New England is leading the way toward a future that is both cleaner and provides greater electric reliability at reduced cost. New England Independent System Operator (ISO-NE) has created an...
Natural Gas Hedging: A Primer for Utilities and Regulators
What LDCs should already know.
put into storage remains there over several months, the stored gas is exposed to significant price risk. 11
Nonetheless, the value of storage is not to be underestimated. And, if a company has rights to storage that enables it to inject gas throughout the year and to withdraw large amounts of gas at times when it is most needed, it may significantly reduce the cost risk exposure associated with storage. It will also improve its bargaining power in the buying of incremental natural gas because it has the option to buy and sell on a large number of days throughout the year. It has flexibility. 12
Operationally flexible storage enables a company to reduce its risk exposure by reducing the amount of gas it needs to have in storage at any one time. It also allows the company to maximize the value of the asset because of the much higher deliverability that is possible from these sites. Storage has its greatest value when temperatures plummet and on those days it is deliverability that matters and not the amount of gas in storage. 13
In fact, utilities that own rights to operationally flexible salt cavern storage in producing parts of the country can combine such storage with knowledge of futures markets to yield arbitrage gains.
Figure 6 displays the difference between the spot and the futures price. Not surprisingly, this difference usually hovers around zero but not always. When the difference or "flex spread" is large and positive, then a utility with operationally flexible storage in markets well connected to the Henry Hub may be able to sell gas out of storage and buy gas under a futures contract and receive a profit. In this case, the utility will earn a return equal to the flex spread less any operating and transaction costs. As long as the transaction does not increase any volume risk exposure, the companies should consider pursuing such opportunities.
Collateral Benefits: From Credit Rating to Convenience Yield
In addition to stabilizing prices, cost and customer bills and arbitrage returns there are other direct and indirect benefits for a utility from engaging in a price risk management program.
Involvement in the futures market could promote better forward planning. The stabilization of cost and revenues could even increase the credit rating of the utility. Many companies use the derivatives market for just this purpose. This advantage could prove especially important as utilities become increasingly exposed to business risk with more competition at the retail end.
Furthermore, these programs foster the development of the types of skills and require the types of tools useful for conducting business in today's more market-oriented and riskier energy industry. These programs also require companies to marshal information that could also be used by the company to estimate the market value of its assets and its rights to assets. For example the difference between the spot and nearby futures market at the Henry Hub could be used to evaluate some of the value of operationally flexible storage in the area.
When bills and costs are stabilized by a