Discussion
of Issues
Issue 1:
Is it
in the consumers’ best interest for the utilities to continue natural gas
financial hedging activities?
Recommendation:
Yes.
The purpose of hedging is to protect customers from large price increases and
to minimize mark-to-market losses that occur when prices settle below projected
levels. Fuel price hedging has benefits and risks. However, when executed in an
economically efficient manner, staff believes that fuel price hedging activities
are in consumers’ best interest. (Barrett, Cicchetti)
Staff Analysis:
Testimony
and evidence was presented for this issue in the hearing for Docket No.
150001-EI, which is summarized below. In 2015, the IOUs favored continuing
hedging activities because such activities are in customer’s best interest, and
most intervening parties advocated putting an end to hedging. Settlement
agreements aside, these positions remain unchanged.
Summary
of IOUs’ position (from 2015)
Generally,
the IOU witnesses in 2015 asserted that continuing natural gas financial
hedging was in customers’ best interest for two primary reasons:
1)
Hedging
is a tool every generating IOU in Florida uses to reduce the volatility of fuel
rates over time.
2)
Hedging
a portion of their natural gas procurement provides a greater degree of fuel
price certainty for customers.
Historically,
the IOUs’ hedging programs involved placing hedges in a non-speculative,
structured manner for a certain percentage of natural gas over time whether prices
were high or low, in accordance with the respective risk management plans under
which each company operated. By placing hedges in this manner, the customers
received a degree of price certainty for fuel purchases, which was achieved
without the IOUs engaging in speculation to “out-guess” the market. Without
such hedging, price certainty is gone, and customers have no protection against
price swings. Without the protection from hedging a portion of natural gas
purchases, significant swings in market prices could subject customers to large
under and over recoveries and mid-course corrections.
In
summary, because the hedging programs provide price stability to customers and
a measure of protection against unanticipated dramatic price increases, the IOUs
believe hedging should be continued and is in the customers’ best interest.
Summary
of Intervenor’s position (from 2015)
OPC
witnesses stated that the marginal benefit that customers received from hedging
was vastly overshadowed by the historic hedging losses they have had to pay.
Year over year losses from the IOUs’ hedging programs demonstrate that the
expectation that hedging gains and losses would offset one another did not
occur. According to OPC, long term forecasts indicate an abundance of future supply
coupled with slower growth in prices have led to lower price volatility for
natural gas. Although the IOUs’ hedging programs are designed to reduce the
variability or volatility of fuel prices, external factors have already done
this.
Commission
Decision (from 2015)
In
its 2015 Fuel Order, the Commission found that continuing natural gas hedging
was in the customers’ best interest, stating, in part:
What this record clearly establishes is
that without hedging, customers have a very significant exposure to natural gas
price volatility due to a very dynamic natural gas market. Today natural gas
prices are low and gas supply is forecasted to be abundant. However, demand for
natural gas is increasing and is heavily influenced by weather and uncertain supply
conditions.
Analysis
In
Order No. PSC-16-0547-FOF-EI (2016 Fuel Order), the Commission found that resolving
the hedging issues will, or may, involve looking at multiple options:
As was requested by the parties to the
Joint Stipulation, we hereby direct Commission staff to open a generic
docket as soon as possible to allow all interested parties to engage in a
workshop or workshops to consider all alternatives to prospectively resolving
the hedging issues, including but not limited to the Gettings/Cicchetti
approach, a reduction in the current levels of hedging and hedging durations,
use of different financial products, or the termination of financial
hedging altogether, with the goal of providing guidelines for risk management
plans for 2018 and beyond that all stakeholders can either agree upon or not
object to.
Staff
believes the “public interest” threshold is the first decision point the
Commission should address. The February 21, 2017 workshop brought that
consideration to the forefront.
February
21, 2017 Workshop and post-workshop comments
At
the February 21, 2017 workshop, the IOUs collectively discussed a proposal to
continue hedging. In post-workshop comments, the IOUs contend that the goals of
hedging and the “public interest” consideration are closely related. If the
Commission decides that the goal of hedging is to mitigate price spikes and to
limit exposure to hedging transactions that result in losses, then the IOUs believe
their current proposal accomplishes these objectives. However, if the Commission decides
that the goal of hedging is to mirror the market, the IOUs contend that hedging
should be eliminated. As stated in FPL’s post-workshop comments, a decision on
the public interest and goal of hedging is imperative, and “there is no free
lunch.”
In
live comments at the workshop and in post-workshop written comments thereafter,
OPC and FIPUG advocated the same general position stated in earlier documents,
asserting that hedging should end. OPC advocated that other mechanisms are
already available to address price volatility, as reflected in customer bills,
and FIPUG asserted that it prefers to “pay at the pump.” White Springs believes
that targeted-volume hedging should end, but stated that hedging is in the
public interest. White Springs contended production advances and abundant
reserves of natural gas are factors that have fundamentally impacted today’s
market, and that the IOUs should develop hedging methods that systematically
address fuel price trends and risks.
Conclusion
Staff
believes the public interest decision is a threshold matter. The purpose
of hedging is to minimize customer pain associated with energy price (consumer
cost) increases. That is different than simply reducing volatility because
customer pain is not symmetrical. The asymmetry is due to the fact that
customer’s tolerance for upside cost exposure in rising-price markets is
different than their tolerance for hedge losses in declining-price markets.
Cost increases occur in rising cost markets where unfavorable outcomes, if
unmitigated, can be severe. Hedge losses occur in declining cost markets, so
outcomes are still beneficial, even if less so due to hedging. Fuel price hedging
has benefits and risks. However, when executed in an economically efficient
manner, staff believes that fuel price hedging activities are in customers’
best interest.
Issue 2:
What changes, if any, should be made to the manner
in which electric utilities conduct their natural gas financial hedging
activities?
Recommendation:
Consistent with the
recommendation in Issue 1, staff believes that continuing fuel price hedging
activities in an economically efficient manner is in the consumers’ best
interest and the Commission has the discretion to consider implementing changes
to the manner in which the IOUs conduct their natural gas financial hedging
activities. (Barrett, Cicchetti)
Staff Analysis:
Similar to Issue 1, this
issue also was presented in the hearing for Docket No. 150001-EI. In 2015, the
record evidence for this issue was limited, with the IOUs advocating that no
changes were warranted. OPC recommended that hedging be completely eliminated
on a prospective basis. By advancing that position, OPC expressed that it was
unnecessary to propose changes. With the exception of White Springs, the
intervening parties largely supported OPC’s position.
Commission Decision (2015)
In the 2015 Fuel Order, the
Commission directed staff and the parties to more fully examine potential
changes to the utilities’ hedging programs:
Our decision to continue hedging at this time is based on the evidence
presented in this record which in large part consists of arguments to either
completely eliminate hedging or to continue the procedures in place at this
time. There was no written testimony from any party and very limited cross
examination on possible changes to the manner in which the IOUs conduct natural
gas financial hedging activities or alternatives to hedging: cost sharing of
hedging gains and losses between the IOUs and ratepayers, alternative
accounting treatment for recovery of gains and losses (VMM program), or
imposing limits on the percentage of natural gas purchases hedged. All
witnesses agreed that any changes to the hedging protocol should be prospective
and that the current hedges should be allowed to terminate on their original
contract dates. Notwithstanding our decision on hedging, we recognize that the
cost of this program is significant by any measure for each Florida IOU and
deserves further analysis. Therefore, we direct our staff, in conjunction with
the parties to this docket, to explore possible changes to the current hedging protocol
that will minimize potential losses to customers.
