Hedging strategies: How are companies adjusting their strategies to adjust to today’s market?

SPEAKER A

Our final session today focuses on hedging strategies, as you can see. Great set of panelists. Let me introduce Mike, a member at Dorset Fund Management, who is our moderator. Mike, over to you, sir.

SPEAKER B

All right, thanks very much. So welcome to the panel. This afternoon, we're going to broaden the topic here. This is not going to be a panel on how to hedge a point estimate with a point risk. We're going to broaden this to talk about what has to be behind a hedging strategy to make sense. And we have quite a sophisticated panel here. I'm very fortunate to have people that are very experienced in the industry, and we'll give them a chance to say a couple of words about that. I just want to give you a preface. We're going to talk about hedging as a portfolio process of looking at a portfolio of risks and trying to assess what you really need to hedge and to see whether the hedge is a proper mechanism for what risks you're trying to hedge. We'll go through a couple of examples from the sophisticated traders here on how they generate the concept behind the hedge and how they implement the hedge. We'll have a couple of practical examples. And for the group here, if you've got a hedge idea that you want to throw back to us, please raise your hand. We're going to be communicating with each other all along. If you've got a question during the conversation, just raise your hand and we'll make you part of it. We're going to get into things like what's the risk policy in place at the company and how is the hedger evaluated. These are all important parts of the whole hedging aspect. I'll let the panelists say a few words. We'll make it really short before we get into it, and I'll provide a little more of an overview. Why don't we go down the panel, and each of you say something briefly to showcase the sophistication we have here. Go ahead.

SPEAKER C

Yeah, I'm Jim Hennigan. I'm a board member at Greenfield Holdings, an integrated ag company based out of Denver, Colorado. I'm an advisor to Greenfield. I do advisory capacity to Grow Intelligence and other companies as well. My background is in physical and financial trading, with most of my 20-some-odd years at Louis Dreyfus, then BTG Pactual, the Brazilian bank, and Freepoint, an energy company here in Stamford, Connecticut. Nice to be here.

SPEAKER B

Great.

SPEAKER D

My name is Gregory Ehrichman. I am a power trader at Terraform Power, a portfolio company of Brookfield Renewables. Previously, I had experience working as both a power originator and trader at EDF Renewables, RWE, and Con Edison as well.

SPEAKER E

Nice to see everyone. Thanks for coming out. My name is Nate Palacek. I'm a founding partner at Yieldpoint Stable Value Fund. I've been in the commodity space for about 21 years now. I look a little bit younger than I really am. I started out at Goldman Sachs, then worked for Ray Dalio over at Bridgewater Associates, then AQR, a large quantitative hedge fund. Our strategy at Yieldpoint is really around trade finance. We provide loans for the movement of physical commodities, and through that, for our 129 investors, we're able to roughly double the risk-free rate for them.

SPEAKER F

Thanks, everyone, for having me here. My name is Brock Masoski. I'm the co-founder and VP of analytics with a company called Ceqant IO. We're an energy analytics software-as-a-service company. We focus primarily on energy companies, which runs a gamut from independent power producers, utilities, trading shops, and consultancies, and help them with everything from asset valuation to portfolio optimization. Really excited to be talking on the panel today.

