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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

protected from an imprudence disallowance. However, it may not be protected if it is found that in the execution of the plan, consumer price risk protection was not always the focus of the company and price risk protection was compromised as a consequence. 8

In any case, a plan once proposed by the company and/or approved by the commission should be followed. Plans not followed invariably lead to problems.

Nonetheless, the completion of every case is a mark of success because each ruling establishes business practice in an area of business that is rife with possible conflicts of interest. Toward the end of last year, these conflicts were aired in important hearings in Oklahoma and Rhode Island.

Rhode Island & Oklahoma PSCs: Allowance Rules Vary From State-to-State

In Rhode Island at end of October 2001, the commission stated that it was prescribing a disallowance of hedging for several reasons. 9 The commission had either approved a utility pilot hedging program to manage the impact of price volatility, or it had instructed the utility to prepare for price spikes through hedging and the utility had done nothing, or not enough.

The company had adequate time to prepare a hedging proposal if they had thought it necessary to get approval, but the company had not acted. Furthermore, the fact that other utilities did not engage in hedging did not shield the company from a finding of imprudence.

The commission ruled that one utility was imprudent because it did not hedge. The other utility was imprudent because it didn't hedge enough.

As a consequence, a disallowance was recommended that amounted to 22 percent of the company's net income. The commission concluded, "The Companies in 2000 acted like the grasshopper in the fable of 'The Grasshopper and the Ant.' Like the grasshopper, the Companies frolicked during the spring and summer and did not prepare or plan ahead for the winter. When the winter came, the grasshopper perished. Unless the company wanted to share the fate of the grasshopper, it should plan ahead and be proactive."

Meanwhile, in November 2001, the Oklahoma commission ruled on an important, contentious, and very controversial case. 10 It found that the company did not have any financial hedges. The company also did not have storage service as a hedge during the heating season of 2000/2001, even though it had access to storage and had used storage services in the past. Instead, it had contracted for a load following service, which effectively provided it with all the gas that it might need, but at a market price. In other words, the customers of the company were completely exposed to price risk.

The company had contracted for the load following service with an affiliate of the parent company. The affiliate had rights to the storage service that the company had previously contracted for. This provided the marketing affiliate with an asset that might be expected to have a very high value during the period, since supplies were recognized as tight and both the price level and price volatility was high as a consequence.