No doubt you’ve noticed how much your utility bill has skyrocketed.
It’s due, in part, to the ongoing efforts of natural gas deregulation that began in the Reagan era and culminated in the early 1990s when natural gas futures started trading on the NASDAQ.
Before deregulation, utilities companies artificially set prices, and only larger gas end-users negotiated price breaks.
“It was an old boys’ network. Those with good plans saved money, and smaller companies bore the brunt of the risk,” explains Kenneth Rasmussen, account manager for Armarata-Hess, a natural gas production, distribution and marketing company.
Things have definitely changed in the last few years.
“Natural gas contracts have become more like futures,” Rasmussen says.
And the best laid plans of lower cost and competitive prices were stymied by a lack of utility infrastructure growth, cold winters, hot summers and a generally volatile stock market.
“It’s a tricky market right now,” he says.
Conventional wisdom — as well as traditional market indicators that have allowed businesses to gauge when to buy natural gas contracts — have taken a back seat to conservative long-term planning.
“That ‘just give me a number’ attitude is disappearing,” Rasmussen says. “What they are finding is that the lowest cost now does not always mean you will pay less in the long run.”
There are seven variables that drive the natural gas market.
“The first, needless to say, is weather,” Rasmussen says. “It is a double-edged sword. Both winter and summer impact it.”
Storage is another variable. Typically, gas is funneled into storage during the summer months to supplement needs on peak winter days. Private storage companies use this peak demand to raise prices and generate profits.
Basic supply and demand affects prices, as well.
Unseasonably warm or cold weather, coupled with a strong economy and a drop in production, has proven that the old laws of supply and demand do, in fact, work. That’s where the market as a whole factors in.
“It is a natural phenomena that if the market gets to a certain low point that investors will step in and buy the contract if they see opportunity to invest and make money. It is like hedging your bets on buying gold contracts,” says Rasmussen.
Recently, the market has seen some of the highest rates of volatility in history, with swings both up and down. Prices have fluctuated from the $2 range to more than $10, and these fluctuations affect the overall long-term price. Rasmussen says he is not overly optimistic about the future.
“Right now, we do not see volatility disappearing,” he says. “We are going to see dramatic price swings both upward and downward, probably for the same 18 to 24 months, based on storage, demand and weather.”
Current and future prices also affect the market.
“It’s kind of an emotional issue,” says Rasmussen.
He likens it to people’s reaction to gasoline prices. After paying $2 a gallon, anything less seems better.
Now that everything has changed and prices are high, what can a business do to hedge its costs when buying natural gas? In today’s market, Rasmussen suggests rethinking the way businesses purchase utilities.
“It is a changing market out there, and it causes people to re-evaluate how they are doing things,” he says.
Strategic planning and careful consideration of market indicators and price tolerance are key. The amount of risk any business owner takes needs to be based on the how much of the product cost is derived from energy purchases. Rasmussen uses recent events as an example of how trying to play the market can backfire.
“In 1998, natural gas prices dipped to their lowest point in five years, and people thought it was going to get lower in the summertime,” he recalls.
What actually happened is that the price went from $2.51 to $9.97 in nine months and the market hasn’t seen prices dip like that again.
The scenario can be complex, depending on the specific needs of each company. However, Rasmussen says, a strategic plan can be developed to hedge against rising prices.
One option is to set margins in the market. The margin has triggers to buy at both the high and low ends of what a company wants to pay. Triggers hedge against high prices, while allowing a business to work within a preplanned budget.
“They will probably not get the absolute lowest price in the market, but what they may get in the long run will beat the market 80 percent of the time,” Rasmussen says.
What is probably the most profound difference in the natural gas market today is that the end of summer season prices are the lowest of the year. Recently, business owners who waited to buy gas until the summer, “thought that prices are lower in the summertime, and historically, they were; before 1997 it worked out financially.”
But with hotter summers, more air conditioners and different market conditions, that is no longer true.
Another method of watching energy costs while getting a manageable price is to buy contracts in percentages. Taking into consideration a client’s short- and long-term objectives, and current and future market indicators, Rassmussen sometimes suggests buying energy contracts in part.
“If somebody is using 20,000 units a month, we will buy one-third for that month at the current price, then buy another before the winter if we were worrying about prices rising, while leaving the last third open in case the market drops lower,” he says.
The key is careful analysis of the market and setting triggers so a business is not caught at the end of an upward price swing.
“We re-evaluate (market prices) every day,” Rasmussen says.
Whatever approach you take, there’s no overemphasizing the importance of a long-range plan.
“Plan further out because you have more time for all of these market fundamentals to play into your hands,” Rasmussen says.
In some cases, that means buying contracts two, three or even five years out. Historically, even a contract of 18 months was deemed too long, but that seems to be changing.
“From the conversations I have with more and more of my customers, they are not afraid to get into long-term contracts,” Rasmussen says.
And why not? With no end in sight for market volatility, your business simply cannot afford to get caught short-sighted. How to reach: Armarata-Hess, (440) 461-3523
Kim Palmer ([email protected]) is managing editor of SBN Magazine.
