The natural gas supply market is very mature and includes a robust network of suppliers and producers nationwide. Despite the established market place, you may find yourself in a natural gas deal that is not competitive and doesn’t fit your needs well.
Before initiating any natural gas procurement process, you should define your organization’s strategy, which, determined by the factors discussed below, will help you strike the lowest cost deal while exposing you to the appropriate level of risk.
Product and Risk Tolerance
You should consider two key factors when choosing a product: your company’s risk tolerance (price and volume) and the unique volatility of the natural gas region in which you consume gas. The chart below represents the most common volume and price options ranging from the most price certainty (left) to the least price certainty (right).
If you are comfortable with predicting usage and want to lock in 100% of your costs for budget certainty, a fixed price product will work well. A fixed price product locks in the NYMEX (commodity) and basis (regional adder) costs. On the inverse, if you are not able to accurately predict usage and have the risk appetite to accept daily market pricing, a Gas Daily price may work well. A Gas Daily price does not lock down any aspect of cost.
Most commonly, end-users tend to gravitate towards a fixed basis product, which provides basis price certainty while allowing the NYMEX to float with the monthly market. This product typically allows for you to fix NYMEX portion of cost during the term of the deal as well.
When determining if you should float on the monthly index or gas daily market, you cannot ignore the geographic region in which your facility is located. This region dictates the pricing volatility of that market.
For example, the Northeast has historically been a highly volatile market due to heavy winter heating demands and lack of pipeline infrastructure. As such, a monthly index (regional) price could range from $1.93/MMBtu to $9.69/MMBtu, which is a swing of $7.76/MMBtu. (Aug15 and Feb15 respectively, for gas delivered into New York). In high demand areas, you would generally want to avoid entering in to an index or gas daily deal, even if usage volumes are challenging to predict. The potential for unexpected high prices in these markets is typically more risk than end-users wish to assume.
Term (Length of Deal)
In most regions of the country, suppliers are willing to offer prices for physical gas for periods varying from one month up to five years in duration. Once you decide on an appropriate product(s), you need to evaluate the fundamental pricing factors of the region to decide whether a short- or long-term deal provides the most value.
Some fundamental factors that can dictate pricing for demand region include natural gas production, pipeline infrastructure, natural gas storage levels, and weather forecasts. For example, the past few years (2013 – 2015) have been an ideal time to lock long-term supply deals in Northeast Ohio due to increased levels of natural gas production in the region with no new pipelines to carry supply to alternate demand centers. In the last six months, pricing has been on the rise as two major pipeline projects, Rover and Nexus, have progressed. These projects will move gas out of the region into higher priced areas such as Chicago and Michigan.
Generally, clients will choose deals for a term of one or two years dependent on pricing opportunities in the region. Your risk management strategy may also weigh into your decision regarding term length. End-users who execute physical hedges may execute a supply deal if the NYMEX is priced right. Many companies have broader risk management policies requiring long-term natural gas supply coverage.
While product, structure and term are crucial elements of a natural gas procurement strategy, many end-users forget to consider supplier choice, incremental pricing and contract terms. While the market offers many supplier choices, not all suppliers or their offers are created equal. It is important to award your deal to a reputable supplier who has a deep knowledge of the pipelines and utilities that deliver gas to your facility. Your supplier must be capable of reliably delivering gas to your facility while minimizing the risk of penalty.
In addition, any incremental pricing for the contract (above or below contract value) should be stated at a transparent price that can be audited against a published index. Many suppliers offer incremental pricing as an opaque and vague “market” price. Incremental pricing can be a significant driver of cost. Vague pricing terms can be difficult to challenge.
Lastly, it is crucial to perform a thorough evaluation of the final contract that will be signed. Often, suppliers will push maximum risk to the end-user in their standard agreements. End-users can negotiate for better terms that place risk back on the supplier.
Once target product and term length have been established, you should begin to monitor the market for an opportune time to initiate a supply deal. Based on the fundamental and technical market factors, a goal price should be targeted for market entry, providing your company the best chance to capture market savings and meet your company goals.
In today’s complex energy environment, smart energy management is vital for your organization’s success. In order to meet cost, risk and resilience or sustainability needs, organizations must have an advisor who can deliver independent, comprehensive, expert and data driven energy solutions.
To find out more about how to get independent, comprehensive, expert and data driven advice on your natural gas supply management, contact Edison Energy today.