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A Milestone Year: Power in the Commodity Markets

Fortnightly Magazine - May 15 1996

and out of each of these investment groupings. In addition, as Figure 4 indicates, evidence suggests that speculator money flows under the care of professional management, rather than haphazardly among asset classes. By some estimates, the amount of money invested in "Managed Futures Accounts" and in "Hedge Funds" has increased from zero to about $30 billion in the United States alone over the past decade.6

Speculators typically take a rather large position in the crude oil and gasoline futures markets - by certain estimates, some 25 percent of the total open interest positions in crude oil, and 18 percent of natural gas, at the end of the third quarter of 1995.7 One can expect that speculators will assume the same role in the emergent paper markets for electric power. And the depth of commercial versus investor/speculator participation in the futures markets will likely exert a significant effect on electricity price volatility, as well as on the ability of large investors to dominate short-term pricing.

Market Makers:

Patterns and Similarities

The commodity market for electric power should demonstrate similarities to that of other fuels and forms of energy.

For reference, one of the peculiarities of the oil futures market comes from the relatively small number of large institutional end users of finished products. The bulk of U.S. oil consumption lies in transportation, where consumers exhibit an exceptionally small per-unit exposure to the price of fuel. Of course, consumers do not remain indifferent to gasoline prices - efforts to boost gasoline taxes often run headlong into strong public opposition - but they don't generally hedge the market. By contrast, while the proportion of petroleum product consumption by large institutions is relatively small, their financial statements indicate a general awareness of fuel-hedging possibilities and a widespread

propensity to use the futures market to hedge part of the fuel-cost exposure.

This example suggests that, in the power sector, large industrial customers will exploit their purchasing power to maximum effect both in the physical and paper markets. Other organized bulk buyers, such as municipals and cooperatives, will learn to do the same. Utilities themselves, one must assume, will also enter the commodity markets to hedge fuels, purchased-power contracts, or contracts for differences. And, residential and commercial customers will remain least likely to seek hedging vehicles unless, as some analysts predict, municipalization or other aggregations take place in response to the perception of an uneven distribution of benefits from utility restructuring.

In sum, the prognosis points to a far more complex market for electricity than that which has governed supply and demand during the last near-century of regulation. Power prices will become more volatile, but also more reflective of actual market conditions, and will, on average, be lower than they are today. As the pace of deregulation accelerates, both the physical and the paper power markets will grow, perhaps to dominate the commodity market itself. t

Edward Krapels and Vito Stagliano are directors of Energy Security Analysis, Inc. (ESAI), an energy/

economic consulting firm based in Washington, DC.

Electric Power Futures

Geographic Loci

. COB & Palo Verde.