- Email: [email protected]
Wholesale power marketing in restructured electricity markets
Energy Policy. Vol. 26, No. 14, pp. 1099 — 1104, 1998 1999 Published by Elsevier Science Ltd. All rights reserved Printed in Great Britain 0301-4215/98/$ — see front matter
PII: S0301-4215 (98) 00047-0
Communication Wholesale power marketing in restructured electricity markets
Fereidoon P. Sioshansi* and Art Altman Convector Consulting, Inc. (CCI), 750 Menlo Ave, Suite 200, Menlo Park, CA 94025, USA Electric Power Research Institute (EPRI), 3412 Hillview Ave, Palo Alto, CA 94304, USA
Prior to 1992, very few people had heard the term power marketing. Today, power marketing is wellrecognized, however, few people know what is behind the industry’s exponential growth. This communication, which is based on a major study recently completed for the Electric Power Research Institute (EPRI), explains what power marketing is, who the power marketers are, what they do, and what’s behind the industry’s explosive growth in the past few years. It also explains what types of products and services power marketers offer, and what are the fundamental drivers of this demand. Understanding the last item is particularly significant, namely the growth of power marketing in the context of the rapid restructuring of the wholesale — soon to be followed by the retail — electricity markets in the US. 1999 Published by Elsevier science Ltd. All rights reserved.
Introduction
Power marketing: definition
Prior to 1992, mentioning the term power marketing would produce a blank look for most people in the electric power industry. Today, owing to several years of exponential growth (Figure 1), nearly everyone would recognize the word. The industry’s volume of trade in 1997, for example, was 1.2 billion MWh; more than five times what it was in 1996. This paper explains what power marketing is, who power marketers are, what they do, why they do it, and what’s behind their explosive growth in the past few years. This paper also explains what types of products and services they offer, why these products and services are in demand, and what are the fundamental drivers for this demand. Understanding the last item is particularly significant: namely, the rapid restructuring of the wholesale — soon to be followed by the retail — electricity markets in the US. Another equally important impetus for the industry’s growth is the passage of the highly significant Energy Policy Act in 1992 and, more recently, the promulgation of the Federal Energy Regulatory Commission’s Order 888 and 889 in 1996, in the absences of which there would be no power marketing industry as we know it today.
The term power marketing refers to any number of financial and/or physical transactions associated with the ultimate delivery of a host of desirable energy-related services and products to wholesale — and increasingly retail — customers. Power marketers, those engaged in such trade, however, need not — and generally don’t — own any generation, transmission or distribution facilities or assets, but rely on others for the physical delivery of the underlying physical services. Moreover, power marketers operate primarily as contractual intermediaries. Power marketers provide a number of highly-valued products and value-added services designed to fit the individual needs of their clients. Some of these products and services are aimed at reducing the costs, improving the performance, increasing the revenues, or increasing the profits associated with the clients’ underlying energy generation, transmission, or delivery business. Other desired services are associated with reducing the clients’ risk exposure to price fluctuations or other market volatilities. For some clients, power marketers offer a measure of performance or security in an otherwise risky business environment. Some customized services are designed to address a particular concern, cover a menacing risk exposure, finance a complicated transaction, or facilitate risk
*Corresponding Author.
1099
1100
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
Figure 1 Power marketing’s phenomenal growth in recent past Source: Edison Times, March 1998, Edison Electric Institute
and profit sharing among a diverse group of parties who would not otherwise engage in the risky and/or complex transaction. Many of the products and services offered by power marketers have gained in significance in the last few years because of the introduction of price volatility — and considerable risks — in the competitive wholesale electricity markets. The underlying risks, which have always been there, have now become exposed and explicit. They must be understood, and properly managed. Risk management is one of the critical services offered by power marketers. As retail markets are opened to competition across the US over the next several years, similar pressures — as well as opportunities — will emerge in the competitive retail markets. The energy related services provided by power marketers typically include the actual physical delivery and/or a financial obligation or promise to do so. The products may include electricity, natural gas, or their energy-equivalent in a particular time, delivery point, and with a fixed or variable price. The delivery of the goods may be firm or non-firm, short-term or longterm, a one-time deal or an agreement stretching over time. If the price is variable, it may be indexed to any number of other commodities, or may be derived from a combination of underlying commodity prices, hence a derivative price. The services associated with the energy-related products typically include measures or features that provide some degree of price stability or offer some performance guarantee. The level or degree of firmness with which the goods are to be delivered, notably price
stability, firmness of physical delivery, and the time and place of delivery, can be adjusted to fit the client’s needs and risk tolerance. Providing such services becomes increasingly more significant as both wholesale and retail markets become competitive and subject to market price fluctuations, exposing both the buyers and sellers to risks they poorly understand and, in many cases, can ill afford. Moreover, many new generators, energy providers, and retailers entering competitive energy markets will not be able to properly function or provide the services their clients expect without the power marketers.
