the energy wiz: DID YOU CATCH The Brass Ring?
MORE THAN USUAL, FORESIGHT REALLY DID PAY OFF LAST WINTER.Opportunity knocks when least expected, but only those who are prepared will reap its benefits. One example is the recent reversal of natural gas and oil prices.
In October 2005, this column (written before Katrina and Rita) warned of high winter natural gas pricing but suggested that readers position themselves for likely price drops in the late winter or early spring. At the time, the tightening supply/demand margin for gas, and its recent history of high floor prices, pointed toward another high-priced winter. None knew at that point, however, what the worst natural disaster to hit the U.S. in a century would do to energy prices.
NATURAL GAS PRICES JUMP, THEN DROPNatural gas users saw bills jump anywhere from 30% to 70% in the months that followed. Due to high fuel oil pricing at the same time, even those with dual-fuel capabilities did not fare well. But then, just as some were returning from Christmas and New Year's holidays, the weather shifted. Where gas use is heavy, high winter temperatures yielded (for much of the U.S.) one of the warmest Januarys on record.
NYMEX forward gas prices dropped over 10% in three days, and another ~30% in the following three few weeks. While nearly all gas used in the U.S. comes from North American wells, much of our oil is imported, making its pricing subject to international markets. Oil prices thus remained generally high during most of the winter and into the spring, dropping only briefly (Figure 1).
SEIZING THE OPPORTUNITYMany dual-fuel boiler plant operators switch between fuels only when told to do so by gas utilities, usually at times when pipeline capacity is short. Unless a utility tells its customers in advance what next month's gas price will be, it may be difficult for a plant operator to know when to switch fuels for purely economic purposes. Even having such knowledge may present a dilemma, because depleting his stored oil at the wrong time could later force him to replace it with much more expensive oil, unless he locked in an oil price before the winter (which could result in storage or other fees if that oil is not taken).
Some dual-fuel plant operators, however, operate under so-called "Btu contracts" that allow them to lock in a fixed price (in $/MMBtu) regardless of which fuel is used. Under such arrangements, one fuel supplier provides both oil and gas to the customer, and tells the plant operator when to switch. The supplier has taken a market position (i.e., secured options to buy gas and oil at known pricing), allowing him to arbitrage based on fuel value. If the customer is burning oil when gas becomes cheaper, the supplier tells him to switch to gas. The supplier then sells the now-more-valuable oil (which he had reserved for the customer) at a higher price on the spot market, splitting the profit with the customer.
POSITIONING FOR THE BRASS RINGThis process must, of course, be in place long before price swings occur. Those that had done so acted swiftly when prices shifted in January, profiting from those who had not. The latter missed the "brass ring," thus paying for their lack of information and preparation. (In the days of carousels, brass rings were positioned so children could try to grab them as they rode by. Each brass ring bought a free ride.)
As indicated last October, those seeking to control energy costs need to be ready when market conditions suddenly shift in their favor. Waiting for a utility or Uncle Sam to tell you what to do instead ensures a position at the back of the line. Will you be ready to catch the next brass ring?