The electric utility industry has turned the corner away from monopoly regulation and into the competitive marketplace. No big surprise. Since the late 1970s, consumers have faced increasing sticker shock. In addition, customers want the same choices over electricity purchases that they have with other products. OK, so how do you disassemble a vertically integrated utility system where access to information product and price is tightly controlled? The answer: Carefully! You
begin by developing independence, comparability, and pricing transparency.
For one group of power marketers, municipal utilities, federal power agencies, and investor-owned utilities (em 18 players in all (em the answer to price transparency comes through the development and distribution of a market price index. These market participants who collaborated on the index represent one-third of the generation in the region. The index will enable electricity to be traded like a commodity, as are corn, oil, and natural gas. This effort should result in a more efficient market and better use of generation resources as well as the development of risk-management tools. The index will be based on the prices and quantities contained in actual transactions and will be published by Dow Jones beginning in March 1995.
What is it For?
Market price indices are indicators of the dynamics of a specific market. Common examples of market price indices include the Dow Jones Industrial Average and Standard and Poors 500. As the natural gas market was deregulated, dozens of publications developed countless price indices that reflected the market at almost every transaction point in the United States and Canada.
Generally, market price indices allow market participants to explicitly view the market price for a particular commodity. They also provide market information for current and future decisionmaking. Players in the spot market can then decide what price levels they should buy or sell at. In the electricity market, indices will promote economic efficiency, including optimal dispatch of resources.
Market indices also allow participants to understand the external variables that impact the market over a period of time. On the West Coast, some of the main factors affecting the electricity market are weather, gas prices, nuclear generating unit availability, and Northwest and California hydroelectric availability. By understanding how such factors affect the electricity market, participants can assess its future direction using their own forecasts.
Eventually, many transactions will be explicitly tied to the value of market indices. For example, a buyer and seller may agree months ahead of time to a transaction with a pricing scheme described as the value of the index plus 2 mills per kilowatt-hour. This type of pricing mechanism will assure both parties that their deal will reflect market conditions at the time the transaction actually occurs.
As has been the case for other commodities, electric market indices will also facilitate the development of financial risk-management instruments that create unlimited customer choices. The proposed indices will allow financial markets to build an infinite array of risk-management tools. These tools will allow all market participants to shift many purchase and sale risks to third parties that specialize in risk management. For example, the New York Mercantile Exchange (NYMEX) electricity futures contract, expected to be in place in 1996, will specify an amount of electricity to be delivered at a specific place for a price fixed in the contract months ahead of time. Market players will use the futures contract to hedge against price fluctuations. It would be difficult for the futures contract to develop without price transparency in the spot market. Finally, the detailed work put into developing the indices paves the way for a Southwest/Arizona index to shore up the West.
How Does it Work?
The broad-based collaborative group that developed the COB Index decided to start with indices for five different electricity "products": 1) daily onpeak firm energy, 2) daily offpeak firm energy, 3) daily peak nonfirm energy, 4) daily offpeak nonfirm energy, and 5) monthly firm energy. To report their transaction information to the publisher, the group agreed to a common definition for firm and nonfirm energy as well as onpeak and offpeak hours.
The trading place locations that will be captured by the indices will be the California-Oregon Border and the Nevada-Oregon Border (COB/NOB). COB/NOB is not a substation, but is considered a single transaction point for the three 500-kilovolt (Kv) AC and single 1000-Kv DC transmission lines that interconnect Northern and Southern California and the Northwest. The COB/NOB area was chosen because it provides trading or transaction points for power sales between entities in the Northwest, California, and Southwest. It forms the equivalent of a trading hub, with a significant amount of energy transacted (about 16,000 gigawatt-hours between January and November 1994). Many market participants have transmission access in or out of the area. Eventually, as occurred in the natural gas market, these types of indices will develop for almost all electricity transaction points. Indices are also likely to develop at the Palo Verde Substation and the Four Corners Substation, both of which are in the Southwest.
Each participant will report to Dow Jones their weighted average price for sales and megawatt-hour volume at COB/NOB by 10:00 am daily for transactions completed the previous day. Dow Jones will calculate the indices and broadcast the results to their electronic news service subscribers (Dow Jones Telerate) and to index participants. The indices will be distributed by Dow Jones to any interested parties, including other publishers, through a low-cost electronic service such as CompuServe, within an hour after distribution to Telerate subscribers. The Wall Street Journal will publish the indices the next day in the commodities section.
Whether you're a customer, utility, broker, or power marketer, the new competitive power marketplace holds new challenges and opportunities. All players are likely to benefit from more efficient markets and innovative new products as whole new areas become open to competition, such as reliability services and energy futures. Pricing transparency is a key element in assuring the creation of these new markets. The COB/NOB indices significantly enhance the cash market for electricity that is essential for liquidity, and serve as the basis for new relationships and products. t
Bernard Speckman, manager, and Steven Schleimer, supervisor, both work in the power contracts division at Pacific Gas and Electric Co. in San Francisco, CA.
Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.