NIPSCO sees stable coal pricing, looks at coal transportation cost hedging

For the three months ended June 30, Northern Indiana Public Service‘s (NIPSCO) fuel requirements for its generating units were supplied by coal (72.37%) and the remainder by natural gas (27.63%), including from gas-fired the Sugar Creek Generating Station.

NIPSCO burns in its coal plants: a blend of Powder River Basin (PRB) and Pittsburgh #8 seam coals in Unit 12 at Michigan City; Illinois Basin high-sulfur coal in Units 7 and 8 at Bailly; and a blend of PRB coal and Pittsburgh #8 coal in Unit 14, PRB coal in Unit 15, and Illinois Basin coal in Units 17 and 18 at R. M. Schahfer. Kevin Strnatka, Director, Fuel Supply for NIPSCO, outlined the utility’s current coal-buying situation in Aug. 2 testimony filed at the Indiana Utility Regulatory Commission in the utility’s latest fuel adjustment clause case. NIPSCO is a unit of NiSource (NYSE: NI).

NIPSCO has five long term-contracts with four coal producers. These coal suppliers are Arch Coal Sales (for PRB coal), Enserco Energy LLC (PRB coal), Consol Pennsylvania Coal (Pittsburgh #8 coal), and two Illinois Basin (ILB) coal contracts with Peabody COALSALES LLC. If needed, the remainder of NIPSCO’s coal requirements would be met through spot purchases. NIPSCO did not make any spot purchases during the reconciliation period in this case, which was the second quarter of this year.

“NIPSCO does not anticipate any issues in securing coal or transportation during the forecast period,” Strnatka added. “The continuing challenge will be to manage NIPSCO’s inventory. Currently, because of the increased demand for coal-fired generation due to the recent excessive heat, NIPSCO’s system inventory is only slightly above target level. However, with the uncertainty of the weather, low natural gas prices and units in planned outages during the shoulder months, it is possible NIPSCO could face another high inventory event. If those circumstances arise, NIPSCO will work with coal and transportation suppliers to defer tons as allowed in the agreements, and redirect coal for consumption from one station to another if necessary, while meeting the minimum volume commitments in our transportation agreements.”

Railroads have annual minimum volume commitments in transportation agreements so it can allocate resources appropriately and incent customers to take a certain volume of coal or pay a specified dollar amount per ton for the shortfall. In NIPSCO’s case, these annual minimum volume commitments are negotiated based on the number of tons NIPSCO projects it needs for a particular coal. As NIPSCO has experienced in past transportation negotiations, achievable minimum volume commitments lead to more favorable transportation rates, and conversely, minimal or no minimum volume commitment, since the railroad can’t plan its capacity, higher transportation rates, Strnatka noted. In years past, NIPSCO has met all of its minimum volume commitments in its rail agreements, and its customers benefited from the lower negotiated transportation rates.

“However, this year posed a challenge due to lower demand for energy experienced earlier this year, and low natural gas prices displacing coal fired generation,” Strnatka added. “Liquidated damages could be incurred this year under at least one transport contract. However, NIPSCO is negotiating a verbal agreement with that railroad to be finalized in the next months to defer any shortfall tons to future years. Based on recent increased demand for coal-fired generation, NIPSCO expects to meet all other railroads’ minimum volume commitments, so NIPSCO will likely be able to avoid any payment for liquidated damages in 2012.”

Three of NIPSCO’s long-term contracts have firm prices that increase each year as specified in the contract. One long-term contract has prices that are adjusted annually for the succeeding year based on the average weekly indexed prices of that particular coal in the previous year. One long-term contract has an annual market price reopener that will determine the contract coal price for the succeeding year of the contract. All term coal contracts are price adjusted (up or down) on a Btu per pound basis. In addition to the Btu adjustments, PRB coal term contracts are adjusted (up or down) based on sulfur content. NIPSCO’s coal contracts are usually for a term of no more than three to five years, and typically the price is adjusted each contract year.

Firm transportation costs help to stabilize coal prices

The delivered cost of coal for the twelve months ending June 30 was $51 per ton or $2.554/mmBtu. The delivered cost of coal for the period of April-June 2012 was $52.12 per ton or an identical $2.554/mmBtu.

