The Promise and the Reality of Wisconsin Wholesale Natural Gas
In 1980, after graduating from Carnegie-Mellon University, I left a rusting Pittsburgh and moved to Houston, Texas, to seek my fortune in the energy industry. Houston at that time was in one of its boom cycles and I was promptly hired by Natural Gas Pipeline Company of America during my very first interview. As a result, except for various excursions overseas as part of the Army Guard, I have spent my entire professional life in the natural gas industry.
Last year, after retiring from the Tennessee Valley Authority and the Army Guard, my wife and I finally achieved one of our long-term goals, to move back to the North, when we moved to Madison. Like many people in my age group, I did not actually retire, but instead went to work with a local company that wanted someone with my expertise. This company
was convinced that many Wisconsin companies and institutions were in dire need of help when it came to natural gas purchasing. Little did I know how right they were in this assessment of the state of affairs.
In a little over 15 months we have performed dozens of audits looking at how Wisconsin businesses and schools purchase their natural gas. The companies range from large, well-known companies to small town operations. The schools range from large urban districts to small north woods schools. In almost all cases however, we have found significant shortcomings within their gas purchasing programs.
The first thing that struck me when we were doing audits was that very few people actually know how to read a contract. My guess is that many of us have gotten used to signing up for cell phone service or company health plans without ever bothering to read the fine print. There seems to be an assumption that someone is watching out for us even when that may not be the case. We become virtually speechless when we see client after client signing retail gas marketing contracts that basically read “you will pay me whatever I bill you”! These contracts have absolutely no protection for the consumer and expose them to greater price risk than if they had stayed with their local, regulated gas utility.
For example, one term that is common to many gas contracts is “market price”. If one goes to the definitions section of the contract this term is often defined as the price the retail gas marketer, in its sole discretion, determines to be applicable. The reality is that natural gas is traded in hundreds of locations around the country every day and those prices are published in trade papers daily. A market price should be defined as the price at a specific published location as reported in the trade papers so that it is both verifiable and auditable.
Furthermore, natural gas can be priced daily, monthly, seasonally, or annually. Daily prices are the most volatile form of pricing and can be heavily influenced in the short-term by extreme weather. Monthly prices are more stable because they average the price for a month. If a three day cold front blows through, the price is moderated by the prices traded on the warmer days of that month. If your contract simply states “market price” then it is entirely possible that you will get the highest, most volatile of these prices.
And “market price” is far from the only problem with these retail contracts. I am amazed that anyone would sign a contract that allows for “reasonable marketing fees” or for prices that “relate” to something that is in the sole discretion of the retail marketer. As six degrees of separation has shown us, almost everything is relatable. The big question comes down to whether the terms of the contract are auditable? If the pricing is not tied to industry published indexes and the supplier cannot provide data or even a calculation for the pricing, then you have a very serious problem.
The second thing that struck me when I was doing audits was that virtually no one understands the logistics of natural gas. Natural gas is like most other commodities in that it is produced in one location and consumed in another location. The old axiom “out of sight, out of mind” seems to apply to natural gas. Unlike coal which moves on the railroads, natural gas moves from production areas to consuming areas through large, underground, interstate pipelines.
As large as they are, these pipelines still have a finite limit as to how much natural gas they can move at any one time. This fact was driven home during the Polar Vortex Winter of 2013-14. During that winter the U.S. was actually producing record amounts of natural gas. The price spikes of that winter were not the result of too little gas, but rather too little space available in the natural gas pipelines. Thus, as the weather got colder prices spiked as companies bid up those last increments of available capacity with which to ship the natural gas.
But in all the audits that we have done so far, only two companies were actually familiar with this issue and had taken action to limit their exposure to this price threat. In fact this is one of the main reasons why people ask us to do audits. It is hard to say how many times we have been asked by an executive why they paid $2.70 per therm for natural gas when they thought they were hedged at $0.40 per therm.
The fact is that this is another area where unsophisticated consumers get into trouble. Unlike the gas price, which is published in numerous sources, the transportation price, known as basis within the industry, is normally only published in trade papers that most consumers cannot readily access. Therefore, the gas consumer is generally flying blind on this critical element of the delivered gas price.
This section could easily be labeled: “Who’s watching the store / schoolhouse?” We have literally been flabbergasted by an abject failure on the part of companies and institutions in Wisconsin to apply any metrics to their gas purchasing activity. The natural gas industry is one of the most transparent and quantifiable industries out there. Gas prices and the cost of gas transportation are published daily (most local newspapers publish the gas price in their business section). The last piece of pricing, the cost to deliver gas to any facility by the local gas utility, is regulated by the Public Service Commission and is available on both the utility and PSC website.
If these prices are available, then why is no one doing metrics?
In one audit, we reviewed the records of a school district that had been contracting natural gas from a retail gas marketer for 13 years. They paid more money to their retail gas marketer, than they would have paid to their gas utility, in every month during those 13 years except for the two months the U.S. was impacted by Hurricane Katerina back in 2005. Virtually all of the audits that we have done have revealed that the clients were worse off with a retail gas marketer during the Polar Vortex, than if they had simply stayed with the local gas utility. In some cases, the expenses of that winter literally wiped out years of supposed savings they had garnered from the retail gas marketer.
The big question is why have these clients failed to apply any metrics to their gas purchasing.The most obvious question should be “am I actually saving money by buying from a retail gas marketer”? With the publicly available data, that is a really easy question to answer.
The second question that should be asked is “what is my relationship with my retail gas marketer costing me”? While this question is a little more complex, the answer is relatively straightforward. Since we already know what the utility would have charged, we simply need to pull the published data for the gas trading region to find the wholesale price. Once you know the difference between the retail prices and the wholesale price, one can then determine the split of any savings.
We have done this calculation a number of times and the one constant is that the numbers always favor the retail gas marketer. (See chart at top right.) In the case of Company C, a Milwaukee company, the difference between the wholesale prices and the retail prices represented 24% of their total gas spending with 20% going to the retail gas marketer and just 4% going to the company.
As a practical matter, if you have a sound gas contract, your purchases from the wholesale market should beat the utility cost by ~10% to 15% on an annual basis. Those should be the assumed savings during periods of low prices such as the one we are in now. However, if you have a good contract, those savings should be greater during higher priced periods such as the recent Polar Vortex winter.
I have a sign that hangs in my office that says, “If you think it’s expensive to hire a professional, wait until you hire an amateur”. If there is one area of expertise that this applies to in
Wisconsin, it is natural gas purchasing.
The bottom line is that saving money on your natural gas purchases is entirely possible. However, it requires an expertise in contracting and industry knowledge that is missing in many institutional situations. Many companies seek outside experts to help them with their health plans and other complex decisions. After what we have seen over the last 4 years, they would be well served to also seek out independent expertise to help with their natural gas purchasing.