The Application by the BL&P for Approval to Apply the Results and Costs of Hedging to the Calculation of the Fuel Clause Adjustment

• Jurisdiction: Barbados
• Judgment Date: 29 December 2016
• Docket Number: Document No: FTC/UR/DECCHFCA/2016-04
• Court: Fair Trading Commission (Barbados)

The Application by the BL&P for Approval to Apply the Results and Costs of Hedging to the Calculation of the Fuel Clause Adjustment

Document No: FTC/UR/DECCHFCA/2016-04

FAIR TRADING COMMISSION

DECISION

Table of Contents

Section 1 Executive Summary	3
Section 2 Introduction	5
Section 3 Legislative Framework	7
Section 4 Intervenors' Participation	9
Section 5 Written Submissions and Affidavits	11
Section 6 Analysis	16
Section 7 The Determination	30

Section 1 Executive Summary

1 The Fair Trading Commission (the Commission) has completed its analysis of the Application by the Barbados Light and Power Company Limited (BL&P) for approval to apply the results and costs of fuel hedging to the calculation of the Fuel Clause Adjustment (FCA).

2 In March 2016, the Commission received an Application from the BL&P for approval to apply the administrative results (losses or gains) and costs of a fuel hedging programme to the calculation of the FCA (the Application). This was done in accordance with Section 16 of the Utilities Regulation Act, CAP.282 of the Laws of Barbados (URA). This section gives the Commission the authority, on its own motion or by application, to review the rates, principles and standards of service for the supply of a utility service.

3 The proposed fuel hedging programme would allow the BL&P to hedge 80% to 90% of its Heavy Fuel Oil (HFO) consumption volumes with a third party and would be a financial hedge, using fixed price swaps. The annual administrative cost was estimated at BDS$600,000 with Emera Energy Services, an affiliate based in Nova Scotia, identified as the hedge administrator. No specific duration was stated in the Application.

4 In accordance with Rule 37 of the Utilities Regulation (Procedural) Rules, 2003 (S.I. 2003 No. 104) (URPR), made under Section 39 of the URA, the Commission invited written submissions from interested parties on May 23, 2016. The written hearing gave the parties an opportunity to be heard and ensured that there was transparency in the Decision of the Commission.

5 Five interested parties met the criteria to participate in the hearing through the submission of letters of intervention. They were CARITEL, Mr. Tony Gibbs, Division of Energy and Telecommunications, CIBC FirstCaribbean and Mr. Andrew Hart. The written submissions received from these intervenors were considered during the Commission's decision making process.

6 The responses received varied — some intervenors argued that the BL&P had not provided sufficient evidence to support the application of hedge losses/gains and administrative costs to the determination of the FCA and that any decisions to hedge should come after attempts to improve its generation efficiencies; other intervenors considered that the use of such a financial risk strategy to control price risk could be beneficial to the Barbadian consumer. Issues generally addressed one of three categories: risk, transparency related to administrative costs and plant efficiency.

7 While hedging has proved to be beneficial in reducing volatility, it also comes with significant risks. Additionally, despite this ability to reduce volatility, the existence of a hedge programme could result in higher overall costs of electricity. This exposes the BL&P to the possibility of incurring accumulated losses, which would ultimately be passed on to the customer in the form of higher bills.

8 After a detailed analysis of the issues involved, the Commission determined that:

The BL&P's Application to apply the results and costs of fuel hedging to the FCA is hereby denied on the following grounds:

• • The Commission is conscious of the risks associated with fuel hedging and does not agree that the BL&P should be allowed to pass the cost of hedging and associated gains or losses onto the consumers of Barbados.

• • The Applicant has not provided enough evidence to suggest that the Barbadian public is willing to pay for the reduced volatility in fuel prices.

Section 2 Introduction

9 On March 29, 2016, the BL&P applied to the Commission for approval to apply the results and the costs associated with a fuel hedging programme, to the calculation of the FCA. The Barbados National Oil Company Limited (BNOCL) is the sole, authorised importer of fuel into Barbados. Therefore, while the BL&P is not in a position to undertake physical fuel hedging, it is not restricted from engaging in financial hedging. The BL&P purchases fuel under contract with BNOCL, with prices linked to the New York Harbor Residual Fuel No. 6 index. The BL&P uses approximately 250,000 tons of fuel each year at an estimated cost of BDS $205 million 1. Based on projected fuel prices to the end of 2016, total fuel cost for this year is estimated at BDS $200 million. Seventy-five percent of the total cost of fuel is attributed to HFO. The remainder of the cost is distributed between aviation jet fuel (21%) and diesel (4%). The Application relates to hedging on HFO.

