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OPC alleges Empire lost $100 million due to risky practices

JEFFERSON CITY, Mo. – Empire Electric Company could be facing some significant allegations as the Missouri Public Service Commission continues delving into a prudence review of the company’s fuel adjustment clause.

“The reason we’re here today was regarding Empire’s fuel adjustment clause and to show how Empire’s imprudent actions cause ratepayers’ harm,” Mark Poston of the Office of Public Counsel said in his opening statement.

But from there, OPC began to paint a rather negative picture of Empire, one of a company recklessly gambling with fuel prices.

At issue is the natural gas purchases made to fuel Empire’s generators, or more specifically, around Empire’s 2001 risk management policy and the natural gas hedging portion.

“A hedge is essentially a bet. The company is betting that the price it locks in today years in advance will be at or below the future price that the company would otherwise pay if it didn’t lock in the price earlier,” Poston said. “It’s a gamble using ratepayer money.”

They do this through two types of contracts: Forward or fiscal contracts are entered with suppliers where they lock in a price, amount, and a delivery date. Future contracts are traded on NYMEX just like other commodities and they, too, lock in price, amount, and a date in the future.

OPC contends that the policy is extremely inflexible as it mandates predetermined volumes of gas be hedged well in advance, regardless of what the market is doing. In fact, OPC says that in 2012, Empire was encouraged to re-examine their policy and look to add flexibility, but chose to ignore it.

As of 2003, Empire’s hedging policy required that they begin hedging four years ahead by hedging 10 percent of the gas need four years later. That means that in the second year, they’ve hedged 20 percent of their need. In year 3, that number rises to 40 percent, and finally, one year before delivery, they would have hedged 60 percent of their need. 

Poston noted that beginning hedging four years out is earlier than any other Missouri electric company hedges for gas.

“Hedging gas and betting you’ll beat the market may be reasonable during a period where the market is rising or even during a period of market volatility, but when prices are declining or when prices are no longer volatile, hedging is no longer reasonable,” he added.

So what does that mean in terms of cost?

“By the beginning of 2011, they had already racked up $37 million in losses in just two years since the market changed, but did they change their policy? No. They continued marching ahead, 10 percent, 20 percent, 40 percent, 60 percent, and they added another 9 million losses in 2011,” Poston said. “They want to continue a policy that recognizes — that requires minimum hedges without the flexibility to recognize changes in the market. A policy that has racked up 95 million in total company losses since 2008.”

OPC’s allegations claim that, in less than a decade, Empire racked up just under $100 million. In the prudence review period, OPC says that Empire incurred 16 million in total company hedging losses, 13 million of which were passed onto their Missouri customers. They said that 38 cents of every dollar that Missouri customers pay for natural gas were due to hedging losses.

Furthermore, OPC says that the company continued accepting hedging losses each month, saying the evidence presented shows Empire entering into hedging contracts at the very next month they recorded as a loss. 

“If this were a competitive company that couldn’t pass its losses onto a captive customer base, I would expect those making these decisions to be fired, but Empire has little to no skin in the game. So, they have no incentive to change their policy,” Poston said.

And the “captive consumer base”, as Poston called it, consists of more than 125,000 residential customers, more than 300,000 people in the southwest portion of Missouri as well as northwestern parts of the state. And when trying to determine prudence, OPC argues they must consider how many people are living at the poverty level in the areas.

Empire’s representation at the hearing acknowledged the harsh poverty situation in their service territory but said that cannot be the basis of a decision on prudence.

“You must look at what Empire did under the circumstances,” Diana Carter, appearing on behalf of Empire, said. “In order for Empire to continue providing service, we can’t order disallowances and change prices based solely on the income of customers.”

Carter also reminded everyone that OPC’s opening statement is not evidence. She also noted that in five previous prudence reviews, OPC took no issue with the hedging plan, but in the sixth and current review, they now have an issue with the plan.

“The hedging policy that OPC is now attacking in this sixth prudence review is the same hedging policy that was in place when the FAC was authorized was in place in all five of the rate cases where the FAC was continued, all with the Commission determination that hedging losses were to be passed through the FAC, and it’s also the same policy that was in place in the five prior FAC prudence reviews, all where no imprudence was found,” Carter said. “It seems disingenuous for OPC to now say hedging is a risk or a gamble or automatically imprudent because of this policy that has been before the Commission and has been reviewed by OPC for all these years, all with agreement and Commission approval that hedging losses would flow through the FAC.”

She also stated that in the past, both the PSC and OPC have referred to hedging as being more like insurance than gambling.

“We hedged to ensure against risk,” she said. “While a dollar to dollar comparison may result in the recording of a loss or gain for financial hedges, Empire’s customers still benefit from Empire’s risk management policy which effectively manages risk and provides price stability.”

“The Commission faced a somewhat similar situation approximately five years ago. It was a GMO prudence review where staff alleged that GMO’s hedging policy was inflexible and asked for approximately 15 million to be refunded to customers,” Carter pointed out. “The Commission found in favor of GMO and did not order any disallowances, finding that you cannot determine the success or failure of a hedging program by looking only at the futures market transaction and that hedging losses cannot be known until after the fact or in hindsight.”

Interestingly enough, the PSC staff did not identify any evidence of imprudence on the part of Empire during the review period. Staff’s counsel, however, stated that their job was to ensure that the company is following the policy in its FAC tariff correctly, not whether the practice of hedging is prudent.

The next step in the process will be for the PSC to rule on the complaint.