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Curtailment: Why Does It Cost So Much?

February 2014

  • Factors driving the price of gas during a curtailment are complex. The first thing to bear in mind is that a curtailment is called generally when there is not enough gas supply to meet demand so gas prices are likely to be above normal.
  • Price is not necessarily being driven by the cost of supplying gas, but rather by the competing bids of buyers to get the scarce supply. The scarce gas will be allocated to the buyer who values it most.
  • The choice to go interruptible should only be made if there is a viable strategy to curtail the load, as there is no guarantee that replacement supply will be found during any given curtailment, at any price. The consequence of not curtailing when required to do so can be very expensive.

During a curtailment by the local utility, a gas user with interruptible distribution service can often stay on gas if they can source incremental supply to meet their needs during the curtailment period. As explained here, this enables the interruptible customer to continue using gas without impact to the utility’s firm distribution customers. 

But when interruptible customers go out to buy incremental supply under these conditions, they are often shocked by the price for this gas. During curtailments in January 2014, prices from $12/GJ to $68/GJ were heard for gas in southern Ontario. Why does curtailment cost so much? Am I being gouged?

The factors driving the price of gas during a curtailment are complex. The first thing to bear in mind is that a curtailment is called generally when there is not enough gas supply to meet demand. It is no surprise, then, that gas prices are likely to be above normal.

When there is more demand for a good than there is supply, it creates a phenomenon economists call “economic rent”. Simply put, this is the excess of price above opportunity cost. In other words, price is not necessarily being driven by the cost of supplying gas, but rather by the competing bids of buyers to get the scarce supply. In this case, the scarce gas will be allocated to the buyer who values it most, which is very satisfying to an economist, but not always so to a gas buyer under curtailment.

For example, one buyer may have furnace oil available to supply his boilers if his gas is cut off. Based on the price of furnace oil (much more expensive than natural gas), he may be willing to pay up to $35/GJ for gas to avoid switching to oil. Across town, a power generator is looking at electricity prices over $300/MWh. Based on the efficiency of its operation, it can afford to pay up to $50/GJ and still justify running its generator.

In a competition between these two, when there is not enough gas for both, the generator wins, and the price of gas will be somewhere above $35/GJ.

A similar competition exists geographically. A marketer may have transportation capacity to move gas from Dawn to eastern Ontario, but it can also drop the gas off in the Toronto area. When eastern Ontario and the Toronto area are both under curtailment, they are competing with one another for the scarce available supply. If a market in eastern Ontario will net the marketer $60/GJ, then the Toronto-area customer will have to bid a price that offers that return or better in order to get the gas.

To help reduce the economic impact of curtailments it is important for the interruptible customer to have a portfolio of suppliers. This gives the customer more potential supply alternatives. Since supply is scarce, it often pays to be able to respond quickly before the supply is sold out, so the buyer should do some analysis to understand what volume of gas will be needed (per hour of operation) during a curtailment and what break-even price for gas is justified. This kind of analysis is best done on the first crisp day of autumn, not on a cold, dark Saturday night in January with a curtailment notice in hand.

It goes without saying (but we’ll say it anyway) that the choice to go interruptible should only be made if there is a viable strategy to curtail the load, as there is no guarantee that replacement supply will be found during any given curtailment, at any price. The consequence of not curtailing when required to do so can be very expensive too!

While the very high prices for gas during curtailments may seem shocking, it is important that they be put in context when evaluating the economic merits of being on an interruptible rate. Certainly, over the last several years, curtailments have been rare. An interruptible customer may save money most of the time over several winters, while only being hit with high priced replacement gas on a limited number of severe-weather days. The cost of the replacement gas must be weighed against the benefit of lower distribution rates over the longer term in order to determine if the strategy is suitable.

Curtailment: What Is It? Read more »

Energy Buyers Benefit from Competition among Suppliers Read more »