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No Regrets When Hedges Don’t Pay Off

electric company worker in bucket truck inspecting power lines
A Florida Power & Light employee at work. Photo by Elvert Barnes.

I live in a modern home equipped with a sprinkler system, so I get a pretty good price on fire insurance. I duly pay my premiums year after year, even though I have never had a fire.

Am I wasting my money?

I don’t think so. I can afford the insurance premiums and the whole point of insurance is to protect against painful or catastrophic losses in case the worst happens.

So it is with financial hedges. When farmers buy hedges for their crops or airlines buy hedges against the cost of fuel, they actually hope to be out of pocket. No one wants to have to collect. That means those buying hedges do not find it wasteful when they can get cost-effective hedges against some of the vagaries of business and life, even if the worst never comes to pass.

Unfortunately, not all consumers - or, more accurately, groups claiming to speak for consumers - are so rational and well-informed. With fuel prices falling recently, utility companies that bought hedges for fuel costs have, in some cases, locked in higher than market prices. Since these costs are passed on to customers, some customers have complained that they are not seeing the benefits of the global oil glut that pushed prices to 7-year lows this month, affecting a variety of fuel types. These same consumers, naturally, do not complain when hedges spare them abrupt and sharp increases in the costs of heating their homes or running their electric devices.

Customer groups in Florida, for instance, recently pushed legislators to stop electric utilities from hedging the price of natural gas. Jon Moyle, a representative for Florida Industrial Power Users Group, told commissioners that clients would rather “pay at the pump” - that is, bear the potential costs of fuel price volatility. Of course, that is a much easier claim to make now, when prices are low, than when customers would actually have to pay for a dramatic increase in the cost of power.

Fortunately, most regulators have better sense. The Florida Public Service Commission unanimously voted to continue allowing electric utilities to hedge natural gas. Lisa Edgar, a commissioner, said that hedging “is a tool that in many years [has] proven to benefit the customers as it was intended to do.” The time to evaluate whether hedges help customers is not when prices are remarkably low, but when they inevitably swing upward.

Without hedges, utility companies face a market in which demand is subject to the whims of the weather, as The Wall Street Journal recently reported, and would struggle to keep prices predictable enough to prevent sticker shock when a bill arrives. The increased reliance on natural gas for power means that gas prices, especially, could make bills fluctuate wildly if there were no built-in check on volatility.

In a debate about hedging strategies for Georgia Power, the utility’s comptroller told commissioners that a $1 increase in the price of natural gas would have cost Georgia Power customers about $100 million in 2007 but $300 million today based on increased use.

Luckily, regulators know there is value to be had in predictability and safety. They also know that right now is a nearly ideal time to lock in fuel costs, even if prices slide further below current levels. After all, at today’s prices, fuel costs are hardly a burden on customers or businesses accustomed to paying rates we saw as recently as 2014.

Prudent homeowners do not look around their unburnt houses and think, “All that insurance is going to waste.” They should neither want nor expect their utility companies think that way.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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