SPEAKER B

All right, and Dorset is a hedge fund that I started with a partner. We allocate to discretionary commodity traders. We're replicating the old Commodities Corp model for those who know what that is, which became part of Goldman Sachs. We allocate to discretionary traders who have an information edge from their backgrounds in the physical markets. We have a fund. That’s a bit of an overview of the expertise we’ve got up here. To give you an example of hedging strategies that weren't working when I first came to Wall Street in the seventies, I came from Harvard with a doctorate, and I headed a 20-person consulting business on hedging for multinationals. We talked to these multinationals whose problem was they couldn’t forecast their quarterly earnings because currencies were screwing it up. They didn’t know what the impact was going to be. So we sat down with them. Our expertise was in predicting where the Deutsche Mark was going and structuring a hedge. Well, first of all, they didn’t have the data on their exposures. They didn’t know what their balance sheets were exactly. They couldn’t decide what they were hedging. Were they going to hedge the balance sheet or some receivables or payables? How were they going to evaluate these hedges? And by the way, what’s the borderline between hedging and speculating? And not to mention the accounting issues. You have an economic exposure, whether it’s a future receivable or your margin that you’re trying to hedge. And you’ve got an open futures contract over here. This is going to be mark-to-market this quarter. This one hasn’t even arrived yet. So you better figure out how all these things fit together. We’re approaching this conversation on hedging as a strategy. You need to combine a lot of elements into it. I'm going to start off by letting Brock speak a little bit about that because his business is about sitting down with companies, particularly in the energy industry, looking at their total exposure and saying, well, if you’re just going to put a hedge on over here, maybe there’s some other group in the business that’s putting a hedge on over there. And the two of them make sense together. So we need to think of hedging just like an investment portfolio. You’ve got a portfolio of risks that you’re trying to hedge. You better make sure that you’ve got the hedges designed to capture the different risks. Brock, just give us a bit of your thought process on hedging strategies as a portfolio. Then we'll get into a couple of examples and show how a particular hedge is generated. We’ll get one in the electric power industry, which is nicely complicated, and you’ve got to have a risk policy in place within the company to make sure you know you’re doing the right thing and that people are going to evaluate you properly. Brock, go ahead, just give us a few thoughts about the overview of.

SPEAKER F

Sure, sure. As I mentioned, Ceqant works primarily with energy companies, primarily in the electric power space, but also with companies that have exposure to natural gas, coal, oil, and other energy-related commodities. What we really encourage our customers to do, and what our software is primarily designed to do, is look at net positions across an entire portfolio of exposures. Despite the fact that this might be relatively commonplace for Wall Street or for even a lot of commodity shops, what we find is that organizations that are out in the electric power industry, procuring power a lot of times, are not as well versed in some of these aspects of modern portfolio theory that require you to diversify a portfolio to stabilize the cash flows. What we see is that organizations are very siloed in their approach to procuring energy in terms of their management of different assets and different trading books, even when these different components across different arms of the organization may be very strongly correlated, or in some cases, anti-correlated. One of the things that Mike was alluding to is sometimes we see organizations that are trying to enact hedges or to de-risk different components of the portfolio without that broader context. At the company level, at the level of the entire balance sheet, that can actually go against you. You may have different covariant relationships between renewable energy and customer demand, between power prices and natural gas exposures or other fuel-related commodities. Even when you’re looking at something like weather risk, right? All these things co-vary, and there are many different positions and targets to manage, especially within energy portfolios. A lot of our customers are pursuing sustainability targets. They’re not just going after renewable energy; they’re also going after attributes, as we call them. These are renewable energy certificates, greenhouse gas-free certificates, resource adequacy, sometimes even carbon volumes themselves, tracked with locational marginal emission rates. When you add all of that to the volatility and the uncertainty that exists within the electric power markets themselves, you have a very complex portfolio of exposures. One of the things we focus on, and I think something that resonates with commodities traders and traders in general, is the need to manage that very holistically, to simultaneously manage multiple different exposures and the covariant relationships between them.

SPEAKER B

And by the way, these hedges aren’t necessarily just a futures contract, right?

SPEAKER F

That’s right. A lot of these hedges are very long-lived positions. You’re talking about power purchase agreements that may exist for 15 or 20 years. They’re delivering multiple different attributes. There may be an energy component, a REC component, a renewable energy certificate, a resource adequacy component. Sometimes they can have very complex settlement structures and terms that add very strong nonlinearity. Things like basis buyback provisions, where there’s a cliff in the exposure, and then all of a sudden the exposure changes extremely non-linearly at some point within the contract year. Floors, ceilings, all kinds of embedded optionality may exist as well. And then you start looking at

batteries, and of course, those are real options that respond on a very fine time granularity. So, yeah, it’s much more complex than kind of block trades or future positions. Being able to understand the value of each component of the portfolio, even in the case of complex structured transactions, and then how that value layers on top of the rest of the value within the portfolio is something that I think is really essential in today’s market.

