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Will Low Prices for Natural Gas Cause Gas Utilities to File for Rate Cases?

May 9, 2012

The sharp and sustained drop in the level of natural gas prices has caused a significant decline in utility rates. However, the levels of gas utility revenues have also declined. Will reduced revenues from low natural gas prices engender more gas utility rate cases? The answer is no; indeed low natural gas prices will tend to lessen the frequency of cases.

What accounts for this counterintuitive conclusion? The reality is that lower revenues induced by the decline in gas prices generally do not impact the earnings of gas utilities. Changes in the price of the gas commodity are passed along dollar-for-dollar to customers via gas adjustment clauses. Therefore, reduced revenues from lower gas prices do not impact a utility’s gross margin (i.e., revenues minus the cost of gas obtained by a utility for its customers). Since gross margins are unaffected by changes in gas prices, the earnings of gas utilities are similarly insulated.

However, margins and by consequence earnings are very much affected by the number of customers a gas utility serves. This is because profits are derived from the act of delivering volumes of gas to customers, not from the price of the commodity. Low gas prices are causing residential and commercial customers to convert away from more expensive energy forms, particularly fuel oil. Conversions to gas produced over 8,000 new National Grid customers in New England during that utility’s recently concluded fiscal year. This was a 61% increase from the prior year. UGI in Pennsylvania has been adding roughly 1,000 new customers per month from conversions, up fifty percent from its last fiscal year. Conversions at Boston’s NStar have tripled during the past three years.

Conversions tend to be quite profitable for utilities. This is because these customers are usually located in close proximity to existing gas mains, thereby mitigating the incremental investment for connections. New Jersey Natural Gas, for example, realizes about $400 in additional gross margin per year for each residence that it converts to natural gas. During the first six months of the current fiscal year, this utility converted 2,048 customers, up from 1,360 in last year’s comparable period. Indeed, vibrant customer growth is a major reason why the utility has no plans to file a rate case in the foreseeable future.

Industrial customers are also turning to natural gas. NiSource, which serves major portions of the Midwest, delivered ten percent more gas to industry during the first quarter of 2012 relative to the year-ago period. Lower gas prices were a major factor. Last year, Piedmont Natural Gas in North Carolina acquired 28 large customers via conversions away from oil and propane. Several major industrial concerns in Northwest Natural Gas’ service territory recently converted to natural gas.

A specific example of an industrial conversion from fuel oil to natural gas is provided by a major chemical plant in New England with a workforce of nearly one-hundred. The owner ran a pipeline from the local gas utility to the plant. When completed last November, the $1 million project was expected to have a very attractive payback of one-year. However, in the ensuing months, the price ratio of oil to natural gas has steadily widened, and is now near historic levels. This has yielded enhanced savings for the project, producing a payback expectation that is now outstanding. Besides helping to ensure the plant’s ongoing competitiveness, the project has reduced emissions by thirty percent. Utilities Analyses, Inc. recommended the switch to natural gas, and provided assistance that was instrumental to the project coming to fruition.

Lower utility bills produce a drop in bad debts. This is another benefit to gas utilities from reduced gas prices that in turn decreases the likelihood of a rate case filing.

The favorable implications for utility earnings from lower natural gas prices has lowered the likelihood of upward adjustments in gas utility rates. To the extent that rate increases can be avoided or moderated, customers of gas utilities will benefit accordingly. The advantages conferred by low gas prices are multi-dimensional and pervasive. It is in the interest of customers to capitalize fully on the low natural gas price environment by retaining experts who can optimize the sourcing and usage of this energy resource.

Ken Eisdorfer

Since 1986, UAI has provided energy supply management services that reduce utility costs for multi-site industrial, commercial, and governmental customers.  UAI’s core team of unbiased utility rate analysts and deregulated energy procurement experts manage over $2 billion in annualized energy spend and are focused on lowering the cost of utilities for end-use customers. UAI’s comprehensive energy cost management services include deregulated energy procurement, utility rate analysis, utility bill auditing and overall utility bill processing services that result in reduced energy costs and measurable utility savings. For more information on Utilities Analyses, Inc., visit www.utilitiesanalyses.com

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