Reliability is the hallmark of the natural gas industry. One of the biggest challenges facing local utility companies today is how to acquire natural gas supplies sufficient to meet the needs of customers who purchase natural gas from them at competitive prices.
Natural gas utilities use a variety of techniques to manage natural gas prices and supplies, including the following:
ACQUISITION AND MANAGEMENT OF GAS SUPPLIES
- Storage: A popular technique used by utilities to help keep natural gas costs affordable for their retail customers is to purchase natural gas supplies during warm-weather months, when prices can be lower, and storing it in underground storage facilities, from which it can be retrieved to meet customers’ needs during winter, when market prices tend to be higher. Approximately 20 percent of the natural gas used during the winter heating season comes from underground storage.
- Diversified portfolios: The way that natural gas utilities purchase natural gas supplies for their customers has been evolving for the past 20 years. Instead of purchasing most of their gas supplies under multi-year contracts (15-20 years) at a fixed price, as in the past, utilities today typically purchase natural gas for their customers by negotiating a mix of long-term (1+ year), mid-term (1-12 months), short-term (1-30 days) and daily market contracts. Multiple gas purchase contract terms enables utilities to take advantage of changing market conditions.
- Hedging: The term “hedging” generally refers to an effort to reduce the uncertainty of an inherently risky activity. Local utilities might seek permission from state regulators to hedge part of the natural gas supplies they buy on behalf of customers in an effort to manage the risks associated with fluctuations in the market price of natural gas. Hedging is not guaranteed to provide the lowest price; instead, its goal is to bring some price stability.
- Futures: The most familiar type of financial hedge is the purchase of futures contracts, which are agreements between buyers and sellers that lock in a price for natural gas at a certain time. Buyers can purchase contracts for certain quantities of natural gas at a given price up to six years in advance. Futures contracts must either be liquidated or held to physical delivery of the natural gas that was contracted for. Since 1990, natural gas futures have been traded on the New York Mercantile Exchange (NYMEX), where the contracts’ delivery site is Henry Hub, near Erath, La.
- Options: Options contracts allow their holders to achieve price protection while retaining the ability to participate in favorable price moves. In essence, options work like an insurance policy. If a homeowner wants to protect himself against risk, he pays an up-front premium. If the risk occurs, he is reimbursed. If the risk doesn’t occur, he is out nothing but his premium. With options, in return for a one-time, up-front premium, the holder of an option has the right, but not the obligation, to buy or sell a futures contract at a specific price at a specified time. There are two types of options: “calls” (which gives the holder the right to buy futures at a specific price, for a specific period of time) and “puts” (which give the holder the right to sell futures at a specific price for a specific period of time).
- Weather-based products: Weather derivatives and weather-risk insurance can protect a utility’s exposure to weather-related changes in the amount of natural gas delivered to customers, such as a milder-than-normal winter that could depress a utility’s revenue.
- Weather normalization adjustment mechanisms: Many local natural gas utilities use weather-normalization adjustment mechanisms to help moderate natural gas bills during severe winter weather, thus mitigating a worst-case scenario in which consumers pay extremely high winter bills because natural gas prices were high and they consumed large amounts of natural gas to heat their homes. For example, when winter weather is colder than normal, this mechanism would automatically reduce the total cost of gas charged to consumers and thus help ease consumers’ bills. During a warmer winter, the gas utility would raise the total cost of gas charged to consumers.
SOURCES FOR ADDITIONAL INFORMATION
1. National Association of Regulatory Utility Commissioners (NARUC) www.naruc.org
2. National Regulatory Research Institute (NRRI, the research arm of NARUC)
3. NYMEX www.nymex.com
4. Commodity Futures Trading Commission www.cftc.gov