A New Index Prices the Market
California, Oregon, and Nevada have developed a regional response to pricing transparency.
The electric utility industry has turned the corner away from monopoly regulation and into the competitive marketplace. No big surprise. Since the late 1970s, consumers have faced increasing sticker shock. In addition, customers want the same choices over electricity purchases that they have with other products. OK, so how do you disassemble a vertically integrated utility system where access to information product and price is tightly controlled? The answer: Carefully! You
begin by developing independence, comparability, and pricing transparency.
For one group of power marketers, municipal utilities, federal power agencies, and investor-owned utilities (em 18 players in all (em the answer to price transparency comes through the development and distribution of a market price index. These market participants who collaborated on the index represent one-third of the generation in the region. The index will enable electricity to be traded like a commodity, as are corn, oil, and natural gas. This effort should result in a more efficient market and better use of generation resources as well as the development of risk-management tools. The index will be based on the prices and quantities contained in actual transactions and will be published by Dow Jones beginning in March 1995.
What is it For?
Market price indices are indicators of the dynamics of a specific market. Common examples of market price indices include the Dow Jones Industrial Average and Standard and Poors 500. As the natural gas market was deregulated, dozens of publications developed countless price indices that reflected the market at almost every transaction point in the United States and Canada.
Generally, market price indices allow market participants to explicitly view the market price for a particular commodity. They also provide market information for current and future decisionmaking. Players in the spot market can then decide what price levels they should buy or sell at. In the electricity market, indices will promote economic efficiency, including optimal dispatch of resources.
Market indices also allow participants to understand the external variables that impact the market over a period of time. On the West Coast, some of the main factors affecting the electricity market are weather, gas prices, nuclear generating unit availability, and Northwest and California hydroelectric availability. By understanding how such factors affect the electricity market, participants can assess its future direction using their own forecasts.
Eventually, many transactions will be explicitly tied to the value of market indices. For example, a buyer and seller may agree months ahead of time to a transaction with a pricing scheme described as the value of the index plus 2 mills per kilowatt-hour. This type of pricing mechanism will assure both parties that their deal will reflect market conditions at the time the transaction actually occurs.
As has been the case for other commodities, electric market indices will also facilitate the development of financial risk-management instruments that create unlimited customer choices. The proposed indices will allow financial markets to build an infinite array of risk-management tools. These tools will allow all market participants to shift many purchase