Energy Risk Awards 2016
In 2015, natural gas markets on both sides of the Atlantic were characterised by low price volatility and a relatively flat forward curve. That drove demand for long-term hedging transactions by consumers eager to lock in cheap prices, market participants say. Yet it wasn't easy to get such deals done, given poor liquidity at the back end of the curve.
In this environment, BP stood out for its ability to provide long-dated hedges. The oil major has built up its derivatives business in recent years as banks – the traditional source of liquidity in big-ticket financial gas trades – have retreated from commodity markets.
"Transacting longer-dated business often requires combining expertise in physical and financial markets," says Ryan McGeachie, BP's Houston-based chief commercial officer for its Americas' structured products business. "Our gas teams in Europe and North America have a major presence in both that is matched by few of our competitors."
BP is the largest physical gas marketer in North America, with 2015 volumes more than double those of the second-biggest player, Royal Dutch Shell, according to New York-based price-reporting agency Platts. BP also estimates it has access to about 10 billion cubic feet per day of transport capacity in North America. On the financial side, its trading arm in Houston is registered as a swap dealer under the US Dodd-Frank Act, which puts it on the same footing as Wall Street banks when it comes to offering risk management products.
Thanks to these unique capabilities, BP has played a behind-the-scenes role in the so-called ‘industrial renaissance', in which cheap shale gas has fuelled the construction of numerous petrochemical plants, gas-to-liquids facilities and other gas-consuming projects, mainly along the US Gulf Coast. According to the Washington, DC-based American Chemistry Council, around 100 such projects have been completed or are under way while 145 are more in the planning phase.
Many transactions in 2015 involved BP as the gas supplier, physical commodity offtaker and financial hedge provider. In part, that is because of the increased presence of private equity firms in financing projects. Unlike banks, private equity firms don't have their own hedging desks, which gives BP an opportunity to structure long-term hedges. "These transactions do present a myriad of risk management needs," says McGeachie. "BP's ability to provide the liquidity and expertise to manage both the physical and financial risks in the market puts us in these conversations every day."
Underlying all of BP's transactions are its strong analytical capabilities, says Max Nuttall, BP's London-based global head of structured products. "We often understand at quite a microscopic level what's happening at not just the major gas hubs, but most of the basis markets," he says. "That gives us the confidence from time to time to manage risks that aren't totally liquid. Sometimes, especially long-term, the market is not there, so you have to have a view."
BP has been active in Europe as well. In January, it concluded a significant five-year wholesale energy agreement with Utilita, a UK-based gas and electricity retailer. An independent seeking to grab market share from the Big Six utilities, the firm was adding around 5,000 customers a week. To maintain that pace of growth, it needed access to competitively priced supplies without having to post large sums of collateral on physical forwards contracts.
"Variation margin was the biggest obstacle to our growth," explains Utilita chief executive Bill Bullen. "We had to temper our growth based on the amount of cash we needed to keep aside in case of a big move in prices."
Under the deal, BP committed to supply Utilita with all its gas and power for the next five years, mostly through contracts with two-year tenors, priced against the UK's National Balancing Point. All existing supply contracts were novated to BP under new collateralisation agreements that freed up £15 million ($22 million) in working capital for Utilita, Bullen says.
Thanks to BP's extensive market reach, the deal gives Utilita access to the most competitively priced gas and power available, both parties believe. "We have established documentation and relationships with hundreds of counterparties, increasing the chances that the best possible price is accessible by us," says Chris Schemers, London-based head of origination for BP's European gas and power business.
Rather than collecting cash collateral, BP got the comfort it needed to execute the deal by working with Utilita to understand its growth strategy, cashflow cycle and entire chain of risk so that it could ensure appropriate hedges were in place, says Schemers.
Utilita is pleased as well. Bullen says its customer numbers have grown from around 250,000 to 330,000 since the BP deal was reached.