The impact of volume risk on hedge effectiveness: the case of a natural gas independent power producer operation

Larry A. Johnson

Abstract

ABSTRACT

This article explores whether optimal hedging strategies for an independent power producer (IPP) meet the criteria for hedge accounting treatment under the Financial Accounting Standards Board (FASB) Statement 133. This paper demonstrates that the volume uncertainty associated with the option of purchased electricity and the volatility of natural gas cash and futures prices can lead to ineffectiveness of the natural gas hedged positions. While hedging can still be justified from an economic perspective, the ineffectiveness of the hedge may prevent hedging activities from being designated as a hedge for accounting purposes.