Wednesday, January 25, 2012

Locking in a Natural Gas Price

Rob Carrick says it’s time to lock in your natural gas price. He reasons that current prices are very low compared to previous highs. Buying a fixed-price contract for natural gas is like buying insurance against price increases, but for natural gas this insurance is quite expensive.

Carrick says that the current gas supply charge he pays is 12 cents per cubic meter. (He also points out that at this low price, the supply charge is only about half of what you pay. The other half is storage and distribution costs.) The peak price was 42 cents per cubic meter. The cheapest price he could find to lock in for the next 5 years is 19.7 cents.

To make these figures more real, let’s use my family’s consumption numbers. We used 4700 cubic meters of natural gas over the last year. This translates to a cost at current rates of $564 per year (plus roughly another $564 for storage and distribution). At the peak price, this would be $1974 (plus $564). At the best 5-year locked in rate, this would be $926 (plus $564) per year.

If natural gas stayed at 12 cents, the added cost of the fixed contract is $362 per year for a total of $1810 over 5 years. On the other hand, if rates were to suddenly shoot to 42 cents and stay there for 5 years, the fixed-price contract would save $5240 over 5 years. So, for an insurance premium of $1810, I could buy protection from big jumps in natural gas prices.

The difficult question to answer is whether this is a good investment. Are big price increases likely? If yes, then why are the suppliers dumb enough to supply gas at 12 cents right now? And why are fixed-rate suppliers willing to lock in 19.7 cents for 5 years? My guess is that like other forms of insurance, this is not a good deal strictly based on the expected outcome. After all, gas prices would have to rise steadily at 20.2% per year for 5 years for you to break even on this insurance.

The real value of insurance is protection from big losses. I buy liability insurance for my car because I don’t want to pay a million dollars if I’m at fault in a serious accident. In the case of natural gas, even in an extreme scenario where gas prices shoot up to 42 cents, it would cost me an extra $1410 per year for 5 years. I can handle this. I wouldn’t like it, but it wouldn’t devastate me.

So, I won’t be buying a fixed price natural gas contract. While it is possible that I’ll lose out by just paying market rates, I believe that the expected outcome is in my favour, and the worst case isn’t all that bad.


  1. It's the same kind of thing as extended warranty.

    As a rule of thumb, when someone with superior knowledge offers me a deal, chances are it's not to my advantage.

  2. I read that article today and was also skeptical. Thanks for doing the math on fixed vs. floating natural gas rates. I've paid the floating rate for years, and won't be switching anytime soon.

    The fixed rate with my provider is set at $6.59/GJ while the current floating rate is $3.82/GJ.

    Like the mortgage industry, energy providers use scare tactics to encourage customers to lock-in to avoid market fluctuations.

    I know I sleep better at night by not paying those fixed rate premiums.

  3. @P2Sam: That's a good rule of thumb, but it does require a person to acknowledge that sometimes others have superior knowledge. Some people can't make that leap :-)

    @Echo: Your provider's fixed rate is over 70% more than the floating rate. So, I'd make the same choice you are making to stay with the floating rate. I can imagine cases where a person's finances are such that it makes sense to lock in the higher rate, but people shouldn't do it out of fear without checking the numbers.

  4. I decided to remove a comment that expressed extreme displeasure about the extra charges on a gas bill. I'm more than happy to discuss this issue and whether people are being over-charged, but I'm not happy with pointless name calling.