Consumer ed quiz: is this a good deal on natural gas?

One of the difficulties in properly managing your money is the vast amounts of decisions you have to make. Someone who is great at investing, finding travel deals, and buying a home can still lose a lot of money by making poor career decisions or racking up credit card debt.

These decisions are hard and should not be underestimated. Today I want to discuss a rather tricky question that I came across in choosing a natural gas supplier for home heating.

I should note this question is math-oriented and involves some dimensional analysis which is why I found it interesting.

So here’s the problem I faced when choosing a natural gas supplier.

Question about natural gas supplier

Nowadays, people have choice in natural gas. They often can choose between an established utility, or they can opt for offers from independent suppliers. Loosely speaking, the suppliers buy energy from the market and offer a specific rate.

The offer is often some fixed rate, followed by a monthly renewal price. The pricing terms can actually get somewhat complicated.

As a point of reference, gas companies often quote prices in terms of “cents per therm,” in much the same way gas companies charge “dollars per gallon.” (thanks to Clark Howard for that great analogy)

Here is an offer for you to evaluate.

Term and Price: Beginning with my next billing cycle, this Agreement will automatically renew … at a month-to-month variable rate calculated by taking the applicable monthly closing NYMEX settlement price each month and adding an amount not to exceed 59 cents per therm…

[Renewal term modified from IGS Energy offer to Indiana NIPSCO customers (link to IGS website)]

The question is, is this a good contract?

In order for you to evaluate, assume the following conditions.

–assume natural gas costs 70 cents per therm for a home
–the next month’s NYMEX settlement price will not swing too drastically (gas prices are volatile, but let’s keep things simple)

Can you figure it out?

I would be extremely impressed if anyone could answer the question at this point.

It took me a good 30 minutes to sort through the numbers and make sense of it. The issue is how to get the NYMEX closing price and then convert that into something meaningful.

Here is what I did to continue the calculation.

NYMEX background

By way of background, the NYMEX is the New York Mercantile exchange, the world’s largest physical commodities futures exchange.

The relevant contract for natural gas is the Henry Hub contract. Henry Hub is a physical location in a Louisiana pipeline that connects to four other major pipelines. The spot price is often seen as a primary gauge for the price of natural gas in America. That’s why this natural gas contract is pegged to price fluctuations in Henry Hub.

Finding the NYMEX settlement price

You can get spot and future NYMEX prices at the CME Group website. Here is a link to the daily settlements for the Henry Hub.

For the current month, we see the settlement price is 4.217. But what does that mean in terms of our contract?

We need to look at the dimensions of the settlement price and convert it into cents per therms for comparison.

Converting NYMEX settlement prices into cents/therms

Looking at the documentation, the Henry Hub contract is quoted in terms of “dollars per MMBTU.” There are two components to the MMBTU:

–BTU is a measure of energy, British thermal units.
–MM is an abbreviation for “one million,” or 1,000,000

We also need to know that:

–100,000 BTU is equal to 1 therm

So now we can calculate:

Since the NYMEX price is 42 cents, when you add the “up to” 59 cents extra, that becomes over $1 per therm for the independent supplier.

This is a lot more expensive than the 70 cents per therm the utility is offering. If you make the wrong choice, you could end up spending nearly 40 percent more on your gas bill!

In conclusion

It is not always easy to arrive at the correct answer, but it is often worthwhile to make the calculation to know what you are getting into.

There may be choice in natural gas companies, but that does not make saving any easier than it was before.