The Basics of Natural Gas Hedging That You Need to Know

If natural gas is a significant underlying cost or a significant source of income for your business there is one term that you would have to live with and perhaps even sleep with – ‘VOLATILITY’. Natural gas is historically one of the most volatile commodities and the price fluctuations that take place can be very troublesome for both consumers and producers. Managing this risk is not always easy, but can be done through the use of a well laid out hedging strategy.

Natural gas hedging is by no means a way a “profit center”, but rather is meant to mitigate the risks involved for your business due to unwanted price fluctuations.

In this article we take a look at some of the basics of natural gas hedging that you need to know.

Hedging is the process of using energy derivatives (forwards, futures, options, swaps, etc.) to lock-in or protect against potentially harmful future price movements in the price of physical energy commodities.

For instance, the price of a utilities electricity that is generated using natural gas fired generators is subject to significant fluctuations given the physical price of natural gas. By buying forward using natural gas futures or swaps the utility can “lock-in” the price of their gas at a given price. By fixing price the utility can then budget and plan accordingly should physical prices continue to rise or fall.

Now that you understand the theory behind hedging it is important to note that making the right decision in terms of fbs price of natural gas and the time to hedge will be a significant part in deciding your hedging program’s success. This is where you should incorporate a statistical model that would offer you scientifically analyzed data to understand the market’s price cycles.  Using this type of model you will be able to make the right decision in terms of when to hedge, the right maturity to use, and the best derivates to meet your hedging goals and risk appetite.

If you are hedging for the long-term, a year or more, scaling in to the hedges is equally important to minimize your risks. These statistical models will also guide you on the right path in terms of decision making.

The biggest advantage of using these models is that they can be used to design a hedging strategy that meets your company’s unique risk management goals and risk appetite. No two companies have the same exposures to natural gas price risk, and therefore, no two hedging programs should be the same.

Hedging is a way to cut down on your exposure to natural gas price risk. You need to choose the right statistical model tool for natural gas hedging to ensure success. 

In this write-up we review some of the basics of natural gas hedging that you need to know to mitigate risk and ensure a successful hedging program.

Report this Page