Analysis
Staff believes this issue and the
“public interest” issue (Issue 1) are inextricably related. Staff believes that
if the Commission decides in Issue 1 that continuing fuel price hedging activities
is in the consumers’ best interest, then the Commission has a range of options from
which it can choose so that electric utilities can continue natural gas
financial hedging. However, if the Commission decides in Issue 1 that it does
not support hedging in any manner, then staff believes this issue is moot.
Activity since the Commission’s
Decision (2015)
On January 25, 2016, an informal
meeting between Commission staff and interested persons was held to discuss
options and procedures for possible changes to the hedging process to minimize
potential losses to customers. Representatives from DEF, FPL, TECO, and Gulf
participated in the meeting, although no specific alternatives were proposed.
On April
22, 2016, Docket No. 160096-EI was opened to address a joint petition seeking
approval of modifications to the IOUs’ respective Risk Management Plans (Joint
Petition). FPL, TECO, and Gulf sought approval of modifications to their
respective 2016 Risk Management Plans, noting that the 2016 plans were approved
in the 2015 Fuel Order. DEF did not join in seeking to modify its 2016 Risk
Management Plan, because DEF believed its then-current Risk Management Plan
afforded it the ability to meet the goals proposed by the other petitioners.
The Joint Petitioners proposed a two-step initiative
to minimize potential losses to customers in periods of falling fuel prices.
First, the Petitioners proposed reducing their hedging target ranges by up to 25 percent for procurement with
hedging instruments. Second,
the Petitioners proposed shorter time horizons over which hedges are placed. In
addition to the limited changes to the 2016 Risk Management Plans, the
Petitioners proposed modifications to their 2017 Risk Management Plans, which
were slated to be considered for approval at the November hearing in the Fuel
Cost Recovery Clause docket (Docket No. 160001-EI). By Order No.
PSC-16-0247-PAA-EI,
the Commission approved the Joint Petition.
On July
15, 2016, OPC timely filed a petition protesting Order No. PSC-16-0247-PAA-EI,
formally requesting an evidentiary hearing. On July 28, 2016, Order No.
PSC-16-0301-PCO-EI,
was issued to consolidate Docket Nos. 160001-EI and 160096-EI. Thereafter, in
Docket No. 160001-EI (the 2016 fuel clause proceeding), the same two issues as
originally proposed in 2015 were identified for resolution.
On September 23, 2016, staff witnesses Mark Anthony
Cicchetti and Michael A. Gettings
provided testimony and exhibits to support a risk-responsive hedging program.
Concurrent with the filings of staff witnesses Cicchetti and Gettings, OPC
filed testimony and exhibits from witnesses Daniel J. Lawton and Tarik Noriega
to advocate the substantially similar position expressed in 2015; that hedging
should cease.
On September 30, 2016, the IOUs filed rebuttals to the
testimony of staff witnesses Cicchetti and Gettings and OPC witnesses Lawton
and Noriega.
On October
24, 2016, DEF, Gulf, TECO, OPC, the Florida Industrial Power Users Group (FIPUG),
and the Florida Retail Federation (FRF) jointly filed a Stipulation and
Agreement for Interim Resolution of Hedging Issues (Joint Stipulation) that
provided that:
·
DEF, Gulf, and TECO will implement a 100%
moratorium on placing new hedges for all of 2017. The moratorium does not apply
to hedging arrangements in place that were entered into pursuant to Risk
Management Plans from prior years.
·
DEF, Gulf, and TECO will withdraw their proposed
Risk Management Plans for 2017.
·
DEF, Gulf, TECO, OPC, FIPUG, and FRF agree to
cooperate with each other and Commission staff to engage in workshop(s) to
consider all alternatives to resolving the pending hedging issues.
·
DEF, Gulf, TECO, OPC, FIPUG, and FRF agree to
negotiate in good faith to reach a settlement or other basis to dispose of the
pending hedging issues on or before the anticipated due date for filing Risk
Management Plans for 2018 (August 1, 2017). If these negotiations are
unsuccessful, then DEF, Gulf, and TECO may submit Risk Management Plans for 2018,
in advance of the expiration of the one year moratorium at the end of 2017.
The 2016 Fuel Order addressed the Joint Stipulation, and,
in part, stated:
Based on the evidence submitted in this docket, we
hereby approve the Joint Stipulation and Agreement for Interim Resolution of
Hedging issues, dated October 24, 2016 (the “Joint Stipulation”). Consistent
with the Joint Stipulation, the parties have agreed to a moratorium
on any new hedges effective immediately upon our approval of the stipulated
positions offered on the hedging issues in this docket, with that moratorium
extending through calendar year 2017. We therefore find that the hedging issues
shall be deferred to the 2017 docket and the Joint Stipulation accepted as the
replacement for the signatory companies’ respective Risk Management Plans for
2017, rendering moot the company specific issues regarding their request for
approval of their respective Risk Management Plans as filed for 2017. As was
requested by the parties to the Joint Stipulation, we hereby direct Commission
staff to open a generic docket as soon as possible to allow all
interested parties to engage in a workshop or workshops to consider all
alternatives to prospectively resolving the hedging issues, including but not
limited to the Gettings/Cicchetti approach, a reduction in the current levels
of hedging and hedging durations, use of different financial products, or
the termination of financial hedging altogether, with the goal of
providing guidelines for risk management plans for 2018 and beyond that all
stakeholders can either agree upon or not object to.
. . .
Consistent with our decision above, we accept the
Joint Stipulation as the replacement for the signatory companies’ respective
Risk Management Plans for 2017, rendering moot the company specific issues
regarding their request for approval of their respective Risk Management Plans
as filed for 2017.
Staff notes that although FPL was not a signatory to the
Joint Stipulation, in a contemporaneous filing, FPL affirmed its support and
agreement to follow the directives of the agreement. In a separately docketed matter, FPL agreed
to a four-year moratorium on financial hedging in a settlement agreement
reached in FPL’s 2016 rate case and other consolidated dockets (FPL
Settlement). The Commission approved the FPL Settlement in Order No.
PSC-16-0560-AS-EI.
Pursuant to the terms of the agreement, FPL will not execute any new natural
gas financial hedges during the term of the agreement, which runs through
December 31, 2020.
On January
10-12, 2017, a series of five conferences were scheduled between Mr. Gettings
and interested stakeholders regarding possible changes to the hedging practices
in Florida. For the
purposes of these conferences, Mr. Gettings developed an EXCEL-based
risk-responsive model that used market data from the period 2001-2012. His
model assumed a $2.5 billion fuel budget hedged in a risk-responsive fashion up
to a maximum 65 percent of the fuel portfolio. Using these input variables, he
graphically demonstrated the results of a risk-responsive hedging program compared
to a targeted-volume hedging program. According to the findings, Mr. Gettings
stated that the risk-responsive strategy produced market-average outcomes with
mitigated peaks and valleys for that time period, compared to the targeted-volume
hedging strategy, which produced a $1.1 billion loss.
