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Utility Hedging Against Gas Price Volatility Remains Essential, PG&E Fuel Manager Says

Although they probably won't stay that way, natural gas prices have been relatively low in recent weeks in Northern California -- in the $6/MMBtu area -- because the region has been over-saturated with rain, causing Pacific Gas and Electric Co. to call on more hydroelectric supplies and use less gas, according to Peter Koszalka, PG&E's utility manager of electric fuels.

"We'd like natural gas prices to stay at this level, but there is no assurance that they will," Koszalka told NGI in a preview of a presentation he plans to give at GasMart on May 3 (see http://gasmart.com/). He predicted that gas prices won't dip below $5/MMBtu for some time, and said volatility in the wholesale market continues to "get worse."

"I don't really have a view on where volatility is headed at this point. I really don't expect it to come down any, though," he added, noting that for utility power buyers and operators, such as PG&E's utility, the expectation is they will have to continue to deal with volatility as a regular part of the business, placing increasing importance on their hedging programs.

"That is part of our strategy -- we use swaps and options -- and part of the swaps are futures, so we're active traders in the futures market," Koszalka said. "We have been for several years." He doesn't expect that to change. He said PG&E is trading more through IntercontinentalExchange's online over-the-counter market than it had in the past. "On the financial side, you see a lot more electric power trading there [ICE] than you do on the Nymex," he said.

The part of PG&E's fuel-buying strategies that is critical, Koszalka said, relates to the basis price swings between the California border and Henry Hub, since he thinks in California those basis differences can swing more wildly than in other areas of the country. Lately, however, he confirmed that the Henry Hub and California border prices have been closer in balance, offsetting one another from a hedging standpoint.

"We can hedge all we want on the Nymex, but if we ignore the basis spread, we would get clobbered," he said. When Henry Hub and California border prices tend to offset one another, that's all right with Koszalka because PG&E would like its hedges not to pay off, he said. "If you're gaining on your hedges, you have offsetting losses on the physical side, so you have to look at the whole picture.

"If you're not 100% hedged, our customers are better off if our hedges lose money, although that is hard for people to understand. In reality you bought some insurance, so it is analogous to being better off if your house doesn't burn down and you don't collect on the policy."

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