Hedging by utilities has cost Washington ratepayers $800M
OLYMPIA, Wash. (AP) - The hedging practices of natural gas companies in Washington state have cost ratepayers hundreds of millions of dollars in recent years, and officials said Thursday they are recommending a moratorium on new hedging arrangements.
The state attorney general's office said it wants the Washington Utilities and Transportation Commission to continue investigating the hedging strategies used by utilities, in which the companies purchase gas futures in order to protect against sudden price increases. Lisa W. Gafken, an assistant attorney general, said companies have no real incentive to improve their purchasing efforts - something that is evident in the losses during recent years.
"They didn't prudently manage their hedging strategies," she said.
In the last five years, the natural gas companies incurred hedging losses of about $800 million, according to the attorney general's office. Those costs are passed directly to ratepayers. Gafken said ratepayers face more losses in the future because the companies already are locked in other futures contracts at high gas rates.
Utilities use hedging to avoid dramatic changes in gas prices. With an economic downturn and increased domestic production in recent years, natural gas prices fell, contributing to the hedging losses. But Gafken said there were losses in other years, too, including $60 million in net losses between 2002 and 2007 - a period in which prices increased.
The attorney general's office is recommending that officials place a moratorium on companies from entering into new hedging arrangements. It also wants state regulators to explore whether there is a way to prevent some hedging costs from being passed to ratepayers. Officials also want to investigate how best to address market fluctuations.
David Mills, vice president of energy supply operations at Puget Sound Energy, compared the hedging efforts to buying insurance. He said the company's gas traders are not aggressively speculating on the market but following a steady process based on multiyear forecasts.
Mills said there will be times when there are losses, but the program isn't designed to gain or lose on the investment. Instead, it helps protect consumers from sudden spikes and upward trends in the market. Mills said removing the ability to purchase futures contracts on natural gas would leave ratepayers at the whim of the spot price, making it even more volatile.
"The hedging is really just a method to remove variability," he said.
The Washington Utilities and Transportation Commission is holding a meeting on the issue Friday.
The state attorney general's office said it wants the Washington Utilities and Transportation Commission to continue investigating the hedging strategies used by utilities, in which the companies purchase gas futures in order to protect against sudden price increases. Lisa W. Gafken, an assistant attorney general, said companies have no real incentive to improve their purchasing efforts - something that is evident in the losses during recent years.
"They didn't prudently manage their hedging strategies," she said.
In the last five years, the natural gas companies incurred hedging losses of about $800 million, according to the attorney general's office. Those costs are passed directly to ratepayers. Gafken said ratepayers face more losses in the future because the companies already are locked in other futures contracts at high gas rates.
Utilities use hedging to avoid dramatic changes in gas prices. With an economic downturn and increased domestic production in recent years, natural gas prices fell, contributing to the hedging losses. But Gafken said there were losses in other years, too, including $60 million in net losses between 2002 and 2007 - a period in which prices increased.
The attorney general's office is recommending that officials place a moratorium on companies from entering into new hedging arrangements. It also wants state regulators to explore whether there is a way to prevent some hedging costs from being passed to ratepayers. Officials also want to investigate how best to address market fluctuations.
David Mills, vice president of energy supply operations at Puget Sound Energy, compared the hedging efforts to buying insurance. He said the company's gas traders are not aggressively speculating on the market but following a steady process based on multiyear forecasts.
Mills said there will be times when there are losses, but the program isn't designed to gain or lose on the investment. Instead, it helps protect consumers from sudden spikes and upward trends in the market. Mills said removing the ability to purchase futures contracts on natural gas would leave ratepayers at the whim of the spot price, making it even more volatile.
"The hedging is really just a method to remove variability," he said.
The Washington Utilities and Transportation Commission is holding a meeting on the issue Friday.
Really stupid article the way it is written.
