Wednesday, April 08, 2009

Time for the PSC to Reconsider its Policy of Volatile Pricing of Natural Gas

Today's Newsday story, Natural Gas Prices to Plummet in May, draws attention to the gap between current high utility charges for natural gas and much lower wholesale rates, such as the NYMEX monthly rate. The utility rates are expected to drop soon, but the change will not occur until after the heating season.

Utilities have a portfolio of supply for their retail residential and small customers, purchased in advance. Typically, the supply portfolio is made up of a combination of gas in storage bought previously, gas bought under contract in advance, and short term purchases for cold spells. Utilities may also use other methods, such as financial derivatives, to lock in future prices. Thus, it is normal and to be expected that there will be a gap between short term wholesale prices, which could be higher or lower than the utility price. When short term prices go up, the utility price should go up slower (due to the part of the portfolio purchased in advance at lower prices) and when short term prices go down, as they now have, the utility price will come down slower, again, due to the part of their portfolio that was acquired when prices were higher.

What few people realize is that over the past decade, the Public Service Commission, in a misguided effort to drive customers into buying gas from ESCOs, adopted policies to flow through short term price swings to utility customers, starting first with the largest customers, and eventually planning to do the same for all residential and small business customers. This deliberate introduction of price instability, volatility, and price spikes in order to foster competition is contrary to principles long embedded in statutes which militate for glacial changes in utility rates, least cost gas purchasing, and price predictability. The destruction of price transparency and predictability to promote "competition" is roundly condemned by NASUCA in its resolution on introduction of competition and provider of last resort pricing.
the introduction of competition does not diminish the essential role which continued electric or natural gas service plays for residential households or the unacceptability of any customer having fewer opportunities to obtain service or greater hardship than would have existed before the introduction of competition ****residential customers participating in these competitive markets should have access to a regulated service that is comparable or equivalent to the service previously available **** [Utilities should] not simply pass through wholesale spot market rates for the energy or gas commodity portion
A major advocate of exposing all customers to volatile, spiking, and sometimes manipulated short term wholesale gas markets was Enron. After the demise of Enron in 2001, the New York PSC put on hold its plans to roll out price volatility. Then, in 2004 the Commission again renewed its deregulatory thrust, and issued an order in which it recommitted to the Enronian vision of driving all utility customers to ESCOs for deregulated electricity and natural gas. As stated by then PSC Chairman WIlliam Flynn
[I]n January of this year, I revived the "competitive markets" proceeding and the Commission made key policy decisions in August 2004 in the following areas:
· Its vision of the end state, which includes utilities becoming primarily transmission and distribution providers over time; **** and a transition of default commodity service toward a pass through of short term market prices for all customer classes, starting with the largest customers. Ultimately, we see ESCOs providing hedges. Utilities that enter into long-term contracts to retain market share will do so at their own risk.
In its August 2004 Statement of Policy on Further Steps Toward Competition in Retail Energy Markets, Provider of Last Resort, Retail Competitive Opportunities, the Commission recognized that moving immediately to a system of flowing through spot market natural gas prices to residential customers would not be acceptable to the public, giving lip service to the notion that small customers should be protected by continuation of portfolio purchasing practices, but then said at page 33 of the order that the maximum advance purchase of natural gas should be only for "a year or so."

In fact this was not really a continuation of traditional gas portfolio purchasing practices but was a major deviation from them.

To their credit, National Fuel Gas and Con Edison sought rehearing, pointing out that natural gas prices are cyclical and that to achieve the goal of least cost purchasing, and to provide the price predictability and stability needed by residential customers, they needed to smooth out spikes (and dips) in the volatile wholesale short term markets, requiring significant longer term purchases three or four years in advance.

National Grid, still an adherent of the Enron model, did not join the other utilities in their protest. (Testimony in the Niagara Mohawk gas rate case, now pending, indicates that Grid does not arrange for gas purchasing more than one year in advance, following the guidance of the PSC).

The PSC rejected the rehearing requests of NFG and Con Edison in 2004. As a result, when short term natural gas prices skyrocketed last year, utilities were buying much of their supply for the 2008 - 09 winter at those very high prices. If they had a more balanced portfolio with some long term supply, the effects of the 2008 short term price spike - which some believe was not due to fundamentals of supply and demand, but to hedge fund speculation - would have been dampened.

For many natural gas customers living on fixed incomes, without savings to absorb the cost of price spikes, the result is disastrous for their family budgets. It should come as no surprise that utilities are experiencing unprecedented arrears balances, that utility terminations exceeded 330,000 in 2008, and are likely to increase in 2009.

With natural gas prices much lower now, this is a good time for the utilities to again act in the interest of their customers and begin prudently to acquire a portion of their wholesale supply for more than "a year or so" in advance.

To be sure, short term prices could go down even lower than they are today . But the potential for further downside movement is limited, while volatility and the upside price risk are likely to cause far greater harm to customers in the future. And it would be a good time for the PSC to reflect on policies and the harm they cause to residential and small business customers by introducing unpredictable prices in the name of helping ESCOs, and to reconsider its ratemaking philosophy.

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