Natural Gas Hedging: A Primer for Utilities and Regulators

Deck: 
What commissions need to learn. <br>What LDCs should already know.
Fortnightly Magazine - October 1 2001
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Natural Gas Hedging: A Primer for Utilities and Regulators



 

What commissions need to learn.
What LDCs should already know.

The facts are now in. If utilities had hedged their natural gas purchases during the 1990s, they could have earned windfalls for those they serve, given the wild price gyrations of the past decade (). Yet few if any households or businesses saw any windfall, because few utilities were engaged in futures and other derivatives markets.

All the same, any windfall gains for utilities that hedge are perhaps best viewed as a matter of luck. Many (including regulators) will still see the derivatives markets as protection from ordinary ups and downs in price-not as a source of profit.

And so one can easily understand why utilities have shown a marked reluctance to embrace derivatives markets. Without adequate controls, utility companies (by design or ignorance) might end up transforming their hedging programs into trading programs. Remember also that commodity volumes can carry huge risks. Thus the possible losses from a derelict hedging program are huge. It is not unknown to hear of a hedging program that derailed into disaster.

Some utilities with excellent credit ratings, high rates of return and regular large cash flows didn't need to hedge during much of the last decade. They could offer their customers fixed bills without using the derivatives markets.1 But even this strategy harbors hidden costs. Utilities choosing this path still proved unable to protect their customers from the large shift in prices that occurred in 2000.

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