Hedging is not gambling. Just the opposite. It is a risk reduction/risk avoidance device. It is meant to mitigate the risks of certain events....such as price spikes.Â
There is a cost to putting a hedge in place. Much like there is a cost to buying a life insurance policy...and then you don't die. But does that mean you were gambling on life insurance? of course not. Stupid
@NBA_Is_Useless Hedging is not gambling? Seriously? If you're not gambling then there is no chance of losing? Hedging is entirely gambling. You are gambling on the fact that what you are purchasing today at a fixed rate will be more in the future. Hence, you purchased low. Buy a gallon of gas today for $4 hoping that gallon next year or in the future will be $5. Hence, you gambled that it would go up and you saved money. Make sense? It a gamble.
@d_2 @NBA_Is_Useless Neither of you understand the purpose of hedging.  It's insurance against rising prices, and also to some limited extent a way to guarantee supply.
Those who "invest" in the futures market without being participants in the underlying market are effectively gambling. Â That is entirely different.
@d_2 @Kary If you're actually going to be buying the commodity in the future, it's more a form of insurance than gambling.  That was the distinction I tried to make above.
If you're just participating in the futures market without ever buying the product, that would be akin to gambling. Â
Both types of participants are useful to the overall market, because you need to have two sides to every transaction.
@KaryThis hedging protects those people, so I can live with it (although I would think it may need to be limited some). Limited - yes. At the very least. Due in fact this Hedging activity is actually going to cost those people money now that their purchase of insurance or gamble (however you want to describe it) failed. Great debate... we are getting closer. However, we can agree to disagree that hedging is a form of gambling. It is a form of a risk, or buying into something in order to avoid the risk of going up or down.
@d_2 @Kary I'm not saying I like what was done, only that your arguments are false.
Personally I'd prefer to see gas rates change about 6x a year so that they accurately reflected the market. Â The downside to that is it would hurt people living paycheck to paycheck. Â This hedging protects those people, so I can live with it (although I would think it may need to be limited some).
The other reason this hedging is done is probably  because people are stupid.  If gas prices go up, then PSE will have to charge more, and they'll get a lot of bad press for raising rates.  They want to avoid that.  It's like back during the California energy crisis when consumers were upset with their utilities, even though the utilities were forced into bankruptcy by being required to sell electricity well below their cost.  The consumers didn't understand what role the utility played in the process.  They were the main victim in many ways.
@Kary Oh... like Credit Default Swaps - right. Insurance - buy protection in the event of a claim. This 'insurance' cost consumers 800 million dollars. Now, one could say... would consumers complain if it was $$ well spent and saved them $$. Yes. Me, not so much. As a regulated industry it should not be afforded the ability to insure, gamble or risk at the cost or benefit of the consumer. Insurance against rising prices that does not pay off if the price goes down. Tell me you think this 800 mil was well spent and invested. I'll wait...
@NBA_Is_Useless It is gambling. You take a position on a stock or commodity and then you bet the exact opposite position. Its used in blackjack, they call it insurance. Its really just gambling and has no benefit and many risks to the public in the way of artificially inflating commodity prices. Its the inflation thats really killing us. The last 40 years of inflation have out paced any rises in salaries for us regular folks.
Hedge bets are pure gambling and nothing more. And public utilities should never be allowed to gamble with our money. They are  very poor gamblers anyways. Congress should end the commodity boards and all derivatives and get wall street back to what it use to be good at, which was stocks and mutual funds. Everything else is just a scam.
@Blindman Futures markets provide liquidity to the underlying markets.  They are also useful for those in the underlying markets for other reasons.  For example, a farmer might sell a portion of their crop via futures as a way of financing operations or locking in prices at the time a planting decision is made.
The last time a state government prevented utilities from buying futures we ended up with the California energy crisis. Â That was just one of several stupid ideas California imposed on their energy system. Â Hedging serves a useful purpose besides protecting against price increases, and that probably explains why the utilities were hedging during a time when prices were expected to drop.
If it's just price increases the utilities are concerned about, which I don't think is the case, that could be dealt with by providing a way for them to raise prices on an expedited basis.
@Kary California energy crisis? You mean Enron? Commodities should not have the ability to gamble - period. It's only useful if the gamble pays off. When it doesn't, how useful is that?
