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The Standard Power Contract: A Hedge Against Price Spikes?

The Fine Print: Who Won, Who Lost
Fortnightly Magazine - June 1 2000


 

EEI's contract is ready to go for physical trades of electricity, but the architects say it's likely too late to make a difference this summer.

Will the return of summer again find power marketers glued to computer screens , watching for that killer price spike that in minutes could wipe out a year's worth of profits?

The fear is real. Suppliers who default can cause havoc if the underlying contract for physical energy delivery fails to spell out the financial liabilities. And in the past, that's been the case in U.S. power markets, says Chuck Shivery, president and chief executive officer at Constellation Power Source.

"Part of the reason we have contractual risk," he notes, "is because there is not standardization within the industry. Everything works well and [then] when there are problems, you get into significant disagreement about this term or that term."

Yet all that may change - and for the better - if the industry embraces the long-anticipated standardized contract for physical trades of electricity, which was introduced in New York city in April, at a conference sponsored by the Edison Electric Institute.

The contract, developed by EEI, the Alliance of Energy Suppliers, and the National Energy Marketers Association, defines a common set of terms for physical transactions for both utilities and marketers. EEI's work to create the contract was spurred by the finding that differences in legal terms have magnified financial problems for energy companies in times of market stress.

The new contract creates six precisely defined physical electricity products: 1) Non-firm energy, 2) Unit firm, 3) System firm, 4) Firm with liquidated damages, 5) Energy "into" a delivery point, and 6) Firm with no force majeure exception. Also, the contract is flexible enough to allow electronic agreements on trades, and many of the real-time credit provisions fit well in that online environment, say analysts.

In fact, EnronOnline, an Internet-based transaction system for trading energy-related products and other commodities with Enron, is working with Standard & Poor's to create a real-time credit system, according to an S&P executive. Enron executives hope such a system would prevent defaults from increasing as a result of the quick pace of online trading, he explained.

In addition, there are provisions that can be added within the contract allowing for further financial guarantees, collateral, or letters of credit in response to a standard counterpart's ratings downgrade. Of course, that option would apply to both companies in a bilateral agreement. (For more details, see "EEI's Master Contract: If You Draw It Up, Will They Trade?" , Jan. 1, 2000, p. 38.)

Overall, EEI and others believe that these new definitions (and other rights and duties specified in the contract) will make traders more confident. They hope to avoid the pitfalls of the summer of 1998, when price spikes and market defaults focused industry attention on credit concerns and risk management, and those of last year as well, when events drew attention to inconsistencies between tariffs and contracts.

"What obligations or liabilities do you have?" asked one speaker at the April meeting.

"If the

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