A Hedge of a Different Color
Posted on September 1, 2016 by Samuel Pastrick
Tags, Energy
Earlier this spring, Portland General Electric (PGE) filed its 2017 “Annual Power Cost Update Tariff”, or “Annual Update Tariff” (AUT). In simpler terms, PGE’s AUT is a mini-rate case that is limited to annual changes in their power costs such as fuel. In contrast, a General Rate Case looks at all costs, including payroll, profits, and investments. In their recent filing, PGE lays out, among other things, a proposal to implement a “long-term natural gas hedging program”.
CUB has several concerns with PGE’s long-term gas-hedging proposal, and earlier this summer laid them out in written testimony to the Oregon Public Utility Commission.
First, what exactly is a “hedge”? The simple answer is that it’s an economic decision to reduce risk. Think of the idiom “to hedge one’s bets” and the following example: I inherit stock in a coal company but am concerned about the risk of climate change, so I sell half of the coal stock and purchase stock in a solar company.
In a utility context, a company can theoretically reduce risks associated with volatile fuel prices by implementing a successful hedging strategy.
When it comes to fossil fuels, most electric utilities, regardless of their organizational structure (investor-held, consumer or publicly owned) are power generation and distribution companies. They purchase a fuel like natural gas to generate electricity and then sell that electricity to their customers.
Because utilities do not often have expertise in fuel production, they rarely (if ever) propose to engage in resource extraction activities like natural gas drilling. The reason being that resource production, as opposed to electric generation, carries added risks such as dry holes, spills, tax litigation, and water contamination – to name only a few.
Yet, in their recent AUT filing, PGE proposed to “hedge” against future price volatility to “protect” consumers by purchasing natural gas reserves in the form of currently untapped gas in the ground. Yes, you read that correctly: PGE wants to go into the gas drilling business.
CUB argues that, from even a pure business angle, this is a uniquely bad idea. With no prior experience in natural gas production, PGE will expose its customers to unnecessary risk. Furthermore, procuring gas reserves with the intent of drilling through an affiliated (but PGE owned and operated) supply company to sell back to PGE’s generation arm is not, by definition, a hedge.
Rather, PGE’s proposal is an investment in the company’s general rate base, and therefore has no place in an AUT filing (mini-rate case), dealing with net variable fuel costs and not large, multi-year capital investments. PGE’s proposal, while distinctly flawed, is allowable – but only in a general rate case where CUB has ample time to review for prudence and ensure strong customer protections.
• But why isn’t PGE’s proposal a true hedge against natural gas price volatility? Well, because it involves a significant and poorly planned capital investment. In its proposal, PGE describes a depreciation schedule that front-loads fuel expense. This means that PGE’s customers would pay well-above-market prices in the early years of production and well-below-market prices in the later years – creating serious equity concerns. CUB does not agree with this rationale.
• But why would PGE propose such a plan? Because PGE shareholders earn a return on this 30-year investment. In the first year, PGE can recover one year of depreciation plus a return on 29 years of undepreciated investment. That return (sometimes called profit) pushes the costs up in the early years when the bulk of the investment has not yet depreciated. CUB does not agree with this rationale.
CUB strongly opposes PGE’s proposal for a “long-term natural gas hedging program”. The program as it’s described is not variable in cost, and therefore does not belong in an AUT filing. It will expose customers to undue risk due to fundamental issues with its revenue requirements.
PGE’s “long-term natural gas hedging program” is just the start of an ongoing plan to invest hundreds of millions of dollars in untapped natural gas reserves that would extend beyond the life of PGE’s generating resources. As a capital investment, customers will carry the risk while shareholders recover their costs and earn a profit. CUB opposes this strategy in general – but especially in the context of an AUT filing.
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09/05/22 | 0 Comments | A Hedge of a Different Color