As someone who works as a consultant on energy projects, including negotiating natural gas contracts for ethanol plants, Dave Neubauer, president of Chalkstone Consulting LLC, knows why so many producers turn to the fuel. He quickly rattles off just a few of the reasons: It's simple to use, on-site storage isn't a problem, it's a clean-burning fuel, the technology is proven, and it's safe. "It is the fuel of choice," he tells EPM. "But it's got the one caveat—the pricing right now is pretty high."
As customers will quickly say, it's not just the current price that's scary—people are losing sleep over $6.25 natural gas. Rather, it's the fact that price of the clean fossil fuel can swing rapidly upward in a short period of time. After record-high prices last winter, consumers are still a bit jumpy. "There's a nervousness in the marketplace," Neubauer says, adding that natural gas prices aren't just impacted by supply and demand, but expectation of supply and demand.
That's why there's been a fair amount of investigation and investment in harnessing different power sources, according to Casey Whelan, vice president of business development for Minneapolis-based U.S. Energy Services. The company has worked with more than 80 ethanol plants, doling out advice on what power source to select and helping to secure energy contracts. A lot of the newer plants are making the decision to utilize coal as a power source, he says. At least one Minnesota facility is burning the syrup that would otherwise be mixed in with DDGS; others are talking about even burning DDGS. Still others are harnessing biogas or collocating with power plants to utilize excess process steam.
"If the price continues to remain high, people will continue to get creative with other energy sources," Neubauer says.
Still, about 80 percent of the time, the reality is that natural gas is the only viable option for producers. First off, the energy decision is very geographically driven, Whelan says. If there's no closely located coal supply or power plant for steam power, for example, natural gas is one of the only energy answers for many ethanol plants.
Another alluring feature about the energy source is that usually it's not all that difficult to get hooked into the natural gas grid, Neubauer says. "You might not like the price, but there aren't very many places where you can't have access to it," he says, adding that there are a few exceptions.
Analyzing Pricing
If ethanol producers don't have the ability to drop natural gas in favor of a different power source, they would like to at least know what to expect on their bill. Canadian analyst C.M. "Chuck" Baumgart, president of Middleton Management Company Ltd., doesn't have a crystal ball, but he does provide price advisory services for natural gas producers and consumers, using fundamental and technical strategies.
The first thing to keep in mind is that oil and natural gas prices are linked in some ways, he tells EPM. Essentially, if the price of oil goes up, natural gas prices typically follow; if the price of oil drops, natural gas prices drop.
Over the next one to three years, Baumgart says prices could average about $9 per MMBtu. That's about where analysts would put the fair market value of the product. Of course, that price level would change if there were any major political upheavals around the world, or a series of hurricanes affecting production in the Gulf Coast.
Mark Stultz, vice president of industry and public affairs for the Natural Gas Supply Association, an advocacy and trade group, tells EPM that natural gas prices will likely remain high in the next one to three years. The market will continue to be tight. As demand continues to grow in certain markets, such as electrical generation, more traditional markets, such as the industrial sector, have reduced their use of the power source, he says. Finding it harder to pay the higher prices, some companies, such as chemical or fertilizer companies, have taken their operations overseas to take advantage of reduced energy costs. "Markets always balance out," he explains. "It's a fundamental rule of markets that demand will not exceed supply."
Declining natural gas production is why the Natural Gas Supply Association advocates lifting restrictions in areas such as the East and West Coasts and in multi-use federal lands in the Rocky Mountains. The organization considers it a matter of national interest. "I think if we want to continue to have both clean air and a robust economy, we're going to need access to additional supply," Stultz tells EPM.
If the process was streamlined and the go-ahead to drill additional wells was granted, it would have a positive economic effect. "Additional supply will help put downward pressure on price and allow demand to grow," Stultz says.
While domestic production is getting smaller, it is growing in other areas of the world, according to Stephen Smith, president of Stephen Smith Energy Associates. He spoke at the 18th Annual Energy Conference—a natural gas meeting put on by U.S. Energy Services in mid-May—and said the "super-giant fields" of gas in the world were found 31 to 45 years ago. "The idea that we're going to somehow drill our way out of this thing … needs some work," he said, to laughter of audience members.
