Pipeline Security - We're All in this Together

Today’s PACE Blog is an abridged version of a PACE column published yesterday by Morning Consult.

When it comes to ensuring a resilient energy grid capable of serving American customers no matter what comes our way, there are few things more vital than safeguarding the security of our energy and electricity delivery systems.

Despite cybersecurity being front and center across the energy and electricity value chain for years, the Department of Energy (DOE) recently asserted that pipeline operators in the U.S. are not adequately prepared for cyber-attacks and that natural gas pipelines specifically are “increasingly vulnerable to cyber- and physical attacks.”

It’s true that cyber threats are real and that constant defense and vigilance is required. However, when it comes to cyber and physical security, it’s critical that government and industry work together, across fuels and organizational charts on a common mission – securing the entire energy infrastructure that is the backbone of our way of life.

Having recognized the magnitude of cybersecurity issues for well over a decade, industry and federal partners continue to build a robust defense network and establish a clearinghouse of information and best practices for utilities and infrastructure operators to utilize. Just this year both the Transportation Security Administration and the National Institute of Standards and Technology – two key agencies involved in the security of our nation’s energy grid – released updated versions of their cybersecurity guidelines for pipelines.

Information sharing is a central component of preparedness and response. The Oil and Natural Gas Information Sharing and Analysis Center, created in 2014 as a “dynamic cyber security hub” that shares and analyzes threat information. More than 50 companies participate, including a number of the nation’s largest natural gas pipeline operators. This intelligence and its use are also being tested in threat simulations like one conducted last year by North American Electric Reliability Corporation (NERC) that included more than 6,000 stakeholders from utilities and government agencies in an exercise to test coordination and response to cyber and armed assaults on energy resources.

With these developments in mind, many were surprised at DOE’s statement about pipeline security. The North American Electric Reliability Corporation concluded in its 2018 Summer Reliability Assessment that grid resilience is actually improving, despite new threats. The current approach of cooperation and investment is working, along with awareness that constant vigilance is required to stay prepared.

A combination of federal regulations and market forces have increased the use of natural gas for U.S. energy production. Natural gas is also a key ingredient to climate action, as the use of our nation’s abundant natural gas supplies have helped deliver near 30-year lows for carbon dioxide emissions from the electricity sector. That’s why lawmakers must understand that protecting pipelines from threats is a matter of national security. But that’s also why they must carefully weigh claims about pipeline security and focus instead on creating a culture of information sharing and cooperation across the energy sector and government.


Hedging 101, Part 2

This week, we continue our conversation with hedging expert Andy Whitesitt. Over two decades, and as a senior executive with ACES, he’s helped dozens of utilities smooth cost curves and mitigate risk. Hedging helps consumers across the country every day. 

What’s the difference between financial hedging and physical hedging?

Financial hedging is locking in only the price risk by utilizing either a futures contract or a swap. After locking in the price, the utility still must go out and procure the natural gas needed to run the generation unit.

Physical hedging is a purchase of physical gas to be delivered to a specific location at a specific price. Physical hedging locks in both the price and the supply. Another way to hedge physical gas is to purchase natural gas reserves – in other words, natural gas still in the ground, yet to be produced. If natural gas prices increase, the utility can produce the natural gas for consumption or to sell and offset the price of other gas purchases.

Who are typical counterparties for utility hedges?

Counterparties change over time based on who is most active in the market, meaning they are constantly in the market showing bids to buy natural gas futures and offers to sell natural gas futures. Their goal is to transact with utilities, or other end-users, and producers. Usually these are banks, global oil and natural gas producers and marketers, or companies that transact in the markets, taking risks to generate income.

How long has hedging been part of utility business practices? 

Natural gas futures contracts were first introduced in 1990 and quickly became a widely-used tool for hedging price risk. However, utilities have long signed into fixed price coal contracts or long-term power price agreements to hedge price and supply risk. For the past two decades that I’ve been involved in the electric utility business, hedging has been a common and well-utilized tool for utilities to reduce potential risks associated with providing consumers with electricity.

How many years ahead do utilities hedge?

In my experience, the average utility hedges anywhere from 1 year to 5 years in the future with the overall average being closer to 3 years. However, some see the wisdom in going out 10 years in the future.

Why hedge when natural gas futures prices are so low?

As we look to the future, natural gas prices can be locked in at less than $3.00/MMBtu for the next 10 years. Many believe natural gas prices will remain this low forever. However, there are fundamental factors that it is prudent to analyze and weigh. The US is producing much more natural gas than we can use. However, much of that supply growth comes from a small number of counties in Pennsylvania and as a byproduct of crude oil production.

It’s important to recognize this doesn’t provide a very diverse supply portfolio for the years ahead. Additionally, the U.S. has just started exporting natural gas to other countries as Liquefied Natural Gas (LNG) and is quickly shipping more and more natural gas to other markets. This could increase demand and subject the US natural gas market to global market prices outside of our control.

Freedom from Worry

Recently, Energy Fairness asked Andy Whitesitt, Vice President of Business Development & Customer Service at ACES, to talk with us about hedging basics.

We hope the following Q & A interview will help you understand how utility hedging programs work to remove some worry about future costs. Next week, we’ll follow up with some additional insights about this common business practice many utilities routinely deploy to protect consumers.

Can you provide a 101 explanation of hedging?  

Hedging is simply locking in the price of a commodity in order to reduce the risks of potential impacts. When electric utilities use natural gas to fire a power plant, the price of electricity generated and passed on to consumers is directly impacted by the price of natural gas.

Natural gas has historically been a volatile commodity. To reduce potential volatility of the ultimate rates and bills paid by consumers, a utility can hedge the price of the natural gas or in other words, lock in the price, so short term price fluctuations have less of a chance to impact overall electricity prices.

Where do hedges take place?  

In order to hedge the price of natural gas, utilities often look to the futures market. The futures market allows utilities, producers and other market participants to transact for natural gas and other commodities for future months. The most liquid futures market for natural gas is the Henry Hub in Louisiana. However, there are other locations around the country where gas is purchased and sold based on where the gas is produced or delivered to. These “natural gas hubs” can also be hedged with what are called basis hedges. Basis is simply the difference between the price of the benchmark Henry Hub contract and the price at the location where the gas is physically being purchased and sold.

What does the term “futures contract” cover?

A futures contract is a standardized contract for a specific volume and specific time period in the future that is traded on an organized exchange. For example, natural gas futures can be traded on the NYMEX which is a part of the Chicago Mercantile Exchange. The Henry Hub futures contract traded most frequently is equal to 10,000 MMBtu. It can be traded for each individual month in the future and settles against the Henry Hub monthly index in Louisiana.

What are some other terms and concepts important in hedging? 

In addition to the standard futures contract, many utilities utilize swaps to hedge commodities. A swap contract is a contract between two counterparties based on mutual agreements. Swaps can be customized to any volume, settle at any location, and can be transacted for any time period in the future.