|
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 : |
<html>
<head>
<title>Trading Hubs: Where Power Is Traded And Why</title>
</head>
<body style="font-family: Arial" vlink="#808080">
<div align="center"><center>
<table border="0" cellpadding="8" cellspacing="0" width="98%" bgcolor="#000000">
<tr>
<td width="100%" valign="middle"><a name="top"></a><img src="../images/pmamagsm.gif" alt="PMA Online Magazine" border="0" align="right" WIDTH="229" HEIGHT="100"></td>
</tr>
</table>
</center></div><div align="center"><center>
<table border="0" cellpadding="8" width="98%">
<tr>
<td width="25%" valign="top" align="center"><!--webbot bot="ImageMap" rectangle="(14,297) (97,322) http://www.powermarketers.com/adrates.html" rectangle="(11,230) (95,257) http://www.powermarketers.com/pmajobs.htm" rectangle="(12,163) (96,189) http://www.powermarketers.com/main.htm##_parent" rectangle="(12,95) (96,121) http://www.powermarketers.com/power2.htm##_blank" rectangle="(11,29) (96,54) ../pmamag.htm" src="../images/magmenu.gif" alt="PMA OnLine Magazine Menu" border="0" align="center" startspan --><MAP NAME="FrontPageMap"><AREA SHAPE="RECT" COORDS="14, 297, 97, 322" HREF="http://www.powermarketers.com/adrates.html"><AREA SHAPE="RECT" COORDS="11, 230, 95, 257" HREF="http://www.powermarketers.com/pmajobs.htm"><AREA SHAPE="RECT" COORDS="12, 163, 96, 189" HREF="http://www.powermarketers.com/main.htm" TARGET="_parent"><AREA SHAPE="RECT" COORDS="12, 95, 96, 121" HREF="http://www.powermarketers.com/power2.htm" TARGET="_blank"><AREA SHAPE="RECT" COORDS="11, 29, 96, 54" HREF="../pmamag.htm"></MAP><a href="../_vti_bin/shtml.dll/archives/trading.htm/map"><img src="../images/magmenu.gif" alt="PMA OnLine Magazine Menu" border="0" align="center" ismap width="110" height="350" usemap="#FrontPageMap"></a><!--webbot bot="ImageMap" endspan i-checksum="28526" --><p><a href="../searchpma.htm"><img src="../images/archives.gif" alt="Archives Search" border="0" align="center" WIDTH="70" HEIGHT="40"></a></p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p><a href="trading.htm#top"><img src="../images/b-t-top.gif" alt="Back To Top" border="0" WIDTH="71" HEIGHT="35"></a></p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </p>
<p> </td>
<td width="75%" valign="top"><p ALIGN="left"><font face="Arial" size="6"><b><strong>TRADING
HUBS: WHERE POWER IS TRADED AND WHY</strong></b></font></p>
<p><strong><font face="Arial" size="4">BY E. RUSSELL BRAZIEL<br>
</font><font face="Arial" size="3"><em>The Power Marketing Association's Fifth Annual
Meeting <br>
November 19-20, 1998 <br>
Washington, D.C.</em></font></strong><font face="Arial" size="4"><br>
</font><font face="Arial" size="3">(<em>originally published by PMA OnLine Magazine: 12/98</em>)</font><font size="4"></p>
</font><div align="center"><center><table border="0" width="100%">
<tr>
<td width="50%"><font FACE="Arial"><p ALIGN="JUSTIFY">Over the past few months, the power
trading market has received quite an education in the commodity trading business.