SPEAKER B

So parts of the existing operations might already be providing the hedge that they don’t need. Nate, you’re going to give us at the end a complex exposure, nonlinear exposure, to think about. But maybe, Greg, we were talking about power a little bit. Go through an example of a hedge and what you need to do internally to know whether they’re going to understand that your hedge is the right hedge and how they are going to evaluate you on the hedge.

SPEAKER D

Yeah, absolutely. I think that’s a good example Brock brought up because I can speak to not just how a hedge is formed, but also why the perspective might not always be at a portfolio level. Power projects are usually considered on a project-level basis, as they are encompassed by project companies. I work for Terraform Power, and let me preface by saying that my views are not necessarily the views of Terraform Power or Brookfield Corporation, but my own. I work for Terraform Power, and we have over two gigawatts of operating renewable assets on the grid. Within that portfolio of two gigawatts of assets, each individual project company has its own exposures and its own challenges in the power trading space. The main hedge that we would use to encompass these exposures is the PPA, the power purchase agreement. This is the traditional structure in which the power industry functioned for a long period of time, in which a corporation or a development company, a company that owns power, would be able to firm up its expected revenues through contracts where prices would be agreed to in the future. They wouldn’t be exposed to open prices on the market. The problem, or not necessarily the problem, but an outcome of these agreements is that you will still leave exposures out there. No hedge is going to be perfect. Brock mentioned something called basis, power basis. I think that’s an important example to talk through. When you sign a contract, your contract will be to deliver power to a certain location. Usually, there will be a few locations in a large power market. We’re talking about areas as large as states, larger than states, and your individual project is going to get paid based on where it is. This difference is the power basis, and the difference in prices that occur at the different locations is a constant exposure for most power contracts. Recently, development and the origination of power contracts have been working around basis in contract language, coming up with possible caps where either party might be exposed up to a certain point to that basis, among a number of different contractual terms that might solve for that. The PPA, working through a contract, is going to be the best way for you to de-risk your asset to that extent. At the same time, nothing’s going to be perfect. When you have a number of different project companies and a number of open exposures, the best thing to do is to look at them as a sum total and to understand the total of your exposures across the asset fleet. Depending on what those exposures look like, they create opportunities for beneficial trades for a commercial team within a trading shop. My perspective at Terraform Power, I think it’s more fair to describe our commercial desk as an asset management and hedging shop, as opposed to a proper speculative trading shop. Our real main focus is to secure our revenues in the future.

SPEAKER B

So how far out are you able to hedge or are they willing to let you hedge?

SPEAKER D

Well, that’s a good point because the main importance of the PPA we're discussing is that it will allow you to go much further than any open market. You’ll sign a PPA, it will be usually 15 to 20 years. If I’m going on an open financial market, it’s going to be extremely difficult to find liquidity past, let’s say, three years. Even still, those prices are going to be volatile all the time. The PPA is going to be the foundation. But even after that point, you’re still going to be left open in certain ways. You could try to work around that in contract terms, but ultimately you’re going to be left with some sort of book of exposures. That’s where a trader can come in, and one specific product that a trader can work with to deal with this basis example we talked about, without getting into too much detail, is something called an FTR, financial transmission rate. You can pretty much go to the market and purchase the right to flow power in the future. You can purchase what that basis will be like for the next two years at a maximum. So we’re not hedging on this financial product, this power product, past two years. But still, there are ways to deal with these open exposures outside of contract terms and even outside of financial markets where you might be able to trade.

SPEAKER B

I mean, we get the others involved too. But where do you draw the line between knowing what you’re hedging and seeing an opportunity and speculating? Do they know what you’re doing enough to tell?

SPEAKER D

I hope so.

SPEAKER B

I mean, they’re not out here looking.