@d_2 @Kary I mean the system California imposed that allowed Enron to do what it did, yes.  That system was moronic from the get go, and lead to all sorts of foreseeable problems..  Enron didn't cause the problem--politicians did.  Enron took advantage of the situation.
BTW, at the end of that process, when energy rates were very high, California decided futures weren't so bad, so they stepped in and bought a ton of futures. Â More than they could use, so they lost a ton of money there too. Â California was just totally incompetent dealing with that mess, and it allowed some companies to make a ton of money, and caused other companies (and consumers) to lose a ton of money.
@d_2 @Kary Enron was a small player and turned into a ready scapegoat because of their accounting scandal problems.  If they were a major player and cause of the California energy crisis, they would not have gone bankrupt.  I don't know how I can make that clearer!
You fell for the politicians' lies. Â What do you think Enron was doing with all the money they made from California and the rest of the west coast? Â If they were the major player in that problem, they wouldn't have gone bankrupt even if the rest of their business was shredding $100 bills.
@Kary Enron clearly was the cause of the problem. Had they conducted themselves in an ethical manner none of this would have happened. I don't know how I can be any more clear. Cooking the books was legal? I suggest you read up on Sarbanes Oxley. Just about everything Enron did was illegal. Tyco and Worldcom - same thing. Regulated companies should not be allowed to hedge. Considering their own admitted position states that it was not for profit. Regardless of your position, it does appear that further legislation around regulated industries and this practice will be enacted or at least be considered.
Lisa W. Gafken, an assistant attorney general, said companies have no real incentive to improve their purchasing efforts - something that is evident in the losses during recent years.Â
@d_2 @Kary I have watched Smartest Guys in the Room.  In it Gov. Davis finally admitted the mistakes that California made, and the mistakes of his advisers. Â
Again, Enron didn't cause the problems, they took advantage of the situation. Â I don't know how much clearer I can say that. Â I'm not saying what Enron did was right (although a lot of it was perfectly legal), but that but for stupid California politicians it wouldn't have happened at all.
@Kary 'The Smartest Guys in the Room. Fascinating and disturbing at the same time. SOX compliance soon followed. Only because greed will trump ethics 9 out of 10 times. Have a great day....
@Kary Enron didn't cause the problem? Because there is a loop-hole, that doesn't give Enron a free pass for conducting business in an unethical manner. Because my front door is unlocked does not mean you're invited in. I recommend you watch the movie 'The Smarted Guys in the Room'.
"The hedging is really just a method to remove variability," he said. What a friggin clown! Hedging is a method of gambling to remove variability. Without consequences. When there is a loss... extend it to the customer. Profit - line the pockets of the company coffers. Actions like this should be considered when they ask for future rate increases.Â
@d_2Â Do you have any evidence that profits would be kept? Â The way prices are regulated, that's doubtful.
Lots of companies hedge. Â At one time Southwest Airlines was able to keep their ticket prices lower than competitors due to having bought futures and they did make a ton of money (their not being regulated). At other times it has cost them money.
@Kary The evidence is the rates continue to increase. So... I'll throw it back to you, where is the evidence that hedging has been extended to the customer. I'm thinking that it's bupkiss. Just my theory. You want evidence, where is yours?
I am completely aware that Companies Hedge all over the place. Especially airlines and fuel. However, you have a choice of what airline to fly. Do you have a choice of what Utilities company you can purchase your Power or Natural gas from? No. Commodities should not be able to hedge or gamble. I'll wait for your evidence now as well. Thanks.
@d_2 @Kary One alternative to this system would be to allow each consumer a choice.  Some oil delivery companies allow their customers the option to lock in prices by agreeing to buy a certain amount of oil over the winter.  The gas companies could do the same.  Then if there was a spike in prices, only those consumers who didn't pay for the price protection would have their rates rise.  And if rates didn't rise, the loss would fall exclusively on those consumers who bought the protection.
@d_2 @Kary Natural monopolies just exist.  Imagine the extra cost if you had three companies running water and sewer lines to your house!  But because it's better for those services to be provided only by one company, the prices need to be regulated.  That does not mean it's a good situation.
