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Utility Gas Hedging Programs Under More Scrutiny

In the midst of mostly stable U.S. natural gas prices and a steady boom in domestic supplies, utility gas hedging programs have come under increasing scrutiny, with regulators and consumer advocates questioning the overall costs of hedging in recent years.

For the municipal Colorado Springs Utilities, which began a hedging program in 1997, city auditors of late are questioning whether a calculated $208 million in extra retail gas utility charges paid by customers was worth it on a cost-benefit basis.

A recent audit showed that the combination of continuing low wholesale gas prices and abundant domestic supplies made the Colorado public sector utility's bet against price volatility more costly than it had been prior to 2010.

Two years ago the National Regulatory Research Institute (NRRI) completed a research report urging regulators to become more proactive in reviewing utility gas hedging programs both prospectively and retrospectively.

"Until now [May 2011], regulators have penalized utilities only infrequently for hedging practices that in retrospect, were suboptimal and led to large losses that were passed on to customers," said Ken Costello, NRRI's principal researcher and author of the hedging report.

"Regulators have not been as active as they might in reviewing and even prescribing elements of a hedging plan," Costello said in recommending that they get active in "every aspect' of hedging plans.

"The result has been that when a utility applies for recovery of costs in implementing a hedging plan, the regulator may lack a solid basis for approving or partially rejecting the application because a prudence review cannot be grounded simply on judging the result [after the fact] in the absence of a standard for performance."

Costello told NGI on Monday that he thinks his 2011 report is still relevant today. Although he hasn't done a formal survey, Costello said "it is my impression that utilities as well as commissions have revisited hedging programs to determine whether they are still justifiable or require some changes."

Costello's report cited several examples of utility losses due to hedging practices that failed in recent years (see Daily GPIMay 17, 2011). Without naming names, he said one California utility lost almost $60 million during 2007-2008; another utility in the state had losses exceeding $37 million during 2008-2009. Also during 2008-2009, one North Carolina utility had losses of more than $156 million.

In 2010, California regulators shifted the risk partially in utility gas hedging programs (see Daily GPIJan. 25, 2010), and later in the year reported the state's lowest retail rates for natural gas in more than five years (see Daily GPI,June 15, 2010).

Officials on all sides of the issue currently acknowledge that gas hedging is a form of insurance against significant price spikes, and therefore there is going to be some cost. The question for regulators is was the cost prudent. Was it mostly due to forces beyond a single utility's control, or was it all or in part caused by mismanagement of risk by the utility?

Colorado Spring Utilities spent $2.4 billion for natural gas through hedging during its 14-year program, and during that period citizens served by the municipal utility had rate stability, according to a utility spokesperson. In 2011, the Colorado muni halted its hedging program when trying to predict the gas market was going against the utility's customers. However, customers are still paying three-year fixed prices established by the final hedges in 2010.

 "Regulators should require utilities to revisit the merits of hedging today," Costello said two years ago. "The main reason for a utility not to hedge is if it appears that the price-protecting benefits from hedging will not justify its costs, such as during a period when relatively stable prices are expected, as many expect for the immediate future."

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