It hasn't been a good year for energy. California utilities struggled publicly all summer to avoid blackouts, and customers of San Diego Gas & Electric Co. saw their electric bills more than double, prompting $2.6 million in federal aid and an investigation by the Federal Energy Regulatory Commission. And the news promises to get worse.
The East Coast is expected to get a shock this winter, but not from electricity. Gas companies are warning of natural gas price increases ranging from 15 percent to 40 percent, say American Gas Association officials, and the Clinton Administration has been scrambling to boost low heating-oil supplies in the region. "Stocks are one-third of what they were last year at this time," says analyst Randall Nottingham of Boston-based Yankee Group. "Heating oil will be in very short supply, and if we get even an average winter, you will see price spikes and shortages."
Companies facing such spikes can lock in prices now with fixed contracts. But that's no defense against physical shortages caused by Mother Nature. Space heating and cooling accounts for up to one-third of an office building's energy costs, and a bitter cold snap or a heat wave can wreak havoc with an energy budget.
"We protect ourselves against warmer than normal winters by buying weather derivatives," notes Paul Forrest, CFO of Heating Oil Partners LP, in Darien, Conn., which distributes heating oil throughout the Northeast. "CFOs who want protection against colder than normal winters can go into the same market." As for the cost of heating oil this winter, says Forrest, "Companies can also fix their oil price with a cap and buy a put against it that compensates them if the price goes lower," he says.
Most companies will sign contracts that leave such exotic hedges to their utility or energy service provider, says Yankee Group senior analyst Richard Baxter. But the deregulated energy market is forcing its way onto the finance radar screen. "The average facility manager does not have the sophistication to handle forwards, puts, and weather derivatives," notes Forrest. "You need heavy financial analysis."