On February 21, 2017, staff held a workshop to discuss
natural gas hedging and related topics. During the workshop, the IOUs presented
a proposal titled Out-of-The-Money (OTM) Call Options as an Alternative Form of
Risk Responsive Hedging (IOU Proposal or OTM Call Options Approach). All of the
IOUs, the Sierra Club, FIPUG, White Springs, and OPC filed post-workshop
comments on March 6, 2017.
Goals
of hedging for the Commission to consider
The Second
Clarifying Order stated that the purpose of hedging is to “reduce the impact of
volatility in the fuel adjustment charges paid by an IOU’s customers.” Staff
notes that this language has been cited frequently in various hedging-related
pleadings since the inception of hedging. Staff believes this citation from the
Second Clarifying Order is clearly associated with legacy hedging programs. As
the discussion evolved about considering changes to hedging, staff believes the
topic of “What should be the goals of hedging?” has been introduced, and needs
to be addressed. As more fully explained in the analysis to follow, the
discussion will present options the Commission may consider. Within that
discussion, staff believes the options for such changes align with what,
arguably, are newly defined goals of hedging.
Mr. Gettings
testified that “the primary reason for hedging is to mitigate upside cost
exposures, and the potential for hedge losses is an associated consequence
which needs to be managed as well.” That
testimony addressed a risk-responsive hedging approach that will be more fully
explained below.
A second
option for the Commission to consider was presented by the IOUs. The
alternative presented by the IOUs revolves around two somewhat “new” goals of
hedging:
1.
To protect customers from large price increases, and
2.
To minimize the losses that occur when natural gas
prices decline from projected levels.
Staff
believes the goals for hedging presented above by Mr. Gettings and the IOU’s
are essentially the same, but differ from the goal of simply “reducing
volatility.” In evaluating the options, it is important to note the distinction
between “cost-risk” and “loss-risk.” Cost-risk is associated with higher
natural gas prices while loss-risk is associated with hedging losses in a
declining-price market. Staff further believes that the most relevant question
is, “What is the most economically efficient way to accomplish the goal of
minimizing cost increases while minimizing hedge losses?” The analysis to
follow will examine the nuances between the viewpoints set forth in the
proposals of Mr. Gettings and the IOUs.
Options
for the Commission to consider
Staff
believes there are three primary options the Commission may consider in
addressing this issue. The first option is the risk-responsive hedging approach,
which was originally presented in staff-sponsored testimony and exhibits for
the Fuel Clause hearing in 2016. The second option is the IOU Proposal presented
at the February 2017 workshop. The third option is reinstatement of the hedging
activities as conducted before the IOUs voluntarily suspended placing new
hedges. This option is labeled the “status quo” option, although staff presents
two variations that can be considered.
Option 1: The Risk-Responsive
Hedging Approach
In Docket No. 160001-EI, Mr. Gettings provided testimony
recommending that a risk-responsive hedging approach be implemented for fuel
hedging. Mr. Gettings stated that mitigating upside costs as well as mitigating
hedging losses is a different approach than simply reducing the price volatility
exposure for customers, as was the goal of the legacy hedging methods. He used
the term “customer pain” to refer to the customer’s acceptance for bill
fluctuations, asserting that the reactions for rising or falling prices are not
symmetrical, as explained below:
[Asymmetric pain] is due to the fact that tolerance
for upside cost exposure in rising markets is different than the tolerance for
hedge losses in downward markets. Using a simple analogy for residential
customers, taking a $500 better vacation with utility-bill savings would be a
good thing and if utility hedge losses moderate those savings so that they are
$300 rather than $500 it is still a good net outcome despite the $200 foregone
savings. On the other hand, that same customer might struggle to meet necessary
expenses if faced with an unmitigated $500 increase in utility costs, and that
would be a very bad thing. Said differently, hedge losses occur in low-cost
markets, so outcomes are still beneficial but less so; in low-cost markets
customer impacts are constrained to discretionary choices regarding alternative
uses of reduced savings. Cost increases occur in high-cost markets where
unfavorable outcomes, if unmitigated, can be severe; also the customers’ budget
response is more likely to impact non-discretionary spending. So on balance,
customers experience greater value from potential cost mitigation than they
forego with potential hedge losses.
In preparing his testimony, Mr. Gettings reviewed the 2017
Risk Management Plans, and noted that each IOU used a targeted-volume approach
to accumulate hedges in accordance with a predetermined timeline. He testified
that none of the 2017 Risk Management Plans provided information about how the
IOUs measured risk in a quantitative fashion. Mr. Gettings observed that the
accumulation of hedging losses since the natural gas pricing peak in 2008 was
primarily due to hedging a targeted volume without a plan for responsive
adjustments.
Mr. Gettings testified that a customer-focused
risk-responsive hedging program would be an improvement over the targeted-volume
approach. The risk-responsive program he recommends would use quantitative
tools to measure volatility-related cost-risk and loss-risk, and the
measurements would then serve as a basis for risk-responsive hedging decisions.
Stated in a different manner, a risk-responsive hedging program would set Value
at Risk (VAR) metrics for high and low tolerance bands, and formulate a
strategy of prescribed responses to defend those tolerances against whatever
risk conditions emerge.
Mr. Gettings
stated that his recommended approach to a risk-responsive hedging program has
four components:
1.
A
programmatic hedging portion for a low to moderate level of an IOUs fuel burn,
15 percent to 20 percent, for example.
2.
A
defensive hedging portion, with action boundaries when market prices are
rising.
3.
A
contingent hedging portion, with action boundaries when market prices are
declining.
4.
A
discretionary portion, which is very small, but available to take advantage of
market opportunities. Mr. Gettings does not recommend using discretionary
hedges and emphasizes that hedges should be executed based on a “risk-view” and
not on a “market view.”
Mr. Gettings
believes the dual goals of mitigating upside cost exposures, and actively
managing the potential for hedge losses can be accomplished by following the risk-responsive
(Option 1) approach. He recommended that hedging into a 36 month period is a
good foundation for building a risk-responsive model, and emphasized that each
IOU would have the flexibility to establish specific parameters, action limits,
and boundaries to suit their risk profile. As noted above, Mr. Gettings provided
a simulation for the period 2001-2012 using a basic risk-responsive strategy
for a $2.5 billion dollar fuel burn compared to a 50 percent targeted-volume
hedging strategy similar to the strategy employed by Florida IOUs over that
period. The risk-responsive approach achieved essentially market price for
natural gas while the targeted-volume approach achieved a $1.1 billion dollar
loss.
Option 2: The IOU
Proposal (OTM Call Options Approach)
The IOU
Proposal was transmitted to staff as a PowerPoint file on February 20, 2017.
Penelope Rusk, an employee of TECO, was the chief spokesperson for the IOUs and
conveyed their proposal as a PowerPoint presentation to the workshop attendees.
The IOUs developed their plan to respond to what they believe are the new goals
of hedging, which are to specify and constrain the cost threshold for upside
price movement protection, and also maintain participation in declining-price
markets. The IOUs believe their OTM Call Options Approach meets these goals of
hedging in a simpler manner, without the complexity of multiple decision points
required by the Gettings risk-responsive approach.
The IOU
proposal defines an OTM Call Option as a “financial instrument that requires
the purchaser to pay an up-front premium in return for the ability to receive
payment if the future price of an underlying asset rises above a strike price
that is higher than the current market for that asset.”
