High Gas Prices and Bad Debt Versus Public Policy and Supply Obligation

Market commentary by Gerry Keenan, PalmerBelvue

Open any newspaper, tune in to any nightly business program and you're likely to see a story on the recent, dramatic increase in natural gas prices over last winter.  "The combination of much higher gas prices and a colder winter in most of the eastern half of the country are expected to provide a rude shock for most homes and businesses that use natural gas for space heating.

Estimates vary, but increases in seasonal gas bills of 25 to 40 percent are not uncommon. Last fall, Public Service of Colorado projected a 75 percent increase for its customers. That dramatic increase was created by abnormally low prices in the winter of 2002-03, which resulted from supply-demand imbalance in the Rockies that winter – way too much supply, not enough pipeline capacity to transport the gas to market.

Less attention has been given to the consequences of the price increases, especially the substantial increase in old accounts receivable that will be held by gas distributors and the eventual increases in uncollectibles and bad debt that are likely to follow. Similar developments followed the price spikes in the winter of 2000-01, with some distributors experiencing a doubling or tripling of bad debt write-offs in the 12 months following that winter.

Peoples Energy, Chicago’s hometown distributor, has seen its bad debt costs double from $20 million to about $40 million since 2000. The company’s 2004 budget forecasts a bad debt provision of 2.5 percent of its gas distribution unit’s revenues, or $40 million. Last year’s actual bad debt write-off was $42.5 million (2.8 percent of revenues), compared with the gas distribution unit’s operating earnings of $174 million. The $20 million increase in bad debt provisions amounts to about 11.5 percent of the distribution unit’s reported operating earnings, and about 20 percent of the entire corporation’s net income for 2003. Peoples put up these bad debt numbers after the application of LIHEAP funds and all other private and public contributions.

Until recently, bad debt provisions of more than 1 percent of revenues raised red flags with analysts and shareholders, with some urban gas distributors having somewhat higher numbers. However, the expectation that gas prices are staying higher than $4 to 4.50/mmBtu for at least the next several years is sure to cause concern that bad debts will be on the rise again.  Although definitive figures are elusive, a significant portion of the increase in bad debt costs can be attributed to gas distributors being pressed into the roles of social service agencies.

Over the past 25 years, gas distributors have become increasingly enmeshed in the business of subsidizing gas service for those customers who either can’t or won’t pay gas bills. The direct cause has been the credit and collection rules enacted by state governments regarding disconnection of service during cold weather, reconnection of service prior to winter months and the variety of payment plans that must be offered before any disconnection can take place. A combination of public and governmental pressure also often drives distributors to make accommodations beyond the rules, especially for disconnected former customers still without service in November and December.

Emerging public policy has begun to regard residential utility service as a right, rather than an important service. Regarding it that way may work for government, but it does not address the fact that gas distributors have to absorb bad-debt costs – to the detriment of their other customers and their shareholders.

Before the brickbats start flying, let me explain.. There are indeed people who have a need for utility service, but insufficient means to pay for what they will use. Unless we are to abandon these folks to the elements, funds must be made available to pay these costs. The current system does not do so. Further, it consigns those who cannot pay to a hellish existence of being disconnected every spring and then scrambling for funds or charity to be reconnected before the snow flies six months later. The current system punishes the poor for being poor, forcing them to accept financial responsibility for utility service on which they know they will default and be disconnected, as if their lives weren’t already difficult enough.

The rules that have developed regarding credit, collection, disconnection and reconnection are at least partially responsible for the bad debt problems, because they apply equally to those who can’t pay and those who won’t pay. Since the rules often don’t apply just to residential customers but to multifamily apartment buildings where gas provides the source of central heating, those who won’t pay are often owners of apartment buildings. Any urban gas distributor can tell you what happens when the cold weather rules go into effect – lots of customers stop paying bills until spring. Some will pay in the spring, others will never pay and the building’s gas service will be disconnected in May or June. Come next October, a "new owner" will seek to establish service and disavow any knowledge of the previous owner who scammed the gas company for $10,000 or $20,000 of free gas after charging tenants for it in monthly rental payments.

The costs of the current system are not only measured in bad-debt costs. Distributors incur significant extra costs from the layers of contacts and notices that must be observed before final (and often effective) collection action can be taken – additional personnel, costs of carrying past due accounts for months, etc. These costs also fall on other customers or shareholders.

In order to provide protection for those who can’t pay, one-size-fits-all regulations provide substantial benefits to those who can pay, but won’t – at least until there is a realistic threat of disconnection.

The current regulations generally arise from the natural gas prices run-ups of the early 1980s. They were reactions to real public policy concerns. Now, 20 years later, it is an opportune time to re-examine them to reduce the bureaucracy, increase the pressure to pay on those who can and deal compassionately with those who need the gas service to survive, but have no reasonably hope of paying for the service.

We’ll consider some solutions in the near future.

Gerald Keenan is the Managing Director of Palmer Bellevue, LLC, a private investment and strategic advisory firm in Chicago. He welcomes comments and suggestions at gkeenan@palmerbellevue.com.