THERE ARE IMPORTANT lessons to be learned from the failure of BL&P to get the Fair Trading Commission (FTC) to agree to their request to apply the costs of financial hedging to the Fuel Clause Adjustment.
First and foremost, the ruling by the FTC is attributable, in no small measure, to the excellent advocacy of the intervenors who by their substantial contributions and valuable technical inputs enabled the commission to reach the best decision possible for consumers.
Interventions
Consumer and public interest groups make valuable interventions and contributions to regulatory proceedings. In so doing, they speak on behalf of a substantial segment of the population that has no voice or otherwise may go unheard. Such efforts need to be commended, encouraged, and compensated.
Utility intervention is characterised by information asymmetry. In order to make a plausible case, an intervenor has to produce evidence that supports his claim and collect data necessary for economic proof.
Evidence is generally not easily accessible and access to evidence is critical to the expert who depends on firm-specific data to make his case.
This difficulty is currently compounded by the fact that BL no longer publishes annual reports and the little publicly available information is buried in the consolidated financial statements of Emera, the parent company.
These obstacles, notwithstanding, were not enough to prevent the weakness of BL’s recent case before the FTC from being exposed.
The application to pass through the costs and results of financial hedging to the consumer by way of the FCA was very important to Emera’s rate stability corporate objectives. Until now, the utility has had a stellar record of successes in rulings before the FTC and the outcome of this ruling was expected to be no different from those that went before it. So why then did it fail?
The application failed because there were major aspects of BL hedging proposal that were not sufficiently analysed or totally ignored. This created the distinct possibility of significant hedging losses and higher fuel costs to ratepayers.
The burden of proof was on the utility to demonstrate that the benefits ratepayers receive from fuel price hedging outweigh the costs and that they would have been be better off with it, than without. In that regard BL’s application failed.
Analysis
Rather than allaying these concerns, the application merely postulated that volatility would some day adversely affect ratepayers without making any serious attempt to measure or analyse the very thing hedging was designed to prevent or control.
Another reason for the application’s failure relates to the proposed financial derivative, namely, the fixed price swap. The company touted that this was the preferred instrument to be used for reducing volatility and improving price stability and that a similar instrument was being used by two of its affiliates, St Lucia Electricity Services (LUCELEC) and Grand Bahama Power Company (GBPC).
However, what BL appeared oblivious to was the fact that LUCELEC had abandoned fixed price swaps for option contracts, almost a year earlier, after suffering significant hedging losses.
This new direction in LUCELEC’s risk management strategy was a significant departure from the one BL was proposing and it therefore raised considerable questions and some doubts about what kind of hedging, if any at all, should the local utility be engaging.
Moreover, the application provided no analysis of the risk potential of this form of hedging or of the risk appetite of local ratepayers who ultimately had to bear the costs. Added to these concerns were questions pertaining to the independence of the risk management professionals upon whose expertise BL were relying.
Finally, one important lesson to be learned from this particular regulatory exercise is that it perhaps unwise to embark on a financial hedging strategy before embarking on a fuel efficiency programme.
BL has ageing steam plants that are inefficient and very costly to operate, especially on base-load duty cycles. Fuel represents a significant cost component of the utility and its inefficient use represents an additional and unnecessary cost burden to consumers.
To overlay on this burden the additional cost of hedging appears too much to ask of ratepayers and of the FTC, who made the correct decision in denying BL’s application.
– TONY GIBBS (energy commentator)
