Natural gas price changes are driven by several different factors, some of which the utility has control over, and others it does not. Some of these costs are subject to regulatory oversight, while others are not. Some of these factors change infrequently and in small increments, while others swing widely from month-to-month. Still others vary by the season. The following natural gas rates section describes the factors that cause natural gas price fluctuations and the Public Service Commission of Wisconsin’s (PSC or Commission) role in regulating gas utilities.
Natural Gas Rates
Natural gas rates include the following three components:
◾ Commodity Costs: The wellhead (or commodity) price of gas is unregulated. The price of gas is the most unstable and difficult factor to predict as supply and demand for the commodity drive the price up or down. For example, unseasonably warm winter weather can cause prices to drop as the demand for gas is reduced, whereas a sudden unexpected cold snap can cause prices to rise as the demand for gas increases.
The costs that the utility incurs to acquire the gas commodity is passed along directly to customers, meaning that the utility does not earn a profit on the sale of the commodity. During a rate case proceeding, the Commission sets a base price for the commodity cost. For utilities to recover the actual commodity costs paid for the gas, the PSC uses a purchased gas adjustment (PGA) cost recovery mechanism, which is on customers’ bills. The PSC is responsible for reviewing each utility’s commodity purchases on a monthly basis and determining if the costs were prudently incurred.
Interstate Pipeline Costs: Interstate pipeline costs (or capacity costs) are regulated by the Federal Energy Regulatory Commission (FERC). Interstate pipeline costs represent the space (capacity) used on the pipeline transmission system to transport natural gas from the wellhead to a utility’s local distribution system. Pipeline costs are much more stable than commodity prices. The overall level of pipeline charges changes very little from year to year. Occasionally, FERC sets new pipeline rates that must be passed on to customers, but in most years, the pipeline rates are fairly constant.
The PSC requires gas utilities to use a seasonal pricing approach to collect pipeline costs. The concept is shown in Figure 2 below. The winter period runs from November through either March or April, depending on the utility. The important point to note is that pipeline charges increase by about $0.10 per therm of gas used during the winter period, which starts on November 1. This is a hefty increase for most customers. This means that even if commodity costs are stable from October to November, gas bills are likely to rise noticeably once October ends.
Distribution Service Costs: Local distribution service rates are regulated by the PSC. Distribution service costs reflect the utility's cost of maintaining and operating its local gas distribution system. The local gas distribution system is responsible for the delivery of natural gas to homes and business. These costs, like interstate pipeline rates, are fairly stable from year to year. Unlike interstate pipeline rates, however, local distribution rates do not vary by season. These rates change only when the PSC has a formal rate proceeding for the utility. In most cases, these rates are not changed more than once every two years.
Other Costs and Credits: In addition, natural gas rates can change due to reasons that occur irregularly. For example, in recent years, several Wisconsin utilities were required to return to customers a refund of pipeline costs. Other utilities might be allowed to or required to pass on to customers slight surcharges or credits based on their performance under gas cost incentive mechanisms. It is difficult to know when and if these types of costs might be incurred. In any event, they tend to be quite small relative to the commodity, interstate pipeline, and distribution service costs.
What do utilities do to protect customers from price volatility?
Storage: Utilities purchase gas during the warmer (off-season) months when the price for gas is lower and store it for use in the winter. Gas storage ensures that sufficient gas inventory will be available to satisfy customers’ total demand for gas in the winter. If gas is put in storage in the summer and withdrawn in the winter, the cost of gas charged to customers in the winter will be a blend of the current market price and the cost incurred when buying in the summer. This blending tends to limit price volatility to some extent. Since on any given day Wisconsin gas utilities can meet only a fraction of their gas demands with supplies from storage, they are always buying relatively large amounts of gas at market prices. Therefore, even if storage services are used to their maximum capacity, market price changes always filter through to the prices paid by customers if no other action is taken.
Hedging: Hedging involves the use of financial instruments such as futures, options, and swap contracts for natural gas traded on the New York Mercantile Exchange (NYMEX). Proper use of these contracts allows the utilities to lock in prices or to put ceilings on prices, for example, which limits the volatility of gas costs that flow through to consumers. The goal of using financial instruments is generally to control price volatility, not to speculate on the future direction of energy prices or not even to reduce gas costs. The utility’s cost of administering its hedging program is passed on to its customers so that, over a long period of time, a hedged gas supply portfolio will tend to produce slightly higher gas prices than if the portfolio were not hedged. The prices will, on the other hand, be more stable and more predictable. However, more Wisconsin gas utilities have decided to use this approach as energy prices have become more volatile since 2000. The PSC reviews each utility’s hedging strategies on an annual basis.