Easy is Not Always Better - A Case Against "Coloring" Natural Gas

Coloring natural gas is a method used by energy companies to allocate natural gas costs across generation assets in power plants or city gates in different utility markets. Individual natural gas pool purchases are assigned to a specific trade book representing a generation plant, utility market or storage location. Fixed and variable costs are also distributed in a similar manner to arrive at a delivered cost of natural gas.

Coloring natural gas is a simple way of determining the efficiency of generation assets, the profitability of a product sold in a utility market or the cost of storage. This approach may be acceptable for companies that purchase large quantities of term natural gas and/or deliver to a few utility markets. However, the more varied the supply prices and delivery locations, the less accurate the allocation.

In the current economic and regulatory environment, it is critical to understand the efficiency of assets and the profitability of different utility markets. Inaccuracy in determining these costs may lead to ineffective pricing, hedging and trader compensation programs.

There are two alternate approaches to computing the landed cost of gas. Option one is to compute a daily system-wide cost of gas and the associated variable and fixed costs that are weighted to usage or storage. Option two, a more complex approach, is to utilize a net forward methodology, which applies a weighted average (WACOG) at the pool and allocates the fixed and/or variable cost at each intermediate transportation point on the pipeline, thus computing a more accurate landed cost of natural gas by delivery location.

Developing a daily average or net forward tool using Excel could be cumbersome and difficult to maintain. Changes in trade price or unexpected pipeline events, such as cuts and Operational Flow Orders, would require modifying the spreadsheet frequently. The recursive nature of the net forward calculation would require a fairly sophisticated spreadsheet and would prove challenging for the average Excel user. Lastly, these spreadsheets may inadvertently produce incorrect results. It was recently reported by Market Watch that 88% of all spreadsheets contain some formula error.

Consistently computing such an allocation is easier to accomplish if an organization is currently using an energy trading and risk management system (ETRM). Some ETRM’s have a net forward function built-in while others may require a “bolt on” or outside function that extracts data from the underlying database to perform the calculation. These approaches are preferable because unexpected changes flow seamlessly to the function, thus delivering a more dependable result.

Employing such an approach may yield very similar results to coloring. However, consider a retail energy provider in a highly competitive natural gas market -- a better understanding of the cost of delivery may save the organization from pursuing a Commercial and Industrial contract that is not as lucrative as forecast or pursuing a more aggressive pricing approach to win more customers.

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