American National Power announced three executive changes: Joseph E. Cofelice, senior v.p., was given the added post of COO; Jim Murray, senior v.p., was given additional duties of CFO; and David...
Utility Risk Programs: Success or Failure?
State public service commissions are insisting that utilities adopt risk management programs, and are allowing less pass-through for those that don't.
Judging the success of natural gas utility price risk management programs for a heating season is slippery business. Volume risk, the large, unpredictable and, at times, unsettling variability in customer loads during the heating season and a key consideration in a price risk management program for a utility, is of relatively minor importance for most other natural gas businesses that practice price risk management. Accordingly, producers and marketers were once again more successful in 2001/2002 in hedging price risk.
Success in price risk management for producing companies in 2001/2002 often meant locking in a forward price that was large relative to a known forward cost of production. 1 Success in price risk management for marketing companies in 2001/2002 meant doing a lot of deals in which the derivatives market was used to lock in a large number of relatively small returns with a focus on creating a relatively steady cash flow as a base for growth in other areas. Sad to say, the leveraging off of a sound trading operation got out of hand for several companies during the last several years. 2
Yet, utilities generally do not have the opportunity to lock in returns on trading positions like marketers, nor do they have a natural yardstick for gauging possible success like producers. 3
Moreover, commissions are a major part of the equation for success with utilities. A disallowance because of imprudent price risk management decisions can significantly damage a company's overall net return for an entire year. Yet, sometimes the commission's voice may not be heard for at least a year after the heating season price risk management decisions are made.
Thus, a report for utility price risk management programs for a recent heating season may include information from the current heating season. It might also include information from previous heating seasons about which commissions have recently taken positions. This state of affairs is particularly interesting now, because price risk management programs have been put to the test of two heating seasons that have been completely different in terms of weather and the business environment.
Greater Price Turbulence in 2000-2002: Utility Risk Managers Face Uncertainty
The price of natural gas was near $2/MMBtu in November 1999, but had increased five-fold 13 months later, to $10/MMBtu as of December 2000. Yet, nine months later, in the fall of 2001, the price was back down to $2/MMBtu. ()
Price risk managers had to contend not only with a constantly moving price level 4 (), but also with changes in price volatility, or the ordinary movement up and down around a price level. Some of the change in price volatility during 2001 was predictable, but some clearly was not.
A useful and simple indicator of price volatility is the variability in percentage changes in price as indicated by the lengths of the lines in Figure 2. The lines indicate that price volatility increased from spring and summer levels in the fall and heating