Although presented as a joint proposal, in practice each IOU would develop company-specific
budgets for call options and thresholds that would be defined in Risk
Management Plans. The decision points for each company would include setting
price protection levels, the time horizon for options, and optioned volumes.
From an accounting perspective, all call option premiums would be recorded as
clause-recoverable fuel expenses. The IOUs characterize the cost of call
options as akin to an “insurance premium” for protecting against price spikes.
Staff believes examples will help illustrate the concept of call options in
rising and falling markets.
Call Option Example Rising Price Market
(Market Price > Option Price)
The IOU
Proposal asserts that using OTM call options will protect against upward price
movements because call options expiring “in the money” will provide price
increase protection. Staff agrees, noting that understanding the concept of an
“in the money” transaction is straightforward. “In the money” results when the
option price is lower than the market price. However, the total price will
include the commodity price plus a premium that was incurred in order to secure
the option. The premium is incurred whether the option is exercised or not
exercised. In this instance (the rising price market), the total option price
is lower than the market price on the date the transaction is executed, which
means the transaction was “in the money.”
Call Option Example in a Falling Price
Market
(Option Price > Market Price)
The IOU
Proposal asserts that call options expiring “out of the money” will not be
exercised, and therefore, will not result in hedging losses beyond the up-front
premium. Staff notes that in this scenario, the total price is not favorable to
the market price on the date the transaction is executed, because the total price
is higher than the market. The IOU Proposal asserts that since the option is
not exercised, unfavorable hedging outcomes do not occur. However, just as in
the rising market, staff observes that any time an option transaction is
entered into, a premium is incurred in order to secure the option, whether the
option was exercised or not exercised. In this instance (the falling price market),
the fuel costs would consist of fuel purchased at a market price, plus the
expense for the option premium when the option was entered into, even though
the option was not exercised.
At the
workshop and repeated in post-workshop filings, the IOUs stated that the
risk-responsive approach is less favorable than their proposal for a number of
reasons: First, the risk-responsive approach involves the use of a complex
model each IOU would have to develop with significant administrative and
implementation costs. Second, because this approach requires each IOU to
establish cost/loss tolerances and formulate a strategy of prescribed
responses, the IOUs may need to supplement their computing resources, and/or
allocate a considerable amount of development time to implement that approach.
In contrast, the IOUs contend that their recommended approach can be implemented
quickly and easily. Third, the IOUs believe the risk-responsive approach sets
up a possible conflict between contingent and defensive hedging triggers. Staff
notes that possible conflicts between contingent and defensive hedging triggers
are rare occurrences and the response, should that condition occur, would be
addressed beforehand in the risk management plans. According to the IOUs, no
such conflict would exist using the OTM Call Options approach. Fourth, the IOUs
believe their proposal is more favorable than the risk-responsive approach
because regulatory reporting will be substantially similar to what the IOUs are
currently doing. Furthermore, the IOUs believe the regulatory reviews and
audits will be easier to administer than under the risk-responsive approach. Finally,
the IOUs believe the OTM Call Options approach will require fewer guidelines
from the Commission to get up and running. These points were expressed in the
workshop presentation, and reiterated in their post-workshop comments.
Observations
from the Workshop
DEF, FPL,
Gulf, and TECO individually contributed and presented portions of the IOU
Proposal at the February 21, 2017 workshop.
DEF and
FPL presented the results of modeling and analysis they performed in order to
show what hypothetical results would have been achieved using an OTM Options
method. DEF “back-tested” actual historical volume and hedging costs from 2013-2016,
and FPL conducted a similar analysis using 2011-2016 data. In each time period
evaluated, natural gas prices were relatively stable. In its model, DEF found
that in 2013, 2015, and in 2016, the actual hedging results from programmatic
hedging practices incurred higher costs than the (modeled) equivalent OTM
Option amounts for those years. In 2014 the opposite occurred, as DEF found
that the gross equivalent cost for option premiums was modeled to have greater cost
than actual hedging costs incurred in that period. DEF states that its modeling
demonstrates that call options protect against price increases above
established cost price thresholds.
FPL’s
modeling was somewhat similar to DEF’s, although staff notes that FPL used
historical data for 2011-2016, and tested hypothetical results for hedging
using a risk-responsive approach, compared to an OTM Call Option approach. For
the hypothetical risk-responsive approach, FPL used a strategy modeling
Defensive hedging up to a maximum 65 percent of the fuel burn. For the
hypothetical OTM Call Option modeling, FPL used a 15 percent level for OTM
Options covering 60 percent of the fuel burn, and the OTM cost total included
the cost of option premiums. FPL stated the results of its modeling indicate:
1.
The OTM Call Option Approach accomplishes an important
goal: it provides a viable hedge against upside price risk while providing
market price on the downside.
2.
The OTM Call Option Approach shows significant cost
advantages over the risk-responsive model when prices decline. The risk-responsive
strategy had a slightly lower net gas cost in periods of rising prices.
The
analyses Gulf and TECO performed were somewhat different from the analyses
performed by DEF and FPL. Gulf provided graphs to show the relationship between
market prices and call option prices. TECO did not back test, but instead
presented information to demonstrate what OTM thresholds at 15 percent and 30
percent would look like using various theoretical 2018 market settlement
prices. When it developed this data, TECO stated that the 2018 forward curve
price of natural gas was $3.11/mmBtu (as of February 2017). For its modeling,
TECO assumed call option premium costs of between $10-18 million were rolled
into the final resulting price for OTM hedges. Using those thresholds, TECO’s
model indicated that:
1.
If the final market settlement price ends up being
lower than the OTM strike price, then the resulting price for the hedged
natural gas will be above market.
2.
If the final market settlement price ends up being
above the OTM strike price, then the resulting price for the hedged natural gas
will be below market, and premium cost increases will be limited.
An excerpt
of the results of TECO’s model is shown in Table 2-1 below:
Table 2-1
Modeled Results of Hypothetical OTM
Call Options Approach from TECO
|
2018 Theoretical Market Settlement Price
($/mmBtu)
|
15 Percent OTM Call Options ($/mmBtu)
|
30 Percent OTM Call Options
($/mmBtu)
|
|
$2.50
|
$2.75
|
$2.64
|
|
$3.00
|
$3.25
|
$3.14
|
|
$3.50
|
$3.72
|
$3.64
|
|
$4.00
|
$3.72
|
$4.08
|
|
$4.50
|
$3.72
|
$4.08
|
Source:
Excerpt of Slide No. 8 from IOU Proposal (FPSC Document Number 02730-17)
Joint Analysis (of
Options 1 and 2)
On March 6, 2017, all 4 IOUs
filed post-workshop comments, along with Sierra Club, FIPUG, White Springs, and
OPC. These comments are summarized below:
OPC Comments
In its comments, OPC believes
three threshold questions must be addressed before critiquing the Gettings
approach (Option 1) or any hedging alternative. The questions OPC presented are
as follows:
1.
What
should the Commission’s volatility response policy (VRP) be as it relates to
the price of natural gas recovered through the annual fuel adjustment clause?
2.
Is
there a lower cost or cost-free mechanism to mitigate fuel price volatility
experienced by the customer?
3.
