The Marketplace: Is it really an advantage to lock into a natural gas contract?

Michael Prentice
Ottawa Business Journal
November 2, 2005

Lately I have been a two-time loser when it came to selecting a mortgage and deciding how to pay my natural gas bill. I made the wrong choice – or so some would argue – on both over the past five years.

I chose a five-year fixed-rate mortgage, as usual, thereby paying substantially more in interest than I would have paid if I had opted for the bank’s floating interest rates or short-term rates over the five-year period.

Conversely, I chose to pay floating rates to cool and heat my home, and ended up paying higher prices for natural gas than I would have paid with some fixed-rate plans.

We are supposed to learn from our mistakes, but I don’t think I made any here.

When interest rates are low, it makes sense to me to go for a fixed rate, five-year mortgage, with a monthly payment that’s within my means. If interest rates shoot up during the five-year period, I’m protected. If they don’t, I don’t mind paying the extra interest required on a five-year loan. I see it as the cost of peace of mind.

With natural gas and now also electricity, it’s different. Despite soaring energy costs, I can stand the risk of a continuing price surge in natural gas and electricity. By not locking into a fixed price for future energy supplies, I shall be a winner unless future price hikes are steeper than expected.

Businesses offering fixed rates for future supplies of natural gas for home or office are making much of the fact that many of their customers have saved money over the past five years.

Direct Energy Essential Home Services, one of the most successful and aggressive marketers of fixed-price energy, has been running ads stating that its typical Ontario residential customer saved $848 on natural gas between 2000 and 2005.

That sum represents the difference between what the Direct Energy customer paid for natural gas and what the average home owner paid at the floating rate charged by the local utility, which is Enbridge Gas Distribution in the case of Ottawa customers.

No one can foretell the future, but consumers should be wary of locking into fixed prices for natural gas and electricity, says Tom Adams, executive director of Energy Probe, an Ontario-based consumer advocacy group.

Marketers of fixed-price natural gas and electricity are middlemen, operating much like banks, he says. A bank offers a five-year fixed-rate mortgage loan with money borrowed from customers who bought five-year guaranteed investment certificates, or GICs. The bank’s profit is the difference between the interest rate charged to the borrower, who obtains a mortgage, and the interest paid to the lender, who invests savings in a GIC.

Similarly, says Mr. Adams, energy marketers take little or no risk in offering fixed prices for future delivery of natural gas and, increasingly, electricity. Their retail prices are based on contracts they have already made with natural gas and electricity producers, for delivery as much as five years ahead.

“My criticism of marketers (of natural gas and electricity) is that their mark-ups are quite steep,” says Mr. Adams. “The mark-up is typically around 20 per cent.”

Purchasers of fixed-price contracts are gambling that future prices of natural gas and electricity will rise faster than expected, says Mr. Adams. Even if prices do rise faster than expected, he says, the increase must exceed the marketer’s mark-up in order for the customer to come out ahead of those paying floating rates for energy.

Utilities like Enbridge and Hydro Ottawa make their money by delivering the product, not on the sale of the product itself.

Energyshop.com is a good website to review prices and options for the purchase of energy. It notes: “If you choose to buy from a gas marketer, your gas delivery won’t change. You will still get a bill from your distribution utility. (This) will indicate a regulated delivery and transportation charge – about one-third of your bill – that goes to the utility, and a gas supply charge (price of the gas). The remaining two-thirds – that goes to the competitive supplier you chose.”

Energyshop.com estimates that, by the start of 2006, Enbridge’s price of the natural gas itself is likely to be above 38 cents a cubic metre. Direct Energy recently offered a five-year contract at 42.7 cents a cubic metre for the first year, and 43.7 cents thereafter.

You make your pick and pay your money.

 

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