Energy purchasing - natural gas

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Natural gas and liquefied petroleum gas (LPG) have a wide range of applications in agriculture, from space heating for animal sheds, greenhouses and nurseries to produce drying on crops including grain, cotton and nuts.

Historically, natural gas has been cheaper than LPG and electricity, and has been the preferred option for most farmers with mains access. Predicted increases in natural gas prices may change this scenario, however. This paper looks at the drivers of natural gas markets and how they affect the price of gas. It also discusses measures for managing gas supply costs, such as: negotiating shorter-term and more favourable contracts, switching equipment to other energy sources, and implementing efficiency measures that reduce the use of gas.

Natural gas price drivers

Australia’s abundant supply of natural gas, adequate pipeline capacity and ‘stranded’ domestic market have meant that historically, its gas prices have been low by world standards. This situation is changing as a result of recent major investment in gas production. An increase in demand for gas and consequent hikes in gas prices in Asia have driven investment in Australia and the formation of an export industry on both west and east coasts. Approximately $50 billion in investment has already been committed on the east coast and approximately $116 billion on the west coast of Australia.

Gas is a regional rather than a national market. Physically, the eastern market is the largest and most mature, competitive and interconnected gas market in Australia. It covers Queensland, New South Wales, the Australian Capital Territory, Victoria, South Australia and Tasmania. However, Western Australia is leading the rest of the nation in the development of an export market for liquefied natural gas (LNG). The first shipment of east-coast LNG to offshore markets is due in 2014. This represents a key shift in the dynamics of the east-coast gas market.

Like Western Australian gas prices, eastern-state domestic gas prices will no longer be determined in isolation but will be linked to international prices. Therefore, even though east-coast gas supply will be boosted by new coal seam gas (CSG) projects coming on stream, so – counterintuitively – will prices. This structural change in the gas industry has significant implications for farmers who currently rely on natural gas as an energy source.

Prevailing prices and expected price trends

Forecasting gas prices is difficult; the gas market is less transparent than the electricity market, since the vast majority of natural gas is traded through long-term bilateral contracts. The international price for LNG is around double the historic local price. Tender responses in the second half of 2013 suggest that customers are already paying $8 to $10 per gigajoule (GJ), up from $4–$5/GJ in the previous year. These prices are gas commodity cost at well head, including the cost of carbon (approximately $1.50/GJ).

The upward pressure on gas prices is expected to continue in the medium term, with some analysts forecasting eastern market prices to peak in 2018. Although the carbon cost element is anticipated to reduce, the wholesale gas component is anticipated to increase by a further $2/GJ. (Oakley Greenwood, 2013)

Delivered prices to businesses are substantially higher than the gas commodity cost at well head. For example, for businesses using more than 10 terrajoules (TJ), delivered cost will range between $11 and $15 per gigajoule. Smaller businesses could pay above $30/GJ if they are on retail tariffs  (Energy Australia, 2013). Gas sellers add the following components to the ‘well-head price’ to derive the price they charge end users:

  • transmission pipeline capacity cost,
  • distribution pipelines charges,
  • meter data agent and other charges, and
  • own cost and profit margin.

LPG: an easily accessible alternative fuel source for off-mains farms

LPG is a naturally occurring by-product of natural gas extraction (60%) and crude oil refining (40%). (World LP Gas Association, 2014) LPG prices, like electricity and natural gas, have two parts: a ‘commodity price’ and a ‘supply cost’ (i.e. the costs of commodity and transportation).

LPG prices are more variable than those of natural gas, as the LPG commodity price tends to move in line with crude oil prices and is sensitive to seasonal demand (e.g. European winters). Although Australia is self-sufficient in the supply of LPG, the commodity component of LPG pricing is linked to the Saudi Aramco Contract Price (Saudi CP) (World LP Gas Association, 2014), as a reference price for exports and domestic sales to wholesalers.

Currently, LPG is more expensive than natural gas due to the extra activities it requires – such as the refining process, decanting, road transportation and the costs of cylinder rental and handling. Geographic location is thus a major driver of LPG ‘supply cost’.