How
has natural gas price volatility decreased as a result of the discovery,
production (fracking), and development of enormous natural gas reserves
(supply) in recent years?
The OPC
believes hedging was developed as a mitigation tool for price volatility, not expressly
to provide fuel cost savings. Even without hedging, OPC believes the Commission
already has access to VRP tools to address price volatility. The annual
resetting of fuel cost recovery factors is one such tool, the mid-course
correction process is another, and case-by-case considerations for spreading
costs over extended time periods is another, according to OPC. OPC acknowledges
that the Gettings approach might be more favorable than targeted-volume
hedging, yet doubts whether the method would limit costs. OPC believes today’s
market is more mature and less prone to wide swings in volatility, due to ample,
long-term supply reserves.
Sierra Club Comments
Although
not squarely directed at Options 1 or 2, the Sierra Club believes the
over-reliance on natural gas in Florida puts significant risk on all
ratepayers, and financial mechanisms like these approaches are akin to “fixing
pot-holes” as opposed to repaving the road. The Sierra Club believes the
Commission should require the IOUs to invest in energy efficiency and
generating sources that provide electricity without volatile fuel costs.
According to the Sierra Club, the approach it recommends can limit ratepayer
exposure to risk without relying on financial mechanisms.
White Springs and FIPUG Comments
White Springs and FIPUG offered
general comments on hedging methods and results, but did not specifically
comment on the Gettings approach (Option 1) or on the OTM Call Options Approach
(Option 2).
Comments from the IOUs
As noted previously, the IOUs
first challenged the risk-responsive approach (Option 1) in rebuttal testimony
in September 2016. In the January 2017 series of conferences, subject matter
experts from each IOU were given the opportunity to learn more about the risk-responsive
approach, and directly questioned Mr. Gettings as they critically examined the
EXCEL-based risk-responsive model developed specifically for those conferences.
That model used historical data and parameters to graphically show how the
hedging results he recommended under a risk-responsive hedging program compared
to a targeted-volume hedging program. After actively participating in the
January conferences, and thoroughly studying the risk-responsive approach, the
IOUs collectively worked to develop an alternative to it, which resulted in
their own proposal (OTM Call Options Approach, Option 2).
In post-workshop comments, the
IOUs stated that the risk-responsive approach is considerably more complex than
their own proposal. The IOUs believe the risk-responsive approach has merits,
but does not completely eliminate hedging losses and involves many challenges
for implementation and regulatory review. The IOUs contend that under risk-responsive
hedging (Option 1), setting Company-specific action boundaries and
risk-response protocols will be a significant undertaking; a task that no other
IOU in the United States has undertaken. Staff notes this statement is
inaccurate. Mr. Gettings has stated that IOUs in numerous states and Canada
have deployed these methods but client confidentiality precludes disclosure of
exactly which companies. IOUs in Pennsylvania, Indiana, Louisiana, and
Washington, as well as public power companies in New York, Texas, California, the
Carolinas, etc. have used these methods. It is true that the risk-responsive methodology
has been more widely accepted by large public power companies, but the reason
has nothing to do with effectiveness. As explained in Mr. Gettings’ testimony,
the reason is that prudence risk looms large in the IOU space, and barring an
understanding with regulators, most IOUs prefer to adopt risk-blind
methodologies.
Staff
Analysis
On March 13, 2017, the Washington
Utilities and Transportation Commission issued a Policy and Interpretive
Statement on Local Distribution Companies’ Natural Gas Hedging Practices
(Washington Commission Statement) that endorsed the adoption of what is
presented here as risk-responsive hedging (Option 1). Staff
believes this action has important implications for the instant matter before
this body. Staff acknowledges that at the time the IOUs prepared their
post-workshop comments, no regulatory body had ordered the implementation of
hedging plans built around the concepts of a risk-responsive plan. In part, the
Washington Commission Statement provides:
The [Gettings] White
Paper serves as a foundational document for the Commission’s policy position on
natural gas utility hedging practices. The White Paper provided the Commission
with convincing evidence that strict programmatic hedging strategies disable
utility capacity to adequately mitigate price risk to ratepayers. In describing
the function of risk-responsive hedge strategies, which demonstrate the value
of measuring and responding to changing market risk conditions, the White Paper
provides guidance to lead the Companies toward more robust risk management
programs.
It is the
Commission’s explicit policy preference that the Companies employ
risk-responsive hedge strategies. The singular programmatic hedging approach employed
by many utilities fails to balance upside price risk with hedge loss risk in
any meaningful way. An inflexible plan makes a utility’s hedging less adaptable
to changing conditions. Utilities must find a way to manage, simultaneously and
continuously, upside price risk and downside hedging loss, and evaluate whether
the “insurance” benefit justifies the cost.
. .
.
The Companies should
develop a framework for risk mitigation informed by quantitative metrics.
Quantitative metrics allow utilities to measure, monitor market risk
conditions, and facilitate identification of meaningful hedging responses.
While we stop short of requiring use of the specific value-at-risk (VaR)
methodology described in the White Paper, it is clear to us that each utility must
develop robust analytical methods and incorporate these methods in their risk
management frameworks.
The IOUs contend that implementing
the risk-responsive approach (Option 1) is complex and that ramp-up activities
for implementing it would be costly, and take up to 2 years. Staff observes that the Washington Commission
Statement also acknowledged that implementing a risk-responsive hedging program
will take time to get up and running, stating “the Commission expects that full
implementation will take no longer than 30 months.”
In addition, the IOUs contend the
risk responsive approach (Option 1) is not the best path forward because
components of the plan involve discretionary transactions, which invites
uncertainty in terms of regulatory reviews. The uncertainty comes about because
individual IOUs participating in a common market may use that discretion by
reacting to market signals in different ways. Staff notes that the Washington
Commission Statement addressed the topic of uncertainty and prudence reviews as
well, stating:
Consistent with our
intention not to be overly prescriptive about how the Companies develop
more robust, risk-responsive hedge strategies, we decline here to be formulaic
in suggesting how utilities ought to operate in a prudent manner. We adopt an
affirmative policy that natural gas company hedging programs must adapt to
constantly changing market risk conditions, and that utilities should seek to
“[implement the most economically superior strategy] that produces a
cost-mitigation tolerance with the smallest hedge-loss exposure.”
The Companies must determine how best to achieve these objectives.
Nevertheless, the
Commission expects utilities to make reasonable progress in developing a more
sophisticated risk management framework consistent with this policy statement.
As we move forward, we are more likely to entertain arguments regarding the prudency
of extraordinary hedging losses, particularly for companies that continue to
rely upon a strict programmatic hedging approach. Therefore, continuing to
maintain largely static hedge ratios without justification will become an
increasingly risky proposition.
In light of expert
recommendation and comments filed in this proceeding, we determine that the
Commission’s existing prudence standard remains sufficient to evaluate
decisions and subsequent outcomes related to hedging losses.
In Florida, the Commission’s
process for prudence review is similarly structured to accommodate any
modifications the Commission approves to the IOUs’ methods of hedging.
