Gas Hedging Hegemony Pursued by CPUC, Munis

By Published On: October 28, 2005

Utilities were given latitude to invest in contracts to smooth out natural gas prices this winter the same week gas prices hit record highs. At its October 27 meeting, the California Public Utilities Commission approved, on a 4-0 vote, two more utilities’ plans to enter into hedging deals. Commissioner John Bohn recused himself because of a potential conflict of interest. I assume “utilities will do everything they can” to invest in ratepayers’ interest, said commissioner Geoffrey Brown. He noted, however, that “ratepayers are at risk and shareholders are totally exempt.” The commission said that it would cost San Diego Gas & Electric and SoCal Gas ratepayers about $2 a month on average this winter to pay for gas hedging. With a total of 6.3 million customers, and assuming at least three months of winter weather, that would reach about $40 million for both SDG&E and SoCal Gas. However, utility spokespeople refused to either confirm or deny that assumption. “The level of new hedges is confidential,” said Peter Hidalgo for the utilities. He would not say what sort of hedges the Sempra utilities plan to engage in, or whether they even plan to do so in the near future. In theory, financial devices could smooth out potential price spikes and perhaps save ratepayers money over the long run if the price of natural gas creeps up even higher. The commission noted that utility bills could be as much as 70 percent higher this winter than last year. This week, gas hit $14.35/MMBtu in the short-term market. A 12-month contract closed at $12.36/MMBtu. In June, contracts were running about $7/MMBtu. The commission’s move follows an October 6 vote of 3-0 to allow Pacific Gas & Electric to pursue financial “call option” contracts. These allow the utility to lock in a price for the gas this winter, but not to physically buy the gas. “We do not believe PG&E’s hedging plan as proposed is risky or contrary to the interest of the ratepayers,” said commissioners. Unlike the Sempra utilities, PG&E readily revealed the utility’s expectation that gas hedging would cost ratepayers about $60 million, according to spokesperson Jason Alderman. He wouldn’t say, however, what percentage of the utility’s gas would be under those deals or provide details on physical or financial terms. Alderman would say only that contracts have been signed. It’s assumed that the commission, following its approval, will not hold utilities up to an after-the-fact reasonableness review, according to sources. If that is so, utilities would not be potentially hit with a disallowance if it’s found their investments harmed ratepayers. But that assumption was not explicit in the commission’s hedging approval decision for PG&E, and its most recent decision was unavailable at press time. When PG&E asked the commission for hedging approval, an administrative law judge’s proposal would have increased the utility’s ability to use its performance-based gas procurement mechanism to cover more hedging. Generally, the performance-based mechanisms have been used to contract for physical supplies of gas in multiyear “strips.” That mechanism was usurped by direct contract approval by a joint decision penned by CPUC president Mike Peevey and commissioner Susan Kennedy. The utilities feared a “financial penalty” if hedging contracts are pursued through the performance-based mechanism that already applies to the utilities. “We subject ourselves to potential shareholder losses under the current incentive mechanism,” according to Sempra spokesperson Denise King. The CPUC hedging approval is for pass-through gas to utility core customers to be consumed in such uses as heating and cooking. It is not to be used in procuring fuel for power plants. Several municipal utilities in Southern California have already entered into numerous types of hedging contracts for gas to run their power plants. They are planning to hedge even more. Unlike investor-owned utilities, though, they have not kept the contract terms in the dark. The Southern California Public Power Authority (SCPPA) bought its own gas field in Wyoming for $300 million. It began delivering gas to member munis this July at a price of $5/MMBtu, according to Bill Carnahan, SCPPA executive director. He explained that the field currently has 38 gas wells supplying, on average, 15 percent of members’ supplies. More wells can be drilled at the field, and it’s expected to operate for 20 to 25 years, he added. The field that SCPPA bought into, Pinedale, could serve one-third of the needs of Los Angeles if environmental restrictions were lifted, according to Senator Pete Domenici (R-New Mexico). He instructed government agencies October 27 to research removing bans on winter pumping that protect wildlife to expand production in that area. Another method of hedging is also being explored by the munis. “We just put an RFP out for prepay agreements,” Carnahan said. In that scenario, a buyer doesn’t own the gas but has locked in a price by putting money down ahead of time. This is unlike a call option, in which a gas buyer has the right, but not the obligation, to buy a specific futures contract at a predetermined price within a limited period of time. California appears to be ahead of the national trend for states to allow utility hedging. The National Association of Regulatory Utility Commissioners in conjunction with the Interstate Oil and Gas Compact Commission issued an October 24 report critical of states’ inhibitions concerning betting on hedging contracts. “Because of the high uncertainty surrounding future market conditions, shippers as well as state regulators have taken a short-term, if not myopic, perspective regarding market transactions for gas supplies and gas-delivery services, a situation that may be jeopardizing the financing of new gas infrastructure projects,” notes the report. It adds that regulators should “avoid second guessing utilities because a contract could later be deemed unattractive during a limited timeframe.” Pipelines Seek Disincentives to Gas Gaming:Midwest Looks to Controls Many things have been increased by hurricanes Katrina and Rita, including the incentives to “game” the natural gas pipeline system?that is, incentives for customers to deliberately take more or less gas out of a pipeline than they had contracted for delivery. That behavior will damage pipe integrity, according to industry executives. As the U.S. Court of Appeals for the District of Columbia pointed out this month when it upheld increased penalties for such actions on the Northern Natural Gas system, rising prices have increased the incentive for such actions because the “cash-out” price paid later provided the gas user with lower-cost fuel. Pipeline executives have been telling the Federal Energy Regulatory Commission that the hurricanes have added the potential of tight supply to the list of incentives to game the system by taking more gas than shipped. “We will be seeking a change in our penalty tariff provisions” in order to address gaming, stated Duke Energy Gas Transmission chief executive officer Martha Wyrsch. Duke’s Texas Eastern pipeline penalty is now capped at $25/decatherm-an amount, she said, that is not a deterrent in a high-price environment. Texas Eastern asked FERC to remove that cap effective November 14. In the Midwest, attorneys general from Minnesota, Wisconsin, Iowa, Illinois, and Missouri are beginning investigations that could lead to price controls. In letters sent October 17, those states asked for information on price projections from regulated utilities. -Jim Brumm

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