PALM DESERT, Calif., Oct. 22, 2002 — Seeking to boost liquidity in electric markets and wholesale energy trading, the Edison Electric Institute today unveiled a new Master Netting Agreement, a standardized master contract that will help mitigate credit risk for energy traders.
The new contract will allow trading counterparties to “net” their collateral requirements when making wholesale power trades, and it will offset positive balances of one transaction with negative balances of another.
Netting helps minimize counterparty exposure and capital required to trade, which are essential practices for managing risk and reducing liability when making energy trades.
“This new Master Netting Agreement is an essential tool that will help stem the tide of shrinking liquidity and lack of access to capital markets that our industry now faces,” said Thomas R. Kuhn, president of EEI. “We believe the new contract should help ease the current financial crisis that has been threatening the ability of electric power companies to provide a reliable supply of energy at affordable prices.”
In its simplest form, here’s how “netting” works: If Trader A defaults on obligations to Trader B, and Trader B has separate, offsetting obligations to Trader A, then Trader B is exposed only up to the net amount of the mutual obligations.
For example: If Trader A sells Trader B $1,000 worth of electricity, and Trader B sells $1,500 of electricity to Trader A, under a netting contract, Trader A can simply secure the difference of $500 in the event that Trader B defaults on its obligation.
“This new contract is needed by the electric power industry to reduce credit exposures and increase liquidity for traders,” Kuhn said. “This is especially true now that capital is so costly and difficult to raise.”
The release of the new contract comes at a critical juncture for the industry, Kuhn continued, pointing to the many credit downgrades that electric companies have absorbed, and the accompanying loss of confidence from investors in the sector.
“We believe there is a lot of value in our industry that is not being adequately recognized,” Kuhn said. “Easing the liquidity crisis may help begin to restore some of the confidence that has been lost.”
The EEI president also noted that the new netting contract can help rebuild confidence in wholesale energy trading and markets, which have come under careful scrutiny in the wake of some irregular trading practices.
“A robust wholesale trading function is critical to well-functioning competitive markets,” Kuhn said. “Trading itself promotes liquidity and provides transparency, and it must not fall by the wayside.”
Kuhn also pointed out that the new contract is very complex and contains many optional provisions to address various scenarios that trading entities likely will face. To ensure that potential users are fully aware of important legal issues affecting use of the Mater Netting Agreement, EEI has prepared a document called a “Legal Landscape.” This document, among other things, helps explain how a netting agreement could be affected by bankruptcy and commercial laws as well as other issues to consider when entering into a Master Netting Agreement.
The Master Netting Agreement was developed cooperatively by EEI member companies, major independent energy traders, financial institutions, and law firms. It is a follow-up to an earlier product developed by EEI in 1999, the “Standard Master Power Purchase and Sale Agreement,” which contained payment- netting arrangements for electricity trades.
However, until today, no master contract existed that covered netting transactions between two companies that trade electricity, natural gas and financial instruments. The contract is available without charge, and any user may access it from EEI’s Web site, http://www.eei.org .
Edison Electric Institute (EEI) is the association of United States shareholder-owned electric utilities and industry affiliates and associates worldwide. Its domestic members generate approximately three-quarters of all the electricity generated by electric utilities in the country and serve about 70 percent of all ultimate customers in the nation.
Source: Edison Electric Institute