Based on
their modeling, the IOUs contend Option 2 will produce results similar to a
risk-responsive plan, without the implementation challenges of the risk
responsive approach (Option 1), or the regulatory review concern. To support
this contention, FPL put forward the results of its comparative model during
the February workshop. As noted previously, the risk-responsive model FPL
compared to its OTM Plan used defensive hedging practices for up to a maximum
of 65 percent of the fuel portfolio. For its hypothetical OTM Call Option
models, FPL used a 15 percent level for OTM Options covering 60 percent of
burn, and the OTM cost total included the cost of option premiums. FPL claims
these results indicate that its OTM Call Option Approach provides a viable
hedge against upside price risk while providing market price on the downside.
In addition, FPL believes the OTM Call Option Approach shows significant cost
advantages over the risk-responsive model when prices decline. The differences
are less significant in a rising price environment, according to FPL.
Staff
notes, however, that FPL’s modeling may not be instructive for several reasons.
First, during the time period FPL selected for its study presented in the
workshop (2011-2016), the market prices for natural gas can be characterized as
stable and low. During this time period, there were no significant peaks or
valleys in the market. Staff notes, however, that in its post-workshop comments
filed on March 6, 2017, FPL expanded its analysis to encompass the 2007-2016
period, as shown below in Table 2-2.
Table 2-2
Comparative Results of OTM Call Option
and
Risk Responsive hedging approaches
from FPL
|
Year
|
Market Settlement Prices
($/mmBtu)
|
Hypothetical Risk/Response Approach Results [with
Defensive hedging up to 65% against price increases]
($/mmBtu)
|
Hypothetical
OTM Call Options
Approach [with 15% OTM Options covering 60% of
burn and includes the cost of option premiums] ($/mmBtu)
|
Difference in Average Annual Cost between
Hypothetical Risk/Response Approach Results and OTM Call Options Results
($/mmBtu)
|
|
2007
|
$6.86
|
$7.70
|
$7.49
|
($0.21)
|
|
2008
|
$9.03
|
$9.07
|
$9.15
|
$0.08
|
|
2009
|
$4.04
|
$5.56
|
$4.48
|
($1.08)
|
|
2010
|
$4.40
|
$5.17
|
$4.77
|
($0.40)
|
|
2011
|
$4.05
|
$4.47
|
$4.32
|
($0.15)
|
|
2012
|
$2.79
|
$3.52
|
$2.92
|
($0.60)
|
|
2013
|
$3.65
|
$3.92
|
$3.80
|
($0.11)
|
|
2014
|
$4.41
|
$4.28
|
$4.46
|
$0.18
|
|
2015
|
$2.66
|
$3.27
|
$2.78
|
($0.49)
|
|
2016
|
$2.46
|
$2.57
|
$2.58
|
$0.01
|
|
2007-2016 Average
|
$4.44
|
$4.95
|
$4.67
|
($0.28)
|
Source:
Excerpt of Exhibit 1 from FPL’s Post-workshop comments (FPSC Document Number
03145-17)
Staff believes FPL’s expanded analysis is a more
instructive comparison than what FPL presented at the workshop because it
includes a period of higher volatility. Table 2-2 shows that FPL would have
spent $374 million in 2007 and $1.7 billion over the ten-year period ending in
2016. That astronomical sum only provides rolling one-year hedge coverage. It
is unlikely that any company would spend that amount of money in options
premiums and it might not even be possible to find counterparties to execute
that magnitude of options. The options market is far less liquid than the swap
market. If in 2007, FPL’s management, facing a prospective $374 million outlay,
decided to limit it’s expenditure to a more reasonable $100 million, the hedge
ratio going into the price spike would have been a fraction of the numbers
presented.
Further, a one-year hedge is of limited value. One can imagine
the prudence discussion if $374 million were expended and prices did not rise
substantially, but going into the next year prices increased dramatically
before hedge coverage was secured. Extending option coverage to a two-year
horizon would increase the options budget to well over twice the $374 million
level because options for the second year would demand about twice the premium
requirements. It is doubtful any firm would have an appetite for an
approximately billion dollar option premium expenditure to cover two gas years.
Staff believes that Table 2-2, taken on face value, illustrates the
impracticality of the out-of-market option strategy.
Staff
notes that the EXCEL-based model that Mr. Gettings developed for the January
2017 conferences used market data for the period 2001-2012, which is a broader
analysis than FPL’s expanded analysis, and encompassed at least two market
peaks driven by weather-related events and a financial crisis. The OTM Call
Options strategy is not risk-responsive. It deploys a predetermined budget on a
calendar-based schedule and does not quantify and monitor risk. In addition,
this strategy does not provide for real-time responses to potentially extreme
cost outcomes. There has been no demonstration that the IOU-proposed OTM Call
Options strategy can respond effectively to stressed cost environments.
In its
post-workshop comments, TECO did not directly challenge the risk-responsive model
as did FPL, but instead presented data comparing the difference between the
performance of legacy hedging to a hypothetical 30% OTM model, as shown in
Table 2-3 below:
Table 2-3
Comparative Results of 30% OTM Call
Option proposal and
legacy hedging approaches from TECO
|
Year
|
Hedging Results of Previous Swap Program
($)
|
Hypothetical
OTM Call Options
Proposal [with 30% OTM Options]
($)
|
Difference in Average Annual Cost between Previous
Swap Program results and a 30% OTM Call Options Results
($)
|
|
2005
|
$53,231,770
|
$59,937,177
|
$6,705,407
|
|
2006
|
($54,482,120)
|
($9,849,134)
|
$44,632,986
|
|
2007
|
($59,691,520)
|
($49,825,107)
|
$9,866,413
|
|
2008
|
$18,147,375
|
($11,485,107)
|
($29,633,374)
|
|
2009
|
($193,185,985)
|
($30,692,292)
|
$162,493,693
|
|
2010
|
($67,840,710)
|
($27,561,549)
|
$40,279,161
|
|
2011
|
($33,889,480)
|
($12,723,142)
|
$21,166,338
|
|
2012
|
($61,518,120)
|
($6,566,356)
|
$54,951,764
|
|
2013
|
($3,256,370)
|
($8,181,402)
|
($4,925,032)
|
|
2014
|
$15,615,785
|
($3,245,652)
|
($18,861,437)
|
|
2015
|
($39,842,325)
|
($3,756,058)
|
$36,086,267
|
|
2016
|
($19,333,375
|
($5,401,428)
|
$13,931,947
|
|
2005-2016 Totals
|
($446,045,075)
|
($109,350,943)
|
$336,694,132
|
Source:
Excerpt of TECO’s Post-workshop comments (FPSC Document Number 03177-17)
Staff
notes, however, that TECO does not provide information on what the options
budget would have been for this period, or whether its impact was rolled into
the totals shown.
Summary
(Pros and Cons of Options 1 and 2)
To
facilitate the Commission’s consideration of the 3 options, staff presents a
summary of the most and least favorable aspects of these options.
Pros of Option 1 (Risk-responsive
approach)
1. Each
IOU would have the flexibility to establish Value at Risk metrics to suit their
risk profile.
2.
Strategies could be structured to achieve the dual
objectives of cost mitigation and hedge loss constraint.
3.
Setting action boundaries “pre-plans” what actions will
be taken when specific market conditions are encountered, and mitigates
regulatory review concerns.
4.
Monitoring risk tolerance levels and action boundaries engages
executive oversight of hedging programs (more so than only hedging to a
targeted volume).
5.
