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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.
Fortnightly Magazine - May 1 2002

storage assets, such as gains on the capacity release market.

Utility price risk management in West Virginia had enough of a history by 2001 that a director at the State Commission was able to prepare a report of that experience.

Not only did West Virginia customers experience more stable costs since 1996, but they paid a price that was significantly less than the average cash price during the period. 5 Naturally, the hedged price in some years was above the cash price and some years it was below. Most importantly, many customers received protection from the high prices in 2000.

When the program was first put in place in 1996, commission staff and the Consumer Advocate proposed as part of a settlement that the utility would lock a price at the average three year NYMEX price. At the time, this was $2/MMBtu. The utility had the option of hedging or not. If it didn't hedge, and if the average spot price paid turned out to be less (more) than the $2/MMBtu, stockholders would receive (incur) the gain (cost).

The report concluded, "when the risk of gas cost increases was transferred to the stockholder, hedging became the strategy of choice." On a policy note, the report concluded, "failure to even consider hedging should be considered as a complete abdication of utility management responsibility."

Utilities in Kentucky-as in California-have also been trying to work out the coordination of utility price risk management with their commission. Especially after the 2000/2001 heating season, Kentucky encouraged utilities to evaluate the use of hedging instruments. Accordingly, companies such as Western Kentucky Gas took positions in the New York Mercantile Exchange natural gas futures contract market for winter 2001/2002.

Yet, Western Kentucky Gas did not place the order directly on the exchange. Like SoCal, it relied on a consultant/broker. The company emphasizes that the hedging program is only part of the overall supply program and its program is manned by supply professionals.

Western Kentucky Gas targets a proportion of its expected requirements to obtain from storage and another smaller proportion to hedge using the NYMEX futures contract. It places the hedges on throughout the non-heating season-the idea is not to put in place all the hedges at one time, and risk the chance of paying a relatively high price. Nonetheless, staff pays much attention to price behavior and market conditions near the time they put the hedges on.

The utility is conservative in its hedging program and hedges a volume of gas purchases for a month that it fully expects to purchase. Thus, it expects to be able to easily match a volume of gas purchased with a futures contract market position. Nonetheless, it plans over time to review its policy as it gains experience using the futures contract market. It views its program as a success in that it is receiving a reduction in price risk exposure for its customers and the cost is viewed as reasonable. The company also worked jointly with the commission to develop the program. The strength of the relationship is also a positive