Natural Gas Hedging – Smart Tool for Diverse Energy Portfolio

Smarter Ways Forward with The Ray
May 24, 2018
Hedging Happens Every Day
June 5, 2018

PACE thanks Morning Consult for publishing this op-ed as original content.

As the U.S. energy portfolio continues to diversify, the tools and tactics electric utilities use to protect consumers and stabilize costs must keep up with the times to accommodate the growth of natural gas, renewable resources, storage and other innovations.

One of the most critical tools is hedging, a fact frequently discussed and underscored by state lawmakers. As an example, Missouri recently passed Senate Concurrent Resolution 43 that reaffirms the state’s policy of allowing electric utilities to hedge natural gas contracts and supports the state’s utility regulators in their role of ensuring hedging is done prudently.

Hedging raises certain connotations, and too often, the explanations of it are complex and off-putting, but it is a necessary and standard practice used by individuals and businesses every day. Simply put, hedging is accomplished by taking actions to reduce the risk of unwanted outcomes.

For utilities, and ultimately their customers, these risks are primarily price spikes and disruptions in supply. To help manage these risks, utilities may enter into physical hedges by taking an ownership stake in additional supplies of natural gas. More commonly, utilities execute contracts that put a ceiling on the price. The low cost of planning and executing the contracts is seen as a reasonable expense to protect supply and manage price volatility for the sake of consumers.

Just like any business, electric utilities have a responsibility to acquire the raw materials needed at the lowest possible cost and from the most reliable suppliers. This duty is elevated by utilities’ obligation to serve 24/7/365, no matter the weather or other hurdles. Most states affirmatively allow utility hedging, and the practice is widespread among investor-owned, cooperative and community-owned electric and gas distribution utilities.

The new resolution is also an acknowledgement that federal policies, such as allowing vastly increased exports of liquefied natural gas or geopolitical currents outside our control, can quickly and unexpectedly impact natural gas prices. Without protections in place, that means families and businesses could pay more to keep the lights on. While the relationship between gas futures prices and consumers’ electric bills fluctuates, if gas futures rise even $1 over a sustained period, a state’s consumers could see hundreds of millions of dollars added to bills.

Therefore, hedging helps utilities keep electricity prices stable, in spite of domestic or international uncertainty. If we made a bumper sticker to advertise the resolution, it might read “chance favors the prepared.” And although it might at first seem counterintuitive to hedge now while prices are low and relatively stable, instead it is beneficial to establish and maintain the needed expertise, relationships and contracts now rather than wait until volatility returns.

While natural gas is currently a smaller portion of Missouri’s generation fuel mix, it will likely increase, as has occurred in countless other states. The U.S. Energy Information Administration reports that natural gas accounted for 31.7 percent of the electrons generated by U.S. utilities in 2017. It is the nation’s leading generation fuel.

U.S. businesses and consumers benefit from clean natural gas generation and from low, stable electricity prices. Embracing hedging will play a small but important part in continuing those wins for years to come.