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Power Prices Today: Growing More Unpredictable
Even the volatility is volatile. And that can play havoc with hedging.
Jeff Skilling resigned from Enron over a year ago-after power prices in markets serving California had fallen 90 percent in three months.
But in July, Bank of America won approval from the Treasury Department to offer cash-settled electricity derivatives-with a former Enron regional director at the head of the desk.
So what has changed, and what hasn't?
Well, power prices, for one. Some may believe they are quieter now, than when California imploded. But more predictable? Hardly.
If anything, power prices are becoming even less predictable, as if they ever were. To explain, let's consider an overly simplified fictitious example that shows where we've been and where we're going.
- "Wild" Prices. Suppose for a few years that power quadruples in price every summer, and then each winter falls back to 25 percent of that peak. Is that volatile? No, it is not. Yes, the price seems "wild"-moving at times by a factor of four-but the pattern is there for all to see. That's not volatility.
- "Mild" Prices. Now suppose instead that the pattern changes after a few years so that power prices only double in summer. But some summers the price doesn't change at all, or even drops a little. And some winters see a steady or even slightly rising price, but you never know when. Power prices seem more "quiet" in this era, but there's less of a pattern. Now that's volatility.
- Reality. Now consider a third reality-what the numbers are telling us today. Today it seems that even the relative degree of unpredictability is changing. Prices seem to be moving back and forth in random fashion between periods of greater relative predictability, and then less relative predictability. It's not so much the size of the price change on the wildest trading day, but more the fact that patterns are extremely difficult to determine. And just when you think you've found one, it vanishes, and in comes a new regime, equally unfathomable in different ways.
In short, we always knew that electricity was the most volatile of traded commodities, but what we've got now is something more-
What does that mean for risk management?
In this article we take stock of price behavior in major wholesale power markets over the last several years, and examine how the markets behaved and whether or how they might be changing. The major markets in terms of volume of trade are "Into Cinergy," which is the volume market leader by a wide margin, and PJM, in second place. Following those two markets, in no particular order, are "Into Entergy," Mid Columbia, Palo Verde, and "Into ComEd."
What we find are two distinct phenomena that are nevertheless difficult to reconcile. First, electricity markets in different geographic regional areas appear to be converging in terms of price, indicating that they are becoming increasingly well-connected and well-integrated. This fact suggests that markets are continuing to evolve and grow in ways consistent with the FERC goal of developing large, regional, increasingly interconnected regional transmission organizations (RTOs). (Note: