MAY 17, 2001 ENERGY MARKETS IN TURMOIL PRESENTED TO THE INSTITUTE FOR REGULATORY POLICY STUDIES

www.RiskMgmt.net

MAY 17, 2001

ENERGY MARKETS IN TURMOIL

PRESENTED TO THE

INSTITUTE FOR REGULATORY POLICYSTUDIES

Energy Markets In TurmoilPage 2

©Copyright Risk Management Inc.

May 17, 2001

1 – NATURAL GAS WINTER 2000/2001 REVIEW

2 – WHY USE RISK MANAGEMENT

3 – HEDGING OBJECTIVES FOR THE ENERGY INDUSTRY

OUTLINE



SECTION 1SECTION 1Natural Gas WinterNatural Gas Winter 2000/2001 Review 2000/2001 Review



1.550

2.0752.290

1.565

2.509

3.063

2.488

1.872

2.554

3.921

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

1991

/199

2

1992

/199

3

1993

/199

4

1994

/199

5

1995

/199

6

1996

/199

7

1997

/199

8

1998

/199

9

1999

/200

0

2000

/200

1

WINTER STRIP VALUES REVIEWWINTER STRIP VALUES REVIEW

WINTER STRIP VALUES

Winter strip values for the 3 summer months averaged 4.27, .27 cents higher than the previous NYMEX all time high monthly close of 3.998

1.550

2.0752.290

1.565

2.509

3.063

2.488

1.872

2.554

4.297

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

4.500

1991

/199

2

1992

/199

3

1993

/199

4

1994

/199

5

1995

/199

6

1996

/199

7

1997

/199

8

1998

/199

9

1999

/200

0

2000

/200

1

June 28, 2000 WINTER STRIP

4.297

1.550

2.0752.290

1.565

2.509

3.063

2.488

1.872

2.554

4.582

0.000

0.5001.000

1.500

2.0002.500

3.000

3.5004.000

4.500

5.000

1991

/199

2

1992

/199

3

1993

/199

4

1994

/199

5

1995

/199

6

1996

/199

7

1997

/199

8

1998

/199

9

1999

/200

0

2000

/200

1

August 31, 2000 WINTER STRIP

4.582

July 28, 2000 WINTER STRIP

3.921



GAS PRODUCTION REVIEWGAS PRODUCTION REVIEW

NATURAL GAS SUPPLY

Natural Gas wells figures reached record level highs as a direct result of skyrocketing prices

MONTHLY US NATURAL GAS WELLS vs NATURAL GAS 12-MONTH STRIPMONTHLY US NATURAL GAS WELLS vs NATURAL GAS 12-MONTH STRIP

0

200

400

600

800

1000

1200

1400

1600

1.00

1.25

1.50

1.75

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

Natural Gas Wells Natural Gas Prices



GAS STORAGE REVIEWGAS STORAGE REVIEW

NATURAL GAS STORAGE

Natural gas storage, while well behind the previous three injection years, was still above mid-1990 injection rates.

-

500

1,000

1,500

2,000

2,500

3,000

3,500

10

/27

11

/27

12

/27

1/2

7

2/2

7

3/2

7

4/2

7

5/2

7

6/2

7

7/2

7

8/2

7

9/2

7

99-0098-9997-9896-9795-9694-95



WEATHER REVIEWWEATHER REVIEW

NATURAL GAS DEMAND

In July of 2000, the National Weather Forecast was calling for an above normal winter, indicating demand should remain manageable.



SECTION 2SECTION 2Why Use Why Use

Risk ManagementRisk Management



RISK MANAGEMENTRISK MANAGEMENT

Identifying, controlling, and minimizing exposure to adverse energy commodity price movement through utilization of financial instruments.

WHAT IS RISK MANAGEMENT?

December 2000 1-Month Range $4.00

1996 – 2000 4-Year Range $2.00



PRICING ALTERNATIVESPRICING ALTERNATIVES

If we could guarantee price below index ANDAND guarantee a reasonable cap, guess where we’d be now...