SPEAKER D

At you, but it’s an opportunity. Our shop is not specifically opportunistic. It will depend on the company and their goals. A lot of development companies, speaking generally, less applicable to my current one, honestly, will focus on hedging so that they can develop. They want to sign PPAs so that they can develop more projects and sign more PPAs, working on operating assets. A little bit different because we are trying to really focus on operational commercial excellence going forward. But the opportunistic stuff really happens more in hedge funds and prop shops and speculative shops as well.

SPEAKER B

James, maybe a less complicated structure that you’re normally talking to people who are in the business of producing grains or other agricultural commodities. It’s maybe a little simpler in concept, but talk a little bit about an example or two. What about the current market with the volatility and other aspects of what’s going on? Are you seeing anything interesting that our participants might be interested in?

SPEAKER C

I think in the ag world, it can be simple, but it can be complicated as well. There can be some sophistication in the space, for sure. It could be as simple as trying to hedge out a biofuels facility, buying the inputs, be it corn or soybean oil, into the facility, or other vegetable oils and selling out the derivatives on the back end, or the outputs, be it ethanol, or gasoline as hedges, or glycerin, or biodiesel, or now renewable diesel in different processes. It could be the other derivatives, soybean meal, locking in that asset return, or locking in an operating return or an equity return for that business. There could be some nominal speculation around that in physical spaces or financial spaces as well. The volatility doesn’t make it easy. I talked earlier today about cocoa markets and wheat markets. If you’re trying to hedge, let’s take wheat for example. There’s not a simple global benchmark for wheat pricing globally. If you’re buying wheat in Russia originating to export out of the Black Sea, there are some instruments out there in the physical market, there are some instruments in the financial market, but they’re not perfect hedges. The same thing if you’re buying wheat in Canada and you’re trying to export that. There are certain hedges that have correlation that are close to use as a good hedge product into different exchange instruments, but it’s not a perfect hedge. So that can create problems and dislocations. There are liquidity concerns. I think thinking about this panel and things about how you adjust the markets and different hedging strategies, they evolve over time. They’re not static. They start initially with what are the goals of the business? I’ve been involved in a variety of businesses in my career. I’ve seen different things. At Louis Dreyfus, I gave the biofuels example because I was part of it. When the RFS went in place, the renewable fuel standard, we had to take facilities, Greenfield to them, build them out and think about how we hedged before the facility even gets built, and crush out the soybean plant and lock in the crush for the ethanol plants. We did it with physical instruments, financial instruments, we did it with crude oil, heating oil, gasoline, all the derivatives, natural gas for the operation of the plants. We did it with swaps, we did it with futures, we did it in physical markets. That evolved over time. I’ve set up businesses at Freepoint Ag team, and the setup was what does the business want? What do the equity owners of this business want?

SPEAKER B

So you help them draft a corporate policy on hedging so that the hedger knows exactly what his limits are and how he’s supposed to be evaluated?

SPEAKER C

Yeah, and that’s where the volatility is definitely a big concern. How much risk-reward appetite does the ultimate owner of the business have? What type of business flows are there? What are the goals? Then you sit down with the owners of that business and say, okay, here’s the risk plan for the opportunity set, and here’s the risk policy to go along with that. I’ve seen that at every stage of my career. Now currently at Greenfield

, we did that. It’s like what do we want out of a physical business with financial hedging and trading as well, with an export business being built in New Orleans, with an inland business with a trading team in Denver, and set the risk policy and the governance around that. That’s required to manage through the volatility and then have that discussion through to our owners, but also to our banks and everybody in the business that’s out there supporting the business. So there’s a lot to it. The ag piece can be very simple, but it can be as complicated as any other space.

