Like coyotes after a wounded animal ...

April 2014

• Gas retailers are stalking residential gas buyers wounded by the sharp increase in utility gas supply charges that took effect April 1. But understanding what the utility rates represent is important to making an informed decision about offers being made by retailers.
• Utility rates adjust quarterly, and the utilities simply pass through the cost of the natural gas commodity they sell to consumers. The April 1 increase is partly due to higher prices projected for the coming months, but almost half of the increase is actually a recovery of costs incurred in January, February and March, when the cold winter forced prices to levels not seen for more than a decade.
• A decision to lock in should be based on the consumer’s tolerance for price uncertainty, not on a desire to “beat the market”.

Like coyotes after a wounded animal, gas retailers are eagerly stalking residential gas buyers wounded by the sharp increase in utility gas supply charges that took effect April 1.

The utility increases have sparked a lot of anger from consumers. Frustration with higher cost is understandable, but much of the anger at the utilities is misplaced, and based on a lack of understanding about how utilities recover the cost of the natural gas they deliver to consumers. Clearly understanding what the utility rates represent is important to making an informed decision about the offers retailers are now making.

Utilities simply pass through the cost of the natural gas commodity they sell to consumers. They do not profit on the cost of that gas. Their profit comes from the delivery service only. Financially, they are indifferent whether the price of gas is high or low. The utilities are not permitted by the regulator to recover the cost of gas price hedging programs, so they simply pass through the market price of gas.

Every calendar quarter, they seek approval from the Ontario Energy Board to adjust the gas cost in their rates. The rate change has two main components. First, they reflect a fresh forecast of what gas is expected to cost in the coming months. Naturally, utilities have to set their price to recover that expected cost. Then they add an adjustment to make up for the difference in the prior period between the price they were allowed to charge for gas and what the gas actually cost them. This adjustment can be a credit if their actual costs were lower than forecast, or a debit if their actual costs were higher. The regulator reviews and approves the rates to ensure that gas costs are passed through over time.

The big April 1 increase in utility gas costs is partly due to higher prices now projected for the coming months, as compared to the prices forecast last December for the last quarterly adjustment. But almost half of the increase is actually a recovery of costs incurred in January, February and March, when the coldest winter in 25 years forced gas prices to levels not seen for more than a decade, prices much higher than what the utility was selling gas for. So in essence, if the utility could have passed through that price instantaneously, we would have seen much higher utility bills over the last couple of months. We are now settling up for the fact that we were paying a price that was much below the market price of the gas we were using.

Nevertheless, taking Union Gas consumers in southern Ontario as an example, they will now see a price for gas something like 22.4 cents per cubic metre on their gas bill. Only about 17.9 cents of this is based on the expected price of gas going forward…the rest is recovery of costs from the prior period.

The retailer, arguably, is also looking at a cost of 17.9 cents going forward. The retailer wasn’t selling you gas last quarter, so the retailer doesn’t need to charge extra to recover costs from last quarter. So the retailer can offer you a price like 21 cents. It looks good to you, since it is below what you would pay the utility. It looks really good to the retailer, as it is well above their cost of gas. Win-win, right?

But, the catch is the utility rate adjusts quarterly, while the retailer rate is typically a 3-5 year fixed price. Will the fixed price deal be a win for you when you look back in 5 years time?

If we look in the wholesale market for natural gas – something it is hard for a retail gas consumer to do – we see that gas for 2015 is trading right now for about 15.4 cents. For calendar 2016, it is trading a little lower (yes, lower), at 14.8 cents. If these market conditions hold true, then the utility rates will be adjusted down at future quarterly adjustments, whereas the retailer contract will remain fixed at 21 cents, or whatever you sign for.

Retailers would have you believe that April’s big increase is the start of a trend of ever increasing prices, so you better lock in with them right now. In fact, prices now trading in the wholesale market suggest that the increase is just a large, but short-lived price spike in an otherwise low-priced market. Over many years, consumers have been conditioned to believe energy prices can only rise, but the fact is that natural gas is about half the price it was 7 years ago. (Source: U.S. Energy Information Administration, NGX)

Should you lock in your price? In natural gas, as in mortgage rates, analysis shows that you pay less in the long run if you do not lock in your price. The decision to lock in should be based on your tolerance for price uncertainty, not on a desire to “beat the market”. We have seen that locking in a retail natural gas rate often has meant the consumer paid hundreds of dollars more than the utility rate every year of the contract, instead of just paying more in that one year out of 5 when prices spiked.

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