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

Energy Trading: Down But Not Out

The speculative electricity trading industry has a bad case of rigor mortis, but current efforts might breathe new life into the practice.

Fortnightly Magazine - January 15 2003

do well. They apply sophisticated econometric models to price deals and nibble off the high-margin business. That’s not a liquid market.”

Exorcising Enron

Electricity trading may not be dead, but it is definitely in a transitory state between its high-flying past life and an unknown future. Fred Cohen, a partner with PricewaterhouseCoopers LLP, says, “Companies are looking to develop a better education around what are the real risks in the utility business, and how can they monitor and manage those risks a lot better.”

Volume eventually must return to the markets, for the simple reason that load growth has not abated and retailers find themselves increasingly short on supply. This situation has left unmet demand for firm contracts as well as options products, which translates into opportunities for creditworthy players.

“The interesting thing is that in liquid markets, you have a tight bid-ask spread, and in illiquid markets that spread gets wider,” says Howell of Dominion. “We work harder to hedge our assets in wholesale markets, but over time we actually perform better in this type of market.”

Smaller players than Dominion are also seeing these opportunities, according to John Bell, head of the energy practice with risk-management system vendor SAS Institute Inc. “We’re involved with a lot of tier-2 and tier-3 companies that are looking at systems and thinking about gearing up.”

Most of the trading that is occurring, however, is closely tied to assets and fundamental risk-management needs. Integrated utilities and merchant generators alike have dramatically scaled back their speculative-trading activities and are now focusing on selling output from their captive power plants (See Table 2, “Evolving Trading Positions”).

“Portfolio optimization is the key,” says Charles Craven, a vice president with system integrator Knowmadic. “The industry is going back to the original vertical-IOU [investor-owned utility] way of doing business, which is to look at what you have relative to other assets and make sure you apply them properly.”

From a systems perspective, this means companies are retooling their trading and risk-management infrastructure to accommodate the new market conditions.

“You have to tailor the risk-management approach and systems to deal with this back-to-basics trend,” says SunGard’s Walker. Companies are implementing risk models that are designed for evaluating the positions of operating assets, in the context of loads, weather, and other factors.

“Mathematically modeling these things is difficult,” Walker says. Problems arise because of operational uncertainties, regulatory issues, and physical constraints. “It’s more complex than the simple calculations that were characteristic of the standard market-making, Enron-type of trades.”

Additionally, the algorithms that make the most sense in today’s market are tailored toward medium- and long-term transactions rather than short-term trades. This means that the value-at-risk (VaR) metrics that were favored just a few months ago are being supplanted by earnings-at-risk (EaR) and cash-flow-at-risk (CFaR) metrics.

“We inherited the concept of VaR from trading in other  more liquid commodities,” Janardhan says. “Generally VaR assumes you can unwind out of a position in 24 hours, but in reality you can’t get rid of your power plants tomorrow.”

EaR and CFaR valuations are more appropriate