Assessing the competitive strength of propane as a consumer energy choice.
Plumas-Sierra Rural Electric Cooperative (PSREC) is entering an era of increased competition, both for electric customers and energy end uses. Plumas-Sierra derives the bulk of its revenues from residential customers. The cooperative has experienced a significant drop in the average use of electricity by this customer class over the past 20 years, primarily due to losing the space heating market to wood stoves. Fortunately, the cooperative has retained the majority of the water heating market, as wood cannot easily be used for water heating. The new home market uses very little electricity for space or water heating due to strict state energy codes that prohibit or severely penalize the use of electricity for back bone energy loads regardless of the economics of the fuel.
The space and water heating markets are on the verge of undergoing a major change once again. Air quality is rapidly becoming an issue in the three largest towns in the cooperative's service area, as well as for the entire state of California. The ability to obtain wood cutting permits is also becoming more difficult, due to increased restrictions in the national forests, the fear of wild fires (resulting from easy forest access) and the competition for wood by cogeneration plants and small log lumber processing mills.
The cooperative's customer demographics are also undergoing significant change. A great number of cooperative members are seasonal or part-time residents who can not rely on wood for heating. The cooperative's customer base is also aging and as a result, losing interest in the labor intensive process of "gathering" wood for winter heating.
As a result of these forces, the cooperative's members are open to conversion to "hassle free" space heating. A growing number of members are giving up the use of wood stoves for the comfort and economy of fossil fueled heating systems, especially direct vented room heaters. The propane industry is in a position to capitalize on the forces currently at work in the home heating market. Unlike wood, propane has the ability to also capture water heating and other large loads once it is in a customer's home.
The propane industry is a very large energy supplier in the U.S., especially in rural areas. On a national level, the top 10 propane retail marketers sold 2,827,245,000 gallons of propane in 1993. It is very difficult to identify corporate ownership of the major players in the propane industry, as the top players are either private companies or are closely held by public companies. As an example, Suburban Propane, the nation's largest propane company, is listed by Duns as a subsidiary of SCANA Corp. SCANA Corporation is a holding company founded in 1984 by South Carolina Electric and Gas Corp.
The inability to locate the ownership of propane distribution companies also makes it nearly impossible to track down financial performance data. Interviews of current and former managers in the propane business indicate that the distribution business can be highly profitable, depending on the level of local competition. Margins of 30% to 45% have been quoted by individuals knowledgable of the industry.
The propane industry is for the most part a vertically integrated industry, with the big players owning refinery assets to distribution outlets. Most of the biggest players have the capability of purchasing gas on the spot market and placing it in bulk storage for future distribution, or through future contracts for time of year delivery. Many of these companies also own their own rail and truck delivery stock (transportation tanks). They also buy and sell fuel to each other to meet regional and seasonal fuel demands. The bigger players also function as both retail and wholesale outlets, often buying and/or selling propane to each other and independent distribution companies as market conditions warrant.
At the local level, propane distribution companies provide several levels of service to their customers. Large customers (industrial, commercial, etc.) with their own onsite fuel storage facilities are able to negotiate bulk delivery of fuel at wholesale prices. Smaller customers have service options ranging from bulk delivery to self-owned tanks to metered service from distributor owned tanks. Generally, the greater the level of service provided by the propane company, the more the customer pays. Propane distributors also provide a variety of "white goods" such as water heaters, stoves, dryers, barbecues, and other appliances that promote the use of propane gas.
The propane industry is built around the process of purchasing and storing bulk fuel as a distribution point, transporting the fuel to the end user, and storing the gas at the end user's property. A retail distribution facility in a rural area usually has bulk storage of 30,000 gallons of propane, which is the size of a large rail car transportation tanker. Rail cars on sidings, or stand alone storage tanks are used to supply the local fuel distribution system. Highway transportation tankers with approximately 10,000 gallons of capacity are used to fill regional distribution facilities not severed by rail. Utility trucks with "bobtail" tanks holding 3,000 gallons of fuel are used to supply customer on-site distribution tanks. The number of "bobtails" used by a propane distribution company is a good yardstick for the number of customers served.
