Hurricane Season: Producers Unbatten Hedges; Will LDCs Panic?

Another hurricane season may just be starting, but natural gas producers haven't forgotten the last one and have tweaked their risk management strategies accordingly. Producers are paying more to preserve upside, but utilities could get caught out later if they lock in too high.

Those producers who hedge their production are less willing to forgo upside potential, Tim Simard, National Bank of Canada managing director, global risk management, told NGI. Producers saw prices spike following hurricanes Katrina and Rita, and if that happens again this year they mean to get as big a piece of it as possible.

"One of the things that certainly has emerged over the last year is that a lot more producers are interested in simply just buying outright insurance," Simard said. "They are paying a premium to acquire puts with the recognition that there is significant upside potential out there. There is a reluctance to give up the upside and to have to explain to boards and shareholders down the road that gas was sold at prices way below market."

Simard noted that three or four months ago some in the market were not even contemplating that natural prices could come down as much as they have. "Now there is concern that we could go below threshold levels and that capital expenditure programs will be endangered.

"There is still a good flow of hedging business happening on both the crude oil and natural gas side."

In Canada where producers often are structured as royalty trusts, the view on hedging is a bit different than in the United States, Simard said. Royalty trusts rely on steady cash flows over time in order to stick with their schedule of steady and nonvolatile distributions. "They are out in the marketplace forecasting their anticipated distributions for the next year or so, and there is strong desire on their part to maintain those distributions."

As a result, royalty trusts tend to hedge mechanistically rather than from any particular assumption of what natural gas prices are going to be over time. Producers that are not royalty trusts are more likely building their hedging programs around their particular price expectations. And, of course, hedging is done to lock in project economics in the case of acquisitions.

At the other end of the natural gas chain, local distribution companies (LDC) have had their view of gas prices and hedging shaped by last year's hurricanes, too. "My fear is that you have a whole bunch of people who've locked in gas at higher prices and they're not going to see the benefit of this decrease in prices that's occurring right at this time of year," Catherine Elder, R.W. Beck senior director and head of the firm's fuels practice, told NGI.

Elder said that producers are more likely to hold a portfolio of prices as a result of their hedging programs. "Whereas buyers, on the other hand, tend to fear higher prices, so they'll lock in at a high price out of the fear of it going even higher, and then they aren't able to capture the benefit when prices drop.

"I think that you probably had a whole bunch of buyers who last fall and in the winter 'freaked out' over $13.85 gas due to the hurricanes. They may not have locked in that $13.85 or $13 or whatever, but they locked in at $9 or $10."

Nevertheless, Elder said she believes the industry -- particularly state regulatory commissions -- needs to be paying more attention to hedging and the benefits it can bring to LDCs and their customers. "The LDCs are still caught in this bizarre world of the expectation of relatively low natural gas prices, and so many state commissions said, 'just buy monthly index spot.' Some of the state commissions have come to realize that wasn't such a bright idea and are giving the LDCs authority to do some hedging. But I believe if you took a survey of LDCs and took a look at what they've actually done, the hedging they've done is for a small part of their portfolios."

Simard said that utilities that do hedge are much more mechanistic in their approach than the typical producer because their actions are later reviewed by regulators. Ideally, the LDC can pre-sell its regulator and consumer advocate intervenors on its hedging strategy in advance to avoid the risk of disallowance of costs on the back end.

Copyright 2006 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.


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