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ENERGY Hedging helps even if you had to learn it the hard way

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For many energy consumers in the metals industry, the crisis began in 2004 with soaring global consumption and the subsequent supply pinch that accompanied Hurricane Katrina the following year. But large buyers on the West Coast are guided by an experience that began three years earlier, rooted in a period not only of rocketing prices but also power interruptions and, ultimately, charges of market manipulation by energy traders.

"That crisis began because of a fictitious shortage that was never there," said Jack Stutz, president and chief executive officer of Tamco Steel Inc., a Rancho Cucamonga producer of steel reinforcing bar that had to deal with the disruptions.

Moreover, consumers in California, where imperfectly conceived power deregulation legislation helped facilitate gaming the system, continue to deal with the hangover from the 2000-01 electric power emergency, which also was accompanied by a spike in natural gas prices that took them to nearly $20 per million British thermal units from less than $3 per mmBtu. A panicked state government made a wrong bet with long-term forward purchases of electricity at prices that have since turned out to be grossly inflated, a penalty that's still part of consumers' bills and that won't go away completely until next year.

All this uncertainty, however, has resulted in a relatively savvy group of power consumers who are now comfortable with futures buying and other tools that help them hedge their risks.

One of the major casualties of the 2000-01 West Coast power crisis was aluminum producer Golden Northwest Aluminum Inc., which was pushed into bankruptcy. Golden Northwest had two smelters in the Pacific Northwest, but the only unit operating today is Northwest Aluminum Specialties Inc. (NWAS), a billet producer in The Dalles, Ore., now employee owned, which recently secured a new multimillion-dollar credit facility.

Unlike in late 2000, when power "went sky high" and helped put its former parent into bankruptcy, NWAS today isn't dependant on the two idle smelters for feedstock, said Bill Reid, the company's president and chief executive officer. Instead, it either remelts scrap or purchases pure aluminum for smaller-diameter billet for direct forge and extrusions. But while electric power doesn't represent its greatest cost, the company nevertheless depends on electricity for both its front-end induction and back-end homogenizing furnaces and it "works hand-in-hand with our local public utility district" to make sure it will have affordable power. So far, it has been able to keep its per-pound costs stable, and produced 63.7 million pounds of billets at its nominal capacity for the 12 months ended June 30 compared with 50.3 million pounds in the year ended Dec. 30, 2006.

In 2000-01, flat rolled steel producer California Steel Industries Inc. (CSI) was forced to absorb frequent electrical power interruptions at its Fontana, Calif., plant, but those disruptions haven't been duplicated since then. Brett Guge, the company's vice president of administration, said CSI now buys electricity both on the open market and as a bundled customer of the local utility, Southern California Edison. "We are told there's a fair amount of confidence that the state has the capacity now to get through any normal kind of summer," he said.

CSI, like most major industrial consumers, can't afford to buy all of its electricity on a prohibitively expensive non-interruptible basis. Nevertheless, it has raised its portion of non-interruptible power to around 16 megawatts from 5 MW previously out of an average of about 38 MW, although usage can go as high as 70 to 80 MW in some cases. In natural gas, where it did little hedging prior to the crisis, CSI typically buys 40 to 80 percent of its needs forward.

Tamco's Stutz noted that while hedging natural gas 50-percent forward "would be a lot for us," the mini-mill recently purchased around 20 percent of is requirement forward because it "saw an opportunity" in the market.

He also pointed out that there's been only a "slight" net increase in electricity generating capacity since the 2000-01 crisis, mainly due to plant additions and modernizations. "Over the years we would have hoped there would have been more electric plants built, but there haven't been," Stutz said.

Even if an individual forward buy goes against the market, it still serves its purpose—and allows the buyer to sleep at night. "We're not speculating—we're trying to lock in our costs where we know we can make money," said William J. Shaw, president of Alpase Inc., a Downey, Calif.,-based producer of cast aluminum plate that recently locked in its gas price for 120 days. As it turned out, it guessed wrong and the price subsequently eased, in part due to greater availability of supply from the Gulf of Mexico.

"Because our furnaces are never turned off, natural gas is a big issue for us," said Shaw, who estimated the July natural gas price at $6.58 per thousand cubic feet (mcf) compared with $11.57 mcf in November 2005. Despite the temporary glitch, Alpase's hedging program has nevertheless done its job—allowing the company to produce cast plate at a profit.

Moreover, Alpase's biggest concern right now is transportation fuel surcharges, which in California are so high that some haulers won't come into the state, Shaw said.


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