The on-site distribution tanks can range from 100 gallons or less to 500 gallons or more, with 250 gallon tanks the most common. These tanks, referred to as "steel goods," are a major investment requirement for the propane industry. These tanks cost approximately $450 each plus an additional $80 for a meter and regulator set. While customers can own their own tanks, it is much more common for the propane supplier to lease the tank to the customer. The price charged for the tank is a competitive point among propane companies and it is not uncommon for companies to offer low tank rentals to lure new customers.
The tank market is divided into new construction (i.e., new homes/businesses) and "charge outs" in which one company's leased tank is replaced by another company's tank. Depending on the competitive nature of the market, both new construction sets and charge outs can be free or covered by a customer charge.
A total of five propane distribution companies have a presence in and around PSREC's electric service area. Only one of these companies (Lassen Plumas Gas) is "locally" owned; the rest are branch offices of national or regional companies. Table 1 provides an overview of the rates, service fees, and storage and distribution capabilities of these propane companies.
[TABULAR DATA NOT REPRODUCIBLE IN ASCII]
It is impossible to obtain a direct count of customers served by an individual propane distribution company. However, an estimate can be derived from the number of bobtails in service and the size of the company's storage system. One bobtail can easily deliver approximately 200,000 gallons of propane a year, or 4,167 gallons a week. The average residential customer in the PSREC service area uses 200 to 700 gallons of propane a year. Working backward, an acceptable rule of thumb for estimating customer count is 290 customers per bobtail delivery truck. This provides an estimate of 4,060 propane customers and 3,600,000 gallons of fuel annually in the four counties served by PSREC. This estimate equals 10 times the storage capacity identified over the five propane distribution companies located in the area (348,000 gallons). It is reasonable to assume that these storage facilities are filled multiple times per year, due to the high cost of developing storage capacity versus the cost of transporting fuel to refill the tanks once they are in place.
PSREC's own customer research shows that 45%, or 2,500, of our members have propane available. The cooperative does not serve the major population centers in its service area which could easily account for another 1,500 propane customers. If the customer per bobtail estimate is off by a factor of 50%, the local propane market would be comprised of 6,000 customers and 5,400,000 gallons of fuel a year.
A summary of the estimated size of the local propane market is shown in Table 2.
[TABULAR DATA NOT REPRODUCIBLE IN ASCII]
ANALYSIS OF COMPETITOR'S
The propane companies in Plumas-Sierra's service area have the potential to become serious competitors for customer's heating and water heating energy requirements. As wood becomes a less desirable source of space heating for area residents, propane has the opportunity to gain entry into homes. If the propane companies aggressively go after market growth, they could pose a serious threat to PSREC's water heating sales. For PSREC members, propane currently has 13% of the home heating market verses 23% for electricity. Propane has captured 28% of the water heating market, and electric water heaters make up 72% of the customer base.
The propane companies have done a good job of providing customer service, with 36% of the cooperative customers who use propane rating their service as excellent, Only 4% of the current propane customers rate their quality of service as less than average. PSREC currently has a strong competitive advantage over propane as 58% of the membership rates electricity with the best service verses 10% giving this recognition to the propane industry. Fortunately for PSREC, the membership rates propane much lower than electricity for safety, reliability, efficiency, convenience, price control, best energy, best for the environment, and cleanest. However, 50% of the membership considers electricity to be the most expensive fuel choice, verses only 24% that consider propane to be the most expensive fuel option.
Propane has some competitive strengths and weaknesses when compared to electricity for space and water heating. At existing PSREC rates ($0.065/Kwh) and at $1.00/gallon for propane (which is slightly lower than average), propane and electricity have nearly identical operating costs if a super efficient electric water heater is compared against a standard propane water heater. For space conditioning, a standard propane furnace (80% rate efficiency) costs twice as much to operate as an electric geothermal heat pump. This gives the advantage to electricity in the new home market for all electric space and water heating for customers who can afford the incremental cost of $3,000 or more associated with geothermal systems.
