Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

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.
Fortnightly Magazine - October 1 2001

explain that the current GCR is $8.70/Mcf, the proposed fixed price is $6.17/Mcf, and 580,000 out of EOG's 1.2 million ratepayers are eligible because they are currently receiving bundled sales service. With no special knowledge of EOG's hedging plans in this matter (or any other), let us posit a plausible approach to making this proposal work, and then pose a few questions.

  1. Estimate the number of customer participants and aggregate load profile. This is your estimated short position.
  2. Announce the plan to your customers, setting your price and a sign-up deadline. (# 2 and # 3 are interchangeable)
  3. (Choice "A") Buy futures, forward contracts and/or physical supplies from your wholesale supplier or trading partners to cover your estimated short position (e.g., lock in your price); or (Choice "B") Buy futures and/or forward contracts to cover a portion of the estimated short position and opportunistically cover the balance in the coming months to better balance customer response with purchase commitments.
  4. See what happens....

Any of a number of things could happen. Some of these things could make EOG a hero in the eyes of the PUCO and Ohio ratepayer/subscribers (e.g., a massive and sustained spot and futures price increase). Other events could make EOG something less of a hero (e.g., a massive and sustained price slump).

And some of these things might leave EOG and parent Dominion Resources shareholders indifferent (e.g., holding perfectly matched long and short positions). Still other things (e.g., an uncomfortably long position at prices well out of the market) could put the ratepayer and the shareholder on opposite ends of a dollar bill and tugging hard.

But none of these outcomes has anything to do with the validity of the reasoning that led to the decision in the first place. Should ratepayers be liable for out-of-the-money forward positions undertaken on their presumed behalf? Should shareholders? Was this forward position prudent? By what objective standard?

Herein lies the crux of the matter: when left undefined, "prudent" can mean anything, and that "anything" tends to lean toward "good in retrospect". But in inherently volatile energy markets, "good in retrospect" can only be fairly applied to decisions, not results. Who knew that spot prices would quadruple last winter? Who knew the 12-month futures strip would drop from $6.50 to $3.50 between January and July of this year?

Toward A New Metric The proper parameters for evaluating prudent and imprudent behavior in commodity portfolio management are recognized, practiced and enforced by every successful commodity trading organization-whether it trades in currencies, pork bellies or natural gas.

  • Set a Goal. Define and adhere to portfolio objectives. Numeric objectives may change quarterly or minute by minute; overall portfolio objectives do not.
  • Impose Oversight. Establish and enforce structurally independent and unavoidable oversight of trading activities.
  • Set Trading Limits. Set and enforce a corporate risk policy, clearly enunciating individual and consolidated trading limits (Value-at-Risk or similar measures) and transaction authorizations for all trading activities.
  • Measure and Monitor. Develop and implement a reporting system that consistently and comprehensively identifies, measures and monitors all forms of financial risk undertaken by