Weather risk management not working for Washington Gas?

by Artemis on February 19, 2009

Earlier this month I wrote about Star Gas Partners and their 10Q report which left you with the impression that they had failed to protect themselves against the vagaries of the weather even though they run what seems a decent weather risk management program. The 10Q perhaps highlighted that just having weather risk insurance and derivatives doesn’t necessarily mean the bottom line isn’t affected. Is this a sign of companies buying into instruments such as weather derivatives to hedge against say a hotter than normal winter but with no way of protecting against the exact opposite when that can have an equally detrimental effect on earnings?

Now I’ve read with interest the 10Q from Washington Gas Light Co. and come away with a similar feeling about them. They detail the outlay on weather insurance and derivatives made during the last quarter of 2008, but the article ends stating that Washington Gas recorded a loss of $1.7m (pre-tax) related to it’s weather derivatives as a result of colder than normal weather. Again this leads you to believe that either they don’t fully understand what they are dabbling with or they’ve been poorly advised.

However, what this really demonstrates is that a weather risk management program needs to be fully rounded and cover needs to be available for both the down and upsides that the weather can bring. You can never fully protect yourself against all weather eventualities, but you can soften the blow significantly and smooth your earnings predictability.

Or maybe weather derivatives just aren’t working for these gas companies? Would they be better sticking to traditional insurance?

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Doug February 19, 2009 at 8:30 pm

After looking at the filing, I think that WGL’s derivative program is doing its job. This company sells natural gas, and it sells more natural gas the colder it gets. Therefore, it only needs to protect against warmer than normal temperatures, by buying contracts that increase in value the warmer it gets.

Since the weather was unseasonably cold, the contracts probably lost value. However, the loss in value from the derivatives was more than offset by the increase in revenues from the extra gas it sold. It wouldn’t make sense for the company to buy contracts that increase in value the colder it gets (like HDD contracts) because its gas business naturally benefits.

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