Propane has a strong competitive advantage over electricity for low to moderately priced heating system conversions. A direct vented propane wall furnace can be installed for $2,500 or less. A geothermal retrofit can cost $8,000 to $12,000. For low to moderate income families, propane can easily become the most affordable alternative to wood heat.
In the new construction market, the propane industry has ignored electricity as a competitor for space and water heating. The California energy construction code basically eliminated electricity from this market in the early 1980s. When PSREC used geothermal heat pumps to re-enter the home heating and water heating market two years ago, the propane industry was quick to respond. After losing the first phase of a large residential development to the cooperative, one of the propane providers offered the developer steeply discounted propane prices for the next phase. Fortunately, this offer was only for a one-year period and the developer was not willing to risk the customer complaints that would result if the price of propane returned to market levels after the first year. This competitive response demonstrated the propane distribution companies' ability to enter into price wars, at least for the short term to gain access to new market share.
About the same time, another propane distribution company installed a bulk distribution facility in another residential development at their own cost. This was the first example of a propane company provided distribution facility in the area. This type of service is used to provide metered gas at individual homes from a bulk tank kept full by the fuel provider. The most striking point of this arrangement is that the propane company put the facility into place even though the developer has no plans to build on the lots served by the facility for at least one more year. This again shows that the propane companies are willing to make substantial investments to gain future market share.
The recent actions taken by the propane companies in the new construction market show that they can be serious competitors for market share. They also show that the propane companies recognize the threat that geothermal heat pumps pose to their current hold on the new home market.
It is very possible that the propane companies will pursue a three prong set of strategic initiatives to gain market share. The first will be to aggressively target wood stoves as an easy market for retrofit. This marketing effort can focus on customer convenience, economy of installation, and environmental benefits. The propane industry has demonstrated its ability to ride on the "clean gas" image carefully developed by the natural gas industry. Just as the pork industry has positioned itself as "the other white meat," propane can position itself as the other clean gas. As part of their wood heat retrofit efforts, the propane companies can capture electric water heating load by offering free water heaters and free service to the water heater location.
Secondly, due to their size and profit margins, the propane industry is in a position to enter into a price war with electricity. This can be done over the entire market, or on a new construction project by project basis. This price war could include both fuel costs and equipment costs. By offering free, or steeply discounted, furnaces and water heaters the propane industry can influence builders and developers to go gas. The costs for this type of front end promotion can easily be recovered by raising prices after the projects are completed.
The last and perhaps most significant threat posed by the propane industry is the eventual promotion of customer self generation of electricity through super efficient small generator sets of fuel cells. The costs of the propane distribution network is much lower than the costs associated with building electric distribution lines, at least in the short run. If technology brings self generation units to the point that they are cost effective with electric generation and distribution costs the propane industry could position itself as the customer's answer to energy independence. If this time comes, the propane industry could target the entire home energy load for its market.
The electric distribution industry needs to be prepared for all three of these competitive threats. In the short run competitive energy pricing, including "special" marketing deals to buy market share needs to be in the industry's tool chest. In the long run, the electric industry needs to recognize that it is in the energy business and be prepared to enter the propane distribution business. By meeting the competition head on in their own market, electric companies will be in a position to capture the customer's entire energy account, regardless of the end use of the energy.
Paul Bony is manager of member services and division manager of the satellite TV programming subsidiary at Plumas-Sierra Rural Electric Cooperative based out of Portola, California. Paul has been with Plumas-Sierra since 1994. Prior to joining the cooperative, Paul spent ten years with Sierra-Pacific Power Company, an electric, gas and water utility based in Reno, Nevada. At Sierra Pacific, Paul developed the company's market planning and development group after holding positions as an energy services supervisor, district office supervisor and operations analyst. Paul received his B.S. in agribusiness from Kansas State University, and his MBA from the University of Nevada. He is a 1996 graduate of NRECA's Management Internship Program.
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|Date:||Sep 22, 1996|
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