In a move that could be replicated as other states open theirelectric markets, Southern California Edison, the nation’s secondlargest electric utility, has purchased options on 740 Bcf offuture natural gas supplies for an undisclosed price as a means ofhedging against what is expected to be a highly volatile wholesaleprice for electricity in California’s newly established mandatorywholesale spot market, called the Power Exchange (PX).

California regulators had earlier given Edison permission totake this risk management route, and the terms and conditions ofEdison’s deal put together by Houston-based Coral FinancialProducts and Services were filed earlier this month with theCalifornia Public Utilities Commission, but they are being keptconfidential for competitive reasons, according to John Butler,Edison’s manager of capital markets. Butler would not say how longthe options are good for, although he did indicate it was for amulti-year period. “We’re required to buy all of our power out ofthe state PX, and the problem is that price is subject to marketfluctuations, so the intent of this program is to try to put a capon the highest price we would have to pay for electricity,” Butlersaid.

“It is not a perfect cap because these are natural gas options,and not options on electricity itself. But for a portion of ourelectric load we are protected.

“These options are exercised in cash, so if it turns out gasprices are high, which would be likely to drive up electricityprices, then rather than receive gas for exercising the options wereceive cash. That helps to offset the cost of having to buy higherpriced power out of the PX. It’s an insurance policy basically.”

Butler indicated that this type of hedge by an electric utilityis still somewhat new. Longer term, he said it is “entirelypossible” for use of gas options to spread to other states aselectricity markets open up and regulation changes.

Coral Financial Products, which brokered the deal, is affiliatedwith Shell Oil Company, Tejas Gas LLC and Shell Canada, but theoptions are not based on any particular supply area; they arelinked to a published natural gas price index. The Edison dealinvolves what Coral calls an “innovative type of natural gasoption,” specifically to mitigate against price spikes in the PX,in which Edison and the other major investor-owned electricutilities are mandated by state law to buy and sell all of theirpower for a four-year interim period.

“…Edison faced a completely new type of risk with apotentially high, yet difficult-to-predict, exposure,” said LeeBarba, Coral Financial’s CEO. “Numerous factors could drive theprice of wholesale electricity, and the complexity of thestructuring came in analyzing and modeling the potential risk.

“We then used our market knowledge to develop a viable hedgeportfolio and execution strategy which successfully assembled therequired quantity of instruments in an efficient and orderlyprogram.”

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