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Fuel prices fall, electricity rises: Confused about energy costs?

By: Alex Kuffner |

If you’ve been following news about energy lately, you couldn’t help but notice that because of a glut of natural gas on the market and unseasonably mild weather, prices for the fuel have plummeted.

So it doesn’t seem to make sense that electric rates for most Rhode Islanders are going up so dramatically beginning in the new year when the state’s primary source of power comes from power plants that burn natural gas.

The Journal set out to try to explain this seeming paradox.

Natural gas prices are going down nationally. Why?

Prices for natural gas have been down in general in recent years as hydraulic fracturing, or fracking, technology has opened up previously unreachable supplies from hard-to-access shale fields. Production in 2014 hit an all-time high, breaking records set in the three previous years, according to the U.S. Energy Information Administration.

And so far this winter, as temperatures have remained at relatively balmy levels, price projections have been higher than actual prices on the spot market. With lower-than expected-heating demand, there’s more available gas in storage. Last week, prices of gas futures in New York plummeted to their lowest level in two years.

But New England prices are still higher than in other parts of the country. Why?

New England is supplied with gas through two major pipeline systems — the Algonquin and the Tennessee Gas — both of which have reached capacity in recent winters. With constraints on gas supply in New England, average prices in the region have been higher than anywhere else in the nation, according to the EIA.

For example, on Monday, the forecast of colder weather pushed the price of power for next-day delivery at Algonquin Citygate, the main supply point for Boston, from $8.82 per million British thermal units to $12.44. At a key supply point in New York, the price was much lower, rising from $1.90 to only $3.29, according to the Natural Gas Intelligence newsletter.

While national prices for natural gas have dropped as much as 50 percent from last year, the same has not happened in New England. The average price of natural gas this past November at Algonquin Citygate was virtually the same as it was in November 2013, according to Independent System Operator New England, which manages the region’s power grid.

What has been the effect on retail rates for consumers who use natural gas for heating?

Although rates in New England are higher than in other parts of the country, they are still relatively low compared with past years for the region. In fact, in Rhode Island, National Grid lowered retail rates for heating supply by 8 percent in November.

The decrease was partly due to a new hedging strategy to better reflect the anomalies at Algonquin Citygate and other points in the region rather than the national benchmark at the Henry Hub in Louisiana, where prices are much lower, said Steve Scialabba, chief accountant at the Rhode Island Division of Public Utilities and Carriers.

So if heating rates are going down, why are electric rates going up?

The answer gets back to the constraints on the pipelines that supply New England. Companies that supply gas for heating essentially get first dibs on the pipelines. Power plants that burn gas to generate electricity get whatever capacity is left over. This isn’t a problem in the summer, when heating demand is low, but it is an increasingly serious issue in the winter, when it’s high.

Heating suppliers get priority on using the pipelines because they are required by regional regulators to lock in long-term contracts for supply. The deals can be up to 20 years in duration. Power generators are not required to put in place long-term contracts and are reluctant to do so voluntarily because they can’t guarantee electric sales down the line, said Scialabba.

Because heating suppliers are guaranteed use of the pipelines, their gas rates are lower. Power generators have no such assurance and are much more exposed to the volatility of the wholesale market, where gas is sold close to when it’s needed.

On cold days, almost all gas supply goes to heating use. Then the power grid must turn to more expensive coal- or oil-fired generators to supply electricity.

That’s reflected in the current electric rate increases throughout New England, which are driven almost entirely by commodity prices. State regulators have little say over these prices and can’t knock down the rate increases in the same way that they can limit administrative charges and other softer costs.

The market for gasoline is not as constrained as the one for natural gas.

Why are pipelines constrained?

Natural gas is a cleaner-burning fossil fuel than coal. As environmental regulations have tightened, more power plants in New England switched over to natural gas. That change accelerated when cheap shale gas started flooding the market. Also, large coal-fired plants have closed or, like Brayton Point Power Station, are set to close.

The region has dramatically increased its reliance on natural gas for power generation in the past decade or so. In 2000, 15 percent of the power produced in New England came from natural gas generation; that share increased to 46 percent in 2013, according to ISO-NE.

What about the effect of households and businesses moving from oil to natural gas for heating?

Households and businesses have been gradually moving away from heating oil because of high prices for the fuel and state incentives to make the switch. But the volume of gas used by the new users pales in comparison to the amounts used by new power plants that use natural gas, said Thomas Kogut, chief of information for the Rhode Island Division of Public Utilities and Carriers.

Even as heating conversions are going up, Rhode Island is not using more gas. This is due to better efficiency. According to the EIA, the volume of gas consumed for heating since 2000 in Rhode Island is actually down among residential and commercial users and up only slightly among industrial users.

Does National Grid buy power ahead of time?

Yes. In Rhode Island, the utility has three customer classes — residential, commercial and industrial — and it purchases electricity under different schedules for each one.

For residential customers, it buys supply in six blocks. Ninety percent of power is purchased before it’s needed — up to two years in advance. The remaining 10 percent is bought as needed on the wholesale market.

The system of advance purchases was set up at the direction of the Rhode Island Public Utilities Commission to help ease the effects of price volatility. National Grid may sometimes pay a premium for power, but the strategy, said Kogut, has protected customers to a certain extent from the current run-up in prices in the region.

That’s because some of the power that ratepayers will use in 2015 was purchased as far back as 2013, when winter electric prices had only started their climb upward.

The base cost of power in Rhode Island is going up 54 percent. In Massachusetts, where utilities make only two advance procurements, the increases range from 59 percent to 95 percent.

If actual prices are lower than what National Grid estimated it would have to spend on the wholesale market, will customers get a refund?

Warmer temperatures have meant that wholesale prices for electricity so far have not been as high as some have predicted.

This is worth noting because while the cost of National Grid’s advance purchases are known with certainty, the cost of the company’s purchases on the wholesale market are estimates. If National Grid pays less for the 10 percent of power it buys on the wholesale market than what it predicted, then it must give ratepayers a credit. This is because under state law power utilities in Rhode Island are not allowed to profit on the sale of power.

Businesses have complained that five or six weeks of notice before implementing the new rates was not enough time for them to prepare. Could National Grid or the state have given them more notice?

Scialabba said the Public Utilities Commission will look at whether that can be done. Because so much power is bought in advance, the commission does get plenty of warning about rate increases. Before National Grid formally proposed the new rates, commission staff members were already looking at ways to ease the effect on ratepayers.