The average spot market price of coal during the reconciliation period (April-June) was $9.03 per ton for PRB coal, $41.10 per ton for ILB coal and $58.04 per ton for Pittsburgh #8 coal. NIPSCO tracks spot market pricing by reviewing various coal publications. These average spot market prices do not include transportation charges.

NIPSCO’s delivered cost of coal during the reconciliation period (April-June) increased compared to the first quarter of 2012 from $50.62 per ton or $2.554/mmBtu to $52.12 per ton, but the average dollar per million Btu remained constant at $2.554/mmBtu. The static per million Btu delivered coal cost represents firm coal and transportation contract pricing in effect for 2012. Fuel surcharges were relatively flat during the reconciliation period.

NIPSCO anticipates that its delivered cost of coal for the forecast period of October-December 2012 will be approximately $48.95 per ton or an estimated $2.592/mmBtu, and it is forecasting a year-end projection for 2012 of $2.56/mmBtu. NIPSCO will be monitoring its projected burn requirements for the remainder of the year, and there could be a need to procure spot market coal, Strnatka noted. “This could favorably influence the delivered cost of coal for the forecast period. If NIPSCO would not need any additional coal, the delivered cost of coal will be reflective of the current coal and transportation agreement pricing. It is important to note that the projected delivered cost in the forecast period could be influenced by the volatility in the diesel fuel market.”

The average spot market prices for calendar year 2013 are currently $11.08 per ton for PRB coal, $44.03 per ton for ILB coal and $63.42 per ton for Pittsburgh #8 coal. These average spot market prices do not include the cost of transportation.

NIPSCO believes the greatest impact on the supply, demand, and cost of coal during the forecast period will be natural gas pricing. “If natural gas fired generation continues to be competitive, and effectively displaces coal fired generation, coal pricing will remain very economical,” Strnatka wrote. “Another factor that requires some attention is the ongoing cutbacks in domestic coal production and the financial impact on the coal producers. Additional factors that will influence the cost of coal include the weather, international demand for domestic coal and evolving federal environmental regulations.”

NIPSCO has transportation agreements in effect for 2012 with firm pricing (exclusive of fuel surcharges), so there will be no transportation price increases in the forecast period. The prices of West Texas Intermediate crude and highway diesel fuel have remained relatively stable. If this price stability continues, NIPSCO’s delivered coal cost will be minimally influenced by fuel surcharges paid to the railroads.

NIPSCO is looking seriously at transportation fuel hedging

Strnatka also addressed the issue, raised in a prior fuel proceeding by a group of industrial power customers, of whether NIPSCO should hedge the diesel fuel surcharge costs passed on to it by the railroads. NIPSCO indicated in that prior case that it would review the industrial group’s recommendation, analyzing, among other things, the possible benefits and costs of such a hedging policy, the various tools available to accomplish a hedging program, and the reduction in transportation price volatility that could be achieved through a hedging policy.

NIPSCO has been working recently to determine the amount of transportation cost that is exposed to risk of automatic adjustment and against what commodities the risk is exposed. This is complicated by the fact that the transportation contracts include fuel surcharge triggers against two different commodities. One contract uses West Texas Intermediate crude prices as its trigger while another uses highway diesel fuel. In addition, different contracts have separate fuel surcharge escalators once a trigger price is reached.

“Notwithstanding the above challenges, two of the three contracts that create fuel surcharge exposure will expire at the end of 2012,” Strnatka wrote. “This may provide an opportunity to mitigate one of the most onerous fuel surcharge mechanisms associated with a railroad that delivers all coal to NIPSCO’s R.M. Schahfer Generating Station. These contract negotiations will commence later this year. NIPSCO’s recommendation would be to defer a decision regarding a coal transportation hedging program until both new transportation agreements have been negotiated, particularly the fuel surcharge mechanism associated with coal delivered to the R.M. Schahfer Generating Station. NIPSCO will continue to reach out and be available to work informally with stakeholders to review further analysis after new agreements take effect. If warranted, the next step would then be to review different options for implementing a hedging program.”

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.