Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

Power Prices Today: Growing More Unpredictable

Even the volatility is volatile. And that can play havoc with hedging.
Fortnightly Magazine - October 1 2002

There does appear to be a pronounced and lingering premium in PJM, judging from the relatively large basis that persists between PJM and Cinergy, ComEd, and Entergy.)

Second, volatility appears to have become more variable over time, as measured across discrete time periods, according to a study of price behavior for Into Cinergy and Into ComEd.

All of this makes hedging more difficult. It may not be enough simply to invest in some forward and long-term contracts. Purchase the contract on the wrong day, and the advantage could be lost-just as a private investor can lose much of the potential of a future bull market if he should buy his entire stake on the wrong day.

One way that companies have avoided this danger in power markets is to use some sort of dollar-cost averaging approach for completing forward deals. The company randomly chooses days over an extended period of time for closing deals for forward months.

In fact, it is clear from an examination of past price history that large increases in price risk may last for only a few days. Therefore, a company may want a forward contract with a term of only a week or weekend during a month, and not for an entire month. The shorter-term standard contracts could, of course, be combined into monthly or several-month contracts.

Nevertheless, at the end of the day, it is not always possible to figure out exactly what has happened.

Many thought that Enron and other major marketing companies regularly were able to set price levels and elevate price volatility, judging from what happened in California at the worst of the crisis. And that's why regulators continue to focus on major weaknesses in the wholesale part of the business.

Yet, wholesale power price levels and volatility in the first six months of 2002 were very similar to what they were in the first six months of 1999 when Enron et al. were active and growing, and the sky was blue. It was only when conditions were extreme-when regulators lacked the means or the resolve to intervene-that these companies seemed able to control price by restraining supplies and creating real or artificial constraints on systems. By contrast, during much of the time (when conditions appeared normal), these traders may have served a very useful role.

But enough of such subjective assumptions. Let's turn to the numbers, to read what they say.

#1-Power Price Levels Vary Greatly

As shown in Figure 1, the extraordinarily high wholesale prices seen from June 2000 to June 2001 in western power markets (such as Palo Verde in Arizona, near the southern California border, and Mid-Columbia in Washington, north of California), tended to dominate and mask price behavior in other markets.

The prices in Figure 1 show 22 day-moving medians (there are generally 22 trading days in a month). They indicate that near the end of December 2001, prices on half the trading days during the previous month were greater than $475.00/MWh at Palo Verde. A host of factors in California contributed to these high prices-a power market