SPEAKER B

Here’s an example that I kept running across with these multinationals. Let’s say they need to buy copper, and they’re making cars or something like that. If the copper price goes up, obviously it’s going to cost more to produce the car, and how quickly can they reprice the car? So how far out do you have to go to hedge? It really is a function of how quickly you can reprice and offset the movement of the commodity or whatever you’re seeing. So let’s say that the guy is given the ability to go out and hedge that purchase a couple of quarters out beyond, and then subsequently the price goes down and he’s losing money on the hedge, but the company is actually going to make money because they’re going to be able to buy the commodity cheaper. Are they going to beat up on the trader? Do you think the hedge policies are clear on this? Because the poor guy has done a good job locking in something, but now it’s losing money because the company is going to make more money, but they’re going to mark-to-market the hedge right now as a loss, and the gain is going to come later on when they buy the commodity cheaper.

SPEAKER C

I don’t know so much about the copper space, but we had exactly that example, but in a positive way, on that biofuel example I gave at Louis Dreyfus, where we hedged out the facilities and we had gains on all those hedges before those plants were ever built. So it was a big question internally about what do we do in terms of how we account for that properly, the treatment of that, making sure that people didn’t think they were heroes because they’re great traders. We did it to lock in the asset returns of that business and ultimately equity returns for the parent organization and the family. So there were a lot of debates internally between the traders and financiers, the CFO, and tax people throughout the organization about what to do with that. It was complicated. I think the right things were done, fortunately.

SPEAKER B

Well, turn the mic. Go ahead.

SPEAKER F

If I can just comment on that too. We see this all the time in the risk management space because of the classic risk manager’s dilemma. You put on your hedges, and the market goes against the hedges, and everyone asks, well, why did you lock in those prices? We’re giving up so much upside here. But the opposite could have happened, right? We’ve seen many cases where that did happen. When we saw the war in Ukraine and the global gas shortage, we saw the prices go through the roof, and that rippled all the way through power markets as far as California. It was global. Organizations that did have those hedges on, that was one of the times where they could point to their hedge book and say, look, it could have been a lot worse. So the risk manager’s in a position where if it looks like they’re giving up upside, if you mark those trades early, it can look like you’re losing money, when in fact you have stabilized the cash flows. But you only ever have one realization of prices.

SPEAKER B

Well, and if the hedge is losing money, it’s because the company is actually gaining money on its future access to what is being hedged. Nate, you’ve been a trader of commodities, and you're running a trade finance fund right now. You had some ideas on asymmetric hedges and some more complex stuff that’s maybe illustrative of what’s out there in the market now, given all the different hedging tools that are available. Maybe you can. You’re the quiet one so far.

SPEAKER E

Yeah, I mean, when you look at a hedge, I’ll just talk high level first before answering the question directly. A hedge ultimately is really a mitigation of risk. It doesn’t necessarily mean hedging in the futures markets or in the financial markets. The core of a hedge and the way we think about it is really just looking at our exposure on a portfolio basis or even on an individual basis, trying to look at the risks that we have and figuring out what we can hedge out, what we can’t hedge out. A big component of hedging also is like ultimately you’re going to be taking that hedge or offlaying that risk on someone else. They may very well charge you an arm and a leg to do that, depending on how far out it is, if it’s hedgeable itself with a futures contract, which maybe you can do yourself. Those are the things that we think about. When I look at the market high level right now, especially in the commodities markets, tail risks are all too common. You look at the markets right now, cocoa’s up about 125% year-to-date. You look at palladium, that’s down 16%, lumber is down 10%. There’s a lot of volatility within it. If you look at commodities, as a rule of thumb, they’re generally between one and a half to two times as volatile as the stock market overall. If you look at the GSCI, commodities are not a buy and hold asset class like the stock market or like equities are. Over the last ten years, the GSCI has been down roughly 3% if you were to buy and hold it. But there’s a lot of volatility up and down along the way. When we speak to customers or corporates, those are the arguments that they have to make when they put on a hedge. They might say, wow, you’re down $40 million on the hedge. What did you screw up? It’s not that we screwed up. It’s that we put the hedge on exactly as we should have. That’s the reality of what hedging is all about. When I think about asymmetric risks and things like that that we have to hedge and that we look at, I can think back to an example that I had back when I worked for Ray Dalio over at Bridgewater. We were approached by Kentucky Fried Chicken, and they were experiencing a lot of P&L swings for chicken prices. All of us in financial markets know that there are no chicken futures that you can hedge with. Talking to Ray, I’m like, Ray, what do we do? The idea behind that is we provide some consultation to them, and then hopefully they'll invest through the corporate pension and Bridgewater Associates in the fund, kind of a consultative relationship. Ultimately, we tried to distill out the ultimate cost for KFC of a chicken. At the end of the day, it’s what they feed the chicken that is the core cost. We ended up coming up with a program where the majority of the feed that goes into that chicken is corn. If I remember correctly, it was around 85% of it. The rest of it was soybean meal. We were able to come up with an esoteric way to hedge those chicken prices. When I think about trade finance and the risks that we try to hedge against, I think about a vessel going through the Red Sea. How do you hedge against that? Your marine cargo policy may or may not cover an attack. It’s really looking at the minutiae and figuring out whether it’s worth hedging or making the vessel go around with the added fuel cost, go around the southern coast of Africa. That might be more profitable for us rather than pay those higher costs to someone else to hedge it out. Those are the high-level things that we look at. A lot of times, if you think creatively about counterparty exposure, there are ways in the market through things like a letter of credit where you’re getting a bank to pay for something on behalf of a corporate client that you have no idea what the credit of them and if they’re going to ultimately pay you back. Doing things like that and being creative and talking to your advisors, there are some really creative hedges that one can put on to offload your risks that are not too costly to do. Those are the things one needs to focus on because a lot of people play in markets and know how to sell a futures contract against a physical.

