Adopting digital capabilities to transform operations and processes holds immense promise for utilities. Indeed, it’s the best path to growth.
Hedging Under Scrutiny
Planning ahead in a low-cost gas market.
and power prices.
Window of Opportunity
Hedging objectives are an important part of the dialogue between commissions and utilities, and avoided costs need to be considered in developing a hedging program. “Hedging” can mean different things to different parties. Therefore, an important first step is to obtain broad consensus about the objectives of the utility’s hedging program. By way of simple example, one objective could be that hedging is intended to protect customers against price spikes during certain high usage seasons, while another objective might be to protect customers against rising price trends that could occur over an extended period of time.
One benefit arising from the increased focus on utility hedging is that regulators and stakeholders have grown increasingly sophisticated about commodity markets and hedging, and some might support more complex programs in the future. However, the more discretionary a program design, the more critical decisional documentation and transparent processes become. Further, there must be rigor and consistency in how hedging is adjusted in different market price environments. It will be important in the design and approval stage that the hedging program has clear triggers for when hedging decisions will be executed. During the implementation stage, it will be important for utilities to document information that was known to them at the time hedges were transacted to demonstrate that reasonable actions were taken, consistent with the program design.
It is somewhat ironic that in today’s market, as the price of hedging has declined, stakeholder support for hedging has waned. The low-price and low market-volatility environment introduces opportunities to execute hedges at historically attractive price levels. If utilities were to abstain from hedging until volatility increased and market prices rose, the cost of hedging would increase to the point where hedging could be deemed by regulators to be too costly for ratepayers.
In jurisdictions where intervenors and perhaps regulators might be reluctant to support an expansive hedging program at current lower market prices, utilities should use a collaborative process to garner support. The first objectives would be to improve stakeholders’ understanding of the supply-demand market fundamentals that have contributed to current lower prices, and to explain future trends and events that could move market prices upward. A better understanding of market drivers and how prices could potentially change will help stakeholders appreciate the utility’s need to be ready with hedging strategies to protect customers from rising wholesale market prices.
The second objective would be to engage stakeholders in a dialogue about how the utility’s current hedging program was developed, and to listen to stakeholders’ concerns. Working collaboratively, it is possible for all the parties to bring a fresh perspective to the hedging program and consider how it might be adapted under varied market conditions. Such efforts will yield the greatest benefit for utilities and their customers if they happen before supply-demand conditions materially change market prices, and the current window of opportunity closes.
1. National Regulatory Research Institute, NRRI Services: Survey on State Commission and Local Gas Distribution Company Actions in Addressing High Natural Gas Prices , (July 3, 2008).