“Should Commissions Pre-Approve a Gas Utility’s Hedging Activities?” Utilities Policy: Strategy, Performance, Regulation, Vol. 11, December 2003.
Original Post
Ken Costello,
Should commissions pre-approve a gas utility’s hedging activities?11This paper was prepared by the National Regulatory Research Institute (NRRI) with funding provided by participating member commissions of the National Association of Regulatory Utility Commissioners (NARUC). The views and opinions of the author do not necessarily express or reflect the views, opinions, or policies of the NRRI, NARUC, or NARUC member commissions.,
Utilities Policy,
Volume 11, Issue 4,
2003,
Pages 185-189,
ISSN 0957-1787,
https://doi.org/10.1016/S0957-1787(03)00047-X.
(https://www.sciencedirect.com/science/article/pii/S095717870300047X)
Section snippets
The policy dilemma
Some gas utilities have recently asked their state public utility commissions (PUCs) to pre-approve hedging plans that would reduce the volatility of natural gas prices to a utility and its customers. The major argument made by these utilities is that the vulnerability of hedging activities to second-guessing, especially when financial instruments are involved, justifies pre-approval of a hedging plan in addition to the associated costs. These gas utilities thus believe that receiving
Major questions
A major question for regulators should be whether, in the absence of pre-approval, the uncertainty of hedging would be so great as to discourage a utility from hedging when it would be in the public interest to do so. On the one hand, too much uncertainty may cause a utility to rationally respond by not hedging. For example, high uncertainty of cost recovery for hedging activities may motivate a utility to purchase all of its natural gas in the spot market. On the other hand, minimizing
The nature of hedging
In contrast to gas procurement, hedging may be best viewed as a customer-oriented value-added service, with the commission arguably obligated to make the judgment of how much hedging (if any) would be preferred by customers.6
A proposal
The major message presented in this paper is that a commission should provide guidance to a utility on the general features of an acceptable hedging plan and actually approve a plan itself, but with the condition that it should not guarantee up-front that all of the costs associated with the plan will ultimately be recovered from customers.10 After all, a plan can be found acceptable, which should
Information problems
Two major questions should underlie an ex ante evaluation of a hedging strategy: (1) does the utility’s strategy reflect the preferences of its customers for stable prices, which is difficult given the varying preferences among customers, and (2) does the strategy represent least-cost hedging (for example, hedging that results in minimum transaction costs for the utility), taking into account the myriad hedging tools available for use? In establishing a prudence standard for hedging, a
Conclusion
This paper proposes that good regulation would include (1) pre-approval of a hedging plan (as noted earlier, hedging is especially susceptible to 20–20 hindsight review when it results in higher average cost during a time of unexpected falling natural gas prices), (2) a review of the actual costs incurred in carrying out the hedging plan as to their conformance with the tactics incorporated into the pre-approved plan (with pre-approval, the scope of prudence reviews would be greatly narrowed)…
References (3)
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