SPEAKER B

Are you seeing more creativity these days than you used to? Or is the volatility shrinking some of the options you’re looking at?

SPEAKER E

So a lot of that stems from profitability. If you’re going into a trade and you have an embedded edge of 12% or something that you’re going to make over 60 to 70 days, the hedges and the volatility and things like that, you can say half the time we’re going to make money, half the time we’re going to lose money, and let’s just not hedge it. But when the profit margins are thinner and you want to lock it in, you don’t want to turn a winner into a loser, that’s when you see a lot of it. It’s hard to generalize about commodities as a whole. It’s going to depend on the market and that sub-niche of the volatility and views on it. But at the end of the day, when you hedge, most of the time you’re going to be taking a bet on something. There are things that you can hedge and things that you can’t hedge

, and you just have to recognize that you have to trust people that are hedging and set up an appropriate risk budget and process for how and what to hedge. But at the end of the day, there’s risk in that as well.

SPEAKER D

And I’ll just add, you were talking a lot before, and I might have been struggling to answer what really makes a good hedger, a good trader. Working within all these boxes we’ve described so far, being able to work creatively is a major factor. Every hedge, every trade is a bet to a certain extent. Depending on the organization, those are trades and hedges that are made within some sort of structure. I work in particularly esoteric products, power, and there’s a lot of complexity there. It creates opportunities to think outside of the box and come up with new solutions. Personally, that’s what I find most enjoyable about the space I’m in. In my experience, it’s been very beneficial for the growth of people within the space.

SPEAKER B

Any comments from you out there in the audience about your perception of how things have changed with the current markets, just from trying to implement a hedge? Do I have any of my friends? I can’t see everyone here from ADM who might want to comment on whether the opportunity sets expanded or declined with the volatility in the market or current conditions.

SPEAKER G

If you like, I’ll share an old story, something along the lines of what Nate was talking about. Maybe everybody will be at least amused by it. This goes back a ways.

SPEAKER B

Is there a microphone here? Make sure everybody can hear your wonderful logic.

SPEAKER G

Is that better?

SPEAKER B

Yeah, perfect.

SPEAKER G

Okay, great. This goes back a long time. As I was saying, it’s along the lines of what Nate was talking about. On paper, it was a simple hedge.

