[BETA] Fortnightly

David A. Foti and Martin F. Nellius III

Retail energy markets entail a unique set of risk management challenges.

The emergence of unregulated retail energy has spurred the formation of a number of new entrants who hope to reap the benefits of a promising new market. Serving the deregulated retail market entails unique risks that energy marketers have not had to concentrate on in the past, specifically full requirements consumption risk, tariff risk, and certain operational risks such as mass-market billing. Successfully dealing with these risks will require a focused risk management initiative but should result in a competitive advantage for those retail energy marketers that are able to execute effectively.

Retail energy marketing was truly born when California opened up its $20 billion 1 power market in 1998. The initial rush to capture market share resulted in such schemes as free power give-aways and unholy alliances with Amway. The initial enthusiasm waned when retail energy providers (REPs) found that they were unable to offer significant discounts to the utilities' standard offer due to the mandated Competitive Transition Charge (CTC) pass-through. As the economics became clear, marketers either rethought their business plans or left the market altogether. 2 For example, Enron Energy Services abandoned the residential market in late 1998 after racking up big losses on advertising programs to entice customers to sign up.

By the end of 2001, a repeat of the California shake out was playing out on a national scale. The three most promising national players-Enron Energy Services, Shell Energy Services, and New Power Company- respectively halted, dramatically scaled back operations, and stood on the edge of financial failure. While a myriad of factors punished these major players, some of their problems could have been ameliorated with a structured risk management program. 3

Retail Energy Marketing vs. Wholesale

Wholesale energy marketing and trading currently has three main incarnations, depending on corporate structure and objectives: on-system wholesale trading in support of production (characterized by asset control and physical trading capabilities), wholesale marketing (characterized by a strong origination & structuring skills), and on- and off-system wholesale and financial trading (characterized by complex modeling skills. ()

Wholesale gas marketing and power marketing, which were unleashed by FERC orders 436 and 888 respectively, are the immediate antecedents to the retail energy market. What specifically differentiates a retail from a wholesale marketing transaction? "

Breakdown of Tariff Risk

Tariff Risk Tariff risk is that risk which the marketer incurs downstream of the uplift. This risk can be broken into Timing Risk (I - III) and Magnitude Risk (IV-VI) as illustrated below. Timing Risks Each of these items have to do with transition period timing. Period I represents the pre-transition duration. During pre-transition customers only have access to the local utility's bundled rate. Period II is the length of transition. Typically during the transition period, customers have the option to either to keep on taking the utility's bundled rate, or standard offer, or procure generation from a third-party marketer though an unbundled tariff. Period III represents the duration of the competitive transition charge (CTC). The