Collectively, the industry is now considerably more astute about credit, price volatility,
risk management and the critical importance of a crystal clear definition of the
obligations of buyer and seller. Through this process, power trading has started to mature
as an industry, and like all mature energy commodities, the market is increasingly
concentrating liquidity at a select group of specific geographic locations or hubs. </font></td>
<td width="50%"><p align="center"><img src="../images/trade01.gif" alt="trade01.gif (6055 bytes)" WIDTH="207" HEIGHT="107"></td>
</tr>
</table>
</center></div><p ALIGN="JUSTIFY"><font FACE="Arial">This geographic concentration of
liquidity serves to support several positive market developments, including enhanced price
discovery, more narrow bid-ask spreads and in general, a more efficient marketplace.</font></p>
<font FACE="Arial"><p ALIGN="JUSTIFY">But while the hub development process in the power
market is progressing, it is far from complete. And as market participants in other energy
commodities have learned, the decision to trade at a particular hub using a particular
contractual instrument, can be as important - if not more important - than the price of
the trade itself.</p>
<p ALIGN="JUSTIFY">In fact, the power business already has some battle scars from the
shifting of trading hubs and trading instruments. For example, earlier this year the
imposition of Location Marginal Pricing (LMP) for 1,600 buses at PJM<a href="trading.htm#f1"><strong><sup>1</sup></strong></a><a name="return"></a> effectively split the established "Seller’s Choice 500KV
line" delivery point into a west hub and an east hub. The western hub has a
significant level of activity, but limited reliable access to high demand areas, while the
east delivery point has the high-demand access, but is occasionally constrained during
on-peak hours. Liquidity dried up in both halves of PJM and took several weeks to recover.
A number of traders that were caught with out-month positions at the old 500KV hub
delivery point incurred substantial financial losses to unwind their positions.</p>
<p>We saw a similar story in ERCOT, which until early this year traded as one huge hub via
a product Undelivered "B." When a north/south transmission constraint developed
in June due to heavy demand, the hub split into at least two areas. Similar to PJM,
liquidity dried up and several traders with out-month deals had to do a lot of work to
protect their positions. Clearly "Hub Trading Delivery Risk" is a component of
the trade that deserves a lot of attention.</font></p>
<font FACE="Arial"><p ALIGN="JUSTIFY">In this paper, I will provide background on the
current state of hub trading in the power market, focusing on the hubs which are
responsible for the majority of the industry’s trading activity.</p>
<p ALIGN="JUSTIFY">I will also address these questions: </p>
<blockquote>
<ul>
<li><p ALIGN="JUSTIFY">How have Hubs Evolved in Other Energy Commodities? What lessons can
be elicited from the commoditization of crude oil, petroleum products, natural gas?</p>
</li>
<li><p ALIGN="JUSTIFY">How will Hubs Evolve in the Wholesale Power Market? Why some hubs
could succeed while others fail? And finally, </p>
</li>
<li>How will Traders Manage Hub Trading Delivery Risk? And how will they leverage the
evolution of hub-based trading in power to improve trading performance?</li>
</ul>
</blockquote>
<b><u><p></u><big>What are Hubs?</big></b></p>
<p>A good definition and description of a power hub can be found on the PJM webpage, as
described below: </p>
<blockquote>
<p>A hub is an aggregation of representative buses grouped by region. Hubs create a common
point for commercial energy trading. </p>
<b><p>1. What is the business reason for Hubs?</b><ul>
<li>Hubs create a common point for commercial trading contracts to settle with or without
going to physical delivery. <br>
</li>
<li>Hubs are intended to create price signals for geographical regions of the control area
by aggregating a group of representative buses. <br>
</li>
<li>The creation of hubs reduces the risk of delivering to one particular bus whose price is
more volatile during a constrain than a collection of bus prices at a weighted average.</li>
</ul>
<b><p>2. Can a hub be a source or a sink?</p>
</b><blockquote>
<p ALIGN="JUSTIFY">In the case of PJM: yes.</p>
</blockquote>
</blockquote>
<b><u><p ALIGN="JUSTIFY"></u><big>Where are the Hubs?</big></b></p>
<p>Potentially the power business could have a very large number of hubs. FERC has
jurisdiction of 166 utilities identified on NERC’s map of regions and control areas
each which theoretically could become a hub or even more than one hub depending upon the
