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A Milestone Year: Power in the Commodity Markets

Fortnightly Magazine - May 15 1996

Two contracts, each providing for the delivery of 736 Mwh over a one-month period. One contract (COB) sets delivery at the California/Oregon border; the other (PV) is based at the Palo Verde switchyard in Arizona.

. PJM. NYMEX is actively consider in another contract with delivery on the East coast, most probably within the territory of the PJM (Pennsylvania-New Jersey-Maryland) Interconnection. Whether three distinct delivery contracts can remain viable in the long-term remains unknown. The market will likely dictate which of the contracts, if any, will emerge dominant.

Terms and Conditions

. Quantity. Power is delivered at a rate 2 Mw throughout every hour of the delivery period, defined as the 16 onpeak hours between 0600 and 2200.

. Price. Prices are quoted in dollars and cents per Mwh, with a minimum price fluctuation of one cent, and a maximum daily price movement of $3/Mwh. However, these limits can expand when the contract settles at its limit, meaning that, during period of extremely large price movements, the NYMEX can authorize an increase in the maximum price fluctuation beyond the nominal $3 limit.1 Energy Information Administration: 1994 Annual Energy Review. Composite prices include those for oil, coal, anthracite, and gas, in real 1987 cents.

2 The Wall Street Journal, April 1, 1996.

3 ESAI has studied oil and gas derivative volumes from information presented in annual reports from oil producers, refiners, and consumers. These studies indicate that the derivatives market may run approximately five to 10 times larger than the Exchange-traded futures market.

4 Various schools of thought vie on what is the "normal" price structure of a commodity. John Maynard Keynes thought that contango should dominate, because speculators require a large risk premium to take the long positions in the prompt months of the futures markets. Another view states that backwardation should rule because the "convenience yield" of oil is so great. For a good general discussion of the oil offer curve, see Jacques Gabillon, "Analyzing the Forward Curve," Managing Energy Price Risk (Risk Publications, London, 1995).

5 In the oil market, the CFTC defines noncommercials as nonhedgers holding more than 300 contracts.

6 A great deal of uncertainty persists about the total amount of investment money managed by hedge funds. By their very nature, these hedge funds do not fall subject to close regulatory scrutiny, nor do they publish their returns.

7 Author's estimates, based on CFTC Commitment of Traders Data.

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