Trading on the Index: Spot Markets and Price Spreads in the Western Interconnection
Using cash and futures markets, traders can tie contracts to a price index.
But which one?
And how to adjust for different delivery points?FOR THE PAST 20 YEARS, THE WESTERN
Systems Coordinating Council (WSCC) has built a reputation for innovation in electric markets. Today, with members in the United States, Canada, and Mexico that serve customers from the Pacific Ocean to the Plains states, and with over 140,000 megawatts (Mw) of generation and transmission stretched across three countries, the WSCC continues to lead change in power markets.
Transparent pricing has become a reality throughout the region.
Last year the Pacific Northwest subregion of the WSSC counted eight large (50 megawatts or more) industrial contracts with spot pricing. Puget Sound Power and Light recently proposed to shift all of its major customers to spot pricing when its current merger proceeding closes. The New York Mercantile Exchange (NYMEX) offers futures trading at Palo Verde and the California/Oregon border (COB). Alberta's new power pool adds a third market-price indicator. Soon we may see spot pricing for bulk power throughout the Western Power Exchange (WEPEX). This growing emphasis on spot pricing turns attention to pricing mechanics.
In one sense, spot pricing is nothing new. Commodity contracts have often included a spot-pricing component. For example, many utility contracts employed stack-pricing components during the 1980s. "Stack pricing" (also known as system lambda or real-time pricing) became more common during the 1980s. But many stack-pricing contracts proved difficult to administer. Sharp turns in the market often required an audit of the mathematics of the stack-pricing calculations (em an unpleasant task for both seller and buyer.
What's new, however, is the reliance on external indices. In markets such as primary metals, chemicals, and fuels, commodities are often priced with reference to an external market or market survey. (Metals Week, for example, is often cited in metals contracts and energy contracts that serve the metals industry.) Electricity will now join the list of markets with contracts pegged to external price indices.
So the real question is not spot pricing, but which index to use.
In electricity, the arrival of NYMEX has encouraged the use of indices based at COB. Nevertheless, for a number of reasons, COB does not make for a very good market for industrial contracts north of California. Other providers have introduced pricing indices (em some good and some poor. Each offers its own advantages and applications, but questions remain.
How can traders index their purchases to an impartial source of market data? How can they choose among the available indices? What adjustments should they make if a price index is geographically distant or applies to slightly different products than the contract commodity?
Markets, Surveys, and Geography
Indices fall into two major groups: market-based and survey-based. At the moment, power traders in the WSSC can turn to only three market-based indices: the Alberta Power Pool, and NYMEX's COB and Palo Verde indices. Prices at the Alberta Power Pool accurately reflect the entire market in the province; unfortunately, however, Alberta lies at the extreme edge of the WSCC. The NYMEX