Natural Gas Purchasing Risks to Consider

1
Natural Gas Purchasing Risks to Consider

• Supply needs
• Expense control
• SOX Accounting compliance

2
When to Contract with a Vendor?

• Run short of office supplies - low risk
• National Account agreements
• Vendor terms

• Natural Gas needs High Risk to operations and
  revenue
• Limited suppliers.

3
Natural Gas Contracts

• 2 types of contracts involved in controlling
  natural gas expense in your Manufacturing
  Facility
• Supply Contracts
• Hedging Contracts (optional management strategy)

4
Just Another Expense

• Supply Contracts
• Hedging Contracts
• Do we need these in writing?

5
Supply Contracts

• Supply contracts for one to two year time periods
• Price set at Indices plus additional 0.10 to
  0.18 per MMBtu.
• Penalties for taking more or less than projected
  supply.
• Your business provides projected volumes.

6
Other Notes on Supply Contracts

• A one year contract for 10,000 MMbtus x NYMEX
  960,000
• Force Majeure
• Statute of Frauds.
• Month to month.

7
Hedging Contracts

• What is Hedging?

8
Exposure to Pricing Fluctuations

• Foreign exchange rates
• Interest rates
• Natural Gas or other fossil fuels

9
Hedging Strategy

• Supply
• Contract to buy natural gas at spot (current
  market) when actual delivery occurs.
• July 7.12, August 11.15, September 12.50 per
  MMBtu
• Enter into Hedging Contracts.
• In June purchase hedges locked in at
• July price of 6.00
• August at 7.50
• September at 8.00

10
Hedging Strategy

• Settlement date spot price and hedge contracted
  difference.
• Get a check or,
• Cut a check

11
Purchase from Supplier
12
Settlement of Forward Contracts
13
Expense offset by Hedges
14
The Sarbanes Oxley Act (SOX)

• Compliance to management policies and procedures
  as well as proper accounting for investment
  instruments.
• FAS 133 Accounting for Derivative Instruments and
  Hedging Activities
• Cash Flow hedging
• Other Comprehensive income

15
Does a hedge contract meet the definition of a
contract?

• Adequate consideration.
• Benefit or detriment.
• Performed within one year.

16
FEDERAL DEPOSIT INSURANCE CORPORATIONVs.UMIC,
INC, a Tennessee corporation CHARLES ALEX DENNEY

• Alex Charles Denney - hedge against the risk of
  further interest rate increases for Universal
  (UMIC).

17
Details of Case

• Universal opened a commodities account
• Agreement was to use only for hedging
• Denney engaged in speculative trading
• Losses incurred.
• The board did not understood that speculative,
  non-hedge trading was occurring.
• Defendant owed fiduciary obligations.

18
Points to Consider

• Accuracy when contracting with suppliers
• Is it in your best interest to employ a hedging
  strategy?
• Who will manage the hedging activities?
• Are you accounting for your expenses properly?
• Do we need contracts for hedges and supply?