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All About Energy

Utilities Hedging Fuel Costs In Favor Of Price Stability

Chris Ward Apr 8, 2016 8:01:00 AM
Chris Ward
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energy prices

The overabundance of supply, paired with weather anomalies (cold spikes and early summers), has caused major upsets in the energy market over the past 10 years.  

 

For both residential and commercial customers, the unforseen increased use in storage levels and unpredictable weather conditions have resulted in volatile price swings.  Utilities will typically mitigate their risk by hedging fuel costs, but has it truly been beneficial to the customers?

 

WHY UTILITIES HEDGE FUEL COSTS

 

Utility companies need to partially hedge fuel costs in order to preserve some degree of price stability.  They have a variety of options when it comes to securing price stability for their end users, but a popular method used is to lock in the cost of fuel.  In doing so, utilities have effectively reduced the price volatility that comes with rapid market movements.  

 

In a recent Wall Street Journal article by Rebecca Smith, she questions if it is beneficial or not for utilities to hedge their fuel costs. Smith contends that the way in which utilities hedge costs is one of the main reasons utilities lose money. [1]

 

PROS AND CONS OF UTILITY HEDGES

 

A problem experts have identified with this is that utilities often create “lock and leave” contracts that aren’t informed by market risks or loss tolerances, according to Michael Gettings, a principal consultant at RiskCentrix, LLC in South Carolina. Gettings said that such hedging programs are simple to understand, administer, and have been the standard for utilities for a long time. 

 

Another concern, according to Gettings, is that utilities are led by fear. For example, after Hurricane Katrina in 2005 many utilities responded to a sharp rise in gas prices by hedging even more.  In this particular situation, utilities reacted, strongly, by hedging the fuel at a very high premium.

 

“Naturally, it was too late by then,” Gettings said, “They got caught just as prices started to collapse.”  Many still perceive this as beneficial to both utilities and consumers, since utilities are trying to keep prices down, but in the end, it's better for the utility since they can pass on hedging costs through their price of gas to their consumer.

 

Given current market conditions where prices are low, there is an abundance of supply in storage, and shale-oil fracking is adding additional resources, there really isn't a reason for generators and load-serving entities to not fully hedge their risk.  With commodity prices being what they are, there is no benefit to partial hedges.  In fact, utilities that don't hedge would really just be increasing their exposure to upward market volatility.  

 

Utilities that are fully-hedged are able to pass on these savings on to their customers, keeping the Price-to-Compare (PTC) relatively low and further encouraging open competition amongst retail electric suppliers. 

 

WHY DEREGULATION WORKS FOR YOU (THE CONSUMER)

 

One of the many reasons that you should take advantage of electric and natural gas deregulation wherever available is because utilities pass on the costs to you.  With open competition, multiple suppliers compete for your business, driving energy prices down even further. 

 

Learn more about how you can get the best energy prices with a free energy savings analysis.

 

Unbundled markets have increased hedging according to Samuel Glasser. [2] “The design of the unbundled market is such that it strongly encourages generators and load-serving entities to hedge their risk,” Ken Anderson from the Texas Public Utilities Commission said, “If a market participant goes unhedged in some way, they’re taking a big, big risk.”

 

A fixed price is another benefit of energy deregulation. “The only way that the retail provider can offer a fixed price is to enter into a contract with a generator and hedge the commodity,” Anderson said. 

 

Get the Energy Solutions guide to learn more about how to take advantage of energy deregulation to save on energy costs.

 

Retail energy providers are a doing a better job of hedging which allows them to offer a more competitive price to their customers. It'll be interesting to see how hedging affects energy prices as well the rules and regulations that govern hedging procedures from state to state in the future. 

 

References

[1] "U.S. Utilities’ Natural-Gas Hedges Turn Sour" by Rebecca Smith http://www.wsj.com/articles/u-s-utilities-natural-gas-hedges-turn-sour-1459726648

 

[2] "Utilities Turn to Global Markets to Hedge Commodity Risks" by Samuel Glasser,
http://bv.com/Home/news/solutions/security-and-risk-management/utilities-turn-to-global-markets-to-hedge-commodity-risks

 

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Topics: Energy Deregulation, Natural Gas, energy prices, Utilities