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Trading on the Index: Spot Markets and Price Spreads in the Western Interconnection

Fortnightly Magazine - October 1 1996

relatively stable relationship to those at COB.

Basis is a relatively simple adjustment, such as: Pacific Northwest = NYMEX COB -.79.

While this adjustment gives a reasonable approximation of prices in the Pacific Northwest, a better model would use linear regression to estimate the relationship. Linear regression has offered a standard tool in utility forecasting and financial managements for many years. Though new to power contracting, linear regression represents a logical step in making price signals to the customer as precise as possible.

The linear regression relationship between NYMEX COB and the Pacific Northwest is: Pacific Northwest=.857 ' NYMEX COB +.837.

This equation provides a more nearly exact approximation of spot prices in the Pacific Northwest, given NYMEX COB prices. The slope (.857) reflects the greater volatility of COB prices as compared to comparable prices in the Pacific Northwest. Simply adjusting the prices on a one-to-one basis tends to overstate the highs and lows in the local geographic market.

The regression approach also accounts for real operating concerns. As mentioned above, the hydroelectric surplus in the Pacific Northwest tends to depress market prices below COB in the spring. A regression arrangement can adjust for this effect by adding an additional term for the months of May and June: Pacific Northwest = 1.237 +.832 ' NYMEX COB -.724 (if May or June).

Is this precision necessary in all cases? The answer depends upon the contract and the objectives of the parties. Most Pacific Northwest parties would like to sell more power during May and June. The approach used in the second regression equation would tend to lower prices in those months and increase sales. This method would prove appropriate in some cases, but not where customers are unlikely to respond to the price signal.

* * *

All in all, the shift to spot pricing appears to be a fait accompli. Adjusting to this shift, however, requires work and some inspiration. It also requires use of the increasing amounts of valuable data being generated on power markets from Canada to Mexico. Luckily, the data and the tools are in hand (em only the work remains. t

Robert McCullough is the managing partner of McCullough Research, an energy policy and economics consulting firm in Portland, OR. McCullough Research specializes in public policy issues throughout the United States and Canada, primarily regarding the electric power industry. Recently, Mr. McCullough has been representing the Grand Council of the Cree in their negotiations with Hydro-Québec concerning the massive proposed developments on the rivers emptying into James Bay. His firm has also released several RFPs for energy resources and services delivered in the Northwest (em seeking over 600 Mw in the 1997-2001 timeframe. Mr. McCullough was previously an officer at Portland General Corp., with responsibilities in finance, power marketing, and rate setting.

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