|
Server : Apache/2.4.62 System : FreeBSD fbsdweb2.web.rcn.net 14.1-RELEASE FreeBSD 14.1-RELEASE releng/14.1-n267679-10e31f0946d8 GENERIC amd64 User : www ( 80) PHP Version : 8.3.8 Disable Function : NONE Directory : /domains/enrgy/archives/ |
Upload File : |
<!DOCTYPE HTML PUBLIC "-//IETF//DTD HTML//EN">
<html>
<head>
<title>How Suppliers Can Profit in a Competitve Electric Market</title>
<meta name="GENERATOR" content="Microsoft FrontPage 3.0">
</head>
<body background="../images/pma-wm2.gif" bgcolor="#FFFFFF" bgproperties="fixed" align="left" link="#8C1717" vlink="#545454" alink="#FF0000">
<ul>
</ul>
<div align="center"><center>
<table width="80%">
<tr>
<td width="100%"><blockquote>
<blockquote>
<p align="center"><img src="../images/colorbar.gif" align="bottom" WIDTH="585" HEIGHT="1"> </p>
<p align="left"><font size="7" color="#000080"><strong>HOW SUPPLIERS CAN PROFIT IN A
COMPETITIVE ELECTRIC MARKET</strong></font><br>
<br>
<font size="4"><strong>by <br>
Larry Weiss<br>
President, The ComPower Group<br>
</strong></font></p>
<p align="left"> </p>
<p align="center"><img src="..\images/colorbar.gif" align="bottom"> </p>
<p><a href="http://www.compowergroup.com/weissart.zip"><img src="../images/cball.gif" border="0" WIDTH="14" HEIGHT="14"> Click here to download this article in Microsoft Word format <i>(.zip file)</i></a></p>
<p align="center"><img src="../images/colorbar.gif" align="bottom" WIDTH="585" HEIGHT="1"> </p>
<p align="left"><br>
Suppliers to the traditional utility industry will have to change their strategies if they
are to survive and prosper in a competitive market. Those companies seeking to merely
provide a good or a service for a price will be at a major competitive disadvantage
compared to those who are willing to form partnerships with their purchasers. This is
especially true for fuel suppliers.<br>
<br>
<font color="#000080"><em><strong>The electric market is changing</strong></em></font><br>
<br>
The electric industry historically has contained several major barriers to competition in
the wholesale markets. Perhaps the two most important of these has been the lack of
transmission access and a cost-based regulatory scheme. The significance of both of these
barriers have diminished in recent years.<br>
<br>
Transmission ownership is no longer a strategic asset for those marketing power. The
Energy Policy Act gave FERC explicit authority to order transmission access. Commission
decisions in recent years have shown that the agency will use this power vigorously to
promote a competitive marketplace. Order 888 further diminishes the importance of line
ownership by requiring all utilities to file tariffs offering comparable access. The
functional unbundling requirement, if properly implemented, also should place all sellers
on an equal footing.<br>
<br>
Cost-based regulation limited competition by precluding a marketer from buying at one
price and selling at a higher price. Since intermediaries had no opportunity to profit
(and no assurance they could move the power even if they bought it), the electric industry
lacked the market-clearing mechanisms present in competitive industries. The result was
that was broad inter-regional price differences.<br>
<br>
The first crack in cost-based regulation occurred with the passage of the Public Utilities
Regulatory Policies Act (PURPA) which gave qualifying facilities (QF) the right to sell
power at the purchasing utility’s avoided cost rather than the QF’s cost of
production. FERC began attacking the issue of market-based rates for non-QFs in the
mid-Eighties, allowing entities which lacked (or mitigated their) market power to sell at
whatever the market would bear. For the first time we saw the elements of a rudimentary
price discovery regime in place.<br>
<br>
In other industries undergoing the transition toward greater customer choice liquidity
plus price discovery has meant the entry of new parties into the industry who look at
things differently than industry incumbents. Not tied to the regulated past, these new
entrants, who seek entrepreneurial rather than utility returns, are more willing to do
things differently. Notable examples in other industries include MCI in telecommunication,
Southwest Air in air transport, and Charles Schwab in financial services. These new
entrants act as a catalyst for change, transforming the industry.<br>
<br>
In the electric industry the catalysts for change are the power marketers. IPMs
(independent power marketers) own neither generation or transmission, are not affiliated
with any entity owning generation or transmission, and are not affiliated with any entity
have a franchised service territory. They make their money by buying and selling power.
