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Hedging Isn't a Cure for Natural Gas Price Spikes

June 03, 2003

Re "DWP's Gas Bill to Climb Next Year," May 28: At issue is whether the L.A. Department of Water and Power was aggressive enough in taking advantage of the hedge market that developed in natural gas when stable prices became volatile. A natural gas user like the DWP can use hedging to protect itself from price spikes by purchasing gas from suppliers at a fixed price for a specific period of time or by entering into hedge contracts with Wall Street firms that will pay the difference if the price goes up. However, hedging is a new tool with inherent dangers. If the price goes down instead of up, L.A. ratepayers could find themselves owing millions to large Wall Street entities or be forced to pay too much for natural gas under long-term contracts.

While the DWP ultimately did hedge about 15% of its purchases, we were strongly advised by the city attorney's office to hold off on several other contracts until a number of complex legal issues could be resolved. As the DWP gains more experience with hedging, we will find more opportunities to bring its financial benefits to the people of L.A. But hedging is no panacea.

The fiscal impact of the hedge issue has been grossly overstated. The failure to hedge natural gas prices this year explains only a fraction of the potential $100-million increase in natural gas costs. Moreover, the $100-million figure is a worst-case scenario for which we must prepare but do not expect.

David H. Wiggs

General Manager

Los Angeles DWP

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