Normally, the price of natural gas is passed on to utility customers, whether the gas is used directly by customers of gas utilities or by electric utilities to fuel their gas-fired power plants. Even so, it is incorrect to assume that gas prices don’t affect utilities.
In general, low gas prices are good for regulated utility operations, but not good for most nonutility businesses. Here are some ways that low gas prices benefit utilities:
• Reduced likelihood of disallowances. Although the full cost of natural gas is typically recovered by utilities, state regulatory commissions can disallow costs that are considered imprudent. In 2007, MichCon, the gas utility subsidiary of DTE Energy (DTE), had $8 million of gas costs disallowed. Understandably, the lower the price of gas, the less likely that a commission will disallow recovery.
• Lower prices for customers. When the commodity portion of customers’ rates is lower, this makes it easier for gas utilities when they have to file a base rate case to recover costs of distributing gas. That’s because a decline in purchased gas costs can offset most, or even all, of the requested increase in base tariffs, thereby limiting the effect of the base tariff hike on customers’ bills. Furthermore, lower prices make it easier for ratepayers to pay their bills. This lessens gas utilities’ bad-debt expense.
• Lower working capital needs. Gas utilities inject natural gas into their storage facilities during the summer, but don’t recover the cost of that gas until it is delivered to customers when the weather turns cold. Low gas prices mean that utilities need to spend less money up front.
• Lower fuel costs for electric utilities. In some states, fuel costs aren’t entirely passed on to customers. Utilities in states such as Washington, Oregon, and Missouri have some exposure to fuel and purchased-power costs. (The price of gas often influences the cost of purchased power.) High gas and purchased-power costs hurt the earnings of Empire District Electric (EDE) for several years until Missouri passed a law allowing the state commission to institute fuel-adjustment clauses. In 2008, Empire District was granted such a mechanism, which covers 95% of its fuel costs.
• Conversions to gas heating. When gas prices are low, this increases the possibility that homeowners who use other fuel sources, such as oil or propane, will switch to gas heat.
On the other hand, low gas prices are generally negative for utilities’ nonregulated activities. Most notably, natural gas prices are typically “on the margin” in competitive markets. This means that merchant gas-fired power plants often determine wholesale power prices. Consequently, there is a correlation between natural gas prices and wholesale power prices. Depending on the hedges that a company put in place in previous years, companies with nonregulated generating assets are experiencing lower margins this year or will do so in 2012. Exelon (EXC), Public Service Enterprise Group (PEG), Constellation Energy (CEG), Edison International (EIX), and Ameren (AEE) are among the companies that are being hurt by unfavorable conditions in the power markets.
Some utilities also have gas and oil exploration and production subsidiaries. These operations are predominantly gas, so today’s high oil prices aren’t enough to offset the effects of low gas prices. Black Hills Corporation (BKH) has an E&P subsidiary. Several gas companies own gas utilities and E&P operations. MDU Resources (MDU), National Fuel Gas (NFG), and Energen (EGN) are among them.
There is one nonutility activity that benefits from low gas prices: the competitive energy supply business. When gas prices are low, many large gas users are eager to sign long-term contracts. Companies, such as Constellation Energy, that have subsidiaries that supply gas to industrial or institutional customers can command higher margins.
Traditional utilities want low gas prices for the reasons mentioned above. For a diversified utility, whether low gas prices help or hurt depends on its business mix. In most cases, though, low gas prices are a negative for diversified utilities.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.