Power marketers can do this more efficiently than traditional utilities by physically
unbundling the kilowatt and separating its functional from its physical aspects.<br>
<br>
Physical unbundling involves a new way of looking at a kilowatt. A traditional utility
sells a bundled kilowatt, usually generated in its own boilers. As can be seen in <em>Chart
1</em>, a kilowatt-hour consists of a number of discrete services. At one level a kilowatt
consists of four general services: generation, transmission, distribution, and legislated
obligations (social objectives placed on the utility and its customers). Each of these
services can be further broken down. Generation, for example, may be viewed as consisting
of at least five separate services.<br>
<br>
<font color="#000080"><em><strong>Chart 1</strong></em></font>:<br>
</p>
<div align="center"><center><table width="85%">
<tr>
<td width="50%"><p align="right"><font size="4" color="#000080"><strong>GENERATION</strong></font></td>
<td width="50%"><ul>
<li><strong>Energy</strong></li>
<li><strong>Capacity</strong></li>
<li><strong>Load following</strong></li>
<li><strong>Standby power</strong></li>
<li><strong>Loss compensation </strong></li>
</ul>
</td>
</tr>
<tr>
<td width="50%"><p align="right"><font size="4" color="#000080"><strong>TRANSMISSION</strong></font></td>
<td width="50%"><ul>
<li><strong>Transportation </strong></li>
<li><strong>Capacity</strong></li>
<li><strong>Scheduling, system control, dispatch</strong></li>
<li><strong>Reactive supply/voltage control</strong></li>
<li><strong>Regulation/frequency response</strong></li>
<li><strong>Energy imbalance</strong></li>
<li><strong>Spinning reserve</strong></li>
<li><strong>Supplemental service </strong></li>
</ul>
</td>
</tr>
<tr>
<td width="50%"><p align="right"><font size="4" color="#000080"><strong>DISTRIBUTION </strong></font></td>
<td width="50%"><ul>
<li><strong>Transportation</strong></li>
<li><strong>Capacity</strong></li>
<li><strong>Voltage control</strong></li>
<li><strong>Frequency control</strong></li>
<li><strong>Metering</strong></li>
<li><strong>Billing </strong></li>
</ul>
</td>
</tr>
<tr>
<td width="50%"><p align="right"><font size="4" color="#000080"><strong>LEGISLATED
OBLIGATIONS</strong></font></td>
<td width="50%"><ul>
<li><strong>DSM</strong></li>
<li><strong>Lifeline rates</strong></li>
<li><strong>etc. </strong></li>
</ul>
</td>
</tr>
</table>
</center></div><p><br>
What marketers do is purchase each service from the supplier who can provide it most
economically. A marketer might buy energy from producer A, capacity from B, and load
following services from C. It might buy interruptible service from a number of suppliers,
and, in the unlikely event all suppliers fail, back up those supplies with power from an
old clunker it was able to buy for next to nothing. It might buy a large block of cheap
power from one supplier, and then sell that power in discrete blocks as the opportunity
arises.<br>
<br>
A marketer is able to reduce its risks and offer new services through the use of risk
management techniques that utilities traditionally have been reluctant to use because of
regulatory concerns. Rather than purchase capacity outright a marketer will buy an option
on the right to schedule the plant. This option is substantially cheaper than paying the
demand charge which such sales generally employ. Future price risks will be minimized by
using such financial instruments as futures and swaps. The ability to hedge risk permits
marketers to lock in margin and offer new pricing options, such as caps, collars, and
fixed prices.<br>
<br>
<br>
<font color="#000080"><em><strong>Impact of changes on suppliers</strong></em></font><br>
<br>
The changing electric marketplace will have an impact on the way business is conducted.<br>
<br>
The notion of price might be common to most companies, but it is alien to cost-based
utilities. Now, for the first time, we are seeing regional price indices. Every day the
Wall Street Journal is publishing price indices for power in the Western United States.
McGraw-Hill is publishing daily price indices for power in other regions of the country.
The New York Mercantile Exchange has inaugurated trading in electric futures, giving one a
real time way to lock in power prices.<br>
<br>
Once you have a price to benchmark power supplies within a region, a futures contract to
trade against and a liquid market, the cost of power at the busbar becomes key. You also
have the ability to arbitrage fuels. This means utilities will continue to place pressure
on fuel producers to renegotiate above market prices and there will be continued downward
pressure on the price of fuels as commodities.<br>
<br>
The electric markets also are likely to become much more complex than they have been in
the past. In the traditional electric market <em>(Chart 2)</em> a utility generator sold
power to the end-user over the utility’s own lines. In the new electric market <em>(Chart
3)</em> a number of arrangements are likely. One will see suppliers selling directly to
end-users, to aggregators (marketers), and to the spot market.<br>
<br>
<br>
<font color="#000080"><em><strong>Chart 2</strong></em></font><br>
</p>
<p align-center><img src="http://www.compowergroup.com/images/chart2.gif" border="0" alt="Chart 2" width="466" height="349"></p>
<p><br>
<font color="#000080"><em><strong>Chart 3</strong></em></font><br>
</p>
<p align-center><img src="http://www.compowergroup.com/images/chart3.gif" border="0" alt="Chart 3" width="466" height="349"></p>
<p><br>
The result will be a change in the value chain. Traditionally, fuel suppliers sold power
to generators which added value and then shipped the power to captive customers. Since the
customer had little choice in its supplier, marketing added little value. In the new
marketplace the marketer having the customer is supreme. The generator, like the fuel
supplier, is producing a commodity. <br>
<br>
This creates enormous dangers as well as opportunities. Incumbents in industries
undergoing radical change often indulge in self-denial, saying that major changes are
impossible because “my industry is different.” This mantra caused the downfall
of such one-time industry leaders as Penn Central, PanAm, and Columbia Gas. Is the
electric industry any different? Only time will tell, but our betting is that the above
list of failures is likely to grow significantly longer in the near future.<br>
<br>
<br>
<font color="#000080"><em><strong>Opportunities in the new power markets</strong></em></font><br>
<br>
The change in the value chain creates opportunities for entrepreneurial rewards for those
who can adjust quickly to the changing marketplace. In the following paragraphs we discuss
four exciting new opportunities for coal suppliers in today’s world.<br>
<br>
<font color="#0000FF"><strong>Power Marketing</strong></font> <br>
<br>
Electricity is a $200 billion market at retail, $40 billion at wholesale. The California
retail market alone is $28 billion. Few companies have the in-house expertise to fulfill
the needs of all customers. Alliances between fuel suppliers and traditional marketers
have a variety of synergies which could lead to a powerful force in the market.