SPEAKER B

We had put the microphone, a Texas-based company who shall go unnamed, wanting to sell their natural gas production forward. But they wanted to sell it forward for a decade. The term structure of the futures market and any other damn thing that we could find really didn’t have an appropriate mechanism to house that duration. There’s just no way to do it. It was a messy question. We nevertheless engaged. What happened was it took almost a year to structure it, an intermediary of a law firm in Houston. What we actually did was deconstruct the problem, think about what was happening, and ask where the natural buyer for this product over that duration was. After thinking about it, the answer was quite simple. There are investors, if we could only assemble them in a room, who would give anything to have a ten-year lock at a fixed price on natural gas because, for their portfolios, that was wonderful. We created, in essence, what you might call an OTC swap with a ten-year duration. On one side were the speculators, investors who wanted to own ten years of natural gas risk, and on the other side was this power company.

SPEAKER B

Interesting.

SPEAKER G

Yeah. That worked out well. One more, and then I’ll stop. In a different situation, we had to hedge bunker fuel, the stuff that runs the big ships out on the ocean. The only way that they were comfortable doing it was with crude oil, which is sort of silly for 100 reasons. All the basis risks in the ports don’t match at all. It’s horrible. They had a brilliant statistician. What he did was he looked at an r-squared that was totally inappropriate for hedging, and he reduced it to small packets, little structures of time. He found that they had fabulous domain knowledge about when, where, and why crude correlated or decorrelated with bunker fuel. He represented to his board and said, you can’t do this as a vanilla hedge. You can do it at certain times because there are mean-reverting aspects here when it’s an actually compelling opportunity and there’s P&L in the hedge. That’s how we solved that one. It goes on and on. You need to understand what both sides are. I should return this to you.

SPEAKER B

Okay. I like your creative approach. Maybe there’s somebody else with a good idea. Anybody else with any thoughts or questions about a hedge that you’re thinking of putting on that might relate? Thanks.

SPEAKER H

I’m kind of helping put together our energy hedging strategy. Basically, we have a consumer of natural gas. I’m in the middle because we’ve got treasury wanting to do hedges systematically to come up with an average price. Then we’ve got commercial who argues that if we do that, they lose control over the costs. In that situation, what would your recommendation be?

SPEAKER B

We have the consultant here.

SPEAKER C

I’m going to defer to the energy experts here.

SPEAKER D

Natural gas is a tough market, and it’s a vague question. It’s really reliant on what the goal of the company is to a large extent. Are you planning to make money around the volatility in natural gas? If not, then you might not want to expose yourself to that volatility. From my perspective, natural gas specifically is a really important product. You look just in the past couple of years in the United States, you look in Europe, there’s a lot of volatility there. It’s hard to speculate what that’s going to look like, but there are a lot of developments, and it’s a very complex product. There’s a lot to consider there. Are you going to have a whole natural gas shop to work around it? If not, then you might want to reconsider how much you expose yourself to it.

SPEAKER E

I’ll just chime in. In my own experience with natural gas, I would definitely lean on your coverage people like Neil, etc. It’s very easy from a trading perspective to back into guaranteeing you a monthly average using features that already existed. I would recommend speaking to a couple of coverage providers and figuring out what the cost might be to do something like that. It’s something that a lot of people don’t know happens. I know that from the metals markets, you can get a monthly average instead of a June future, a Sep future, a Dec future, etc. The linearity of that, the street has ways of actually pretty cheaply getting you a monthly average. It’s worth exploring that to let you sit easy on that.

SPEAKER H

Thank you.

SPEAKER B

Anybody else have a question out there that we can address? We have plenty of questions here, but… All right, well, yeah, here we go.

SPEAKER I

How has the process changed in the actual discussions or consulting you do with clients? Is there more of a digital component to this now? Are there any RFPs or systems that they use to interact with your companies? Do your companies auto-adjust dynamically based on what’s happening in the markets at the same time? Any insights on the automation of it would be great.

SPEAKER B

Anybody want to go ahead?

