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Natural Gas Hedging Presentation

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Final Presentation to Global Supply Chain Unit at International Paper during an internship in the Global Energy Sourcing division. Presented July, 2010.

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Natural Gas Hedging Presentation

  1. 1. Natural Gas Hedging Program Analysis Ryan Pamplin Global Energy Sourcing December 18, 2009
  2. 2. Today’s Agenda <ul><li>Hedge Basics </li></ul><ul><li>Existing Hedge Program </li></ul><ul><li>Results </li></ul><ul><li>Hedge Program Proposal </li></ul><ul><li>Discussion – Path Forward </li></ul>
  3. 3. Hedge Basics
  4. 4. Physical vs. Financial Hedge
  5. 5. Existing Program Objectives
  6. 6. Existing Hedge Program
  7. 7. Price Volatility – Catastrophic Events
  8. 8. Existing Hedge Program
  9. 9. Existing Program Initial Strategic Plan
  10. 10. Existing Hedge Program Example January 2010 $/MCF Average Price = $8.77
  11. 11. Existing Hedge Program
  12. 12. Existing Hedge Program
  13. 13. Existing Program Results $MM
  14. 14. Existing Hedge Program Results
  15. 15. Existing Hedge Program Analysis Pros – Reasons to Hedge <ul><li>Volatility was Reduced </li></ul><ul><li>Reduced Impact of Spikes </li></ul><ul><li>Perception </li></ul><ul><ul><li>Board </li></ul></ul><ul><ul><li>Shareholders </li></ul></ul>Cons – Reasons Not to Hedge <ul><li>Cost of Volatility Reduction </li></ul><ul><ul><li>61 mm over 3.5 years </li></ul></ul><ul><li>Hedge Accounting </li></ul><ul><ul><li>Lack of flexibility tied to mills </li></ul></ul><ul><li>Lost Opportunity Cost </li></ul>
  16. 16. Program Proposals
  17. 17. Natural Gas Hedging Analysis
  18. 18. Stable Gas Prices Ahead?
  19. 19. Not So Fast…
  20. 20. Accounting Treatment Guidelines <ul><li>FASB has developed guidelines on hedge accounting (FAS133) for derivative contracts </li></ul><ul><ul><li>If a contract does not qualify for hedge accounting, the change in fair value is recorded in earnings each quarter </li></ul></ul><ul><ul><li>If it does qualify, the change in fair value is recorded in Other Comprehensive Income (balance sheet equity account) for the effective portion and in earnings for the ineffective portion </li></ul></ul><ul><ul><ul><li>Hedge results are captured in the same period as the underlying exposure </li></ul></ul></ul><ul><li>To qualify, the hedge must be highly effective at offsetting changes in the fair value of cash flows of the underlying exposure </li></ul><ul><li>Effectiveness testing done </li></ul><ul><ul><ul><li>Prior to start of hedge program to support use of hedge accounting </li></ul></ul></ul><ul><ul><ul><li>Quarterly to determine amount of ineffectiveness </li></ul></ul></ul><ul><li>Hedge of a component of a commodity does not qualify for hedge accounting </li></ul>
  21. 21. Appendix A <ul><li>Understanding Hedging Lingo </li></ul><ul><li>Hedge – An offsetting financial position intended to </li></ul><ul><li>counteract a fluctuation in a commodity price. </li></ul><ul><li>Hedge Costs – Expenses associated with transactions, </li></ul><ul><li>premiums paid for the purchase of derivatives. Sometimes </li></ul><ul><li>Mark to Market adjustments. </li></ul><ul><li>Mark to Market - The difference between the hedge price </li></ul><ul><li>established by a hedge transaction compared to the current </li></ul><ul><li>market prices of the underlying commodity. </li></ul><ul><li>NYMEX – A national trading exchange for commodities. </li></ul><ul><li>NYMEX Forward Price Curves – Future (1 - 72 months) prices </li></ul><ul><li>expressed graphically comprised of existing future </li></ul><ul><li>commodity prices measured at Henry Hub on any given day </li></ul>
  22. 22. Appendix A (cont.) <ul><li>Futures – Futures are fixed price products which “lock-in” the </li></ul><ul><li>price you will pay for fuel in a future month at a fixed price. </li></ul><ul><li>Call Option – A call allows an investor to buy a futures </li></ul><ul><li>contract on an underlying commodity at a specific price for a </li></ul><ul><li>limited period of time, where the investor is not required to </li></ul><ul><li>make the purchase. </li></ul><ul><li>Put Option – An agreement allowing an investor to sell a </li></ul><ul><li>futures contract or other underlying commodity at a specific </li></ul><ul><li>price for a limited period of time, where the investor is not </li></ul><ul><li>obligated to sell. </li></ul><ul><li>Derivative - A financial instrument that is contingent on the </li></ul><ul><li>price of an underlying commodity usually traded on a </li></ul><ul><li>recognized exchange. </li></ul>
  23. 23. Program Proposals