Natural Gas Hedging Presentation

Natural Gas HedgingProgram AnalysisNatural Gas HedgingProgram Analysis

Ryan Pamplin

Global Energy Sourcing

December 18, 2009

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Today’s AgendaToday’s Agenda

Hedge Basics

Existing Hedge Program

Results

Hedge Program Proposal

Discussion – Path Forward

Slide 3

Hedge BasicsHedge Basics

Slide 4

Physical vs. Financial HedgePhysical vs. Financial Hedge

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Existing Program ObjectivesExisting Program Objectives

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Existing Hedge ProgramExisting Hedge Program

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Price Volatility – Catastrophic EventsPrice Volatility – Catastrophic Events

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Existing Program Initial Strategic PlanExisting Program Initial Strategic Plan

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Existing Hedge Program ExampleJanuary 2010Existing Hedge Program ExampleJanuary 2010

$/MCF

Average Price = $8.77

JAN

'07

FEB

'07

MA

R'0

7

AP

R'0

7

MA

Y'0

7

JUN

'07

JUL'

07

AU

G'0

7

SEP

'07

OC

T'0

7

NO

V'0

7

DEC

'07

JAN

'08

FEB

'08

MA

R'0

8

AP

R'0

8

MA

Y'0

8

JUN

'08

JUL'

08

AU

G'0

8

SEP

'08

OC

T'0

8

NO

V'0

8

DEC

'08

JAN

'09

FEB

'09

MA

R'0

9

AP

R'0

9

MA

Y'0

9

JUN

'09

JUL'

09

AU

G'0

9

SEP

'09

OC

T'0

9

NO

V'0

9

DEC

'09

Scale: = 70000 MCF

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Existing Program ResultsExisting Program Results

$MM

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Existing Hedge Program ResultsExisting Hedge Program Results

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Existing Hedge Program AnalysisExisting Hedge Program Analysis

Pros – Reasons to Hedge

• Volatility was Reduced

•Reduced Impact of Spikes

•Perception•Board•Shareholders

Cons – Reasons Not to Hedge

•Cost of Volatility Reduction•61 mm over 3.5 years

•Hedge Accounting•Lack of flexibility tied to mills

•Lost Opportunity Cost

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Program ProposalsProgram Proposals

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Natural Gas Hedging AnalysisNatural Gas Hedging Analysis

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Stable Gas Prices Ahead?Stable Gas Prices Ahead?

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Not So Fast…Not So Fast…

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Accounting Treatment GuidelinesAccounting Treatment Guidelines

• FASB has developed guidelines on hedge accounting (FAS133) for derivative contracts

– If a contract does not qualify for hedge accounting, the change in fair value is recorded in earnings each quarter

– If it does qualify, the change in fair value is recorded in Other Comprehensive Income (balance sheet equity account) for the effective portion and in earnings for the ineffective portion

Hedge results are captured in the same period as the underlying exposure

• To qualify, the hedge must be highly effective at offsetting changes in the fair value of cash flows of the underlying exposure

• Effectiveness testing done

Prior to start of hedge program to support use of hedge accounting

Quarterly to determine amount of ineffectiveness

• Hedge of a component of a commodity does not qualify for hedge accounting

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Appendix AAppendix A

Understanding Hedging Lingo

• Hedge – An offsetting financial position intended to

counteract a fluctuation in a commodity price.

• Hedge Costs – Expenses associated with transactions,

premiums paid for the purchase of derivatives. Sometimes

Mark to Market adjustments.

• Mark to Market - The difference between the hedge price

established by a hedge transaction compared to the current

market prices of the underlying commodity.

• NYMEX – A national trading exchange for commodities.

• NYMEX Forward Price Curves – Future (1 - 72 months) prices

expressed graphically comprised of existing future

commodity prices measured at Henry Hub on any given day

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Appendix A (cont.)Appendix A (cont.)

• Futures – Futures are fixed price products which “lock-in” the

price you will pay for fuel in a future month at a fixed price.

• Call Option – A call allows an investor to buy a futures

contract on an underlying commodity at a specific price for a

limited period of time, where the investor is not required to

make the purchase.

• Put Option – An agreement allowing an investor to sell a

futures contract or other underlying commodity at a specific

price for a limited period of time, where the investor is not

obligated to sell.

• Derivative - A financial instrument that is contingent on the

price of an underlying commodity usually traded on a

recognized exchange.

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Program Proposals Program Proposals