THE GALENA TERRITORY PROPANE CO-OP PURCHASING PROGRAM

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1 THE GALENA TERRITORY PROPANE CO-OP PURCHASING PROGRAM What The Galena Territory s Propane Co-op Purchasing Program pools homeowners together to achieve group purchasing power, with the intention of realizing lower home fuel prices. Why A Co-op approach introduces favorable economies of scale, thereby allowing participating owners to purchase their propane at a price that has proven, over the history of the Co-op program, to be about 30 percent less than if they did not participate in the Co-op. Participants benefit from group purchasing power and the knowledge of the propane market provided by GTA General Manager Joe Mattingley, and a Territory resident with extensive expertise in the energy markets. How Every three years, the GTA solicits bids from area energy providers that wish to be the Co-op s exclusive distributor. A number of factors are considered when reviewing the bids including: Cost of margin range (how much on a per-gallon basis the distributor makes over its cost, usually presented as cost of margin ) Vendor record of reliability Vendor s agreement to meet certain Co-op stipulations including a keep full provision and propane tank sales and/or rentals. The Co-op buys its propane through a wholesale provider directly related to the Co-op s vendor, and the vendor is responsible for distribution and any maintenance of the homes fuel delivery system (tank, fuel lines, etc.) When In February of each year the GTA notifies owners by mail of their opportunity to register for the Co-op program. Applications must be returned to the propane distributor by a set deadline to be included for that purchase year (typically July 1 to June 30). The Co-op purchases its fuel for the upcoming winter season when propane market conditions are favorable any time between October and June. Who The current propane vendor servicing the Co-op is Ferrellgas. The company has been the exclusive vendor since the program s inception in Ferrellgas current 3-year contract runs through June Program History Many of the homeowners in The Galena Territory come from urban areas and are accustomed to having the option of purchasing natural gas to heat their homes. Because of The Territory s rural locale, however, heating options are limited to propane and electric. Roughly 30 percent of Territory homes run on electric and the remainder use propane. Propane-fueled homes have a dedicated tank for storage, which is either owned by the property owner or leased from a propane provider. Fuel usage in The Territory varies depending on many factors including: the home s frequency of use; the size of the structure; its insulation/weather efficiency; and the number of windows. The typical full-time residence uses anywhere from 1,200 to 2,500 gallons of propane per year. Over the years, the propane market has become quite volatile. Like other fuels used for heat, such as heating oil and natural gas, significant price swings can make a homeowners budget process a nightmare. This frustrating reality held true in The Galena Territory, as well, so the GTA started to investigate the efficacy of a Co-op purchasing program pooling many homeowners together as a purchasing unit to secure volume pricing discounts. Propane Co-op White Paper: 7/7/2014 Page 1

2 The GTA introduced its Propane Co-op Purchasing Program in Since then it has grown significantly, from approximately 600 members in 2004 to more than 1,400 members in In 2013, the Co-op purchased 1.8 million gallons of propane for use in Territory homes. Vender Program Requirements While many area vendors have bid to be the exclusive propane provider for the Co-op, Ferrellgas has been selected each time the contract has come up for bid. Ferrellgas has certain size and distribution advantages that enable it to compete quite effectively on criteria outlined in the Co-op s RFP, which is done every three years. In the current contract, Ferrellgas agrees to distribute propane to Co-op users and charge an agreed-upon range of markup on the distribution, commonly called cost of margin. It also agrees to a keep full provision to ensure tanks don t empty during the heating season. That s the delivery portion of the program. Purchasing the propane is where things get interesting. The Co-op has three purchase options: 1. The Hedge Option A highly speculative and risky approach often used by full-time traders. The Co-op has never used this option. 2. Direct Purchase/Fixed Pricing Propane futures are purchased when market conditions suggest the prices will be low. After the propane distributor (Ferrellgas) adds its cost for distribution, the result is a set gallon price that owners can rely upon throughout the year. That price may or may not be favorable compared to what a homeowner could get if he/she purchased the propane outside of the Co-op. Historically, the Co-op has purchased wisely; the average savings over the entirety of the program is approximately 30 percent. (Example: If the Co-op makes four futures market purchases of fuel at $1.05, $1.00, $1.10 and $1.05 in equal quantities each time, the average per-gallon price would be $1.05. Then add the 20-cent margin for Ferrellgas and the cost to the Co-op participant is $1.25.) 3. Index Pricing A new purchasing model, Index pricing eliminates several variables that make purchasing with the other two options more risky: a. cost of money b. cost of futures c. cost of storage Under Index pricing, the propane provider (Ferrellgas in this case) purchases at the daily wholesale price, based on demand, then adds its margin to calculate the cost of the propane for that day s delivery. The Index Pricing method is the least speculative of the three and, over time, has proven to be quite economical. The Co-op committee conducted a study of its propane purchase prices over the last six years and found that its participant homeowners would have saved $300 each over that period if they had used Index Pricing instead of the Direct Purchase/Fixed price method. The one drawback, from some owners perspectives, is that the pergallon price on their monthly invoices will vary, again removing the budgeting certainty that the Direct Purchase method provides. The Co-op is fortunate to have two individuals with extensive expertise in the propane/fuels industry to determine the best times to purchase fuel. The Co-op is required by the GTA to offer both the Fixed and Index pricing options. However, GTA management believes that Index is a better, safer route, which can be sustained over time. Co-op owners are gradually seeing the logic and switching from Fixed to Index. In 2013, 90 percent use Fixed and 10 percent selected Index. Propane Co-op White Paper: 7/7/2014 Page 2

3 Winter of 2013/2014 An unusually cold and long winter placed tremendous pressure on the supply and price of propane. Some Territory owners who utilized the Index pricing method saw brief, significant spikes in their propane prices. Learning from this experience, GTA management and Ferrellgas are looking at steps that can help soften the impact should such an occurrence happen again. Looking Ahead Looking further into the future, The Galena Territory Association may address the real possibility of converting The Territory to natural gas. Currently, natural gas is about 30 to 40 percent cheaper than propane, largely because the delivery from provider to buyer is direct, eliminating middlemen, as well as storage and transportation costs. Additionally, America has vast deposits of natural gas, so scarcity is not a legitimate concern. Still, considerable research and negotiation with outside entities must take place. Significant questions must be addressed, most importantly: How much will it cost homeowners to install the delivery infrastructure? All constituents will be asked to weigh in on the natural gas questions when the time comes. ILLUSTRATIONS Table 1 is a historical comparison among Pre-Paid Pricing, Pay As You Go Pricing and straight Retail Prices for Co-op Program members from seasons 2006/07 to 2013/14. Table 1 Propane Co-op White Paper: 7/7/2014 Page 3

4 Tables 2 & 3 illustrate the savings of using Index Pricing vs. Fixed pricing over the same period. Table 2 Seasonal Index $ vs Fixed $ $4, $3, $3, $2, $2, $1, $1, $ $- 06/'07 07/'08 08/'09 09/'10 10/'11 11/'12 INDEX $ $2, $3, $1, $2, $3, $2, FIXED $ $2, $2, $3, $2, $2, $2, Table 3 Seasonal Variance $1, $ $- $(500.00) Varia $(1,000.00) $(1,500.00) $(2,000.00) 06/'07 07/'08 08/'09 09/'10 10/'11 11/'12 Total Variance $( $ $(1,540. $ $ $( $( Propane Co-op White Paper: 7/7/2014 Page 4

5 Propane Co-op White Paper: 7/7/2014 Page 5