Is fuel hedging a good policy for Barbados to pursue?
Up to last week’s decision from the Fair Trading Commission (FTC), most news about fuel hedging would likely have gone unnoticed in Barbados.
Fuel hedging is a mechanism used by large fuel users, including utilities, airlines, and cruise companies, where they purchase fuel at a fixed price over a contracted period. It is considered a major safeguard against fluctuating, and especially increasing, oil prices.
While FTC’s decision to turn down the Barbados Light & Power Company’s (BL&P) application to use fuel hedging was reported widely, this issue is one that grabbed the public’s attention internationally in 2016, especially Florida.
In November, a website called St Peters Blog reported that four Florida utilities, public counsel and consumer groups decided to pause natural gas hedging programmes, having suffered US$6.5 billion in losses since 2002.
Florida’s Public Service Commission had allowed the programmes to continue in December 2015 despite mounting losses, but recently decided it was best to put them on hold throughout this year pending an investigation on how they can be improved.
On April 3, last year, The Wall Street Journal (WSJ) reported that while natural gas prices “plunged” 74 per cent in the past ten years, some American utilities did not benefit fully because they were locked into fuel hedging contracts.
WSJ said while experts could not quantify how much money all American utilities had lost on such hedges, the “fairly typical” approach used in Florida suggested that losses were “considerable”.
The publication quoted Ken Costello, an economist at the nonprofit National Regulatory Research Institute, which advises utility commissions, as saying that while small hedging losses were normal, “there’s something wrong if you have losses as big as what Florida experienced”.
Michael Gettings, principal consultant at RiskCentrix LLC in South Carolina, was also reported as saying one problem was that utilities often have “lock and leave” contracts that were not informed by market risks or loss tolerances.
In the United Kingdom in August last year, energy market intelligence firm ICIS said UK energy utilities were facing a fuel hedging strategy rethink. It said long-term hedging strategies adopted by the UK’s largest six utilities were likely to change following the publication of recent results indicating reduced profits in power generation despite an improvement in spark spreads over the last 12 months.
“Despite a sustained recovery in spark spreads – the crude profit margin for gas-fired generation – since the end of 2015, length built up on the forward curve has prevented utilities from profiting from the relatively recent upturn. This is because their hedging strategies often meant locking in forward costs and income before the increase in sparks occurred,” the report stated.
Commenting on the issue, Inspired Energy risk manager Nick Campbell, said: “Utilities, if they want to maximise returns, will have to develop a new hedging strategy which is more prompt and near-curve focused as the volatility is there to drive greater profitability as more and more intermittent generation connects to the grid.”
Black & Veatch, a US engineering firm, said natural gas and electricity futures contracts were introduced in the early and mid-1990s and that there were about 250 electricity and 300 natural gas futures, options and cleared swaps contracts available to market participants from both the New York Mercantile Exchange and the Intercontinental Exchange. These covered various delivery points, quantities and time spans, it said.
BL&P is owned by Canadian energy company Emera Inc., which uses fuel hedging. Emera is majority owner of Grand Bahama Power Company (GBPC) and is an investor in St Lucia Electricity Services Ltd. (LUCELEC).
LUCELEC has used a fuel price hedging programme since 2009 “to minimise large fluctuations in the fuel surcharge”. GBPC began hedging in 2014, a policy that “allows it to buy fuel which will be burned in the future (out to 2019)”.
In 2015, LUCELEC managing director Trevor Louisy said the company regularly evaluated its hedging programme and was satisfied that it had successfully spared customers from oil price shocks.
“In fact, for 2013 and 2014 customers paid less per unit of electricity than they did in 2012. For nearly that entire period the fuel surcharge was negative, meaning the amount of the surcharge was subtracted from the basic tariff per unit instead of being added, except for the brief period between August and October last year,” he said.
“So customers have been benefiting both from reductions in the price they pay and greater stability in the price.”
GBPC officials said “hedging helps to smooth out the volatile fluctuations in the fuel charge, which improves energy cost predictability for our customers”.
“It is a long term, multi-year strategy designed to secure small amounts of our future oil requirements, at various known pricing contracts. Because we negotiate a fixed price to minimise the risks, the fuel charge will not precisely track the price of fuel on the world market,” the company added.
“This could mean customers might not always see the benefit of a falling market, however, hedging does offer protection from rising costs by securing a fixed price.”