Gaming Natural Gas Prices
Here’s a business you want to be in: Selling natural gas to consumers. You wouldn’t think so, because natural gas prices are cratering. But this may be the one business where the actual commodity price is pretty much irrelevant.
As we head into winter, a whole new rate structure determines what our natural gas bills look like, courtesy of CenterPoint Energy of Houston, Texas; the Minnesota Legislature; and the Minnesota Public Utilities Commission (PUC)—with support from, believe it or not, the Izaak Walton League and other environmentalists. The story stretches back to the Minnesota Next Generation Energy Act of 2007, a law that ordered utilities to promote conservation. But the story isn’t unique to CenterPoint or to Minnesota. As of last August, 20 states had allowed similar revisions to natural gas pricing.
Natural gas hit an all-time high of $13.91 per thousand cubic feet (Mcf) in October 2005, dipped a bit, then shot up again to $13.10 in July 2008. Prices have tanked since then, falling to $3.34 per Mcf as of October 26, 2010—down 76 percent from that July 2008 peak.
You’d think your gas bill might go down that much, too. Not a chance.
Last December, the PUC awarded CenterPoint Energy $43 million in higher rates, granting the company an allowed overall rate of return of 8.09 percent and a 10.24 percent return on equity. CenterPoint, which acquired Minnegasco in 1990, supplies much of the natural gas in the Twin Cities. Xcel Energy still supplies gas to St. Paul.
That seemingly routine rate hike, put in place last July, contained two new and controversial pricing provisions: “decoupling” and “inverted block pricing,” which in one fell swoop have the potential to both substantially raise natural gas bills, especially for large residential users, and provide CenterPoint shareholders with a nearly risk-free return on their investment.
Under a traditional pricing scheme, natural gas distributors are allowed to tack a certain amount onto each unit of gas sent out to consumers to recoup operating and distribution costs: pipeline infrastructure, wages, billing, advertising, lobbying, customer service, et cetera. Generally, about 75 percent of your fuel bill was the cost of natural gas, the rest was the cost of getting it to you.
Hence, it was in the interest of utilities to encourage consumers to burn as much natural gas as possible: The more Mcfs the utilities sold, the more incremental dollops of fixed-cost recovery they could collect.
Not good, said legislatures. Let’s allow utilities to recover their distribution costs without having to encourage consumption. Under decoupling, a PUC allows a utility to charge a per-unit cost for natural gas and collect a fixed amount to cover distribution costs. But here’s the difference from traditional pricing: The PUC bases that fixed amount on projected sales, and if actual sales turn out to be lower than projected, the utility can later add a surcharge to customers’ bills to make up the difference. If actual sales are higher than projected, the utility issues its customers a credit.
Then there are inverted block rates. Environmental groups, such as the Izaak Walton League, argue that these rates are good for the poor, who use less gas (an unsupported presumption, especially because the poor might, indeed, live in the leakiest houses). Whether rich or poor, under inverted block rates, the more gas you use, the more expensive it gets, ostensibly prompting conservation.
All of this seemed like a good idea when the economy and natural gas consumption were booming. But some funny things happened on the way to these new rate structures. One was a technology breakthrough. The natural gas industry developed the ability to drill horizontally, through narrow but extremely large bands of shale, and capture gas that wasn’t available before. Even when the economy was hitting the skids, the oil and gas industry went on a land grab to lock down newly viable shale deposits. The result, as a friend of mine at the PUC describes it, is that we’re now swimming in a “virtual ocean” of natural gas. In order to retain their leases on all that shale-gas land, oil and gas companies have to be actively drilling. Greater supply, lower prices.
Now, combine that with the fact that usage is down, whether through conservation or dampened demand from a deadbeat economy. Decoupling couldn’t come at a better time for utilities; their revenues to cover distribution costs are set. The rates that Minnesota’s PUC set for CenterPoint in December 2009 are effective until the utility presents a new rate case for approval.
CenterPoint got the best of all worlds. It got to design its own inverted block pricing. When residential consumers use more gas, the price goes up—a lot; for commercial and industrial customers, not so much. High-use residential customers now subsidize not only low-use residential customers, but commercial and industrial customers, too.
Pricing models that CenterPoint filed with the Minnesota PUC show that at the lowest usage tier—pegged to average household use in the summer—gas for residential customers costs $5.98 per Mcf. The price nearly doubles to $9.91 per Mcf in the highest residential usage tier. Households using 180 Mcfs of fuel per year, about twice the forecast average per customer, will see their bills increase by nearly $171 over preceding rates. By comparison, bills for commercial and industrial customers using 265.5 Mcfs—again, twice the forecast average per customer—go up only $134.23.
That might give you incentive to conserve, but recall that under decoupling, if sales are low, CenterPoint will be adding a surcharge to your bill to collect its guaranteed revenues to cover operating costs. According to one PUC exhibit, over the two years from May 2007 through April 2009, if decoupling had been in place, CenterPoint’s residential customers would have been socked for just shy of $8 million in higher rates. Commercial and industrial customers would have seen a refund of $934,820.
All of this is a classic example of a big business taking care of the customer class most likely to complain; of regulators being pressured by legislative mandate to do something, whether it’s well thought out or not; and of admirable goals—conservation and equitable shareholder returns—being gamed in a way that tips the tables in favor of a regulated utility.
For the record, two of the five PUC commissioners voted against the rate increase: David Boyd and Dennis O’Brien. Commissioners Phyllis Reha, Thomas Pugh, and Betsy Wergen voted in favor.