Is fuel hedging a good policy for Barbados to pursue?
While hedging has proved to be beneficial in reducing volatility, it also comes with significant risks. Additionally, despite this ability to reduce volatility, the existence of a hedge programme could result in higher overall costs of electricity.
This exposes the Barbados Light & Power (BL&P) to the possibility of incurring accumulated losses, which would ultimately be passed on to the customer in the form of higher bills.
After a detailed analysis of the issues involved, the commission determined that: The BL&P’s application to apply the results and costs of fuel hedging to the Fuel Clause Adjustment (FCA) is hereby denied on the following grounds:
The commission is conscious of the risks associated with fuel hedging and does not agree that the BL&P should be allowed to pass the cost of hedging and associated gains or losses onto the consumers of Barbados. The applicant has not provided enough evidence to suggest that the Barbadian public is willing to pay for the reduced volatility in fuel prices.
The risks associated with fuel hedging are grounded in the ability of the hedger to guarantee the achievement of the objectives that were established at the outset of the programme and the incidence of substantial financial loss. Both would present a burden to the consumers of Barbados, as the FCA is a “pass through” charge. Furthermore, these losses would be in addition to the upfront administrative costs which would also be borne by the consumer.
While research illustrates that the implementation of a hedging strategy could reduce the volatility of fuel prices, this potential reduction is often accompanied by a high risk of hedge losses. This has been the experience of some regional utility companies, as well as some of the larger players within the airline industry. In both industries, hedge losses have accumulated over a number of years. Furthermore, the use of hedging is not expected to materially reduce the cost of fuel over time.
Also of concern to the commission is the failure of the BL&P to include vital evidence to support its application, specifically the omission of proof that the average Barbadian consumer would be willing to bear the costs associated with a reduction in volatility.
According to its application, the intention of the BL&P was to reduce the volatility of fuel prices for the consumer by applying the results and costs of fuel hedging to the FCA. However, while there is sufficient historical data to demonstrate how this may be achieved, the BL&P did not provide sufficient evidence to show how it would accomplish this objective and reduce any negative impact on the consumer.
The commission also considered that the application raised the issue of efficiency optimisation. Research suggests that a robust, preventative maintenance programme, which accounts for planned, scheduled and forced outages, could control the cost consumers pay for electricity. The commission has found that the BL&P has not addressed this option as a complement to a fuel hedging programme.
The commission is conscious of the risks associated with fuel hedging and does not agree that the BL&P should be allowed to pass the cost of hedging and associated gains or losses onto the consumers of Barbados.
This information was taken from the Fair Trading Commission’s decision on Barbados Light & Power Company’s application to “apply the results and costs of hedging to the calculation of the Fuel Clause Adjustment”. The ruling was made last Thursday.
