Is fuel hedging a good policy for Barbados to pursue?
The Barbados Light & Power Company Limited (BL&P) would like to implement a fuel hedging programme to reduce the fluctuations in the fuel component of customers’ bills and to take advantage of the current favourable fuel price environment.
Barbados National Oil Company Limited (BNOCL) has responsibility for fuel importation into Barbados therefore a hedge on the price of fuel is the only type of hedging activity available to BL&P at this time.
A fuel hedging programme would allow BL&P to enter into a financial arrangement with a third party to hedge 80 per cent of its Heavy Fuel Oil consumption volumes. Once market conditions are favourable, the BL&P will consider hedging up to 90 per cent of its heavy fuel oil consumption volumes.
The BL&P intends that the gains and losses from the hedging programme will be matched against fuel purchase prices from BNOCL and along with any other costs associated with the programme to form part of the calculation of the monthly Fuel Clause Adjustment (FCA).
Emera Energy Services, an affiliate based in Nova Scotia, Canada has been identified to function as agent for BL&P to execute the hedging programme. The cost of its administrative services is estimated at $600 000 annually.
Dramatic increases in international oil prices over the last seven years, combined with the subsidy being removed from diesel in Barbados, have resulted in significant fluctuations in the price of electricity in Barbados. BL&P purchases fuel under a contract with BNOCL, with prices linked to New York (NY) Harbour Residual Fuel No.6 2.2 per cent index. The company uses approximately 250 000 tonnes of fuel each year: heavy fuel oil (75 per cent of cost), aviation jet (21 per cent of cost), and diesel (four per cent of cost).
The FCA is approved by the commission as a principle or formula that the BL&P is permitted to use to pass through the cost of fuel used to generate electricity for use by its customers.
Fuel purchases are a “pass through” cost that is applied equally to all customer groups through the FCA charge.
Fluctuations in the FCA are influenced mainly by movements in the purchase price of fuel. BL&P is permitted by the Commission, as part of the FCA calculation, to employ a smoothing technique to reduce the impact on customers where there are significant fluctuations in the FCA from one month to the next.
Notwithstanding BL&P efforts to smooth fuel costs, customers are still, to some degree, exposed to the vagaries of the fuel market and do experience the volatility in fuel costs through the FCA.
Global oil prices have declined from a high of US$133 per barrel in July 2008 to around US$32 per barrel in February 2016. The fall in oil prices is reflected in lower purchase cost of fuel from our main supplier, the BNOCL.
Fuel accounts for more than 50 per cent of customers’ electricity bills and therefore as the cost of fuel declines, customers will experience a commensurate decrease in their electricity bills.
The current low oil prices are welcomed but are unlikely to remain at this low level indefinitely. Timing is an important consideration in hedging. Prudence dictates that the BL&P seek to implement a fuel hedging programme at this time to reduce the volatility of the FCA and to take advantage of the current favourable fuel price environment.
Information taken from the application which Barbados Light & Power Company submitted to the Fair Trading Commission in its quest for fuel hedging permission last March.
