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Risk Management Forum: Desperately Seeking Liquidity

Troubled markets drive defensive tactics.

Fortnightly Magazine - February 2009

commodity business—namely price spikes can cause you to use a lot of capital in the trading business—we took steps before the last rise in commodity prices to sell half of our trading business to Royal Bank of Scotland. By teaming with a large financial institution that can provide capital, Sempra reduced its balance sheet exposure to those kinds of fluctuations. We created a marketing and trading arm with a fixed amount of capital, and that has no other calls on our capital. It’s more like a bond kind of return for Sempra. That took a lot of the volatility out of the trading scheme.

On the regulated side, we don’t have any throughput risk. As demand goes down, that’s perceived by regulators in California as a good thing, and generally speaking it doesn’t affect utility returns. That also means that when demand goes up, utility returns don’t increase. Prices pass straight through to the customer.

Because of the way the rate structure works, we don’t have any shareholder incentive to hedge. But on the gas side, because we’re such a big player in the market, we have the opportunity to put in hedges and lower our customers’ cost. We’ve been doing that successfully over the years, and as a result we’ve been able to save our customers millions of dollars. As it currently stands we don’t have any huge out-of-market hedges in place. On occasion we’ll do that when we have clear signals of where we think prices will go, and we do that to benefit our customers.

When you have price volatility it’s very unsettling to customers, for people and manufacturers, because they can’t predict what their pricing is going to be. That’s one reason we’re actively in the commodity trading business. We offer customers the ability to fix their gas or electricity prices if they choose to do so. That kind of service is more popular during a rising market, but it’s valuable whenever prices are volatile.

 

Fortnightly: What do you see as the most important political risks affecting Sempra in the coming months and years?

Snell: The greatest impact on Sempra is a positive one, and that is pressure to reduce greenhouse gas (GHG) emissions.

We won’t see the kind of cap-and-trade system that a lot of people thought we would. We’ll see something more like what California has done, more like a carbon tax. You won’t get credit for all the emissions you currently have. There will be strict targets for reducing GHGs.

With the Obama administration’s emphasis on reducing GHGs, and because of the lack of technologies around the whole clean-coal idea, which hasn’t proven out yet, and the length of time it will take, if ever, to get new nuclear plants permitted and sited, you’ll see more natural gas plants used to supplement renewable energy portfolios.

The other side is you have a large amount of displacement going on in the natural gas industry. A lot of conventional gas fields in steep decline are being replaced by shale plays and new unconventional gas plays that

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