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Price Spike Roulette: Can Utilities Play By Wall Street's Rules?

Fortnightly Magazine - October 15 1999

tornadoes knocking out generation. They had a big cut in available generation at a same time as a spike in demand. This year they had a spike in demand but they did not lose the same amount of generation. Notwithstanding [that fact], we had perhaps higher demand when the price spikes hit," he says. "This was just bad transmission policy."

Levin says the price spikes will continue to get worse. To manage the risks, market participants need to have access to forward markets, which means forward market commercially usable firm transmission is necessary, he says.

Levin says that forward market commercially usable firm transmission has not been offered attractively in the market to date. Lack of commercially viable firm transmission policy does not support greater participation in more forward markets with physical delivery obligations because people don't have confidence that the markets can perform and they know they will be scrambling in the spot market.

With regard to NYMEX's most successful power futures hub, named after Cinergy, Levin cannot assess the impact of Cinergy's financial loss to the market itself. He says that Cinergy has done well in maintaining its counterparts after its financial losses. "At the moment, it has not impacted the Cinergy futures contract," he says.

Fred Cohen, a partner with PricewaterhouseCoopers responsible for the firm's energy risk management practice, says with the adoption of Financial Accounting Standard 133, Accounting for Derivative Instruments and Hedging Activities, there will be clearer visibility to risk management activities in the financial statements of utility companies. Cohen says that FAS 133 specifically defines many of these methods for determining what is a derivative and the accounting treatment for hedging transactions. More detailed disclosure for risk management activities is required as part of the new accounting. The new accounting and disclosure will result in better visibility to derivative activity at these various companies.

For calendar year-end utilities, required implementation of the standard begins Jan. 1, 2001. Cohen says that this is more than an accounting standard and given the magnitude of the changes, utilities need to aggressively reassess their strategies and practices to develop their plans for implementing the standard. The biggest concern for his utility clients is defining their risk management strategy and how much risk and expected return on that risk they should take in their target markets, he says.

When thinking about this summer's price spikes and contract defaults, Cohen takes a forward-looking view.

"Five years from now we could see a reversal of the last couple of years. Potentially, we could see a need to manage low prices, slim margins and excess generation in certain markets. Utilities will need to develop their skills to manage in dynamic and complex markets," says Cohen. "That is the challenge of this industry. How do you create shareholder value and sustainable profitability while taking acceptable risks in a changing and complex industry?"

Richard Stavros is the senior editor at Public Utilities Fortnightly.

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