Hedging Natural Gas Price Risk presentation to APPA 2004 Joint Action Workshop Dec. 5-7, 2004

1. Hedging Natural Gas Price Risk presentation to APPA 2004 Joint Action Workshop Dec. 5-7, 2004

2. Hedging Natural Gas Price Risk • Why risk manage? • FMPA’s situation • Hedge products pros and cons • Product mix 2

3. Why Risk Manage? • The electric generation business has many inherent risks • Some of these risks bear significant financial impacts • Develop a program to “manage” or mitigate these risks • Avoid bad outcomes 3

4. FMPA’s Precipitating Event 4

5. Other Precipitating Events • Catastrophic failure of generation • Fuel supplier insolvency • Loss of transmission or fuel transportation • Non-performance under long-term commitment 5

6. FMPA’s Response • Identified major risk – i.e. natural gas prices • Educated staff • Hired expertise, staff or consulting • Drafted energy risk management policy • Started slowly 6

7. Natural Gas Price Risks • Some entities may have a fixed price for natural gas imbedded in their rate structure • Others may be exposed to market based prices • Two different approaches • FMPA falls into the former category 7

8. How Much to Hedge? • Varies depending on risk appetite • FMPA started with a: • 33% fixed price, 33% first-of-month index price, 33% daily spot price mixture • Determined that this didn’t provide enough protection • Moved to more fixed price protection 8

9. How Long to Hedge? • FMPA began with hedging the near-term period – roughly 6 months to 1 year • Empirical evidence that showed a 24-36 month hedge profile showed greater success • FMPA moved to a longer-term program • Hedge % more heavily weighted toward near-term 9

10. Hedge Products • Products vary depending on price exposure • NYMEX Futures • Good liquidity for one year to eighteen months • Recognized standard for natural gas market • Works best for fixed price exposure • Margin requirements can be burdensome of cash flow 10

11. Hedge Products Continued • Swaps • Good liquidity for 1-6 years • Requires ISDA agreements with multiple parties • Depending on credit, may or may not require margining • Premium to NYMEX for added liquidity 11

12. Hedge Products Continued • Options • Calls - upside protection while allowing for downside participation • Puts – downside protection of fixed price hedges • Depending on market volatility, can be “expensive” protection 12

13. Hedge Products Continued • Collars • Combination of calls and puts • Sale of puts buys down cost of call • Spreads • Purchase a call, sell a higher strike price call • If market moves above higher strike, have spread advantage over market 13

14. Hedge Products Continued • Fixed price physical purchases • Good liquidity for 1-3 years • If load doesn’t materialize, must sell into market • Contracts with multiple counterparties • Credit becomes a concern 14

15. Hedge Products Continued • Basis Swaps • Good protection for market price exposure • Minimizes exposure to regionalized market swings • Doesn’t protect commodity exposure 15

16. What Products to Use? • Experimentation with a variety of products • Over time optimal mix will become evident • FMPA started with fixed price physical and futures • Current program has mixture of many product 16

17. How Much Does It Cost? • Hire some expertise, staff or consultant • Exchange broker fees are minimal • Option premiums can add up but can help avoid embarrassing outcomes • FMPA has allocated $2 million/year • Costs have run less than half of this 17

18. Final Comments • Determine where your exposures lie • Start slowly and educate staff and board • Hire expertise • Find the optimal product mix • Set expenditure limits and stay within them 18

19. Hedging Natural Gas Price Risk Questions? 19