[BETA] Fortnightly

Gas Price Prudence: From Hedge-and-Hope to Best Practice

Utilities and regulators should follow the same ideas that govern risk management at the largest of commodity trading houses.

The July 5, 2001 issue of offered an update on what utilities and regulators are doing in the area of commodity price hedging for natural gas.

The headline read, "Dominion East Ohio Sales Customers Will Pay 29% Less in Gas Costs under PUCO-Led Encouragement of Hedging Plan...."

One wonders: Since when has regulatory "encouragement" helped anyone save money? But now here's the question that really makes you think: "Less compared to ?"

Theory and Practice at the State PUCs

All across North America, public utility commissions (PUCs) and their charges, the local gas distribution companies (LDCs), are revisiting past assumptions following a recent unpleasant experience-the gas price spikes that occurred this past winter. As the summer of 2000 lapsed into autumn, with spot and forward prices escalating, LDCs that manage storage inventories (and, where permitted, futures and forwards portfolios) were caught in a bind: Commit now and hope the market doesn't crash, or wait and hope it does. The net result was record low storage inventories going into November. The National Weather Service (NWS) then proceeded to report the second-coldest November and seventh-coldest December in NWS history. That was all the traders needed to send prices skyrocketing for the balance of the heating season.

While prices and emotions have returned to more normal levels, LDCs and state commissions are reopening the issue of commodity price risk management as a tool for shielding ratepayers from convulsive market price behavior, otherwise known as volatility. After years of generally holding LDCs to a "market" test for gas purchase prudence, commissioners and commission staff exhibit a marked increase in interest for price hedging, variously defined. 1

• The Arkansas PUC has set out new policy guidelines saying it expects LDCs to use hedging to reduce both volatility and prices and to document their risk management plan. However, no metrics have been established. ()
• The Colorado commission in March adopted an emergency rule requiring utilities to provide a plan for dealing with the volatility of gas prices. ()
• As part of the Missouri PUC investigation into LDC purchasing practices, Missouri Gas Energy offered two gas-pricing alternatives to the review board. The first and preferred pricing alternative is a fixed commodity price within existing purchased gas adjustment mechanisms. This option would be based on the New York Mercantile Exchange Gas Future's contract 12-month weighted average strip from October 2001 to November 2002. This plan would not be subject to a prudence review over the 12-month period. The second alternative plan offered is a hedging alternative, where MGE would hedge costs, and gains or losses from the use of hedges would be passed through the PGA (purchased gas adjustment), subject to prudence review.
• The Iowa Utilities Board has changed the rules governing the review of gas procurement practices. The board now requires a periodic review when deemed necessary with 90 days notice, instead of an annual review. The board also eliminated specific evaluation