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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

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Unlike SoCal and Western Kentucky Gas, Columbia Gas of Ohio, like many other utilities, relies on its gas suppliers to hedge or fix the cost of gas for forward supplies. The utility has contracts with several marketing companies to lock in a price for a certain volume of gas. Utility staff keeps an eye on the NYMEX futures contract price. When they observe a price that follows some criterion as to reasonableness, they lock in the observed price-or a price near the observed price.

The utility negotiates a forward price with the supplier based upon the NYMEX price plus or minus the difference in gas value, between the wholesale market where the utility intends to take ownership of the gas, and the Henry Hub in Louisiana where the NYMEX contract is traded.

In any case, the utility company seems well aware of the Financial Accounting Standards Board (FASB) Order 133/138. Thus, it believes that were it to engage in the NYMEX market directly, there would be the need to maintain accounting records to document the value of the futures position and the hedged physical position over time (marked to market accounting), and to fulfill other requirements of the Order.

It is also concerned about whether costs associated with running a successful hedging program-such as costs associated with variable margin requirements for a NYMEX futures market position-would necessarily be included in standard gas cost recovery accounting.

Columbia Gas of Ohio, like many other utilities, is somewhat conservative in the amount of gas it hedges. This is, in part, because of a successful customer choice program that has resulted in the number of customers supplied by the utility to vary within a year which, of course, complicates determining the volumes to hedge. It is also conservative because storage capacity is a major component of its portfolio. The utility is somewhat less conservative in terms of how far out the hedge can be placed. The utility is always ahead at least two winters into the future.

Despite these and other issues, Columbia Gas of Ohio continues to consider using futures contracts and other derivatives directly, and is planning to start a detailed review and evaluation of its price risk management program within the context of overall supply management program as soon as the summer of 2002.

And Everywhere Else ...

In a variety of states stretching from Maine to New Jersey and Colorado to Kansas utilities, such as Kansas Gas Service in Kansas, used call options, collars, or fixed price contracts to put a cap on price for a certain volume of gas during heating season 2001/2002. 6

By the crude measure of price risk management success-whether companies avoided high prices in the heating season-hedging programs of most utilities using such contracts were failures and companies are kicking themselves as a consequence. 7 Options, for example, increased the cost of gas to consumers without yielding any direct benefit. These instruments are just like insurance. If the accident of high prices occurs, the utility customers are protected. But if the accident of high prices does