Saturday, November 13, 2010

From No Hot Air -- Important

The following article from No Hot Air -- read it.  I will be referring to it for a long time.  We could substitute Duke Energy for "British Gas" and convert "pence" into American dollars, and change "raising gas prices" to "not lowering gas prices more," and substitute Ohio Public Utilities Commission for "Ofgem" and make the same stunning points which this excellent article does.

Why did British Gas raise prices?

Simply put, because they can. Centrica would actually be failing their shareholders if they did not take advantage of the total lack of clarity and knowledgeable regulation provided by Ofgem. I said when SSE raised their prices that any other gas company would have questions to answer to their shareholders if they didn't follow the SSE lead.

The other reason they can is that what is in a gas or electricity price is completely untransparent: Ofgem themselves don't know, and worse, show no interest in knowing.

The cost of service, i.e. what a gas provider pays transporters and meter operators is about 0.9 pence per kWh [England must have a lot of gas-fired electricity] for a domestic user. It varies around the country, but 0.9 is on the high side. Those costs are identical by law. Everyone gets the same price regardless of size.

That leaves the commodity cost of the gas itself.British Gas, as do the other suppliers, tell their customers, and Ofgem who are so clueless that they believe them, that they buy gas 12 months or more in advance.

It beggars belief that a price was settled 12 months ago and carved into stone a year ago. Apart from anything else, it is one of the basic truths of any commodity that spot prices trend lower than futures.

For another thing, the difference between traded and physical volumes is at least 40 to one. That is, the kWh of gas you use today was traded at least forty times before it reaches your meter.

This is how gas is traded in 2010: If it isn't please hire me Mr Centrica, I can really make you some money!

Physical volumes of gas are rarely priced on anything except the spot market as settled daily at a virtual location called the UK National Balancing Point. Almost no gas at all is bought on long term contracts which included a fixed price.

How do we know this? Its no secret. The UK gas market has multiple traders. Centrica is only one, with financial houses like JP Morgan, Barclays Capital and Goldman active although they don't supply anyone. There are producers and utilities from all over the world active in the UK spot market.

But Ofgem, when it investigates gas prices at all, is unaware of those changes. It believes whatever suppliers tell them. There has never been a full analysis of what costs the suppliers actually incur. Why not? Because Ofgem doesn't think it necessary. So they take everything on trust. Imagine if banks were regulated this way!

When a utility buys gas, it agrees the physical volumes, within tolerances, but the price is not set until the gas is delivered to the NBP, which is on the day of actual use.

The NBP market, as we see above is very volatile. The figures on the chart come from the National Grid over the last six months. Price last winter averaged 1.229 [remember, not dollars] and only averaged 1.29 in January , the coldest month in 33 years.

The gas market is volatile because it matches supply and demand, both equally volatile. The market settles each day. Basically a supplier has to balance. They can, and often do, put in gas one day that they bought the day before or traded during the actual day. They never, ever, ever, ever buy gas months or years in advance at the price on the wholesale market. They used to, sure. But not any time this century. They may for example buy July 2012, but the month will actually be traded multiple times before the stuff actually shows up. No way Jose are they stuck with the price for July 2012, or February 2011 or next Tuesday which they have to pass on to you.

The price they pay is pretty close to the prices daily on the chart above. What is the average price? It's complicated, as although it looks like September 18 was a cheap gas day, who used much gas on September 18? But the average gas price since May was in the area of 1.4 pence per kWh. Add the cost of service and the average total cost to BG, or any other supplier, was 2.3 ish [remember, this is not dollars]. Anything else is gravy.

It's hard to figure out how much gravy, unless you actually look at your bill. First problem is the tiered pricing. The first 600 or so kWh each quarter are over 6 pence per kWh most places. They are that high since there are fixed costs to serve that are the same for everyone. They should in theory cover most of the 0.9 cost of service. But if one averages out the cheaper units which are in the area of 2.9 most places, we see that at least 25% of your utility bill is pure margin.

This will mystify North American readers. They have a default option denied to UK consumers. The state regulator publishes clear costs of service. The meter is read every month, usually remotely, usually accurately. It isn't rocket science. National Grid own utilities throughout New York and New England for example and manage that no problem.

The commodity cost is also clear, and is based on an agreed formula linked to wholesale spot markets. It can go up, it can go down. It is completely transparent and clear. Unlike here in the UK, where even Ofgem admitted last year that up to a third of gas consumers who use switching sites "inadvertently" switched to a higher rate.

UK consumers: go to one of those switching sites that run endless moronic TV commercials. Note that they do not exist in other countries. Eighty five percent of New York State consumers and over 95% in a very cold Chicago, remain with their local supplier. Despite it being so easy to switch that it can happen the next day, and not six weeks later as in the UK.

The UK should have a basic, transparent and fair pricing structure. It doesn't. And Ofgem cost the nation billions during a downturn by being asleep.

To the civilians visiting now in light of the BG news. One piece of advice that switching sites won't ever tell you: Don't fix for anything more than the year you are forced to.