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What's a Power Plant Worth

Fortnightly Magazine - September 15 1997

ability to manage market risks will affect its value. After the plant is purchased, a favorable spark spread can be "locked in." This requires coordinated activity in both the electricity and fuel markets. Such measures may include:

• Selling in Load Pockets. Many such opportunities today are created by transmission constraints that create load pockets (e.g., Manhattan, Long Island, San Francisco) or larger constrained areas. Such constraints are likely to diminish in the future as companies invest in transmission-line upgrades and new (often peaking) capacity is built within constrained areas or as regulators address the market power issues. As a result, unique opportunities will grow more difficult to find.

• Electric Market-Based Fuel Contracts. Such contracts tie the price of fuel to that of electricity on specific transactions or through indexing. They are now gaining in popularity among electric generators and fuel suppliers seeking new, cooperative ways to stay competitive. Some fuel suppliers, for example, are touting "alliances" with electric generators. How effective this will be in a market where such practices are commonplace remains unknown. Moreover, these practices will affect the pricing dynamics.

• Tolling. Tolling is the practice of operating a power plant for a fee under contract to another party that provides the fuel and sells the output. It shifts market risk for both fuel and power to the other party. The long-run usefulness of tolling as risk management is questionable, because the plant still needs to operate in the underlying markets no matter who provides the fuel or takes the contract.

• Reverse tolling. Reverse tolling of fuel is a way for a power plant to make money for its owner even when high fuel prices make generation uneconomic. In such a situation, the value of fuel is greater in fuel markets than converted to electricity in the electric markets. The generator may sell contract fuel on spot market for profit and buy incremental electricity. In essence, the generator is conducting arbitrage between the electricity and fuel markets. Reverse tolling requires the generator to establish prior relationships with fuel marketers to sell high-priced fuel as the opportunity arises.

Power plant owners also can combine these techniques. Tolling and reverse tolling may be used, for example, in a complementary fashion to maximize return for a specific plant. The plant may be tolled when the spark spread is positive and reverse tolled when it is negative.

In essence, one invests in the use of a plant asset when the spark spread is positive and in a fuel asset when it is negative. This practice (along with indexing fuel investments to the wholesale power market) serves as a real example of "convergence" of the wholesale electric and fuel markets. t

Jeffrey P. Price is president of Resource Dynamics Corp. The author would like to thank Alex

R. Henney, John H. Herbert and James T. Doudiet for their help with this article.

Merchant Plant Sales Activity

New England. In early August, New England Electric System sold its non-nuclear generating assets (about 4,000 MW) to U.S. Generating Co., an affiliate of Pacific Gas & Electric Co. The