Why Utility Companies Need Natural Gas Hedging
Do utility companies need to hedge their natural gas purchases?
Yes. But how should they think about hedging?
Natural gas hedging is used heavily by two types of utility companies. Natural Gas utilities sell natural gas directly to customers for cooking, heating water, and warming their homes during winter. Power utilities use natural gas as a fuel to make electricity, which they deliver to consumers to power their homes and businesses. Both types of utilities have tremendous natural gas price risk exposure, and both have an obligation to manage their natural gas price risk on behalf of us, the homeowner and ratepayer.
Given this responsibility, what role can an expert advisory firm like Gelber & Associates play in the management of risk for utility companies and consumers?
Between 1990 and 2008, natural gas was the most volatile commodity trading on a regulated futures exchange. Natural gas, during this 18-year time period, traded at roughly 3 times the volatility of the Dow Jones Industrial Average, a large amount by any measure. Prices in the natural gas market have been falling, pretty much unyieldingly, since the onset of the shale revolution in 2008. In this regard, 2008 was arguably the height of a natural gas bull market. Since this time, a large supply of gas from shale has hit the market and caused prices to decline into March of 2016. Presumably, after prices bottomed out in spring of 2016, a bear market for natural gas came to an end. During the period of rising natural gas prices and volatility after 1990, hedging to mitigate risk exposure was commonplace, but the lower prices and reduced volatility in recent years has led utility companies into complacency.
Some industry experts like Gelber & Associates (www.gelbercorp.com) believe that a new bull market for natural gas is nascent but underway. By the year 2020, Gelber believes that a bull market will be in full swing. Presuming this opinion is accurate, how should utility companies manage their natural gas price risk? What should utilities do to adjust their behavior in a downward natural gas market compared to an upward natural gas market? How do they know the difference? How speculative are utility hedging decisions when they are viewed by the Public Utility Commission in the rear-view mirror? Similarly, what should the Public Utility Commission do when reviewing the huge hedge losses that utility companies have taken at the expense of ratepayers since the market began its downward price cycle in 2008?
- Four Florida utilities have reported lost $6.5 billion in natural gas related hedging losses since 2002
- Regulators have invoked an order will halt hedging programs through 2017 while the parties investigate how they can be improved
- Parties will come together in one or more workshops to consider thier alternatives including a halt to all hedging activities
Most importantly, what will utility companies do if higher prices and volatility return to the market? In response to these losses, some states are engaged in efforts to improve the hedging performance of their respective utilities, while others have halted hedging practices completely.
Gelber & Associates’ position is this: halting hedging practices in today’s market is analogous to cancelling flood insurance at the end of a drought period as a tropical storm is developing in the area adjacent to your home. Natural gas price and volatility are both low; this is when creating a hedging strategy can yield the greatest benefit.
Recently, the State of Colorado Public Utility Commission has recognized Gelber & Associates for its skill in handling the hedging on behalf of utilities in their state. We have been successful at “risk adjusting” our utility hedging programs during a variety of market conditions without taking undo speculative risks. On August 17th, the Colorado Utility Commissioners are holding a Commissioners’ Information Meeting in Denver and have asked Gelber & Associates to present on the topic of utility hedging and participate in the subsequent roundtable. The meeting will be a webcast and is open to the public. More information about the Colorado Public Utilities Commission can be found on their website.
Recently the State of Washington has voted on and passed a policy statement and interpretive statement (Dockey UG-132019) instructing the State's natural gas utilities to review, revamp and submit a Comprehensive Hedging Plan. More on this in another article.