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Market Monitor – Natural Gas Swing vs. OFO Penalties

Penalty charges for deviating from expected natural gas consumption come primarily from two sources with distinct and separate circumstances. The first way to incur additional charges is to use more (or less) than the contracted and nominated amount of natural gas, which is referred to as a swing tolerance penalty, or just “swing.” Swing charges are levied by your natural gas supplier. The second is to use more (or less) than your daily nominated amount of natural gas during a type of system emergency called an Operational Flow Order (OFO). OFO charges are levied by natural gas pipeline operators, NOT by your supplier.

Swing tolerance penalties exist to insulate suppliers from having to foot the bill when a customer uses more (or less) natural gas than their agreement specifies. When customers deviate from their contract terms, suppliers must go back to the wholesale market to balance the quantity of natural gas being consumed. Suppliers, in this circumstance, are exposed to market rates and incur real costs, which they pass on to the customer. It is possible for a customer to avoid swing charges by buying what is effectively insurance for the agreement that entitles them to 100% swing (i.e. they can use 100% more or 100% less natural gas than their contract states). This swing tolerance usually comes at a cost, but provides protection from the additional charges.

During times of extreme stress on the interstate natural gas pipeline system, pipeline operators may declare emergencies or Operational Flow Orders (OFOs). OFO charges stem from consumers using more or less natural gas than their daily nomination during these system emergencies. Natural gas pipelines are essentially gigantic high-pressure plumbing systems that are very difficult to manage. The problems become critical when demand on the system is extraordinarily high (or low) and the system is near failure. Thus, in such a situation when a customer uses more (or less) than specified on a given day, the pipeline operator charges penalties to balance their costs of keeping the system functioning. The only way to avoid OFO charges is to use exactly the daily nominated amount of gas on the day of the emergency. No amount of swing tolerance in a supplier contract insulates a customer from an OFO charge.

An example may help, as these concepts are highly similar but are in fact distinct.*

Imagine you are driving on an interstate highway with a posted speed limit of 80 mph. Let’s think of this as the contractual natural gas quantity. Let’s also make 80 mph the daily nominated quantity. You will have to pay a fine for driving faster than 80 mph. Now, let’s say you know could buy the right to exceed the speed limit so that you could drive past a state trooper driving as much as 15 mph above the posted limit without getting a ticket. This is parallel to having a swing clause in your agreement (18.75% swing in this case). In this general case of interstate driving the speeding fine is to safeguard all drivers and to fund the state’s maintenance of the road.

Now, imagine you have entered a construction zone. This is a special situation on the road akin to a natural gas pipeline system emergency. In this case, no matter what the norms of the road are, you dare not deviate from the posted (lower) speed limit. You know that the state trooper will now ticket you for going even 5 mph over the limit. You also know – because you saw signs to this effect – that speeding fines are doubled in this stretch of road. Finally, you know that if you get pulled over, the chances of talking your way out of the ticket are essentially zero because the special circumstances of the construction zone. The tolerance is lower and the fines are higher in this case because the immediate safety of specific road construction workers is the issue, not just the general safety of all drivers.

The ticket in the road construction zone is analogous to an OFO penalty. OFO penalties occur because your behavior affects all other customers (not just you and your supplier) in a bigger way than it does during normal circumstances. It is literally the case that the system could fail, which would result in natural gas not being delivered to anyone if all customers do not behave as they agreed to behave in their daily nomination. Thus, penalties are high to incentivize compliance. Once again, a 100% swing clause in an agreement does not insulate a customer from an OFO charge for deviating from their daily nomination in a declared natural gas pipeline emergency.

*For the record, Tradition Energy does not advocate speeding or any traffic violations of any kind.

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