GOLD FINANCIAL RISK MANAGEMENT WINNER………Timing, it is said, is everything in life. Certainly, that was true for General Electric Co. when it decided in 2005 to develop a Web-based natural gas hedging simulator to tighten its portfolio hedging strategy and allow the business units to better manage their price risk to the volatile natural gas market. The GE hedging simulator went "live" in the fourth quarter of 2005–a period, it turned out, of the kind of extreme price and supply instability the new system was designed to mitigate. In the final four months of that year, daily U.S. production of natural gas fell to a 12-year low of 49.8 billion cubic feet, because of damage to facilities from hurricanes, while spot prices more than doubled from December 2004 to December 2005, to $15.38, only to plummet back to earth seven months later.
To be sure, even before the onslaught of hurricanes, the natural gas market was already wrestling with the pressures from a flood of real demand from emerging economies and speculation by investors. "We, along with everyone else in the market, were experiencing tremendous volatility in natural gas prices," says David Rusate, GE's deputy treasurer of foreign exchange and commodities. "And [given] that increased volatility, we wanted to put more rigor around our risk management approach."
When GE decided to pump up its FRM technology, Rusate and his team, which included Maryann Vando, manager of commodity risk, and Jim Leddy, senior manager of technical accounting, first looked at the online tools used by GE's banking counterparts, but none met GE's requirements. So, Rusate and Vando went up to GE's global research and development center in Schenectady, N.Y., and outlined the mission: GE's primary objective was risk avoidance. "They're rocket scientists up there, and they developed this arithmetic simulator and were able to map out all the different types of scenarios and then plug in the tools that we would use," says Rusate.
Recommended For You
To hedge its exposure, GE employs a portfolio approach, relying on SWAPs, call options and limit orders. It also uses OCO ("one cancels the other") limit orders: If natural gas is trading at $8 and GE has a purchase limit order at $8.25, it can also leave an OCO for $7.75. But "if the market goes to $8.25 first," says Rusate, "you're out of luck."
With the Web-based simulator, business unit managers can now test scenarios on their own without having to call on Vando. This allows Vando to concentrate on tweaking the company's hedging strategies for natural gas and the other 30 commodities she manages.
Still, no project is ever a slam-dunk. There was a measure of "selling" the value of the simulator since there was a cost involved in building it and getting it up and running. But the benefits of having better data available to the business units were clear, given that a 5% movement in natural gas prices costs GE roughly $10 million.
The simulator is accessed through GE's intranet. "[The businesses] can know that if they're hedging their exposure with 50% options and 50% forward contracts, here is what my option cost is going to be [and] here is how much deflation I [will] achieve if prices drop 10% or 20% or 30%," says Rusate.
It can be adapted to hedge other commodities–like copper, which has jumped to $4, from 72 cents, in three years. "We still need historical data on pricing for metals and the other commodities," says Vando, but the key algorithms are the same. More importantly, the simulator has reaffirmed GE's portfolio approach. "Imagine if you were running a business and your cycle for hedging natural gas hit when prices were at $15 and you hedged with a forward contract at $15 and now prices are at $4?" says Rusate. "You'd be at a severe competitive disadvantage."
© 2025 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.