SPEAKER F

A lot of our customers, when they are procuring power purchase agreements, we work with a lot of load-serving entities that use long-term PPAs as a hedge against power prices but also against the renewable attributes they’re interested in procuring. A lot of those come in through RFOs, requests for offers. They’ll go out to the market and accept a whole bunch of offers. Sometimes they’ll get back literally hundreds of different permutations of offers that include renewable energy attributes, resource adequacy, all these different components. Sometimes they’ll have one entity that’ll submit ten different options. It may include a battery tolling agreement, 1 may include hub settlements, 1 may include node settlements. So there’s a lot of options to choose the right thing for that off-taker’s portfolio. One of the things we assist a lot of our clients with is making that choice in an intentional way. Viewing the existing portfolio, I think there was a cool underlying theme that came through all the panelists’ responses, which is no hedge is going to be perfect. You’re always going to have a portfolio of residual exposures, and that portfolio of residuals can behave very differently than the individual underlying commodities. So when you’re looking at an RFO, a set of RFO responses, and you’re saying which one is the best for me, you need to take into account the existing state of the portfolio. From an automation standpoint, it becomes really difficult to automate because all these responses are very custom-tailored and they’re all different. They’re not vanilla products in specifically the PPA class. Maybe some of the other panelists can comment on the more commonly traded products, but automation becomes really difficult. Having an existing baseline view of the portfolio to which you can layer on some of these structures becomes an essential component of making that decision.

SPEAKER D

I’d be curious if this is the case in other markets. Speaking specifically from a power perspective, there are a lot of new service providers posting online marketplaces where they are trying to match buyers and sellers. It’s different from an RFP process, but they’re trying to rework how that procurement occurs. One of the developments within that space as well, specifically power, is the standardization of contract terms, complex contracts, and PPAs. One of the developments in the space is that they’re trying to have everybody on the buy and sell side sign the same contract with very small modifications. It’s interesting for me to see within the space. I’d honestly be interested if there are developments in other commodity

fields along the same lines. From an automation and technological standpoint, that’s definitely an interesting development within my space.

SPEAKER E

There’s a lot more price discovery right now. There’s a lot more data out there. A lot of the logic behind that is from an operator who does a lot of different contracts, especially when you’re buying and selling different materials. Your goal of standardizing it is to have a team that checks the contracts but also to feed it into an AI engine and have the computer check it. You don’t want it to not be able to parse the data appropriately. Going forward, there’s a lot more transparency around things, a lot more access to information, and a lot more ease in doing due diligence on tracking vessels and things like that. That used to be a lot harder to do.

SPEAKER B

So are we seeing AI influence some of these hedging opportunities as you’re saying?

SPEAKER E

Yeah, I just spoke to someone today, a client of ours. There are so many ways to do it better by looking at data and scenarios. It’s really, really good at analyzing those types of scenarios and figuring out the tertiary effects. We’re maybe in the second or third inning of it, but it’s really good at analyzing those scenarios and figuring out the tertiary effects of it.

SPEAKER B

Finding out what’s really driving a relationship is just, here’s a correlation, but what’s causing it, what’s underlying it?

SPEAKER E

Numbers are just… When you look at financial models and feed things into a VAR risk model or something like that, the numbers it feeds out are generally, in my opinion, the tails are a lot fatter than that model will tell you. Using AI can tell you if you look at an event like what really did happen and how did that affect assets, not just as an overall VAR number that you shouldn’t lose more than X dollars in a day. You throw that out the window because that gets broken eight times a year when it shouldn’t.

SPEAKER B

So you’re telling us the bad news is things are riskier than we think, right?

SPEAKER E

Well, riskier. I think the option markets are pricing that accordingly. It used to be you could buy… No one likes to spend money, but you could spend a tick and buy outsized options that were probably unfairly priced. I think you’re seeing the skewness in the tails, at least in the dealers, pricing those is a bit more fair and in line with where the risk really lies.

SPEAKER B

Okay. I’m not sure when we’re supposed to end this panel. I would assume… Pardon, we have a few… Pardon? Now? Okay. Yeah, I thought it was an hour, but I figured somebody would come in and bang on the door. Well, I guess we should end it now. Thank you for attending and thanks to our panel for a great session.