Power contracts take shape under variable conditions

Dana Bacciocco, Associate Editor

“With electricity, whatever you think you’re going to need, you’re going to be wrong,” according to Dr. Anil Suri, CEO of E-lecTrade Inc. Although being in the forward market is the best strategy, companies will no doubt at some point be called or forced into the spot market.

For utilities, trading in the marketplace is essentially a form of resource and capacity management. However, in the past utilities tended to basically give away options without understanding their portfolios. Widespread trading provides opportunity and obstacles for participants, especially because of the unique nature of the commodity: electricity cannot be stored; utilities are always on-further complicated by fluctuating usage levels. The drive for power contract standardization can help facilitate trading, to a degree, but is not the answer to portfolio management.

While portfolio management is maturing, utilities need to take another look at the shape of electricity usage-daily volume, off-peak and peak usage make great swings. Managing usage on the spot market is a challenge. That’s why utilities need to be on the forward market, said Dr. Suri.

Electricity is electricity-as long as it is delivered to the location, it doesn’t matter who supplies it. However, different entities have different shaped pieces they’re willing to sell or buy. While electronic marketplaces can provide a neutral marketplace and expedite trading, they may need to go the extra step in providing for a level of portfolio management and a means for trading non-uniform pieces. This concept is juxtaposed with the trend toward contract standardization.

In the spot or forward market, decisions to buy or sell shaped pieces should depend on accurate and immediate portfolio analysis. Suri said that practically 90 percent of market participants do not have the tools and cannot afford financial consultants or a large investment in sophisticated risk management tools. But their problem is competing with the big players. Suri created the E-lecTrade platform to address the nonstandard, shaped market with tools for use in managing portfolios and managing risk down as companies enter the spot market.

While there is an effort to standardize contract terms, volume and price components, by necessity, remain nonstandard, said Suri. But standardization is important since it clarifies terms and conditions of contracts, he added. It has been significant driver in the development of block trading in the electricity industry. But it still leaves managing variations in generation and load to the spot market or contract market, or relegates a potential trade to a request for proposal. Standardization is still sensible, he said. The hang-up is what used to be free options-contracts in which companies increase draw without paying a penalty or premium.

Getting framed

The level of interest in power contract standardization is growing, according to Andrew Katz, director industry legal affairs at EEI. Since April 2000, Edison Electric Institute’s (EEI) Standardized Master Power Purchase & Sale Agreement “Master Contract” has been available for use by companies as the new standard master agreement for wholesale power transactions. While EEI continues to collect information from contract users and facilitate use, they maintain that full benefits of the master contract will come from wide usage.

While it’s not a financial derivatives contract, the master contract is used for cash market, forward transactions, i.e. physical forward sales and purchases of electricity in bulk. The contract is also being adapted by others like the California Department of Water Resources who is using it as a starting point for negotiations with power suppliers.

Although there are other types of agreements that are favored in some markets, such as the Western Systems Power Pool Agreement, generally the EEI master contract is favored to become the preferred standard, especially since it creates a common documentation infrastructure for contract administration and more importantly for its credit risk management provisions.

“There is the desire for uniformity-knowing that the risk apportionment that applies to any individual transaction is the same,” Katz said. “In multiple daisy-chain transactions, for instance, the risks a company is assuming and then passing on in the chain are basically subject to the same underlying legal and credit terms,” he added.

Most electronic energy exchanges do not back up trades, so there is a need for some kind of agreement to provide credit protection for counterparts meeting in the exchanges. EEI is also working on a variety of supplemental provisions, including one for trading on electronic exchanges. Use of a master contract supplements the electronic trading exchange agreement that is required by the platform provider, which is a separate document.

The working group has also recognized new market situations that warrant other supplemental provisions, including region-specific product definitions, and these will be posted on EEI’s Web site later this year (http://www.eei.org/issues/). However, the intent is to keep the base terms and conditions of the original document (April 2000 version) intact for the foreseeable future.

Suri can be reached at aksuri@e-lectrade. com. Katz can be reached at AKatz@eei.org.

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