Hedging is a risk management strategy designed to offset potential losses. The reduction in risk has a cost, which may be paid upfront, or which may be “paid” as a reduction in potential profits. Hedging may be implemented through structuring of physical commitments or through use of financial instruments such as futures, options, and derivatives. Following are common risks in the gas and electric industries with examples of how they might be hedged:

Risk Hedging technique
Price Contract price terms, financial
Basis Contract price terms, financial, financial transmission rights
Volume Contract firmness / take terms,
Weather derivatives
Counterparty Contract terms, internal procedures
Execution Internal procedures
Regulatory Participation in proceedings
Operational Internal procedures, insurance

It is important to note that there is no perfect hedge and that not all risks can be covered.