How to measure hedging effectiveness and regulatory policy.
Stephen Maloney is with Towers Perrin’s Financial Risk team, where he is responsible for regulatory policy, compliance, and dispute resolution engagements involving commodity markets. He can be reached at steve.maloney@towersperrin.com
Hedging programs promise protection against energy-market price spikes, and they can be important to the regulatory goal of sustainable, lowest long-term service cost. But how much price protection is enough in natural-gas markets? When is too much protection, well, too much? What is the most efficient utilization of risk capital when hedging energy supplies?
Questions of efficiency immediately beg questions of measurement and process control. Many CFOs will say utilities really need better guidance designing and adjusting their energy portfolios (both electric and natural gas). What metrics best characterize the dual goals of lowest service cost and optimal hedging performance? How much accuracy, sensitivity and metric reliability should be expected?
These questions are not rhetorical. The internal control structure and procedures established under Sarbanes-Oxley have improved financial report quality. These structures and procedures do not easily accommodate spreadsheet or ad hoc applications that often are used to structure hedges. CFOs need to have confidence that processes perform to a specified standard, are auditable, and produce reliable results.