price. While fixed price contracts reduce the impact of natural gas price volatility, variable or market prices can assist in offering competitive rates depending on the pricing environment. Prior to 2014, SaskEnergy used financial derivatives, primarily natural gas price swaps, to manage the future purchase price of natural gas. The proceeds or costs of settling financial derivatives are recorded as a cost of gas sold and have no impact on inventory cost or sales revenue. Effective July 1, 2014, the company began to use physical swaps as the primary means to manage the future price of natural gas. Physical gas swap settlements, in contrast to financial derivatives, increase reported revenue and inventory cost. As derivative instruments, natural gas contracts are recorded at fair value until the date of settlement. Changes in the fair value of the derivative instruments, driven by changes in future natural gas prices, are recorded in either commodity sales or commodity purchases depending on the specific contract. Upon settlement of the contract, the amount paid or received by SaskEnergy becomes realized and is recorded in commodity sales or purchases. For 2014, fair value adjustments decreased the margin on commodity sales by $83 million as the $21 million unfavourable fair value position at the end of 2013 declined to $104 million at the end of 2014. The decline was attributable to an increase in the differential between the average purchase price and the average market price on outstanding natural gas contracts, meaning the price of the Corporation’s committed future purchase contracts was higher than the year-end market prices. The market value adjustment at the end of 2014 will be unwound through 2015 and 2016 as natural gas contracts are settled and gas is sold to customers at SaskEnergy’s approved commodity rate. The realized margin on commodity sales excludes the impact of unrealized fair value adjustments on derivative instruments, as these adjustments can fluctuate significantly from one period to the next and do not necessarily represent the amount that will be paid upon settlement of the related natural gas contract. On a consolidated basis, the Corporation realized a $9 million margin on commodity sales, with average revenue of $4.20 per GJ and average cost of gas sold of $4.09 per GJ. This compared to an $18 million realized profit in 2013, with average revenue of $3.79 per GJ and average cost of gas sold of $3.48 per GJ. The higher average revenue per GJ was a result of the Corporation’s first commodity rate increase in six years to $4.84 per GJ from $3.82 per GJ. The rate increase, which would normally be effective April 1, was deferred until July 1, 2014 to allow gas prices to stabilize after a volatile winter, thereby providing some rate stability for the Corporation’s customers. The volume of gas sold in the first half of 2014, prior to the commodity rate increase, was higher than normal as a result of the 2014 winter season being 25 per cent colder than normal. A sharp increase in natural gas market prices occurred as a result of strong demand for natural gas, which increased SaskEnergy’s cost of gas sold above the $3.82 per GJ commodity rate that was in place prior to the rate increase. At the same time the Corporation, through its Natural Gas Price Risk Management Strategy, was able to secure a lower average cost of gas sold than what may have been
Natural Gas Sales and Purchases Included within natural gas sales and purchases are rate- regulated commodity sales to distribution customers and non-regulated gas marketing activities. Although presented together within the consolidated financial statements, the Corporation manages these activities as distinct and separate businesses and, as such, the MD&A addresses these natural gas sales and purchases separately. Commodity Sales to Customers SaskEnergy sells natural gas to its distribution customers at a commodity rate approved by Provincial Cabinet based on the recommendations of the Saskatchewan Rate Review Panel (SRRP). The commodity rate, which is reviewed April 1 and November 1 of each year, is determined based on rate- setting principles and is designed to recover the realized costs associated with natural gas sold to distribution customers without earning a profit or incurring a loss over the long-term. For rate-setting purposes, SaskEnergy accumulates differences between the commodity revenue earned and the cost of natural gas sold in a Gas Cost Variance Account (GCVA). The balance in the GCVA, which is not recorded for financial reporting purposes, is either recovered from or refunded to customers as part of future commodity rates. For financial reporting purposes, the Corporation prepares its financial statements on a consolidated basis while applying IFRS. Consequently, the amounts determined for rate- setting purposes are different than those reported within its consolidated financial statements. While a profit or loss is commonly reported in the Corporation’s consolidated financial statements, it should not be taken as indicative of the results recorded within the GCVA. The commodity sales to customers, as reported in the consolidated financial statements, were as follows:
Commodity Margin (millions)
2014
2013
Change
Commodity sales
$ 230
$ 80
$ 310
Commodity purchases
212
89
301
Realized margin on commodity sales
18
(9)
9
Impact of fair value adjustments
27
(110)
(83)
Margin on commodity sales
$ 45
$ (119)
$ (74)
SaskEnergy manages the purchase price of natural gas it buys through its natural gas price risk management program with two objectives in mind — to reduce the volatility of natural gas prices, and to offer rates that are competitive to other utilities. The two objectives naturally oppose each other, and the balance between the two may change depending on market conditions. In order to ensure a secure supply of natural gas, SaskEnergy contracts for the physical delivery of natural gas using non- financial derivatives, referred to as forward or physical natural gas contracts. The purchase price contained in these forward contracts may be fixed, or it may be based on a variable index
27
2014 Annual Report SaskEnergy
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