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MANAGING NATURAL GAS PRICE VOLATILITY
May 2008
141 W Jackson Blvd • Suite 1521 • Chicago, IL 60604 • 312.373.8250 • [email protected]
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TABLE OF CONTENTS
Section 1 – Macro Economic Influences on
Commodity Pricing
Section 2 – Hedge Plan Structures for Managing
Natural Gas Volatility
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SECTION 1MACRO ECONOMIC
INFLUENCES
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Commercial Trading Houses
Resource Abundance
Weather Variability
Environmental Concern
Strong Dollar
U.S. Led Demand Growth
Resource Scarcity
ROW Led Demand Growth
Weather Extremes
Environmental Crisis
Weak Dollar
Speculators & Investors
MACRO-MARKET PRICE INFLUENCES
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„ROW‟-LED DEMAND GROWTH
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February
blizzard in
China
BP’s Thunderhorse
platform listing in Gulf of
Mexico after Hurricane
Katrina
Flooded Yallourn coal
mine in Australia
WEATHER EXTREMES
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US Dollar and Crude Oil Price Relationship
0
20
40
60
80
100
120
140
Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07
Ind
ex P
oin
ts
0
20
40
60
80
100
120
$/b
arr
el
ICE Prompt-Month US Dollar Index Futures NYMEX Prompt -Month Light, Sweet Crude Oil Futures
WEAK DOLLAR
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Reuters/Jefferies-CRB® Index (1967=100)(monthly close) January 1992 - December 1999
100
150
200
250
300
350
1992 1993 1994 1995 1996 1997 1998 1999 © Reuters
Reuters/Jefferies-CRB® Index (1967=100)(monthly close) January 1992 - February 2008
100
150
200
250
300
350
400
450
1992 1994 1996 1998 2000 2002 2004 2006 2008 © Reuters
Spot Price Change Of Selected Commodities(monthly close) January 1992 - December 1999
-50% -25% 0% 25% 50% 75% 100%
C rude Oil
N atural Gas
C o rn
So ybean M eal
So ybean Oil
Wheat
C o co a
C o ffee
Sugar
Spot Price Change Of Selected Commodities(monthly close) January 2000 - February 2008
0% 50% 100% 150% 200% 250% 300% 350%
C rude Oil
N atural Gas
C o rn
So ybean M eal
So ybean Oil
Wheat
C o co a
C o ffee
Sugar
COMMODITY PRICE TRENDS – WHAT CHANGED?
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Purely Coincidence?Citigroup Inc. Global Commodity
Investment Analysis (US$ billion)
End 2007
Investment
Total
Q1 2008
Investment
Increase
Investment
Total
(3/31/08)
Indexes 145 40 185
CTA’s 80 14 94
Hedge
Funds60 15 75
ETF’s 35 11 46
Total 320 80 400
SPECULATORS & INVESTORS – BY THE NUMBERS
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Page 10
SECTION 2
HEDGE PLAN
STRUCTURES
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GETTING TO THE REAL ISSUES
The Energy Hedger’s Dilemma: How Did I Do?
Why Didn’t You Buy More?
October 2005 Natural Gas Prices
Hurricanes Katrina & Rita Hit in Fall 2005
Why Did You Buy So Much?
October 2006 Natural Gas Prices
No Hurricanes Hit in 2006
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$4.00
$8.00
$12.0
0$1
6.00
Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08
Home
Insurance
Natural Gas
Hedge
Program
Insurance
HEDGE PROTECTION SINCE KATRINA & RITA
Co
st
Be
ne
fit
Co
st
Be
ne
fit
Summer 2005Hot WeatherHurricanes Hit
Overall
prices
Increased
Reduced
gas costs
Homes
destroyed
Reduced
rebuilding
costs
Natural Gas Prices
Winters and Summers to Date
Below Normal Hurricane Activity
Cooler Summers –Normal Winters
Security of protection given unforeseen events
Rebuilding costs not an issue
Security of protection given unforeseen events
LOWER PRICES for the utility
“Hedge” Premium associated with plan protection
“Insurance” Premium associated with plan protection
2008 & Beyond
Plan
protection
provides
security
given
unforeseen
and
catastrophic
events.
Jan – 05 Apr – 05 Oct – 05 Apr – 06 Oct – 06 Apr – 07 Oct – 07 Jan – 08
$4.0
0
$8.0
0
$
12
.00
$
16
.00
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HEDGE PROTECTION/INSURANCE 2008 & BEYOND
• 2008 has proven that just because your house had
not burned recently there was no guaranty that a
fire would not have ensued at some point in the
future
• Having a hedge program is analogous to securing a
home insurance policy
• It is prudent to maintain home insurance just as it
is prudent to maintain a hedge program
The pending direction of natural gas prices is even far less certain.
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PRICING OBJECTIVES
OBJECTIVES
√ Establish Price Stability
√ Buy at Historic Low Value
√ Protect Against Major Price Increases
√ Reduce costs in future years
Quantify your hedge strategy
Maintain structure and discipline in your hedge program
Think long term in a market with a short-term focus
WHAT TO DO?The best advice to offer is ...
