Optimal Hedging Strategy with Natural Ga Futures and Options

Abstract

In this paper, we theoretically examine the optimal hedge strategy for a natural gas company. The use of natural gas derivatives to minimize consumers' per unit cost of natural gas consumed, or to minimize the upside risk associated with extreme bills would be the strategy being considered by local distribution companies (LDCs) and regulators. The objective is, therefore, to stabilize the summer and the winter months' natural gas prices as well as to improve the level of customers' welfare. In general, during the summer injection period, April through October, utility companies purchase a certain amount of natural gas and keep in storage facilities and, hence, during the winter withdrawal months, November through March, utility companies supply natural gas at a predetermined minimal fuel cost rate to residential and commercial customers. Therefore, to manage these conflicts of interests efficiently should natural gas companies be supported by accurate forecast of the natural gas price for the winter months. Otherwise, natural gas companies will trade natural gas derivatives in order to reduce costs charged to customers. The results show that customers benefit from the use of natural gas derivatives. If the natural gas market is deregulated, the typical risk-return trade off shows that natural gas derivatives would provide the most efficient tools for utility companies to minimize the natural gas price volatilities.

Citation

Kwon, S.J. and Kwak, S.J. (2002), "Optimal Hedging Strategy with Natural Ga Futures and Options", Journal of Derivatives and Quantitative Studies: 선물연구, Vol. 10 No. 1, pp. 29-53. https://doi.org/10.1108/JDQS-01-2002-B0002