North Carolina sets cost recovery for local distribution companies

The North Carolina Utilities Commission has concluded that hedging to temper commodity cost volatility is an option that must be considered by natural gas local distribution companies (LDCs) when planning future gas purchasing activities. It ruled that an LDC's decision to make no effort to mitigate price-spikes, including a decision not to hedge, would be subject to review in each of the LDC's annual gas cost prudency reviews.
While acknowledging that an LDC's decision to hedge would also be subject to the same review, the commission said that prudently incurred costs connected with such a decision should be treated as gas costs eligible for automatic recovery from ratepayers. In addition, while state regulatory practice would not allow pre-approval of the hedging costs within the context of an annual prudency review, the commission said that any review would be made on the basis of information available to the utility at the time the decision is made -- and not on the basis of the informationavailable at the time of the prudency review.

Following unprecedented volatility and upward movement in gas prices during the winter of 2000-2001, the commission opened an investigation to determine how to best address the problem from a consumer perspective and found that LDCs had not made broad use of hedging tools, including financial derivatives such as gas price futures contracts and options and fixed-price gas purchase contracts. The commission said that this reluctance was due primarily to concerns about the regulatory treatment that might be applied to such arrangements.
The LDCs had expressed the fear that favourable results would be passed through to ratepayers, but unfavourable results would be deemed imprudent and absorbed by company shareholders. In light of their concern over "backward-looking" adverse regulatory treatment of hedging decisions, the LDC's have perceived the practice of buying gas at the current spot market price to be the safest course of action, the commission said.

While refusing to adopt calls made for pre-approval of hedging activities made by LDCs, the commission said that it accepts the companies' concerns over the fairness, or lack thereof, of hindsight reviews. It said that the LDC's fears were based on a "misapprehension" of North Carolina regulatory law and practice. The commission added that the established standard for a prudence review of utility costs is always limited to a review of the utility decision on the basis of what the utility knew or should have known at the time.
It noted, however, that the record in the case provided little in the way of standards of practice to guide the utilities in the future. The commission said that it agreed with the common thread evident in most of the comments on the issue -- "that the LDCs should look to the market and not to the Utilities Commission for guidance."

It also said that costs of purchasing the derivatives would clearly qualify for automatic adjustment clause recovery in most instances. It noted, however, that a change in adjustment clause rules might be required to accommodate derivative purchases made from entities that might not fit the standard definition of a "gas supplier."
Signalling its willingness to make the needed changes the commission suggested that the LDCs provide comment on the proper form for a new definition.