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News Analysis

Fortnightly Magazine - January 1 2000

But at What Price?

A Cinergy executive in the audience was on hand to debate one of the EEI panels on the logic of provisions that allow a buyer to request market-priced power as a replacement when the seller has defaulted.

For products traded under the EEI contract that provide for liquidated damages if the seller does not deliver, the buyer can be made whole in two ways, according to Andy Katz, senior attorney at EEI's general counsel's office.

The buyer, acting in a commercially reasonable manner, can purchase a replacement of the same product and collect the difference between the contract price and the price of the replacement, Katz explained. In the alternative, the buyer can charge the seller the difference between contract price and the market price of the same product at the time the sale was to occur, Katz said.

The Cinergy executive thought it grossly unfair that a defaulting seller should have to pay the market price during transmission curtailments, since the market price can cost the seller dearly to meet its obligation.

"We were made an island by transmission curtailments and one generator does not make for a market," the Cinergy executive cried, in an attempt to explain the circumstances that led to her own company's contract defaults.

(On Aug. 10, Cinergy had announced cash losses of $73 million after taxes, reflecting increased costs due to hot weather in late July and anticipated liquidated damage claims for failure to meet delivery obligations to several power marketers. See "Price Spike Roulette: Can Utilities Play by Wall Street's Rules?" Public Utilities Fortnightly, Oct. 15, 1999, p. 44.)

Yet others saw no trouble in allowing the buyer to turn to the market.

"If the seller is in default, it is not the buyer's job to get the defaulter out at the cheapest price," argued attorney Dondanville. "If you are short [selling what you don't have] you are not excused from performance," added another panelist, with heated conviction.

Price Spikes: No More Fear?

Dondanville explained that the EEI and others initiated the master contract idea in part as a response to the financial losses that some energy companies have suffered during times of market stress.

"The 1998 June price spikes and market defaults focused discussion on lack of documents and credit concerns, and the 1999 market events focused on tariff, contract inconsistencies," she said.

"The standardized master contract will not make power price spikes go away," she acknowledged. "But it will help [energy companies] better identify, and therefore be able to better manage, the risks they have taken in electricity markets."

Dondanville added that standardization of legal language in contracts is just one of the steps the developing power market needs to take.

During the development of a standardized contract many risk managers told Dondanville that they would hedge one "firm" contract against another without knowing that one was "firm (LD)" and one was "system firm," or the hedged contracts were both "system firm" but were referenced to different utilities' systems.

It is these types of situations that the EEI contract