10 Fuel cost is a “pass through” charge that is applied equally to all customer classes through the FCA charge. Fluctuations in the FCA mainly arise due to movements in the purchase price of fuel. In undertaking a fuel hedging programme, the aim of the BL&P would be to secure a less volatile price for a percentage of its fuel purchases (80% increasing to 90% of its HFO), thereby reducing the potential impact of volatile fuel prices on its consumers.

11 Historically, the BL&P has not hedged its commodity purchases. A similar application, however, was made to the Commission in 2014. That application was rejected due to a lack of supporting information.

12 The aim of this Application was to reduce the BL&P's and, ultimately, the end consumers' exposure to fuel cost volatility. It was intended that the administration fees and the profit or loss arising from hedging would be applied to the actual cost of the fuel purchased. The current FCA formula is:

Where:

FCA _n = Fuel Clause Adjustments for the current month n

Energy Generation _n-1 = Energy generated in previous month

Aux _n-1 = Auxiliary consumption as a percentage of total generation in previous month

Losses = System losses as a percentage of total generation calculated based on a 12 month running average

Fuel Cost _n-1 = Fuel cost in previous month including cumulative under/over recovery, purchase power.

13 Should hedging be allowed, the revised FCA formula would be as follows:

Where:

Hedge Results _n-1 = gains/losses from fuel hedge in previous month

AdminCosts _n-1 = Administrative costs of hedging programme in the previous month.

All other terms remain as defined in Equation 1.

Section 3 Legislative Framework

14 Under Section 4 (3) (a) of the Fair Trading Commission Act, CAP. 326B of the Laws of Barbados (FTCA), the Commission is responsible for establishing principles for arriving at the rates to be charged by service providers. The Commission also has this duty under Section 3 (1) of the URA which states, inter alia:

“The functions of the Commission under this Act are, in relation to service providers, to

(a) establish principles for arriving at the rates to be charged;”

15 In accordance with Section 2 of the FTCA and the URA, “principles” refer to the formula, methodology or framework for determining a rate for a utility service.

16 Additionally, Section 2 of the URA states that “rates” include:-

• “a) every rate, fare, toll, charge, rental or other compensation of a service provider;

• b) a rule, practice, measurement, classification or contract of a service provider relating to a rate; and

• c) a schedule or tariff respecting a rate;”

17 By virtue of Section 16 of the URA, where the Commission has not fixed a period of time in accordance with Section 15 (1) of the said Act, the Commission may, on its own initiative or upon an application by a service provider or consumer, review the rates, principles and standards of service for the supply of a utility service. In light of this provision, the BL&P has correctly filed an application with the Commission seeking approval to apply the results and costs of hedging to the calculation of the FCA.

18 On October 11, 2013, the Commission issued its decision on its own Motion to Review the FCA, pursuant to Section 16 of the URA. The FCA is approved by the Commission as a principle or formula that the BL&P is permitted to use to “pass through” the cost of fuel used to generate electricity for use by its customers.

19 By virtue of Section 36 of the FTCA, the Commission may, on application or on its own motion, review and vary or rescind any decision or order made by it and, where under the Act a hearing is required before any decision or order is made, such decision or order shall not be altered, suspended or revoked without a hearing.

20 Essentially, the Application filed by the BL&P, if successful, would result in the alteration of the FCA formula as previously approved by the Commission in the manner outlined at Equation 2 on page 6, herein.

Section 4 Intervenors' Participation

21 On May 23, 2016, the Commission published a Notice in the media advising members of the public that the BL&P had sought approval to apply the results and costs of fuel hedging to the calculation of the FCA. The Commission invited written submission from interested parties to be received no later than May 30, 2016.

22 Upon request, the Commission granted an extension until August 18, 2016 for interested parties to apply for intervenor status. Intervenor status was granted to the following who actively participated in the hearing:

• • CARITEL;

• • Mr. Tony Gibbs;

• • Division of Energy and Telecommunications;

• • CIBC FirstCaribbean; and

• • Mr. Andrew Hart.

23 Pursuant to Rule 4 of the URPR, the parties were issued with Procedural Directions. The Procedural...