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Hedging Under Scrutiny

Planning ahead in a low-cost gas market.

Fortnightly Magazine - February 2012

tandem with the tiered strategy, using historical pricing to determine the amount of forward market hedging. All parties proposed a reduction in annual hedging caps. The ALJ decision supported the company’s proposed plan, but indicated that certain accelerated purchases under the tiered strategy would require justification by market conditions to be deemed prudent. 16 At this writing, a final decision in this proceeding was pending.

In California, parties to the electric utilities’ procurement plan filings are discussing moving from fixed caps on hedging, as determined by the consumer rate tolerance (CRT) of 1 cent per kilowatt hour, to a restructured CRT that represents a percentage of the individual utility’s system average rate. By moving to a percentage of the system average rate, the percent hedged under the CRT would remain constant and wouldn’t fluctuate with rate changes. 17

Locking-In for the Long-Term

The Public Utility Commission of Oregon approved a $250 million investment in reserves by its gas utility, Northwest Natural. The utility entered an agreement with Encana Oil & Gas (USA) to develop physical gas reserves expected to supply a portion of the utility customers’ requirements over a period of about 30 years, with 8 to 10 percent of Northwest Natural’s average annual requirements supplied through the arrangement. The Commission approved the utility’s plan in April 2011, allowing the utility to recover the costs of gas produced and delivered, plus a rate-base return on investment through its annual PGA mechanism. 18

In Colorado, the Clean Air - Clean Jobs Act of 2010 (HB 10-1365), included a legislative provision to facilitate fuel-switching from coal to natural gas, while protecting ratepayers from volatility in prices. The provision provides regulatory certainty that utilities will be allowed full cost recovery, without risk of future disallowance, for commission-approved, long-term gas contracts—of between three and 20 years in duration—entered into pursuant to the act. 19 To that end, Public Service Company of Colorado and Anadarko entered a 10-year, fixed-price gas supply agreement, subject to annual price escalations, that is projected to result in savings to ratepayers of approximately $97 million, when compared to forecast gas costs without the contract. 20

Black Hills Energy of Colorado has incorporated a long-term hedging strategy into its “Gas Mitigation Plan.” The plan provides for hedging between 50 and 70 percent of its gas requirements under normal conditions, with the remaining gas requirements purchased in the monthly or daily spot market. Of the hedged volumes, half are comprised of fixed-price swaps phased in over three separate terms: three years, five years, and seven years. The long-term hedges, once fully phased-in, will represent approximately half of the company’s normal annual volume requirements. Another 20 percent of the gas supply requirements are hedged using call options in a short-term hedging strategy for the upcoming year. 21

Commissions will continue to review their utilities’ hedging plans in a critical light, and it will be necessary for utilities to work in collaboration with stakeholders to consider adaptations to hedging plans that respond to new market conditions and that protect customers in the event of rising gas