Utilities’ future

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The price of natural gas includes the cost of exploration, transportation, taxes and operating margins for companies that supply it.

What’s the more significant economic driver in Colorado Springs: gas prices — or gas prices?

To be clearer, are we more affected by the price of gasoline, or the price of natural gas?

We all know what gasoline costs, because we buy it directly. The price we pay includes all costs — exploration, production, refining, transportation, taxes and operating margins for the companies that cooperate to make it available to consumers.

We shop for the best price in a robustly competitive market. Many convenience stores offer “kickback” cards, which give customers modest gas discounts. King Soopers and Safeway offer shoppers as much as $1 per gallon credit, depending on supermarket purchases during the past month. Oscillations in gasoline prices can cause either delight or, to trot out a hoary journalistic cliché, “pain at the pump”.

Natural gas is different. Within the city limits, you’re limited to a single monopoly supplier, Colorado Springs Utilities. Private vendors will sell you propane for your outdoor gas grill, but CSU owns and controls the municipal gas-delivery system.

The municipal utility, which operates two gas-fired power plants, supplies natural gas to all commercial and residential customers in the city.

CSU doesn’t make a profit by selling consumers natural gas. Its job is distribution, system construction and maintenance, and safety.

Fluctuating numbers

But how much do we pay for natural gas? Do our bills reflect the vagaries of the market, rising at times of high demand, and declining as demand recedes? Residential consumers, based on a wholly unscientific office-wide survey, don’t have a clue. They know that it’s expensive to heat their homes, but the relationship between natural gas prices and home heating costs is opaque.

If our heating bills seem high, we blame ourselves. Thermostat set too high, house badly insulated, need new windows, etc. And if bills are low, we credit fate — guess it wasn’t that cold, after all!

It doesn’t occur to us that the price of natural gas makes more difference to our pocketbooks than does the price of gasoline.

A residential bill received by the owner of a rambling, drafty Westside Victorian home covered the period from Dec. 11 to Jan. 13. It showed total use of 47.6 thousand cubic feet (mcf) of natural gas. How much should that cost?

CSU billed the homeowner $6.04 per mcf, for an unadjusted gas cost of $287.22. Two separate “gas cost adjustments” lowered the bill to $227.90, but four separate “access charges” raised the total gas bill to $311.55.

A more typical residential bill would show an unadjusted gas cost of $100. But if gas prices stabilize at or near today’s low spot prices (currently $3.03 per mcf), every homeowner would see dramatic savings.

The actual price paid by Colorado Springs consumers is a function of the “city gate price,” the amount paid by CSU when it receives natural gas from a transmission pipeline. But that price is fluid and elusive, as producers, pipeline companies and end users seek to cut beneficial deals.

Reasons for hedging

CSU must have absolutely certain supply sources that won’t cut deliveries during times of high demand. At the same time, the utility wants low prices for its customers. Those conflicting priorities are reconciled by complex hedging strategies based on a single overarching principle: No one knows what natural gas prices will be in the future.

In past years, gas prices have fluctuated wildly. As Duke Energy CEO Jim Rogers remarked: “Ben Franklin said there are two certainties in life: death and taxes. To that, I would add the price volatility of natural gas.” Since 2008, the wellhead price — the price of gas as it comes out of the well, without processing or transportation — has ranged from $1.96 to $12 per mcf.

So volatile is the price of natural gas that the simplest hedge is extremely expensive, as Lisa Huber notes in a recent publication by The Rocky Mountain Institute:

“Theoretically, the price of a straddle contract — combined at-the-money put and call options — should represent the price of volatility. These contracts aren’t cheap — buying straddles two years out on the NYMEX curve costs 20-25 percent of the underlying gas.”

In times of oversupply, spot gas can be extremely cheap compared to gas locked up in long-term contracts. But it’s a jungle out there for any users who haven’t adequately prepared for spikes in demand, as customers in the Northeast discovered last Monday when spot gas for immediate delivery reached $31.50 per mcf.

Between 2002 and 2010, CSU’s gas purchases amounted to $1.22 billion, or approximately $150 million annually.

CSU’s hedges were brilliantly successful until 2008, when gas prices peaked at $12 per mcf and then declined precipitously, driven lower by recession and increasing supply. Hedging had protected the utility against the long rise in prices between 2002 and 2008, but upside protection inherently limits downside opportunities — that’s just the way hedging works. Thanks to plummeting gas prices from 2008-2010, non-hedged costs over the eight-year period would have been $43 million less than the hedged costs.

“We’re talking about big numbers here,” said CSU’s Bruce McCormick, who heads the enterprise’s energy services division. “We spend about $350 million annually on fuel, and our hedging programs serve as insurance.”

With relatively stable gas prices, CSU has shortened the length and volume of its gas hedges.

“We don’t see any significant risk (of gas price increases) in the short term,” said McCormick, “and we feel we have good assurance of supply. (Our goal is) to assure price stability and availability to our customers.”

Natural gas’ price outlook

Low gas prices, if they persist, might have profound economic effects upon this community. Businesses and consumers could see direct benefits in the form of sharply lower utility bills, and the bitter community debate over the Drake Power Plant might quickly end.

Asked about Drake’s future, CSU senior manager George Lewis was blunt.

“It all depends on the price of natural gas,” he said.

Low prices and a tightening regulatory environment might doom Drake, and eventually Nixon as well. Ideally, we could have cheap electricity, cleaner air and a revived southwest downtown — what’s not to like?

Alas, those low prices may be gone before we’ve had time to get used to them.

Earlier this week, Bloomberg reported that “Royal Dutch Shell and Kinder Morgan Inc. will form a company to export liquefied natural gas from a site in Georgia. El Paso Pipeline, controlled by Houston-based Kinder Morgan, will own 51 percent of the entity and operate the facility. Shell, based in The Hague, will own 49 percent and buy all of its output. Project costs weren’t disclosed.”

A half-dozen such deals have been announced recently, signaling a profound market switch. American-produced natural gas, once isolated from world markets, will be exported in large quantities. In all probability, that’ll eventually push up prices and impact home heating prices in Colorado Springs.

Too bad — those low prices were great, even if we never noticed that we had them.