Nowhere are the failings of traditional utility regulation more evident than on Long Island. The New York Public Service Commission (PSC) has raised rates for the Long Island Lighting Co. (LILCO)...
A Milestone Year: Power in the Commodity Markets
taken as a model, we can anticipate that a substantial "paper" power market will develop within two years of the NYMEX March 29 opening. In this context, the term "substantial" refers to the ratio of daily trading volume to physical market consumption. In oil, the combined crude oil and petroleum product futures market trading volumes amount to about 20 days of U.S. consumption. For natural gas, average daily futures trading volume represents about 5 days of physical consumption. With derivative transactions added, the trade volume approximately doubles that of exchange-traded markets.3
If the power futures market does grow as rapidly as anticipated, the key market segments - and the financial strategies likely to be affected by the use of paper transactions - will develop along new lines:
s Hedging vs. Investment. The market will divide to absorb two sets of traders: 1) those companies seeking to use it primarily for hedging purposes - the so-called "commercials," in the terminology of the Commodity Futures Trading Commission (CFTC) - and 2) those seeking to use futures for investment - the so-called "noncommercials" in CFTC argot.
s Speculator Entry. Paper power-market instruments -
particularly the NYMEX contract - will evolve into a convenient vehicle for financial speculators
to use to participate in power
markets. As a result, speculators will routinely add significant paper volumes to physical power demand and supply.
s Benchmark Pricing. With the introduction of power futures contracts, new relationships will develop among three sets of prices: futures, the physical market, and the panoply of regulated prices. In time, the daily volume of paper power trading in the United States will exceed that of physical power trading. As a consequence, paper power prices will come to be regarded as the benchmark prices for power sales.
s New Production. The reduction of interregional transmission "tariffs" (in the trade theory sense of the term) will make it easier for hitherto suppressed low-cost power to find a market. This development will boost the effective power "producibility" in the United States and North America.
s Spare Capacity. The production described above, when coupled with the introduction of power futures trading, will form the building blocks of a market structure capable of optimizing regional and national power capacity and overall use of the transmission grid.
The "transactional dynamics" of power markets will prove entirely different in the regulated and unregulated markets.
In regulated markets, transactions will move forward with bundled command-and-control rates. Thus, utilities will continue to deploy considerable management resources to obtain the favor of regulators. In the unregulated markets, however, intense competition will develop in power production and in gaining access to transmission. This competition will create two sets of market prices - one set of prices at the "power producer gate," including a very influential set of futures prices at the NYMEX settlement area(s), and a second set of prices at the "distribution gate." Both sets of prices will fluctuate constantly, leaving producers, consumers, transmission companies, and investor/speculators with shifting opportunities for financial gains and losses. These gains and losses will