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To Hedge or Not? Ask California Officials

The supply and distribution segments of the natural gas industry butted heads last Tuesday during a California Energy Commission (CEC) workshop examining how gas is bought by utilities and large noncore purchasers. From the utilities' point of view, the state-sanctioned incentive mechanism and month-to-month purchases are resulting in generally low prices for retail consumers.

At issue were the more than 2 Bcf/d of gas bought for the core customers by the two major utilities and another 700 MMBtu/d purchased by large buyers such as Shell, the Sacramento Municipal Utility District and the state of California's gas-buying program for its major agencies and facilities. All use hedging to some degree, but not for long-term purchases beyond a year.

A CEC staff report and a representative of Shell Energy North America raised the possibility that more aggressive hedging might result in greater savings and mitigation against volatile wholesale prices. However, the gas buying managers for Pacific Gas and Electric Co. (PG&E) and Sempra Energy's two gas distribution utilities -- Southern California Gas Co. and San Diego Gas and Electric Co. -- strongly disagreed.

Sempra's Herb Emmrich said month-to-month purchases mixed with one-year contracts have resulted in retail gas utility customers getting "the lowest-cost supplies" for so-called core customers. "We have had the lowest weighted average cost of gas [WACOG] of anyone for the past 10 years," Emmrich said. "It has been an unparalleled success in reducing gas costs for our customers."

PG&E's John Armato echoed much the same remarks, and both utility gas buyers used the example of last year's extreme peak of $13-14/MMBtu gas as an example to support their monthly purchases and mostly short-term contracts. If the utilities had entered hedges for $7 gas last summer -- less than nine months ago -- they would be stuck with contracts at prices $4 higher than the current average California border price of around $3, they said.

"Ratepayers remain fully exposed to high market prices and market volatility," said Laird Dyer, a manager with Shell's North American gas operations.

"The question is should hedging be an acceptable risk for ratepayers, and we think it should be," Dyer said. "Through hedging, ratepayers can experience reduced price volatility, more bill stability, reduced exposure to price spikes, and if the incentive mechanisms are designed properly, lower overall costs may result," he told CEC staff and commissioners attending the workshop.

Noting that there are a number of options available to the utilities regarding hedging, Dyer said Shell "takes issue" with the notion that storage is simply a seasonal tool of buying in the summer and withdrawing in the winter. "We think storage needs to be combined with hedging as well."

A California Public Utilities Commission (CPUC) energy staff director, Richard Meyers, said from the regulatory commission's standpoint the gas cost incentive mechanism that has been in place for more than a decade has "worked quite well," particularly compared to the old adversarial "reasonableness (hindsight) reviews" that took long periods of time for both the utility and the CPUC staff.

"From our point of view, the incentive mechanism is the best framework," Meyers said.

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