Natural gas is in massive quantities by two types of utility companies. The first are utilities that sell natural gas directly to customers for cooking, heating water, and warming their homes during winter. The second are utilities using natural gas as a fuel to produce electricity, then supply it to consumers to power their homes and businesses. Both types of utilities have immense natural gas price risk exposure, and both have a responsibility to properly manage their natural gas price risk.
Given this responsibility, what part can an expert energy hedging advisory firm play in the management of risk for utility companies and consumers?
Do Companies Need to Hedge Natural Gas?
In most cases, yes! Natural gas has historically been one of the most volatile commodities and can experience huge price swings. However, over the past few years, many utilities have been lulled into a false sense of security as prices have settled into a relatively low trading range. However, there is not guarantee that this will last forever, and the increased use of natural gas in the U.S. for electricity generation, exports to Mexico, and the rise in LNG will change the underlying fundamentals of the market in coming months and years. To that end, utilities should now begin to frame a strong natural gas hedging strategy to deal with the likelihood of rising future prices. An experienced energy hedging advisory service will obviously recommend developing a hedging strategy that both mitigates risks and can yield the greatest benefit.
Developing an Effective Hedging Strategy
Every company has different exposures to price risk, but companies engaged in commodity transactions such as natural gas and crude oil can effectively mitigate risk by developing a hedging strategy that accounts for their goals and risk appetite. A statistically based hedging product that pinpoints when to hedge, which maturity to use, how to scale in, and when to restructure, can be very effective for companies who buy and sell energy commodities and look to mitigate their risk exposure. An expert advisory company can further pitch in to help provide a roadmap on hedging with options, futures, and other derivatives.
Statistical Models Rather Than Long-term Forecasts to Manage Risks
Many energy hedgers make the mistake of relying upon long-term energy forecasts to make hedging decisions. Forecasting price, is a lot like forecasting weather. In the short-term we can be accurate, but in the long-term it becomes much more difficult because of underlying factors that change on a day-to-day basis. Therefore, to execute an effective hedging strategy it is important to understand price cycles that will help to gauge when prices are statically high or low, when to hedge, what exposure to hedge, and what types of instruments to use. This can then be custom tailored to first each company’s unique goals and exposure to price risk.
In order to build a strong natural gas hedging strategy companies and traders should rely on a statistically based hedging product. Also, it should be paired with a strategy that used the statistical models hedge triggers to meet each companies unique hedging goals and risk appetite.
Also published on Medium.