Larry Marshall, president of Resource Securities Corp., didn't walk softly around the subject of $15 natural gas prices at the energy conference held in Minneapolis. "Now that it has done it, it can—and it will—do it again," he said.'
The expert on technical analysis of natural gas pricing told conference-goers he wasn't there to talk about production, consumption, pipelines, weather, storage or other influencing factors. The why of price changes can be an entertaining topic, but it isn't important. "You don't pay why, you pay a price," Marshall said.
Marshall was there to try convince the audience there is some consistency to natural gas price changes. While technical analysis provides no "magic bullet" to tell people when to buy or sell, and price cycles aren't set in stone, it can show some consistency in the patterns of price changes, he said.
For instance, analysis of past data shows that natural gas prices have hit highs about every four years fairly consistently with some deviations. The same is true of lows. Another pattern is that there's a significant pricing event in natural gas roughly every 51 weeks, or between 46 to 57 weeks. "I don't see how that can be just a coincidence," he said, adding that the patterns can be used to help consumers determine when to buy natural gas.
Liquefied Natural Gas
Supplies of liquefied natural gas (LNG) expected to come into the marketplace are expected to have an impact on pricing woes. Major expansions are happening on the Gulf Coast, East Coast and Mexican Baja to import LNG from the Middle East or other areas of the world, Baumgart says. "That will have a tendency to basically reduce the peaks in prices like this last winter," he tells EPM. "Had you had a lot of LNG in the market, you would not have had prices go to $15. … You may still have a steady price at $7, $8 or $9 dollars, but you're not going to have the high peaks that you have traditionally."
With the overall supply of natural gas in the United States declining over the past four years, which impacts price levels, a new source is good news for consumers. Experts say that by 2008-'09 the majority of infrastructure to retrieve, ship and distribute LNG in the United States should be in place. "It's hard to say what the absolute price is going to be, but you're going to have less volatility," Baumgart says.
Still, LNG isn't exactly the "savior" of gas prices, Baumgart added at the energy conference. "That's probably not going to happen," he said.
Dr. Benjamin Schlesinger, president of BSA Inc., also spoke about LNG at the energy conference. The decline in natural gas production does mean there will be pipeline capacity for LNG supplies, he said. On the other hand, there is a very high number of LNG terminals being built and proposed across the country. "I think we're going to be at a fair amount of overcapacity," he said, adding that LNG's share of the market will vary between 10 percent to 20 percent within a decade.
Viewed economically as adding a domestic gas field, bringing in LNG supplies should force down natural gas prices. There's a catch, however. Foreign suppliers of LNG, though they don't currently have the same commodity markets for natural gas, will respond to price changes, Schlesinger said to those attending the conference. If the price is forced down and suppliers don't like the price, they can choose to stop supplying it or supply it for the highest price. "It's not exactly clear that LNG is going to drop the price. It may not work that way," he said, adding that short-term price drops are more likely than long term.
Smith's take on LNG was that it makes "enormous sense," even with crude oil prices at only $40 a barrel. However, he did leave conference-goers with a cautionary note on the topic. "Just because you build new terminals doesn't mean you are necessarily going to get all that LNG coming your way," he said.
More than one energy conference speaker mentioned another effect of bringing in LNG supplies. The correlation between natural gas prices and oil will grow stronger. In fact, oil prices will likely be the single largest driver of gas prices by 2008, Baumgart said. And while crude oil prices aren't a perfect driver of natural gas prices, Smith told those at the conference the two markets don't operate independently. That being said, Smith doesn't see oil prices going down quickly. "My gut feeling is that we're probably in for $55 to $70 a barrel oil for a few years," he said.
