A few years ago, an investment group proposed to build a manufacturing plant in southern Indiana for the purpose of converting coal into synthetic natural gas (SNG). The properties of this product were such that it could serve as a substitute for natural gas as fuel in furnaces and other appliances.

Before breaking ground on their plant, these developers tried to interest multiple gas utilities in entering into long-term contracts to purchase the SNG. But when such private arrangements failed to attract sufficient interest from the utilities, the developers succeeded in convincing key political leaders to support legislation calling instead for the State of Indiana to purchase the SNG through the Indiana Finance Authority (IFA) for 30 years at a price based on formula to be developed by the parties.

After two important conditions were added, this legislation was adopted by the Indiana General Assembly with broad bipartisan support and signed by then-Gov. Daniels. The important conditions were that first, any contract entered into between the state and the developers must guarantee gas customers save money. Second, the contract must be reviewed and approved by the Indiana Utility Regulatory Commission.

Two days after the new law was signed, the State issued a request for proposals to enter into a multi-billion-dollar, 30-year SNG purchase contract. The State set a two-week deadline for responses. After receiving a single response from the developers who had advocated for the new law, the State began negotiating the terms of a 30-year SNG purchase contract with that sole respondent, Indiana Gasification, LLC.

By late 2010, Indiana Gasification had concluded its negotiations with the State. Pursuant to their draft contract, the State agreed to buy most of the output from the developers’ SNG plant, and the State would then sell the SNG on the open gas market. In general, if the price determined by the formula that the Indiana Gasification negotiated with the State – that is, the contract price – is less than the market price, then a portion of the savings, less administrative costs, will be passed along to most customers of Indiana’s non-municipal gas utilities. But if the contract price is higher than the market price, as would be the case currently, then these same customers would be required to pay all of the difference through higher gas bills.

The draft contract calls for Indiana Gasification to fund a reserve, up to a capped amount, that would cover anticipated losses up to the cap in the first years of the 30-year contract. Because the contract price for SNG is significantly higher today than the market price for gas, some observers have predicted that the reserve will be exhausted in just a few years.

Even if the market price ever exceeds the contract price, no “savings” are shared with customers until Indiana Gasification is paid back in full for all amounts spent from the reserve account, with no requirement for the reserve account to be replenished. By the State’s own projections, customers would not likely realize any net savings until sometime after the year 2032. Since making these projections, actual gas market prices have declined further, making the prospect for customers to realize any net savings during the 30-year contract term even more speculative.

The contract is on hold pending a legal appeal. Part two of this article will explore some of the arguments raised by the contract’s proponents and opponents as well as recent legislation which could impact the project.