Regulated companies tend to be very inefficient because they don't make more money by being efficient. Â If the regulators base their target profits on expenses, then they can be even more inefficient.
@Kary http://www.investopedia.com/terms/n/natural_monopoly.asp Can you explain how a Natural Monopoly is a benefit to the customer? I would think that Cable and Phone Companies would disagree. Considering the consumer now has the ability to choose which entity to purchase the service. Competition is good. Competition is fair. I can only purchase my Power/Gas from PSE. Although regulated; there is zero consequences for a Natrual Monopoly when they gamble and lose. Win / Win for them. BTW- just try to become energy independent. Provide, produce and consume your own electricity, or water. You can't. You have to become a local Utility consumer if that commodity is provided and accessible. Why is that?
@Kary Then you made my point. What are the consequences for gambling on futures? None. Consumers should pay market prices, not manipulated consumables. But hey... you can't fault them for playing, there is no negative impact if they lose.
@d_2 @Kary We're dealing with another economic term here:  Natural monopoly.  Google it.
No they are not going to eat that gamble, because it's a regulated utility. Â You really need to look up how that system works. Â Over the long run they don't eat the loss and they don't make more profit. Â Their profits are regulated.
@Kary Supply, demand, profits, revenue, budget, forecasting, operations.. completely familiar with ideals. Work with it every day. The fact remains, that gambling with commodities should not be allowed. You don't think Utility companies are going to eat that 800 million dollar gamble do you?
@d_2 @Kary You said "Profit--line the pockets of the company coffers."  I asked you whether you had any evidence to back up that claim.  You now admitted you do not.  Thank you.
I do not have to provide evidence that your claim is false, because I did not make your claim. Â The reason I think your claim is false, however, is because we are dealing with a regulated industry, whose overall profit is regulated. Â That's the reason that the losses are passed on to the consumer. Â Without higher rates, the overall profit would be below the target. Â Presumably it works both directions. Â
$800 million is the same as loosing or misplacing eight brand new 737 jets at retail price. Â If Boeing misplaced 8 of it's jets it would make the front page, but misplace or loose $800 million tax payer fund, didn't even make front page. Â $800 million is 66.67% of the $1.2 billion budget short fall in this state. Â $800 million is enough money to fund the budget of 400 schools. Â If 400 schools were closed would that bother you? Â But ripping off the tax payers for $800 million... is chump change?
haha, has coast. Â nice...at least they're using spell check. Â Too bad there is no grammar check.
While the story is dramatic and 800 mill. sounds like a lot, what are we talking per rate payer? Lets say there was no hedging, even with spikes would we be paying more or less.
@Alert Eagle It sounds like we would be paying less, but that is largely due to the fact that gas prices have been falling dramatically due to frackting.Â
@Alert Eagle There are roughly 7 million people in Washington. The math indicates that, yes, this is actually a lot - over a hundred bucks for every person in the state. Obviously, not all of those folks are taxpayers, so that means the individual cost is higher if you just consider taxpayers.
@FormlessOne um tax payer and rate payer are two different things Tax payer forced at gun point to pay. Don't believe me? stop paying your taxes. Rate payer person who choses to use the service. Not every one is on natural gas.
@Exiled_Patriot You are correct. Not everyone is on natural gas which means it is a bigger hit to the homeowners and companies that are.
"Hedging by utilities has coast Washington ratepayers $800M"
You mean the people living at the beach?
online gambling with my money is a nono, companies gambling with my money is a gogo. lets go american capitalism. winning. obviously. how's the housing market btw?
@Maxim the housing market and all other markets manipulated by governments that ignore the unchangeable laws of economics will create bubbles and worse. The housing market that crashed and burned was made by ignoring the basic laws of economy. Forced lending by banks to take toxic loans to lend money to unqualified people. All in the name of getting votes. then when it came crashing down. the govt blamed the banks who they the government forced to make the market what it is. Had it been a real free market and true capitalist ran economy the market would not have has as bad of problem.
Oh, isn't this just ducky! The exact same story but with all the previous comments deleted.