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HEDGING METHODOLOGY
Quantitative variables to consider to achieve a rational
purchase price…
Risk Analysis – DEFINE RISK
Historic Prices – DEFINE VALUE
Price Targets Beyond Current Year – THINK LONG TERM
Time Targets – PRICE STABILITY
The Application of Multiple Tools – UTILIZE OPTIONS
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$6.00
$7.00
$8.00
$9.00
$10.00
$11.00
$12.00
$13.00
$14.00
$15.00
$16.00
$17.00
Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08
DEFINE & QUANTIFY RISK
On a daily basis, the price risk and opportunity of an energy or
commodity portfolio can be measured using metrics like VaR and the RMI price matrix
• RAR quantifies the price risk by month during a
calendar year
• The proximity of the forward curve to historical value can judged
versus upside price risk
50th Decile: $7.94 - $766 (4 Year Median Value $7.94)
UNHEDGED RISK AT 95% CI
RISK WITH HEDGES IN PLACE
ELIMINATED RISK
40th Decile - $7.66 - $7.40
30th Decile - $7.40 - $7.14
FORWARD PRICE CURVE
Risk Assessment ReportKnow-Risk™
Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Oct 08 Nov 08 Dec 08 Jan 08
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ANNUALMean 8.27
Median 7.94
90% - MAX 10.24 - 15.81
80% - 90% 8.84 - 10.24
70% - 80% 8.38 - 8.84
60% - 70% 8.15 - 8.38
50% - 60% 7.94 - 8.15
40% - 50% 7.66 - 7.94
30% - 40% 7.40 - 7.66
20% - 30% 7.14 - 7.40
10% - 20% 6.62 - 7.14MIN - 10% 4.92 - 6.62
NATURAL GAS - NYMEX
VALUE MANAGEMENT
Define what makes a price expensive or cheap, and develop a strategy to
create a competitive advantage
• Identify prices that represent historical ‘value’ and compare them to the current market
• Prices in the ‘value area’ have inherently lower opportunity risk, and greater strategic value
• Aggressively contract the commodity at pre-determined ‘value’ levels
Value
AreaMedian Value = $7.94
Compiles 4 years of data
Weighted heavily to most recent year’s data
Adjusted for inflation using the PPI
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DEVELOP STRATEGY
Meets company hedge
objectives
Acknowledges
quantified market
risks and volatility
Considers market
opportunities beyond
current year
Contains objective
execution parameters
A Successful Price
Target Strategy:
Value Target
Define ‘good’ long-term
value, and match value
with purchasing
aggressiveness
Time Target
Mitigate risk by ensuring
certain levels of
minimum coverage prior
to a season or planning
period
Pricing Tools
Utilize judgment in the
use of options in
conjunction with fixed
pricing and index gas.
Example:
Dollar Cost Averaging
Example:
Buy Caps, Collars, etc.
Example:
Below Historical Median
QUANTIFY EXECUTION
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Natural Gas Winter Strip 2008 - 2009
$5.50
$6.50
$7.50
$8.50
$9.50
$10.50
$11.50
$12.50
$13.50
Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08
Winter Strip 2008 - 2009
GENERIC WINTER 2008-2009 HEDGE PLAN
$9.884
20%
Total
Purchased
as of
4/23/2008
ASSUMPTIONS:
1. Time Triggers, Value
Triggers and Volumes
Hedged will vary depending on
customer’s risk
tolerance
2. The use of options can
further diversify this
pricing portfolio
Quantity
Price
2 Quarters
Value $8.18 and Below
1 Quarter3 Quarters
VALUE TRIGGERS
Trigger 1 50th Decile
Trigger 2 40th Decile
Trigger 3 30th Decile
Trigger 4 20th Decile
Trigger 5
10th Decile
15% 30%* 45%* 60%* 75%*
$8.18 $7.98 $7.69 $7.43 $7.25
TIME TRIGGERS
Trigger
Dec07
Trigger
Mar08
Trigger
Jun08
Trigger
Sep08
10% 20%* 30%* 40%*
$8.80 $10.97
4 Quarters
* Cumulative Totals
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Natural Gas Winter Strips 2009 - 2011
$6.50
$7.50
$8.50
$9.50
$10.50
$11.50
Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08
NOV/2009 - MAR/2010 NOV/2010 - MAR/2011
GENERIC WINTER 2010-2011 STRIP HEDGE PLANS
ASSUMPTIONS:
1. Time Triggers, Value
Triggers and Volumes
Hedged will vary
depending on customer’s risk
tolerance
2. The use of options can
further diversify this
pricing portfolio
Value Tier 50th $8.18
Value Tier 40th $7.98
Value Tier 30th $7.69
Value Tier 20th $7.43
Value Tier 10th $7.25
VALUE TRIGGERS 2010 2011
50th Decile
40th Decile 10%
30th Decile 10% 10%
20th Decile 10% 10%
10th Decile 10% 10%
TOTAL 40% 30%
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NEW “RULES” OF HEDGING
1. Better Define and Refine Your Objectives
2. Acknowledge and Adjust to Extraordinary Variables, e.g.
Economical and Political Events
3. Utilize a More Mechanical and Quantifiable Approach
4. Compartmentalize Your Use of Discretion
5. Think Beyond the Current Year
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