By Chris Brook, Director of Natural Gas & Energy Services
Do seasonal fluctuations and market volatility leave you wondering about options that exist to help your business conserve energy costs? In my role as Director of Natural Gas & Energy Services at Competitive Energy Services, I talk to clients every day about actively managing their natural gas needs. In so doing, one of the tools I recommend is to fuel switch and arbitrage if the opportunities present themselves. By having dual fuel capabilities, some of our clients are able to take advantage of differences in price between alternative fuels. Fuel switching or arbitrage may be a tool in your toolbelt that helps manage energy use and spend and can have a significant impact on an organization’s bottom line when winter heating costs get expensive. In this article, I’ll outline both possibilities – the why, the how, and the benefits of each.
Why Fuel Switching?
Fuel switching is a straightforward option for businesses that have the capacity or systems to rely on multiple fuel sources. As market conditions change, one fuel source may become cheaper in price than the other and fuel switching allows businesses to switch between the two alternative fuel sources to cut costs. Fuel switching can be done easily and cost effectively if a fixed price position doesn’t have to be unwound.
Why Arbitrage?
Arbitrage involves taking advantage of the difference in price between two fuels or liquidity points. Arbitrage often requires the additional step of unwinding a fixed price position. Clients that are locked into a fixed price may be able to sell back the fixed price commitment, then purchase the alternative fuel at lower market price – realizing the difference in avoided costs.
High natural gas prices in the winter impact everyone through balancing costs. Balancing allows a customer to take gas each day matched to actual demand, and either purchase additional gas needed or sell unused gas back to the market. Although you may have a fixed price agreement, your natural gas use and cost are usually balanced on a daily or monthly basis. The higher the spot market price, the higher the balancing costs will be.
As an example, if you’ve got a fixed price natural gas position through a contract executed with a gas supplier, this is based off of the New York Mercantile Exchange (NYMEX) Henry Hub liquidity point in Louisiana plus a New England basis component. In New England, our spot market price is based on Algonquin City Gates, one of two New England natural gas liquidity points. Arbitrage becomes available when the daily spot price at Algonquin exceeds the price of alternative fuels – like oil or propane. In the non-heating season months of April – October, the spread can be small. In the heating season months of November – March, the spread between spot gas and oil/propane can be large. On a handful of extremely cold winter days when we do not have adequate pipeline capacity to distribute natural gas everywhere its needed, the New England spot market prices can be extremely high. That’s why we work so hard to help clients arbitrage.
How Each Works
Fuel Switching
Compares spot market prices between alternative fuel sources and burning the cheaper of the two. By fuel switching, businesses can cap costs at the lowest of the competing fuel prices.
Arbitrage
Energy arbitrage can be between any two fuels. The most common example begins with having a fixed price, natural gas position through a contract with a supplier.
When natural gas spot market prices rise above the price of the alternative fuel, arbitrage opportunities start to become available. To take advantage of this opportunity, clients sell their fixed price natural gas position back into the marketplace at the current spot market price, burn the alternative fuel at the lower price, and pocket the savings (avoided costs difference). CES actively manages this entire process from concept to performance tracking.
Financial Benefits & Hedging Risk
At a very high level, the benefits are clearly monetary for businesses. It’s about harvesting avoided costs, which can be significant. The ability to switch between fuels and take advantage of volatile market conditions can also help hedge financial risk associated with relying entirely on a single commodity market.
A good example of the benefits of arbitrage is a CES case study from a few years ago (client to remain anonymous). It was the winter of 2014-15, and this client paid zero dollars in the month of January to run their steam plant. We helped navigate them through the arbitrage process, resulting in that net-zero cost for the month of January. In so doing, this client took advantage of the large spread that existed between the fixed price in their contract and the current spot market price. Selling this natural gas position back into the market resulted in enough savings to fully offset the costs of the alternative fuel. In a one-week period, Competitive Energy Services saved them approximately $300,000. Fuel savings of this nature run along a continuum but can be quite significant to companies of all sizes. The savings will vary by winter consumption and the benefits are noteworthy.
Why is considering arbitrage this year critical?
First, the spot market price of natural gas is anticipated to be above $40/MMBtu on some days this winter. Second, although winter prices for alternative fuels like oil and propane are expected to remain high all winter – they are likely to be well below the cost of spot natural gas on the coldest winter days. The opportunity for arbitrage is poised to present itself as an option this winter, in a way that we have not seen since January of 2018.
CES’ Role in Fuel Switching/Arbitrage
CES works hard to let our clients know if fuel switching or arbitrage is an option for them as a way to mitigate heating cost increases. CES keeps a close eye on the market conditions year-round and is prepared to advise clients with dual or tri-source fuel systems on the best time to switch. As each client has different needs, CES provides an in-depth look at the pricing differences between fuel sources, what it’s going to cost to do the switch, how long the switch will take, and if it’s worth it to you and your business in the long run. If a client is switching to a fuel with a higher carbon content, CES can also help clients understand the increase in greenhouse gas emissions that fuel switching, and arbitrage may have and help them offset that impact.
Competitive Energy Services works with clients year-round to develop tailored and effective energy management solutions. Discussions around fuel switching and arbitrage typically occur in the fall, as businesses prepare for the upcoming winter season. However, it is never too early to start planning for next year. Contact CES’ Director of Natural Gas & Energy Services, Chris Brook at (207) 949 - 0312 or cbrook@competitive-energy.com to discuss whether or not these options and opportunities are right for your business.
Photo by Alexander Schimmeck