The simulations of two major price spikes and a
financial crisis between 2001 to 2011 indicate superior performance as to hedge
loss mitigation as compared to the targeted-volume approach.
6.
Risk-responsive strategies will significantly mitigate
hedge losses in falling-price markets compared to targeted-volume approach.
Cons of Option 1 (Risk-responsive
approach)
1.
By and large, this is a new approach for Florida’s
IOUs. Each IOU would have to configure (or procure) resources in order to
implement this option on the front end, and on an on-going basis. However,
staff notes that given the dollars at stake, any administrative cost advantage
of the OTM Call Option strategy is dwarfed by the potential economic advantages
of a superior approach.
2. The
set up time may be up to 2 years. One IOU (Gulf) estimated that its implementation
cost would be $250,000.
3.
Even though only a small portion of hedging under this
plan is discretionary, the IOU faces a degree of uncertainty in regulatory
reviews for this portion of hedging expenses. Although, as Mr. Gettings stated,
discretionary hedges are not required and might never be used. Discretionary
hedges are meant for seasoned managers to be able to take advantage of market
opportunities. The Commission can prohibit discretionary hedges, if it so
desires, in its annual review of the risk management plans.
4.
OPC and other parties do not believe financial hedging
is needed at all.
Pros of Option 2 (OTM
Call Options approach)
1. Each
IOU could implement this option without significant delay or expense.
Transitioning from placing swaps to call options would not require the
resources needed for implementing Option 1.
2.
Having call options in-place benefits customers in
rising markets, but only after price increases exceed premium investments. Call
options provide a hedge against rising prices, and are akin to having an
insurance policy to avoid large hedging losses because customers pay the market
price plus the premiums even if the call options are not exercised.
3.
In falling-price markets, customers will pay the market
price for natural gas, plus the cost of option premiums, thereby avoiding
significant hedge losses.
4.
Minor or no changes are necessary for reporting and/or
regulatory filings. Annual audits will be more straightforward than under
Option 1.
Cons of Option 2 (OTM
Call Options approach)
1.
Option premiums add a “cost” to hedging regardless of
which way the market moves. Although rising markets will mask, offset, or mitigate
this cost, stable or declining markets will expose this cost.
2.
Market activity (which is outside of the IOU’s control)
may drive up the price of call options. It is conceivable that in stressful market
conditions, call options would be unavailable at any price.
3.
A call option strategy is more limiting than a
risk-responsive strategy.
4.
The call option strategy is economically inferior to a
risk-responsive, monitor-and-respond strategy. Loss-risk and cost-risk outcomes
are superior under the risk-responsive approach in the most stressful market
scenarios.
5.
OPC and other parties do not believe financial hedging
is needed at all.
Option 3: Resume Status Quo Hedging
Practices (unrestricted or restricted)
In
presenting the Commission with the choice to resume the current (or legacy) targeted
volume hedging practices, staff is identifying two variations to this option.
For purposes of this analysis, staff will use the terms “unrestricted” and
“restricted” to generally describe whether the Commission decides to impose any
specific parameters on the IOUs.
Prior to
withdrawing their 2017 Risk Management Plans, staff notes that in April 2016,
the IOUs proposed modifications to restrict the time horizons for hedges as
well as to reduce the maximum hedge volumes for their in-place hedging
programs. Recall also that prior to the February 2017 workshop, the risk-responsive
approach (Option 1) was the principle alternative to the legacy targeted volume
hedging practices.
Staff
believes that if the legacy hedging programs are resumed, the Commission may entertain
making changes. As a result, the analysis discussing the resumption of status
quo practices without modifications will assume that the Commission will not specify
any time horizons for placing hedges, or place any limits on hedging volumes.
Similarly, the analysis discussing the resumption of status quo practices with
modifications presumes that the Commission reserves the right to specify
limitations on time horizons for placing hedges, or on hedging volumes for each
IOU.
Unrestricted
In the
Second Clarifying Order, the Commission refined the guidelines for hedging and
risk management plans.
Staff notes that the guidelines clarified the timing and content of the reports
that summarize hedging activities, but allowed the IOUs to exercise discretion
to create and implement flexible risk management plans. Staff believes this
flexibility is primarily the time horizons for hedges and hedge volumes that each
IOU specifies in the confidential portions of their risk management plans.
Without compromising any proprietary information from any party, staff can
attest that this flexibility was evident in current and prior risk management
plans from all four IOUs.
As noted in Issue 1, staff
believes fuel price hedging has benefits and risks. As an alternative in
addressing this issue, staff believes the Commission can consider the
resumption of status quo hedging practices without any modifications.
Restricted
Since the issuance of the 2015
Fuel Order, the Commission has reviewed a substantial amount of hedging-related
data and has evaluated the testimony and exhibits from subject matter experts.
From a historical perspective, staff notes that DEF, FPL, Gulf, and TECO have
all implemented targeted volume hedging programs that are tailored to
Company-specific requirements. Stated differently, because of size, scale, fuel
procurement needs, and other factors, hedging has not been implemented as a
“one-size-fits-all” component of procurement. Nevertheless, staff believes
modifications could be imposed in a manner that preserves the flexibility
intended in the Second Clarifying Order.
Staff believes imposing a time
horizon for placing hedges or placing limits on hedging volumes can be
approached from the perspective of stating maximum allowable limits. Staff
believes uncertainty rises as the maximum time horizons extend prospectively,
and the same is true for hedging volumes. Staff believes the Commission should
strike a balanced approach when considering modifications. Striking such a
balance allows the Commission to set maximum common limits for all IOUs, while
at the same time permitting an individual IOU to optimize its own hedging
program to address its specific needs. Staff believes the following are reasonable
modifications the Commission could implement in resuming targeted volume
hedging practices:
1. Adjust the time horizon for placing
hedges.
2. The maximum volume that IOUs may
hedge is 50 percent of their projected burn.
Conclusion
Consistent with the recommendation in Issue 1, staff believes that
continuing fuel price hedging activities in an economically efficient manner is
in the consumers’ best interest. The Commission has the discretion to consider
implementing changes to the manner in which electric utilities conduct their
natural gas financial hedging activities. Staff believes the Commission should not
be overly prescriptive regarding the IOU’s hedging strategies. However, staff
believes the IOUs should have reasonable plans for dealing with market
volatility and unexpected price shocks. Overall, the IOUs should strive to
balance the risk of price spikes with customers’ concerns about hedging losses.
The historical reliance upon a strict programmatic, targeted-volume hedging
strategy did not achieve such a balance.
Issue 3:
If changes are made to the conduct of natural gas
hedging activities, what regulatory implementation process is appropriate?
Recommendation:
Staff believes the Commission’s decision in Issue 2
will dictate what changes to the regulatory implementation process are needed,
if any. (Barrett, Cicchetti)
Staff Analysis:
Staff notes that Issues 1, 2, and 3 are all
inter-related. As noted in the Case Background, natural gas hedging activities
are described in annually-filed Risk Management Plans. These plans are filed on
a prospective basis to detail each IOU’s plan for hedging in the forward year.
Staff notes, however, that the 2017 Risk Management Plans were withdrawn, and
the crux of this issue is whether 2018 Risk Management Plans, if any, can be
reviewed, approved, and in-place to implement whatever decisions are made in Issues
1 and 2 of this recommendation. Pursuant to Order No. PSC-17-0053-PCO-EI,
the 2018 Risk Management Plans, if any, are due to be filed on July 27, 2017.
