State public service commissions are insisting that utilities adopt risk management programs, and are allowing less pass-through for those that don't.
John H. Herbert is an adjunct professor of statistics at the Northern Virginia Graduate Center of the Virginia Polytechnic Institute and State University. He also provides expert testimony and consulting services on such topics as gas industry analysis, applied econometrics and forecasting, price risk and arbitrage management, asset valuations, purchasing strategies, and the interrelationship between commodity markets. Before opening his private consulting practice, he served as a senior economist at the U.S. Energy Information Administration. He may be reached at firstname.lastname@example.org.
Judging the success of natural gas utility price risk management programs for a heating season is slippery business. Volume risk, the large, unpredictable and, at times, unsettling variability in customer loads during the heating season and a key consideration in a price risk management program for a utility, is of relatively minor importance for most other natural gas businesses that practice price risk management. Accordingly, producers and marketers were once again more successful in 2001/2002 in hedging price risk.
Success in price risk management for producing companies in 2001/2002 often meant locking in a forward price that was large relative to a known forward cost of production.1 Success in price risk management for marketing companies in 2001/2002 meant doing a lot of deals in which the derivatives market was used to lock in a large number of relatively small returns with a focus on creating a relatively steady cash flow as a base for growth in other areas. Sad to say, the leveraging off of a sound trading operation got out of hand for several companies during the last several years.2
Yet, utilities generally do not have the opportunity to lock in returns on trading positions like marketers, nor do they have a natural yardstick for gauging possible success like producers.3