Energy Reduction Success Stories
Corn Plus Co-op LLLP is one example of an ethanol plant that found at least a partial solution to the problem of natural gas pricing. The plant, which is located in Winnebago, Minn., has reduced its natural gas consumption by 54 percent by generating power from burning some of the syrup it produces as a coproduct, says Keith Kor, general manager. By burning the syrup, the remaining distillers grains is reduced by about 18 percent to 20 percent, and the 25 tons of ash produced is sold as fertilizer. All in all, it's more economically sound to burn the syrup than to dry it and sell it. So much so, in fact, that natural gas prices would have to drop to about $3.50 to entice the company to go back to full natural gas power, he says, adding it's not likely to happen.
The project has caught the attention of others interested in using other sources of power. Since Corn Plus started burning its syrup in 2005, about 25 people have toured the plant, with interest in incorporating the plan into other ethanol plant projects.
At Nebraska Energy LLC, an ethanol plant located in Aurora, Neb., Plant Manager Mark Kuzelka doesn't enjoy the ups and downs of depending on natural gas as a power source. Although there are no specific plans to change the facilities process heat and steam source, he doesn't completely discount that possibility. "We are always exploring options," he says. To clamp down on costs, Nebraska Energy is completing an energy efficiency project. At press time, work to increase the efficiency of the distillers grains dryer was underway. The "major overhaul" included modifications to reduce temperatures on the front end, in conjunction with an emission-reduction project. The project showed its worth even before completion. "We've seen about a 7 percent reduction (per ton) already in our natural gas usage at the dryers," Kuzelka tells EPM, adding that when the project is done it's expected to garner a 12 percent reduction.
Hedging Your Bets
For ethanol plants that can't get away from using natural gas as a power source, hedging, or locking in the price of a commodity in advance of use, is one way to help control costs and increase returns. A typical plan calls for an ethanol plant hedging up to 40 percent of its energy costs about 6 to 12 months out, Whelan says. Rather than riding the unpredictable swells of natural gas pricing like the average customer, hedging allows the plant to lock in a price, hopefully at a cost savings.
To be successful at hedging natural gas prices, it's crucial to have a plan, Marshall said at the energy conference. That means supply should be purchased when certain conditions come into play. Unfortunately, not all consumers follow that practice. "If they did have a plan, it was, ‘I'm going to buy gas when I get real scared,' " he said. "And that plan doesn't usually work."
Hedging is an area where the ethanol industry tends to struggle, Neubauer tells EPM. Part of the reason for that is the typical structure of the decision-making body. Unlike many large companies or businesses, many traditional ethanol plants are still run by co-ops, meaning essentially there are many owners instead of one or a few.
When it comes time to make a decision, such as when and how much to lock in future energy prices, it's taken to a board. Rather than a set strategy, opinions and emotions come into play. "It becomes difficult for them to make decisions on these things," Neubauer tells EPM.
Another issue is that ethanol producers tend to put too much focus on the price of corn. Instead, Neubauer advises clients to look at price spreads for corn, ethanol and energy, instead of at an individual commodity driver. "If you really look at the numbers, the energy side is a much bigger driver," he says.
Taking a close look at hedging ethanol prices when the numbers are high is another element of price management, Whelan says. That strategy could help the plant lock in a financial margin.
On the other hand, instead of hedging natural gas prices, Nebraska Energy put an alternate plan in place. The company hired a consultant to work with natural gas suppliers on its behalf. "They are actually keeping us more in the cash market, which has made a significant difference for us," Whelan tells EPM.
Rather than purchasing gas at the New York Mercantile Exchange (NYMEX) prices, Nebraska Energy is purchasing gas off the pipeline daily with its consultant's help. Since suppliers have a good supply of gas they need to sell, many buyers have found those prices to be better than NYMEX prices. "[Nebraska Energy's consultant] is actually out there shopping that all the time," Whelan says.
It has paid off. The consultant's fees have been paid about 50 times over since Oct. 1, 2005, when the consultant was hired, Whelan tells EPM.
Holly Jessen is an Ethanol Producer Magazine staff writer. Reach her at
hjessen@bbibiofuels.com or (701) 746-8385.