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Power Measurements

Energy trading returns, healthier and wiser.
Fortnightly Magazine - August 2004

of $17.6 billion is more than enough to sustain a healthy trading industry. But can a sophisticated trading business really capture this value? The answer is yes-and no. No because there are few liquid option markets (if any), and it is certainly not a $17.6 billion market. Yes because some of the value can be captured through delta hedging in the forward markets (albeit less efficiently and with additional transaction costs), and yes because the market needs it.

Buyers see the same price distribution and fear the potential price spikes that drive the high-value events for generators. They need to buy the options as insurance to protect themselves from these low-probability, high-impact events. As long as we have power price volatility, there will be a need for these markets. In other words, there's more need now than ever for trading to exist.

So, will a healthy trading industry redevelop to fill this void? We believe so. Credit will recover, while improved analytical tools increasingly show the need for more sophisticated hedging. Also, appropriate governance and accounting treatment is now catching up with what was a completely new industry in the 1990s.

Will we return to the speculative trading seen in late 1990s? No. Trading floors are increasing their focus on reducing risk, and systems and people are getting better at identifying and pricing the risks. The CSFB/TXU joint venture, whether ultimately successful or not, is a step toward the reintroduction of a healthy power trading market, one that can bring benefits to both producers and customers.



Strategic Outsourcing for Utilities: Where to Draw the Line?

Business history is littered with both success and failure.

A utility could be damned if it does and damned if it doesn't outsource parts of its operations.

That's the lesson of many IT and manufacturing companies that have undertaken strategic outsourcing, a concept that has been around for decades, but only recently became a phenomenon in the utilities industry. While strategic outsourcing can lower a company's costs, the issue is always about where to draw the line.

Today, utilities are being offered a larger list of outsourcing alternatives, such as accounting, customer information service (CIS), energy trading, and human resources. But whether any of these alternatives are a core skill, and whether outsourcing could impact other core utility skills, or not at all, remains to be seen. What are the utility's core skills? Answering that question correctly is critical for utility managers, experts say.

For example, would TXU lose critical power or resource planning skills as a result of outsourcing in a 50/50 partnership of its energy trading and risk management activities to Credit Suisse First Boston? Did Entergy or Constellation lose critical risk management skills when they devolved their energy trading partnerships with Koch Energy Trading and Goldman Sachs, respectively? Furthermore, what did it cost the companies in competitiveness to replace the talent lost from the failed partnerships, and what was the replacement cost of personnel and systems?

According to Dartmouth Professor James Quinn, in an article published in McKinsey Quarterly in the mid-1990s, outsourcing all