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Energy Trading & Marketing: The Evolution of the Deal

Energy traders and risk managers reengineered their business dealings to manage against unexpected political and financial risks posed by California and Enron in 2001.
Fortnightly Magazine - January 1 2002

if you will, and a bid from Enron that was lower.

"Had they gone for the paper transaction for lower priced power, it would have seemed to make sense for them and would have in some sense given them a better risk profile because they would have a better pricing structure as a result. But the physical risk was too great. What if Enron, for whatever reason couldn't get power to the Olympics? It would be a global disaster. You can't solve all your problems with paper," Shimko says.

PG&E's Maddox, describes the current mix between physical and financial by saying, "In gas, it is 90 percent financial and 10 percent physical. In power, it is the exact opposite. Why is that? With power, we have a lot of financial settlements and not necessarily a lot of physical delivery but they all originate as a physical deal. That is why you see the differences there."

Maddox believes the New York Mercantile Exchange contract has helped natural gas, but it has not developed in power. He believes that the industry continues to head toward increased specialization in the type of deals that it does-which is not complementary to a standardized financial product traded on a futures exchange.

"It is the specialized products where money is being made that it helps with load factors such as load shaping, depending on how states regulate. Until you get liquidity that is standardized from state to state and ISO to ISO, you are going to have products that are unique to those areas that are going to be unique to the weather patterns of those regions," he says.

Maddox says trading companies are looking for new products that solve the real problems by segment. "I think you will see differentiation by industrial product, muni product, and weather products. The real world will have a structured type of commodity product."

Of course, fundamental products such as 5x16s (trading 5 days, 16 hour pre-scheduled deals) are things that a machine could trade, he says, adding that you could program a computer to trade it. He says many trading companies are looking into program trading of this standardized product that would execute in the market at a pre-selected price, as energy companies are over-burdened sometimes with the high volumes that are associated with typical daily business. While there are more specialized products offered by online trading markets, Maddox says his customers are looking for more non-standard type of products.

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