Fuel hedging and electricity costs

The Fair Trading Commission has denied an application from Barbados Light & Power Company Limited (BL&P) for permission to apply “the administrative losses and gains and costs of a fuel hedging programme to the calculation of the Fuel Clause Adjustment” (FCA).

The reasoning was that “due to the risks associated with fuel hedging, the BL&P should not be allowed to pass the cost of hedging and associated gains or losses onto the consumers of Barbados.” The cost was an estimated $600,000 and the hedge administrator was Emera Energy Services, the Canadian parent company of BL&P.

Hedging is essentially the attempt to reduce or transfer risk. In the case of the BL& P, by using the ordinary law of contract. In the fuel hedging game, three methods are generally used, futures contracts, fuel swaps and options. We now attempt to reduce these concepts into a single article and I cannot promise to use strictly layman’s terms.

A futures contract is simply an ordinary contract for the sale and purchase of some commodity. The quantity and selling/purchase price are determined at the date on which the contract is entered. The delivery and actual payment, however, takes place at some future date. These contracts are negotiated on a futures exchange, such as Chicago Mercantile Exchange / New York Mercantile Exchange (CME/NYMEX) or the Intercontinental Exchange (ICE), all privately owned companies, which act as the middle man in such transactions.

These contracts can be bought or sold prior to the date on which delivery is supposed to take place and the price of the commodity at that time, relative to the contract price, determines whether a profit or a loss is made as a result of the hedging. If BL&P wants to hedge against rising fuel prices, then they can buy a futures contract. If someone wants to protect against falling fuel prices, then they would sell a futures contract.

A swap is an agreement whereby one party exchanges their exposure to a floating price for a fixed fuel price, over a specified period of time. The buyer and the seller are swapping their cash flow issues essentially. Swaps are used to crystallise fuel costs for both the buyer and seller. If BL&P purchases a swap and the cost of fuel goes up, then what they gain on the swap will offset the increase in their actual fuel expense. If the cost goes down, then the loss will offset the decrease in their actual fuel expense.

An option is a contract which“provides the buyer of the contract the right, but not the obligation, to purchase or sell a particular amount of specific commodity (or the financial equivalent thereof) on or before a specific date or period of time.” The two main types are call options and put options. The former allows for hedging against rising prices and the latter against falling prices. It is thought that options allow a hedge when prices are higher and resort to market prices when prices are lower.

Since the Fuel Clause Adjustment (the bane of every bill-payer’s existence) means that we, as consumers of electricity, reimburse BL&P for all the fuel they use in the production of electricity, they really don’t have to be concerned with whether prices are high or low which means that only two of the four main reasons for engaging in hedging would apply to them.

Here they are: (1) reducing exposure to volatile prices; (2) mitigating cash flow problems; (3) hedging against short term price increases; and (4) locking in profit margins. Can you guess which one(s) apply? What they wanted was for the rest of us to pay them not only for the fuel but their administrative costs as well.

One of the great mistakes of this latest gambit to have the public pay for the cost of their speculation, is the attempt to use themselves as the administrator. Emera owns BL&P. BL&P is therefore Emera in the same way that your liver is a part of your body.

The Fair Trading Commission pointed out that they had failed to “provide a clear governance structure that enabled the Commission to determine that there would be sufficient transparency and accountability.” I venture to say that even with a clear governance structure, such an arrangement would be like trying not to read your own mind or your brain not knowing what your right hand is doing.

(Alicia Archer is an attorney-at-law in private practice)

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