utility’s transmission system. But, according to trade publications that track spot
prices for next-day power, only about 20 points are actively traded.</p>
<p align="center"><img src="../images/trade02.gif" alt="trade02.gif (15365 bytes)" WIDTH="373" HEIGHT="281"></p>
<p>Five of the points: Mid Columbia, COB, Palo Verde, Four Corners, and Mead are located
in the west. There are seven points in the central U.S. area: ERCOT, Ameren, ComEd, MAIN
north, MAPP, Into Entergy and SPP. The remainder are situated in the east, and include:
Into Cinergy, north ECAR, PJM-west, NEPOOL, NYPP, Into TVA, southern Florida and the
Florida-Georgia border. Although some trading occurs at all of these points, power trading
is primarily concentrated among three major hubs in the east: Cinergy, Entergy and TVA,
and three points in the west: COB, Palo Verde and Mid-C.</p>
<p ALIGN="JUSTIFY">Clearly power trading volumes are concentrated at a small number of
locations. But is this a negative aspect? Why is the market behaving in this manner? And
what is occurring at the remaining points? For answers to these questions, we can look to
the experience of other energy commodities. <b><u></p>
<p ALIGN="JUSTIFY"></u><big>How Have Hubs Evolved in Other Energy Commodities?</big></b></p>
<p ALIGN="JUSTIFY">For crude, petroleum products and natural gas liquids, there are only a
scant number of critical market hubs, each with its own trading standards and execution
tools. In the crude oil business, there are four major market centers: Cushing, OK; West
Texas; Gulf Coast; and the New York Harbor. Petroleum products utilize four: the New York
Harbor, the Houston Ship Channel, Los Angeles and Group 3 (which basically covers the
midwest). In natural gas liquids, market centers are located at: Mt. Belvieu (Texas),
Conway (Kansas), Sarnia, Ontario, and the Los Angeles Basin. For crude, products and
natural gas liquids, other points such as production facilities, refineries and storage
terminals generally trade in an active location-arbitrage marketplace at market
transportation differentials, relative to these major market center points. This relative
pricing structure is what makes hub-based trading work across an entire market.</p>
<p ALIGN="JUSTIFY">A futures market has only been successful at two of these trading
locations <font FACE="Symbol">-</font> Cushing for crude oil, and the New York Harbor for
petroleum products. On the other hand, electronic trading has been very successful in the
natural gas liquids market, with over 40% of spot trades consummated online.</p>
<p ALIGN="JUSTIFY">Natural gas prices are reported daily at about 100 points, and the
commodity is traded very actively at over 30 major locations. Yet natural gas futures have
only been truly successful at the Henry Hub. Hub-based electronic trading has captured a
large portion of the next-day trading market, with 150 to 250 trades each day in the U.S.,
and an additional 200 trades in Canada.</p>
<b><u><p ALIGN="JUSTIFY"></u><big>Key Characteristics of Successful Hubs</big></b></p>
<p ALIGN="JUSTIFY">When we look at successful energy trading hubs across the various
commodities, six key characteristics are consistently present:</p>
<blockquote>
<ol>
<li><p ALIGN="JUSTIFY">First, the location is a natural supply/demand balancing point for a
particular market. It is not necessary that a large number of transmission systems come
together at a single point, although it does seem to be an advantage.</p>
</li>
<li><p ALIGN="JUSTIFY">Second, a successful point requires reliable contractual standards
for delivery and receipt of the energy commodity. Players must be able to rely on delivery
mechanisms where the costs and the ‘risk of curtailment’ are known quantities.</p>
</li>
<li><p ALIGN="JUSTIFY">Third, there must be transparent pricing at the point. Participants
must be confident that trading is on a relatively level playing field, and that no single
player nor group of players can grossly manipulate the market price.</p>
</li>
<li><p ALIGN="JUSTIFY">Fourth, there must be homogeneous pricing across the hub. If prices
vary across the hub and there are no trading conventions to handle the situation, sellers
will always seek to deliver the commodity at the cheapest location, while buyers will
always seek out the most expensive point. If left inadequately addressed, the point will
probably not be actively traded. </p>
</li>
<li><p ALIGN="JUSTIFY">Fifth, there must be convenient tools to execute trades and aggregate
transactions. This includes execution tools like electronic trading systems and futures
exchanges, plus scheduling mechanisms to provide the capability to adjust a portfolio of
supply to a portfolio of demand.</p>
