The horror stories told by commercial and industrial companies this Halloween involved high natural gas prices rather than ghouls and goblins. Gas consumers are struggling to adapt to $7-9/MMBtu natural gas and to the dramatic changes that have taken place in the market over the last four years, according to energy service providers.
“Many customers traditionally bought gas month-to-month and seasonally to try to put together a budget forecast and so on, but the market has changed such that you really need to take a much longer term view of the market,” said Andrew Fellon, co-founder of Fellon McCord Associates, which is now owned by Constellation Energy and manages energy for about 2,800 large commercial and industrial facilities across Canada, the United States and Mexico.
Mike Senff, director of business services at Direct Energy, one of the largest multi-state providers of deregulated retail energy services in North America, said a lot of commercial and industrial customers are “a little shell-shocked by what has happened with prices.”
He said many of them are “in the same boat” because they were waiting this summer for prices to fall. Storage was rising rapidly and was above historical averages. Even with the Gulf of Mexico infrastructure damage from Hurricane Ivan they were still bearish. After all, the weather was mild and the gas that was shut in wasn’t really needed. “But they have been stunned by what they have seen,” Senff said.
What they should have done and what they can still do is think longer term, both Senff and Fellon agreed. “Instead of thinking about buying molecules they really should consider their energy purchases as risk mitigation,” Senff said. “They should lock up their variable pieces, their physical delivery costs first, and then look at some potential longer-term hedging strategies that give them the flexibility and the ability to lock into a fixed price over time. That’s really how we are counseling customers today.”
Senff noted that about 80% of gas consumer costs are commodity costs today. He recommended locking in a geographical index-based price or a Nymex-plus price for physical delivery and then putting together a strategy that involves some kind of cap on prices to avoid a catastrophic event. “Then they should look at a way to lock in a lower fixed price when Nymex retreats,” he said.
“The key to having that flexibility is that you have to lock into a long-term variable-priced product with the ability to convert to fixed. Too often we see customers who wait until the end of their contract and then struggle with the idea of locking into a fixed price when it’s just not available. Meanwhile, if they had locked up onto a variable-priced contract they would be able to take advantage of the market when it dipped.”
Other options for customers include more sophisticated derivative products where they still lock into physical delivery with a long-term contract but begin to look at some risk mitigation strategies that involve price collars.
“There are a lot of customers that are very concerned right now,” said Senff. “They look at their budget and start to understand what the true cost of energy is going to be for this winter. We haven’t had anyone come to us and say, ‘If I get a $12 gas price this winter I’m going to go out of business.’ I don’t know what their internal conversations are, but they are not telling me that. But you can see it on their faces.
“The one thing we always try to counsel customers on is that there is no derivative in the world that is going to change a $10 market to a $6 market. It just doesn’t work like that. A lot of time customers think there is a magic silver bullet out there to change this market but it just doesn’t exist.”
Fellon said oftentimes his customers will tell him that they are very conservative in their energy purchasing but then he later finds out that they have not done any hedging or locked up any physical gas under forward contracts at a fixed price. “Their actions are speaking to a very high-risk tolerance mentality, not a low-risk tolerance mentality.”
He said the biggest thing that customers should be doing right now is looking at the longer-term market, looking for some value in the forward marketplace. That’s not easy when you just paid $4.60 for gas three weeks ago and now the price is three dollars higher. It’s not easy finding value in the forward market when January 2006 is at $8.12, January 2007 is $7.38 and all of next year is more than $7.15.
But even $9.90/MMBtu for January delivery could be a good value for a customer if they don’t have any other choice, Fellon noted. “You know $9.90 is better than $12/MMBtu. It’s all relative.”
He said a lot of commercial and industrial companies knock on his door requesting a formula for success, one they can punch into a computer. “They want us to weigh all of the different factors that are there, plug in the data and spit out an answer. Well as you and I both know, that’s not the case; that’s not how it works.
“What they need to be doing is looking out into the future to those parts of the market in that forward pricing where there is a lot less volatility than what you see today but still adequate liquidity in the marketplace, and discern what is representative of what is going to be good value for natural gas, or other energy sources, at that point in time when they are actually going to consume it.
“When we put in those hedging programs and lock in pricing for them, the market will ebb and flow up and down from that pricing level over time so there may be some opportunity costs along the way and there are definitely some cost savings along the way, called the mark-to-market value. That’s how the customers need to look at the market.”
Â©Copyright 2004 Intelligence Press Inc. Allrights reserved. The preceding news report may not be republishedor redistributed, in whole or in part, in any form, without priorwritten consent of Intelligence Press, Inc.
© 2023 Natural Gas Intelligence. All rights reserved.
ISSN © 2577-9877 | ISSN © 1532-1266 |