Cogeneration might prove a useful model here. In cogeneration projects the fuel supplier
had the task of ensuring the project could beat the price of utility power. Since the fuel
supplier took the greatest risk, it received the bulk of the rewards. Likewise, a fuel
supplier which could allow an allied marketer to undercut the competition should be
handsomely rewarded.<br>
<br>
<font color="#0000FF"><strong>Coal-By-Wire</strong></font> <br>
<br>
This concept goes back to the Seventies where utilities built plants at minemouths and
moved the power to where it was needed. Participation in these projects were limited to
utilities who could get the power to the load centers. Things have changed, however: not
only can utilities own mines, but coal producers can now build powerplants. The right to
transmission access creates new opportunities for entrepreneurs to build so-called
“merchant plants” and sell the power where it will bring the highest price. <br>
<br>
As a utility attempts to lower its costs of power it will compare the cost of buying power
on the open market versus the cost of using it own generators. If rail rates are too high,
a utility would likely buy power and curtail rail deliveries. This places a cap on rail
rates and likely will lead to future reductions in the cost of coal transport.<br>
<br>
<font color="#0000FF"><strong>Coal Tolling</strong></font><br>
<br>
Gas tolling essentially is arbitrage play between the cost of gas and power. Coal tolling
consists of removing risk from the utility. A coal company buys a capacity option for a
fixed fee. The supplier also agrees to pay a utility a mill or two markup if they generate
power. The supplier benefits in that it can more of its coal, and, if power prices rise,
they get more of the profit. The plant owner benefits from the option premium and reduced
heat rates if the plant operates at a higher capacity factor.<br>
<br>
<font color="#0000FF"><strong>Fixed Price Arrangement</strong></font><br>
<br>
In a fixed price arrangement a coal suppliers sells coal at a price tied to regional
electrical prices (e.g., the McGraw-Hill regional average). This fluctuating revenue
stream can then be sold to a financial marketer in exchange for a fixed rate. <em>(This
transaction is illustrated in Chart 4.)</em> Margins also might be locked in though the
use of an electric futures contract. The utility reduces its risks and the marketer gets
to sell more coal. If the coal supplier desires to go unhedged, it also might benefit from
future electric price increases.<br>
<br>
<font color="#000080"><em><strong>Chart 4</strong></em></font><br>
</p>
<p align-center><img src="http://www.compowergroup.com/images/chart4.gif" border="0" alt="Chart 4" width="466" height="349"></p>
<p><br>
<font color="#000080"><em><strong>How can suppliers take advantage of these opportunities?</strong></em></font><br>
<br>
This article has only scratched the surface of the types of opportunities which coal
producers and utilities have during this transitional period.<br>
<br>
Success requires quick action. The window of opportunity is likely to be open for a
relatively short period. Don’t study an opportunity to death. Create a dynamic
business plan which can be changed as the situation warrants.<br>
<br>
Above all, the present situation makes it imperative that fuel suppliers know more about
the utility business than they have in the past. Those which understand the drivers of
change, stay abreast of developments, and take steps to benefit from them should be able
to benefit from these changing conditions.<br>
<br>
</p>
<p align="center"><img src="../images/colorbar.gif" align="bottom" WIDTH="585" HEIGHT="1"> </p>
<div align="center"><center><table width="65%">
<tr>
<td width="100%"><font color="#000080"><em>Larry Weiss is President of The ComPower Group,
which provides electric utilities, power marketers, industry suppliers, and end users with
the information and know-how to compete in today’s competitive power markets. </em></font><p><font color="#000080"><em>The ComPower Group offers services relating to strategic planning as
well as contracting and procurement.</em></font></td>
</tr>
</table>
</center></div><p align="center"><a href="http://www.compowergroup.com/">Visit The
ComPower Group Home Page</a></p>
<p align="center"><img src="../images/colorbar.gif" align="bottom" WIDTH="585" HEIGHT="1"> </p>
</blockquote>
</blockquote>
<p><a href="http://www.powermarketers.com/main.htm" target="_parent"><img src="../images/home.gif" WIDTH="30" HEIGHT="23"></a> Click to return to The PMA Home Page </td>
</tr>
</table>
</center></div>
</body>
</html>