</li>
<li><p ALIGN="JUSTIFY">And finally, yet most important, there must be a critical mass of
buyers and sellers that respond to the five characteristics listed above, and actively
trade the market on a consistent basis. This is the definition of liquidity, which is
clearly the most critical requirement of a successful trading hub. And it is the
importance of liquidity that drives markets to concentrate liquidity to as few locations
as possible. Thus, we can conclude that the concentration of liquidity at a limited number
of points is not a problem for the market. This geographic concentration of hubs functions
efficiently for crude, petroleum products and natural gas liquids.</p>
</li>
</ol>
</blockquote>
<p ALIGN="JUSTIFY">Likewise, we can also conclude that each commodity is unique, requiring
trading instruments and execution mechanisms designed specifically for each individual
energy commodity. For example, natural gas has evolved a more diverse hub trading
structure than the other energy commodities. </p>
<p ALIGN="JUSTIFY">We believe that this diverse structure is due to a number of factors,
the most important of which are: (a) the physical characteristics of the natural gas
delivery system, and (b) the relative value of gas transportation versus the gas
commodity value.</p>
<p ALIGN="JUSTIFY">In other words, most of the physical gas supply system is targeted
toward specific regional markets with unique pricing dynamics, and even more important <font FACE="Symbol">-</font> the cost of gas transportation and storage is high relative to the
cost of gas at the point of production. Thus, the market for gas is more localized than
for the other energy commodities, resulting in a greater number of actively traded hubs
and a very active location arbitrage (basis and EFP) market. This also drives the gas
market to electronic trading tools, which make it easier to discover prices and execute
trades at a large number of trading points.</p>
<b><u><p ALIGN="JUSTIFY"></u><big>Wholesale Power Market Hub Structure</big></b></p>
<p ALIGN="JUSTIFY">From what we know about other energy commodities, we would expect the
wholesale power market to be characterized by:</p>
<blockquote>
<ul>
<li><p ALIGN="JUSTIFY">A large number of geographically diverse hubs used by the market to
effect delivery of the physical commodity;</p>
</li>
<li><p ALIGN="JUSTIFY">An active location arbitrage trading marketplace; </p>
</li>
<li><p ALIGN="JUSTIFY">A robust electronic trading market, consummating hundreds of trades
each day; and</p>
</li>
<li><p ALIGN="JUSTIFY">Pricing at locations distant from hub locations, based primarily on
transmission cost differentials from major trading locations.</p>
</li>
</ul>
</blockquote>
<p ALIGN="JUSTIFY">However, essentially, the wholesale power market possesses none of
these characteristics. </p>
<p ALIGN="JUSTIFY">The market is confined to very few locations and arbitrage is a limited
financial game frequently tied to very few hubs or the natural gas market. The top 10 to
20 players are responsible for the vast majority of the market activity. Electronic
trading beyond the mandatory California PX system is negligible, and up to two thirds of
even daily trades are booked out, resulting in minimal physical deliveries. Additionally,
there is a faint relationship between pricing at the major hubs and pricing at nearby
non-hub delivery locations.</p>
<p ALIGN="JUSTIFY">This schematic is more representative of the true structure of the
power market. Over 85% of power trading is conducted at these 10 trading points. Cinergy,
Entergy and TVA are the core of the market east of the Rockies, with ERCOT, PJM, ComED and
NEPOOL filling out most of the remaining daily marketplace. In the west, most bilateral
trading is at COB, Palo Verde, and Mid Columbia, while the California PX dominates the
next-day market.</p>
<p ALIGN="JUSTIFY">A location arbitrage market exists, but it is almost exclusively
between the seven eastern points as a group, and the three western points. There is
virtually no arbitrage trading between east and west.</p>
<p ALIGN="JUSTIFY"><img src="../images/trade03.gif" alt="trade03.gif (14295 bytes)" WIDTH="699" HEIGHT="565"></p>
<p ALIGN="JUSTIFY"> </p>
<p ALIGN="JUSTIFY">When combined with existing and planned futures contracts also shown on
this schematic, the points on this slide nearly encompass virtually the entire power
trading market as it exists today. The 10 cash market hubs, combined with the six futures
contracts (plus one announced location at PJM), and the NYMEX gas futures contract which
is used by a number of traders as a surrogate for fuel costs, make up the structure of the
wholesale market.</p>