FIX PRICE ORFIX PRICE OR FLOAT INDEX ?FLOAT INDEX ?INDEX PRICING

The buyer or seller will fix the price at a monthly/daily index based on a posted cash price or Nymex price

Currently the commonly used pricing mechanism for many regulated energy providers

A viable pricing tool for energy purchases when prices are at extremely high levels or energy sales when prices are at extremely low levels

Rationale behind index pricing is to avoid fixed pricing that results in a loss

INDEX / ARBITRAGE STRATEGY

INDEX

AR

BIT

RA

GE



FIXFIX PRICE OR FLOAT INDEX ?PRICE OR FLOAT INDEX ?FIXED PRICING

A company will fix prices for multiple months or seasons up to several years.

Short-term fixed-price contracts are attractive when a company wants to lock in prices during volatile price periods such as winter or shoulder months.

The price of the contract may be structured so the cost is the same each year so there is a base price with a yearly escalator.

A long-term fixed price contract is attractive when prices are at extreme low levels that are not expected to hold for a long period of time. FIXED PRICING / RATE FREEZE

FIXED PRICE



FIX PRICE OR FLOAT INDEX ?FIX PRICE OR FLOAT INDEX ?OPTIONS – CAPS/COLLARS/FLOORS

A cap gives a buyer the option of purchasing energy at a predetermined strike level without the obligation of buying at that level. For this protection, the buyer pays a premium similar to an insurance payment.

A collar gives the buyer an obligation and an option at the outer range of two prices. If market prices rise above the high price strike, the buyer is protected at that price. If prices falls through the low price, the buyer accepts the lower price. The high and low price are sometimes referred to as a cap and floor. If prices fall between the high and low price so that neither party exercises its options, the buyer purchases energy at the market price.

CAPS / COLLARS

CAP

FLOOR

COLLAR



GOALS PRICING STRATEGY

Market Sensitive Price Index Pricing

Guaranteed Price Fixed Pricing

Price Stability Cap Pricing

MARKET SENSITIVE PRICE + PRICE STABILITY

REQUIRES

INDEX PRICING, FIXED PRICING, CAPS & COLLARS

NATURAL GAS HEDGING OBJECTIVESNATURAL GAS HEDGING OBJECTIVES



SECTION 3SECTION 3Hedging Objectives For TheHedging Objectives For The

Energy IndustryEnergy Industry



RISK MANAGEMENT PROGRAM OBJECTIVESRISK MANAGEMENT PROGRAM OBJECTIVES

Utilize Market Tools to take Advantage of Market Opportunities Develop a Pricing Plan and Think Ahead

How These Objectives Can Be Achieved:How These Objectives Can Be Achieved:

Natural Gas Buy

BUY Under Budget

BUY to Protect Against a Major Price Increase

BUY Lower than the Competition

BUY as Low as Possible

PRICE PRICE STABILITYSTABILITY

COSTCOSTCONTROLCONTROL



Long-term Price StabilityCompany has price risk versus

annual profit margins

Moderate

RISK SCALERISK SCALE

Short-term Market SensitivityCompany has price risk versus monthly index &/or daily prices

RISK APPETITE FOR ENERGY BUYERS RISK APPETITE FOR ENERGY BUYERS Companies are not homogeneous when it comes to risk tolerances

and risk profiles. Many utilities still need to be tied to month-to-month prices, while

other corporations or municipalities want and need the security of stable pricing, regardless of current values.

The overall company risk strategy will influence how aggressive the

organization will be when it comes time to set budget objectives for raw commodity prices.

REGULATED VERSUS INDUSTRIAL



RISK APPETITE FOR ENERGY BUYERSRISK APPETITE FOR ENERGY BUYERS

$10.00$10.00

$3.75$3.75

$2.00$2.00

4 yr. Median4 yr. Median ValueValue

GREEDGREED

FEARFEAR



OPTION VOLATILITY ANALYSISOPTION VOLATILITY ANALYSIS Historical Volatility measures the market's past volatility.

It is defined as the standard deviation of a series of price changes measured at regular intervals.

It can be used in conjunction with Implied Volatility to gauge how the market's current expectations differ from history

. Annual historic volatility is turning down for the first time since early

last year



KEYS TO SUCCESSFUL HEDGINGKEYS TO SUCCESSFUL HEDGING

Recognize the Importance of the Hedging Program to the Bottom Line

Define Specific Program Objectives

Develop a Hedging Strategy

Maintain Structure and Discipline

Formulate a Continuing Education Program

Practice Proper Interpretation of Hedge Results

Documents

MAY 17, 2001 ENERGY MARKETS IN TURMOIL PRESENTED TO THE INSTITUTE FOR REGULATORY POLICY STUDIES