Staff believes that the discussion addressing regulatory
implementation processes should encompass regulatory review and reporting requirements.
During the January 2017 and February 2017 meetings, the IOUs expressed some
general concerns about reporting and regulatory reviews, and, specifically, how
any changes to the manner in which IOUs hedge would engage new and/or different
regulatory reviews and reporting protocols. Before discussing any possible
changes to regulatory implementation processes, staff will provide information
on regulatory review and reporting steps that are currently in place.
Current Regulatory
Reviews and Reporting
Regulatory
review and reporting are closely related topics. Staff uses the term
“reporting” to describe documents that the IOUs file with the Commission. As
noted in the Case Background, the Hedging Order, first issued in 2002 and later
clarified twice in separate orders in 2008, set forth certain reporting
arrangements that are still in-place.
For the 2016 and prior Risk Management Plans, staff has consistently followed a
4-step regulatory review process summarized below:
1.
After forward year Risk Management Plans are filed by
each of the IOUs in the Fuel Cost Recovery Clause (Fuel Clause) docket, staff
identifies a Company-specific issue for the approval of each plan.
2.
Through its approved Risk Management Plan, each IOU would
conduct the hedging activities set forth therein. From a reporting standpoint,
each IOU would capture the results of all hedging activities, and individually
file bi-annual reports reflecting the hedging results over a historic 12 month
period.
The Commission’s review of hedging covers a 12-month period that runs from
August 1 of the prior year to July 31 of the current year. Because of this
reporting sequence, Commission staff and auditors review Risk Management Plans
from the prior and current years.
3.
On an annual basis, Commission staff and auditors
review and analyze the hedging practices each IOU followed, as well as the
results detailed in the bi-annual reports. Commission staff auditors offer
testimony, with Company-specific audit reports attached as exhibits to their
testimony.
4. Staff
identifies a Company-specific issue to consider whether the IOU took prudent
actions in following its approved Risk Management Plan.
Staff believes the current review process summarized above
has worked well for the Commission’s purposes, and is adaptable to accommodate any
decision that the Commission makes on Issue 2. Commission staff and auditors
carefully review the hedging-related documents on a recurring, annual basis,
and those reviews become the foundation for recommendations that come before
the Commission on an annual basis during the Fuel Clause hearing.
Options
for the Commission to consider
Consistent
with the organization of Issue 2, staff believes this issue can be presented by
examining the options identified in that issue.
Option 1: Risk-Responsive
Hedging Approach
Under the risk-responsive model being considered, Mr.
Gettings recommends that IOUs collect weekly data on their respective hedging
activities, and compile the weekly data into quarterly reports that would be
filed with the Commission.
Mr. Gettings believes the IOUs should reset action boundaries on an annual
basis, and detail any and all changes in their Risk Management Plan filings. He
believes the regulatory review should focus on whether a Risk Management Plan
was followed, which is consistent with the staff’s current objectives in
reviewing hedging-related results.
During the January 2017 meetings and at the February 2017 workshop,
the main implementation concern the IOUs expressed about the risk-responsive hedging
approach was the cost and the complexity of building such a program from the
ground up. In the workshop, representatives stated that the ramp-up time would
be about 2 years, and that all such changes would appear in their Risk
Management Plans for 2020.
Option 2: OTM Call
Options Approach
As noted previously, the IOU
Proposal was not addressed in testimony or exhibits, and came to the forefront
very recently. Nonetheless, the IOUs contend that the OTM Call Options approach
could be implemented very quickly, acknowledging that some transition would be
necessary. The transition, however, would not impact any of the current swap
transactions that were entered into pursuant to older, previously approved Risk
Management Plans, as those transactions would be settled as new call options
are placed. Until all such (older) hedging arrangements have been exercised,
the reporting of hedging results would include both swaps and options. The
current schedule for reporting hedging results (with bi-annual filings, and
forward year Risk Management Plans filed in late July/early August) would work
for the OTM Call Options approach, according to the IOU Proposal.
The most significant step for
implementing the OTM Call Options approach would be setting up the
Company-specific transitional goals and budgets applicable for these programs,
while at the same time monitoring the swap transactions that are “rolling off.”
The IOU Proposal did not specify or recommend what goals or budgeted amounts
would be appropriate for this year, or any future period.
Option 3: Resume Status
Quo Hedging Practices (unrestricted or restricted)
If the Commission decides (in Issue 2) to resume status
quo hedging practices in a modified or unmodified manner, staff believes no
implementation process changes are necessary. Staff believes it is reasonable
for the IOUs (except FPL) to file 2018 Risk Management Plans as scheduled. Staff
believes the current schedule for reviewing the 2018 Risk Management Plans is
adequate.
Joint Analysis (of
Options 1 and 2)
In evaluating Option 1, staff believes the implementation
concern the IOUs raised about the ramp-up time of 2 years is overstated. Staff
believes a more realistic objective would be to treat 2018 as a transition
period, with an aspiration to fully implement a risk-responsive hedging
approach in time for the Risk Management Plans for 2019.
Staff believes the recommendation from Mr. Gettings to
require the filing of 13-week (quarterly) reports is reasonable, and would not
be costly, or burdensome for the IOUs to implement, if the Commission chooses
to adopt it. As described above, the IOUs currently file hedging results (for a
twelve month period) in two reports, and administratively, this recommended
modification would alter the reporting period to thirteen weeks, which would
introduce a requirement for the IOUs to file two new documents with the
Commission. Staff believes, however, that staff and interested parties would
benefit by having access to more current and more frequent data to evaluate.
Staff believes the recommendation from Mr. Gettings to
require the filing of 13-week (quarterly) reports is reasonable, and could be
implemented. Staff believes no other regulatory reporting changes are
necessary, or recommended. Staff believes the review functions currently
followed work well for the Commission’s purposes and can be modified to accommodate
a risk-responsive hedging approach.
Based on the assertions from the
IOUs in the February 2017 presentation made about Option 2, staff agrees with
the statement that the OTM Call Options approach could be implemented quickly.
Although not placing new swap transactions at this time due to the 2017
moratorium, staff believes the hedging staff organizations that each IOU has at
this time could transition to placing OTM Call Options, once program goals and
budgets were established.
If the Commission decides (in
Issue 2) that the OTM Call Options approach should be implemented, staff
believes it is reasonable for the IOUs (except FPL) to address implementation
matters in their 2018 Risk Management Plans. From a reporting perspective,
staff believes no changes are needed.
Analysis (of Option 3)
If the
Commission decides (in Issue 2) to resume status quo hedging practices in a
modified or unmodified manner, staff believes no implementation process changes
are necessary.
Conclusion
Staff believes the Commission’s decision in Issue 2 will
dictate what changes to the regulatory implementation process are needed, if
any.
Issue 4:
Should this docket be closed?
Recommendation:
If no protest is
filed by a person whose substantial interests are affected within 21 days of
the issuance of the Order, this docket should be closed upon the issuance of a
Consummating Order. (Brownless)
Staff Analysis:
If no protest is filed by a person whose substantial
interests are affected within 21 days of the issuance of the Order, this docket
should be closed upon the issuance of a Consummating Order.