<p ALIGN="JUSTIFY">We believe that the variance between this market structure and its
expectations (listed previously) occur mainly due to:</p>
<blockquote>
<ul>
<li><p ALIGN="JUSTIFY">Unreliable and expensive transmission discourages transmission
between hubs to capture pricing differentials;</p>
</li>
<li><p ALIGN="JUSTIFY">Unwieldy tagging rules make it difficult for hubs to be used as true
physical aggregation and balancing points; </p>
</li>
<li><p ALIGN="JUSTIFY">Several hubs have been defined so broadly that prices vary across the
hub, defeating the requirement of homogeneous pricing across the hub; and </p>
</li>
<li><p ALIGN="JUSTIFY">Primarily due to the June price spike, the number of potential
counterparties at any one hub has been reduced by market withdrawals, cutbacks, and
increasingly stringent credit requirements. In other words, there is not a critical mass
of players at some of the hub locations.</p>
</li>
</ul>
</blockquote>
<p ALIGN="JUSTIFY">The power market still has a long way to go before the regulatory
framework and business processes have evolved to the point where a liquid, hub-based
marketplace for physical power exists. This immature state of the power market is not due
to any unique physical properties of electricity, but instead has primarily resulted from
the lack of progress in the development of an truly open transmission network.</p>
<b><u><p ALIGN="JUSTIFY"></u><big>Implications For Power Marketers And Traders</big></b></p>
<p ALIGN="JUSTIFY">The structure of today’s power market is unstable. It is an
evolving market where the risk of being surprised by unforeseen events remains relatively
high:</p>
<blockquote>
<ul>
<li><p ALIGN="JUSTIFY">Active hubs are at risk of being refined, drying up, or fragmenting
into multiple pricing points. Long-term trades must be structured to provide an exit
strategy for either side of the trade if delivery rules or trading conventions at the
contractual delivery point change materially.</p>
</li>
<li><p ALIGN="JUSTIFY">Due to the difficulties in moving power over the transmission grid,
location basis risk may be as high, or higher, than position trades in the outright
commodity. It is difficult to transport power to correct regional imbalances. </p>
</li>
<li><p ALIGN="JUSTIFY">The limited number of trading points today are susceptible to the
domination of a very few players.</p>
</li>
<li><p ALIGN="JUSTIFY">Because physical power underlies only a relatively small portion of
spot market trading, pricing on futures contracts may not converge with the physical spot
market; putting hedging strategies in question. </p>
</li>
<li><p ALIGN="JUSTIFY">The relationship between hub prices and the value of wholesale power
at adjacent points will be volatile.</p>
</li>
</ul>
</blockquote>
<p ALIGN="JUSTIFY">This view of the power market is not presented here to discourage
trading, hub development, or long-term transactions. On the contrary, the intent is to
encourage market participants to manage these risks prudently by utilizing trading tools,
contractual provisions and information systems that are designed to minimize these risks.
Furthermore, the intent is to encourage progress toward greater access to the transmission
network by the trading community, and the development of greater standardization in
business processes and contractual provisions. </p>
<p ALIGN="JUSTIFY">In Order 888, the Federal Energy Regulatory Commission (FERC) stated
its goal "to remove impediments to competition in the wholesale bulk power
marketplace and to bring more efficient, lower cost power to the nation's electricity
consumers." Clearly the immaturity of today’s trading hub structure is exactly
this <font FACE="Symbol">-</font> a considerable impediment to open competition. </p>
<p ALIGN="JUSTIFY">In conclusion, the FERC, state commissions and the power trading
industry must work together to insure that the market’s regulatory framework
encourages a viable, bilateral, hub-based power marketplace.</p>
</font><hr>
<font SIZE="2"><sup><p ALIGN="JUSTIFY"><a name="f1"><strong>1</strong></a></sup>PJM
Interconnection became the first operational Independent System Operator in the U.S. on
January 1, 1998, managing the PJM Open Access Transmission Tariff and facilitating the PJM
Interchange Energy Market. The PJM service area includes all or part of Pennsylvania, New
Jersey, Maryland, Delaware, Virginia and the District of Columbia.<br>
<a href="trading.htm#return">return</a></p>
<p ALIGN="JUSTIFY"></font> </td>
</tr>
</table>
</center></div>
<p align="center"><a href="trading.htm#top"><img src="../images/b-t-top.gif" alt="Back To Top" border="0" WIDTH="71" HEIGHT="35"></a></p>
</body>
</html>