Electric Utility Co-op Eases their Members’ Concerns regarding Weather Hedging

Situation Analysis

Strategic Decisions Group recently advised an electric cooperative that was heavily exposed to irrigation customer load risk. A summer with extreme rainfall the prior year had caused load to drastically decline in the summer months as commercial irrigation customers did not need as much power to operate their pumps and facilities. The decline in load caused rates to increase resulting in unhappy customers across the cooperative. The co-op started investigating ways to protect their members from future weather events to mitigate large rate swings.

Discovery & Solutions

The co-op desired a quick, two-week turnaround on any recommendation so that they could implement any hedging strategy before the next summer came around. SDG was brought in to assist in the accelerated decision-making process. SDG worked with the co-op to collect relevant weather data and build a probabilistic rainfall forecasting model. This was a key deliverable to root the analysis in real-world data and eliminate recency bias of the recent adverse weather.

SDG also worked with the co-op to develop a financial model to estimate member rates and a derivative instruments model to test various hedging alternatives. Both used the probabilistic weather forecasting model as inputs resulting in a full, risk-adjusted view of how different hedging strategies compare.

Results & Impact

After the accelerated two-week effort, SDG concluded that the fixed costs for eliminating weather risk was estimated to be significant and was untenable for the co-op.

• Hedging weather over 12 months or just the three summer months was estimated to be significantly higher than expected.
• Costs for legal, new full-time employees, and consultants. to implement the hedging program would also be expensive.
• The analysis assumed that the counterparty was risk neutral; in reality the utility would have to pay an additional premium for the counterparty to enter into the contract.
• Weather risk cannot be completely eliminated because the relationship between rainfall and load loss is uncertain and likely to change over time.

The principles of Decision Quality allowed for insights to be developed quickly, while saving the organization much time and money in pursuing an imprudent idea. Additionally, it gave the co-op’s members closure on the decision and eliminated circling back to the issue in the future.