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
track the difference between the actual power cum transmission price at any given time and the futures contracts into which the companies will have entered.
As commercial power companies get accustomed to paper markets, they will gain confidence to trade power further into the future. In this way, supply and demand balances will emerge on the NYMEX for as many as five years into the future, providing an "offer curve" similar in scope - if not in shape - to the ones now available for oil and gas.
Here is a key question for the first cohort of market makers: Will the power "offer curve" appear in contango or in backwardation? (See Figure 2.)
In contango, the direction of prices in a futures market slopes upward, indicating that prompt (or immediate) prices stand lower than futures prices. In backwardation, the price line slopes downward as contract delivery is postponed, meaning that prompt prices stand higher than futures prices. The crude oil market is typically in contango, except in times of crisis, such as the initial months of the Iraqi invasion of Kuwait. The power market could be typically in backwardation, given the uncertain consequences of deregulation.4
Another important dynamic will bear watching: the structures of supply and demand. True, supply and demand should always be in balance. But in order to better understand the pricing dynamics of the futures market, one must appreciate the degree to which the capacity of the power sector to supply product will chronically exceed typical demand. This understanding has proven especially critical for markets like oil, where low-cost producers deliberately and voluntarily underproduce for the sake of pursuing monopoly rents. In the power sector - where low-cost producers have been kept from natural markets by regulation - the issue of capability to supply will determine the weight of downward pressure on prices.
Taken together, these ideas underlie the theory that commodity paper markets operate as
"rent-destroyers." As mentioned earlier, the margin between the cost of electric power and the principal generating fuels has been rising steadily since 1980. In other words, electric power prices have failed to reflect the price deflation seen since 1980 for oil, coal, and natural gas. This growing "crack" between power prices and prices for power's "raw material" looms as a rent that the commoditization of electricity will attack and, in all likelihood, destroy.
When examined under a basic economic framework - with typical supply-and-demand curves intersecting at an equilibrium price - paper power markets will exhibit the same characteristics as do other, more traditional markets, but with a different terminology: The willingness to supply being called "short"; the willingness to buy termed "long." Paper traders affect the market by adding either to supply (i.e., they go short) or demand (going long). As in physical markets, one can track structural changes in paper markets (such as how much product a buyer or seller will offer to trade at a given price) by charting movements along the supply (short) or demand (long) curves in the traditional supply-and-demand curve.