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AGA: Utilities Hedging More, Using Longer-Term Supply Contracts

Soaring gas prices prompted U.S. gas utilities to use more aggressive hedging strategies and sign longer term agreements ahead of winter last year to mitigate the impact of rising prices on consumers, according to a new report by the American Gas Association (AGA).

Wholesale gas prices were $3.17 (per million Btus) higher at the start of the 2004-2005 winter season (Nov. 1, 2004) than they were at the same time the previous year, and utilities took unusual steps to help cushion customers from rising commodity costs. Some used futures, options, swaps and longer term supply agreements to protect a greater portion of their natural gas supplies from price fluctuations. Others used underground storage or a combination of storage and financial tools, according to AGA's Local Distribution Companies' Supply Portfolio Management During the 2004-2005 Winter Heating Season.

The report was based on a survey of 54 AGA-member natural gas utilities, with customers in 30 states. Respondents represent nearly half (45%) of the gas delivered by AGA members each year.

"Perhaps because spot natural gas prices have been so high during winter, utilities seem to be purchasing less natural gas on a daily or monthly basis," said Chris McGill, AGA managing director of policy analysis. The survey found that daily and monthly contract terms are less prevalent today than they were two years ago.

"This may indicate that utility companies and the state public service commissions that oversee their rates are becoming more comfortable with longer-term supply contracts." McGill said long-term contracts today typically are shorter than they were in the past. They may mean a two-year supply of gas rather than a 10-year supply.

Long-term agreements were used by 37 companies last winter out of those surveyed, compared to only 29 companies the previous winter. And gas flowing under long-term agreements accounted for more than 50% of the purchased peak-day supply for 15 of the companies compared to only 10 of the companies the previous year, AGA said. Mid-term agreements (more than one-month, less than one year) were utilized more often than one-month and daily agreements for peak-day purchases.

As it turned out, utilities ended up buying more than they needed last winter because temperatures nationwide were warmer than normal. There were 6% fewer heating degree days than normal last winter, and March was the only month that ended up being colder than normal. Regionally, only New England had a colder than normal winter. The central portion of the country had the warmest weather compared to normal.

As a result, AGA said the companies surveyed had an aggregate peak-day sendout of 43.4 million Dth/d last winter, but planned for an aggregate peak-day sendout of 54.2 million Dth/d. It was the second winter in a row in which the aggregate peak sendout ended up being only 80% of the design day.

"Most of the companies we talked to plan to hedge the same amount of their natural gas supplies for the upcoming winter, and 11 companies said they would hedge even more," McGill said.

Storage is always a major part of winter price management and that remained true last winter, AGA said. "Reliability is paramount. On winter's coldest day, utilities' ability to pull gas from underground storage to keep people warm remains critically important," McGill said.

AGA said 70% of the utilities surveyed said they used financial instruments to hedge at least a portion of the gas they purchased on behalf of customers last winter. That compares to only 55% three years ago.

A total of 21 out of 37 companies said they had hedged up to 50% of their gas supply purchases last winter. AGA said options (23 companies), fixed-priced contracts (18 companies) swaps (16 companies) and futures (11 companies) were most often cited as financial tools used to hedge a portion of supply.

AGA found that first-of-the-month index pricing still dominates the market. However, this year's survey also found references to fixed-price, daily and other Nymex-based arrangements. For long-term supply, 30 out of 49 companies said they used first-of-the-month pricing for a portion of their load, including 27 companies that used first-of-the-month pricing for 51-100% of their long-term gas purchases.

About 20 companies said they used fixed prices for their mid-term supply and 13 said they tied mid-term purchases to daily pricing mechanisms. However, 39 companies said their mid-term purchases were most often tied to first of the month indexes, AGA reported.

Forty-five of the 54 companies surveyed used first-of-the-month indexes to price their gas for storage injections last year with 20 of those companies indicating that 76-100% of the gas that went into their storage was based on first-of-the-month pricing. Twenty-one of the companies used fixed prices for a portion of their gas purchased for storage, up from only 14 companies a year earlier.

Copies of the study are available free of charge to AGA members and others who subscribe to AGA's Policy Analysis series at www.aga.org in "Stats and Studies."

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