Unless a large quantity of LPG is required at multiple sites, buying directly from a local supplier may be a cost-competitive option. If you use large quantities (say, worth in excess of $50,000 per annum), it’s a good idea to obtain three competitive quotes to ensure a competitive price.

It’s also advantageous to conduct an assessment of retailer approaches to supply performance and order fill. This starts with requesting that your suppliers provide delivery-in-full-on-time (DIFOT) commitments. To evaluate a retailers’ ability to meet DIFOT commitments, enquire about their level of back orders, stock levels (days of supply) and on-time delivery performance. Also ask for client references.

Purchasing strategies

At present, the gas market is a seller’s market and is likely to remain that way for the next few years. There are fewer respondents to gas tenders, leading to less room to negotiate favourable terms and conditions. Clients should expect to pay more, and contract terms will tend to be shorter as suppliers adjust to the changing market structure.

One option is to take shorter-term contracts that match retailers’ current contracts with their suppliers. Longer-term contracts have the expectation of export parity pricing built in. While this may just delay the inevitable large price increases, it allows time for more local volumes of unconventional gas, especially coal seam gas in NSW and shale gas in Victoria to be proved, similarly to what has happened in the US.

Moreover (as with electricity), if you’re to get the best price for gas it’s important that you ascertain your gas usage in advance – including past history and future projection. Make it as easy and as low-risk for suppliers as possible by including well-considered forward projections, projections of total annual consumption, and estimations of maximum hourly and daily usage quantities.

The pricing you receive will be a function of the ratio between the maximum daily quantity (MDQ) and the total annual quantity or annual contract quantity (ACQ). Typically, as a rule of thumb, the MDQ will be 10 times the maximum hourly quantity (MHQ). The higher the MDQ amount as compared to the ACQ, the higher the price received, as there’s a risk that more gas may suddenly be demanded from the gas network. Thus it makes sense to look at minimising your MHQ and MDQ amounts before you next go to market.

In addition, engage legal expertise early and get them to work with a standard gas contract, not customised versions. Particular attention should be given to the penalties that may be imposed for over- or under-utilising gas. These are commonly enforced by retailers, as they in turn typically have direct back-to-back supply agreements with similar penalty structures.

Also bring lots of sellers into the process and give them time (at least three months) to work. When negotiating, pay particular attention to Take-Or-Pay (TOP) percentages for each retailer offer. Depending on the percentage, your minimum total cost for the year may be substantially higher than it needs to be. If you are unsure of your annual quantity, it is advisable to chase a larger-than-standard take-or-pay percentage aggressively.

Once your contract is in place, you need to manage it actively. Build a system to monitor your ACQ, TOP and MDQ. If you think you are likely to breach them, talk to your retailer.

Energy efficiency

When developing a new contract, it is important to take into account your potential to reduce future demand through implementing efficiency measures. There are several measures you can take within intensive production facilities to improve efficiency of energy use and reduce total usage. NSW Farmers has produced a range of information resources addressing energy efficiency in farm facilities (see Further information).

An energy audit is an important first step in understanding your pattern of energy use and the opportunities that may be available to you to make savings.

Refer to supplementary paper, Energy Planning.

Energy substitution

Increases in the efficiencies of certain technologies, coupled with gas price increases, mean the past decade’s trend of switching from electricity to gas (especially for heating) is being questioned. It is worth revaluating your assessment of natural gas-, LPG- and electricity-based solutions, particularly if you’re commissioning new sheds or planning to replace aging equipment. Payback periods for electricity-based solutions are increasingly attractive.

Refer to supplementary paper, Electricity Purchasing.

Further material

Farm Energy Innovation program - NSW Farmers has produced a range of information resources addressing energy efficiency in farm facilities. These may be accessed here.

The Australian Energy Regulator - The AER’s ‘energy made easy’ website can help small businesses compare electricity and gas prices in their areas.

References

Energy Australia, 2013. Small business rates. [Online]

Gas Energy Australia, 2014. Industry data. [Online]

Oakley Greenwood, 2013. Gas and electricity forecasts for NSW, s.l.: s.n.

World LP Gas Association, 2014. Facts and figures. [Online]


This content was produced with assistance from Energetics
www.energetics.com.au

 

Energy

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