LUCELEC'S FUEL PRICE HEDGING PROGRAMME
For over forty years LUCELEC has been committed to providing excellent service to all its customers and to maintaining the most cost effective tariff possible. In keeping with this we have started a programme which will provide more stability in our fuel costs. This will, in turn, minimise large fluctuations in what is commonly called the ‘fuel surcharge’ since under the provisions of the Electricity Supply Act, fuel costs are passed directly to customers.
Customers will remember how the fuel price changes in 2008 brought great discomfort and uncertainty. LUCELEC is taking steps to avoid this through a Fuel Price Hedging programme.
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What is Fuel Price Hedging?
Why is LUCELEC engaging in Fuel Price Hedging?
How does it work?
What are the benefits of Fuel Price Hedging?
What will LUCELEC gain from such an initiative?
Is LUCELEC equipped to successfully undertake this endeavour?
What are the uncertainties associated with the programme?
What is Fuel Price Hedging?
Fuel Price Hedging is a mechanism companies use to secure a set price or a price range at which they will buy fuel over a period of time, regardless of changes in daily market prices. In other words, if we agree that for the next 3 months we will pay $7.00 per gallon of diesel, no matter what happens with the market price during that time (whether the price moves to $8.00 or $6.00), we pay $7.00.
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Why is LUCELEC engaging in Fuel Price Hedging?
LUCELEC is doing this to reduce risk to the Company as well as to customers, caused by forces outside of the Company’s control. Fuel price hedging will allow LUCELEC to provide more stable fuel prices on a monthly basis and will reduce the volatility in customers’ bill.
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How does it work?
This year, LUCELEC is hedging 75% of the fuel it will purchase using a “Fixed Price Swap” by which the Company will select a fixed price that it is willing to pay for a certain period (usually 3 months). This price is different from the daily market contract that is made with a market trader who will arrange to pay to, or receive from LUCELEC the difference between that fixed price and the market price of fuel. The fixed price will be the price that is passed through to customers.
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What are the benefits of Fuel Price Hedging?
All LUCELEC’s customers stand to benefit from the fuel price hedging programme. Some of the benefits will include:
- More stable prices for fuel
- Fuel surcharges that do not fluctuate as significantly from month to month as before
- If average electricity consumption does not change, customers will be better able to predict, manage and plan their electricity spending.
- Business customers will be better able to manage their expenses, cash flow and forecasting
- Businesses which set prices in advance (such as hotels) will benefit from a level of price stability
- Generally there will be a greater benefit to the local economy from more stable energy prices
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What will LUCELEC gain from such an initiative?
LUCELEC recognizes that volatile billing prices makes customers dissatisfied and weakens their confidence in the company. LUCELEC expects this mechanism to improve its customer satisfaction as well as customers' trust in and loyalty towards the Company.
LUCELEC will also benefit from improved cash management due to more stable billing prices for fuel.
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Is LUCELEC equipped to successfully undertake this endeavour?
LUCELEC undertook a pilot fuel price hedging programme from July- December of 2009. This trial period allowed for professional assistance and support in carrying out the programme and gave the Company the opportunity to become aware of the procedures, processes, risks and benefits. The pilot programme exposed the staff to the hedging strategy, the negotiation and execution of contracts, documentation to satisfy legal, accounting and audit requirements, establishment of governance controls, and reporting tools among other matters.
LUCELEC is well equipped to continue the fuel price hedging programme and has done so from December 2009.
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What are the uncertainties associated with the programme?
Although fuel price hedging will allow for a greater certainty of the price of fuel over a period of time, there may be periods in which the hedged price will be higher than the daily market price. In those instances, customers will continue to pay the hedged price even though it is higher than the current cost of fuel on the market. In order to lessen that possibility, LUCELEC’s Fuel Risk Management Committee (FRMC) will monitor the programme closely.
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Other points to note:
- Fuel price hedging is provided for, in the Electricity Supply Act and its associated amendments.
- Fuel prices are passed through with absolutely NO mark-up to the customer, so there is no financial benefit to LUCELEC.
- The fuel price hedging programme is NOT geared to achieve the lowest price. To attempt this would require that the Company get into speculative activity, which is not consistent with the Company’s Risk Management policies.
- The fuel price hedging programme has been approved by the Company’s external auditors for its compliance with International Financial Reporting Standards.
- LUCELEC’s Board of Directors has given its approval for the programme to continue until the end of 2011 and it is expected that the programme will continue to be extended.
- LUCELEC continually aims to be innovative and forward thinking and it is the first Company to undertake a fuel price hedging programme in the English speaking Caribbean.
- LUCELEC will continue to provide information to its customers about the results of the programme from time to time.
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