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Hedging Under Scrutiny

Planning ahead in a low-cost gas market.

Fortnightly Magazine - February 2012

suspension of the hedging programs of South Carolina Electric and Gas (SCE&G) and Piedmont Natural Gas. The ORS commented that the hedging costs incurred by the utilities might be appropriate for markets where there is significant price volatility, but were not appropriate for more stable natural gas market conditions. According to the ORS, SCE&G’s hedging program cost customers more than $50 million since 2006, and Piedmont’s program cost over $37 million since 2002. 9 This request for suspension was later withdrawn in July 2011, and it was determined that the utilities and the ORS would address the prudence of the hedging activities in each of the companies’ respective annual purchased gas adjustment (PGA) proceedings. 10

In SCE&G’s PGA proceeding, the ORS evaluated the company’s hedging program and affirmed its previous recommendation that the hedging program should be suspended. SCE&G agreed to immediately suspend all hedging until the commission directs it to recommence. The agreement anticipates that changing market conditions— e.g., environmental restrictions on shale gas production—could warrant a resumption of hedging. 11 Conversely, Piedmont’s hedging program was approved in its PGA proceeding with the removal of its previously established minimum hedging requirement of 22.5 percent. Although Piedmont’s gas purchasing and hedging activities were deemed to be prudent, there was disagreement on whether gas purchasing and hedging activities, pursuant to a commission-approved hedging program, should be subject to an after-the-fact prudence determination. The commission requested an ex-parte briefing on the issue of how to measure prudency in hedging programs. 12

Strategic Adaptation

In some jurisdictions, regulators are modifying the hedging program horizon and limiting discretionary actions. In Delaware, Delmarva Power has a programmatic hedging program with periodic hedging at pre-determined intervals. In 2009, the utility reduced the tenor and the total volume of hedging. More recently, in response to Delmarva Power’s “Gas Cost Rate” filing, a consultant for the commission staff proposed two alternative hedging strategies to enhance flexibility in the hedging framework and to provide a greater smoothing effect on gas price spikes. The consultant recommended either lengthening the “hedging interval” beyond 18 months to take advantage of lower volatility in outer months; or implementing dollar cost averaging, 13 with fixed dollars allocated for hedges rather than fixed volumes, so that hedging volumes would increase in low-priced market environments and would decrease in higher-priced market environments. The consultant stated that dollar cost averaging results in lower gas costs when compared to a less-flexible, programmatic hedging strategy. 14 Although no changes were made to Delmarva Power’s gas hedging program, the company agreed to review and discuss the staff consultant’s recommendations for modification. 15

In Michigan, intervenors in the Consumers Energy rate case proposed a range of changes to reduce the volume and tenor of hedging under the utility’s fixed-price hedging program to address concerns that the utility was over-hedging with fixed-price purchases. In that proceeding, intervenors urged the commission to eliminate the “tiered” strategy, which provided for programmatic purchases of fixed price supply in accordance with monthly hedge targets, and suggested modifications to the company’s “quartile” strategy, which it had employed in