Department Policy on Hedging

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Department Policy on Hedging

• Paul G. Afonso, Chairman
• Massachusetts Department of Telecommunications
  Energy
• March 31, 2004

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Hedging _________________________________________
_________________________________________________

• On October 9, 2002, the Department issued an
  Order regarding the implementation of a
  risk-management protocol for Massachusetts local
  distribution companies (LDCs) (Docket No.
  D.T.E. 01-100-A). The Order states that the
  D.T.E. will allow, but not require, Massachusetts
  LDCs to use financial risk-management instruments
  to mitigate natural gas price volatility.

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Hedging (cont.) _________________________________
__________________________________________________
__________________________________________________
_________________

• LDC hedging proposals shall maintain the
  objective of volatility mitigation and price
  stability rather than the objective of procuring
  prices below indices.
• Hedging programs submitted for Department
  approval shall demonstrate the effect that the
  plan would have on the reliability and
  transparency of commodity price. In addition,
  such programs shall ensure fair competition in
  the gas supply market.

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Hedging (cont.) _________________________________
__________________________________________________
__________________________________________________
__

• Customer participation in LDC hedging programs
  shall be voluntary, and not mandatory.
• LDCs shall allocate all costs associated with
  their hedging programs to program participants
  only.

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Hedging (cont.) _________________________________
__________________________________________________
___________

• The use of incentive mechanisms in conjunction
  with LDCs financial risk-management programs
  shall not be allowed because the use of incentive
  mechanisms in conjunction with LDCs hedging
  programs

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Hedging (cont.) _________________________________
__________________________________________________
_________________________________________________

• (1) would not be consistent with the
  Departments goal of promoting market-based
  regulation and enhanced competition in
  that it would not serve as a vehicle to a more
  competitive environment?
• (2) could negatively affect the development
  of retail competition and customer choice in
  Massachusetts?

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Hedging (cont.) _________________________________
__________________________________________________
_________________________________________________

• Approval of LDC risk-management proposals will
  be on a case-specific basis to ensure that any
  hedging proposal does not negatively affect gas
  unbundling and customer choice in Massachusetts.

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Bay State Gas Companys Gas Cost Incentive
Mechanism

• The Department approved a gas cost incentive
  mechanism (GCIM) for Bay State Gas Company
  (Bay State) in an Order issued on December 5,
  2002 (Docket No. D. T. E. 01-81).
• The GCIM will allow Bay State to utilize various
  financial instruments and trading strategies to
  lower the overall commodity cost associated with
  procuring natural gas for its residential
  customers for an initial three-year period.

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Bay State Gas Companys Gas Cost Incentive
Mechanism (cont.)

• The Department notes that Bay States GCIM
  proposal represents the use of innovative
  portfolio management strategies to achieve lower
  gas supply costs for customers than is likely to
  occur under the currently used cost-based CGAC
  mechanism.
• The implementation of the GCIM shall be limited
  to residential customers only so as to minimize
  any negative effect that it might have on the
  development of a fully competitive retail market
  in Massachusetts.

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Bay State Gas Companys Gas Cost Incentive
Mechanism (cont.)

• Bay State shall not hedge more than 25 percent of
  its residential portfolio.
• There shall be a 25 percent to 75 percent
  (25/75") margin sharing between ratepayers
  shareholders if Bay State makes any gains from
  the GCIM. In case of a loss, Bay State shall
  absorb 100 percent of the loss without passing
  any of the losses to ratepayers.

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Bay State Gas Companys Gas Cost Incentive
Mechanism (cont.)

• Bay State shall limit the financial instruments
  that it uses in its hedging program to futures
  and options products, and not over-the-counter
  (OTC) products.
• To recover any administrative costs associated
  with the GCIM program, Bay State shall submit a
  proposal in its next base rate filing to that
  effect, and demonstrate that customer savings
  from the GCIM exceed the level of administrative
  costs to be recovered.

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NOTE BAY STATE DID NOT GO FORWARD WITH THE
DEPARTMENT-APPROVED GCIM, STATING THAT THE
VOLUMES (RESIDENTIAL ONLY) WERE NOT LARGE ENOUGH
TO BRING ABOUT ANY SIGNIFICANT MARGINS
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KeySpan Energy Deliverys Proposed Gas
Procurement Practices

• The Department approved KeySpan Energy Deliverys
  (KeySpan) proposal to change its gas
  procurement practices to mitigate price
  volatility for its customers in an Order issued
  on November 13, 2003 (Docket No. D. T. E. 03-85).
  
• For the winter of 2004-2005, the Company shall
  lock-in the price (equally over the twelve-month
  period) for all of its domestic non-storage gas
  supplies, equaling one-third of its projected
  normal winter requirements.

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KeySpan Energy Deliverys Proposed Gas
Procurement Practices (cont.)

• KeySpan was authorized to use the NYMEX futures
  market but not financial derivatives.