Who are the power marketers? The number of entities with FERC-approved marketbased rates, who can engage in power marketing, has seen a steady growth in recent years (Figure 2). The industry’s top ten players (Table 1) currently account for the lion’s share of the business, as defined by the volume of trade handled. As time goes on, however, the concentration of trade handled by the top players is expected to shrink (Figure 3). In the fourth quarter of 1996, for example, the top ten accounted for 74.5% of the industry’s total volume of trade. By the fourth quarter 1997, this figure had dropped to 56.5%. The volume of trade, however, may be a poor indicator of business profitability. The ranking and composition of the top ten players changes over time. Enron Power Marketing Inc. has been the top contender for some time now, reporting
1101
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
nearly twice the volume of the second-ranked Electric Clearinghouse. Despite its continued dominance, Enron’s market share for 1997 stands at 15.6%, considerably below 35.7% in the first quarter of 1996. Duke
Energy ¹rading and Marketing (formerly PanEnergy Trading and Market Services) in combination with Duke/¸ouis Dreyfus ranks as the third major player.
Figure 2 Growth of power marketers, 1993—1997 Number of power marketers entering business in a given quarter Source: Federal Energy Regulatory Commission
Table 1 Top ten US power marketers; for full year 1997 Top ten marketers Rank (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Marketer Enron Power Marketing, Inc. Electric Clearinghouse, Inc. Duke Energy Trading and Marketing (formerly PanEnergy) Vitol Gas & Electric LLC Southern Energy Trading and Marketing, Inc. Aquila Power Corporation PacifiCorp Power Marketing, Inc. LG&E Power Marketing, Inc. Ilinova Energy Partners Engage Energy US, LP
Includes pre-merger sales by Duke/Louis Dreyfus, LLC. Source: Edison ¹imes, March 1998, ¹he Edison Electric Institute.
Figure 3 Market share of power marketers; 1997
Sales (Million MWh) Market share; (%)
Change; old rank (From first quarter)
72.0 (16.0%) 38.1 (8.4%) 36.1 (8.0%)
#94.1% 1 #133.7% 2 #101.7% 4
29.5 28.3 24.6 19.9 19.9 14.5 12.9
#136.0% #167.0% #110.3% #521.9% #105.2% #81.3% #72.0%
(6.5%) (6.5%) (5.5%) (4.4%) (4.4%) (3.2%) (2.9)
3 6 5 21 7 8 9
1102
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
What business are they in and what’s driving their exponential growth? The fast evolving power marketing business is part hard work, part hard science, and part old fashioned marketing, product packaging and deal making. The hard work is to figure out what the clients need and want, and the best way to offer it to them at prices they can afford. The hard science is understanding the considerable risks, and managing them through mitigating and/or offsetting hedging strategies. Small, uncorrelated risks may simply be managed through risk pooling. The marketing and deal making is particularly important in packaging and offering the so-called structured (ie, non-standard) products.
Non-standard products have higher profit margins — but also higher risks, and higher costs — and add considerable value to an otherwise mundane transaction. As previously reported, US power marketers reported sales of over 1.2 billion MWh in 1997. More amazing is the fact that power marketers have experienced continued growth in quarterly sales in every quarter since the fourth quarter of 1994 with the exception of the fourth quarter of 1997 (recall Figure 1). This, however, may be the tip of the iceberg. According to Jim Lee, an industry analyst and Vice President of ¹he Power Company of America ¸P, an energy marketing firm based in Greenwich, CT, the annual volume of wholesale electricity commodity trading may reach $2.5 trillion by the year
Table 2 Services offered by power marketers Services offered by power marketers Power marketers continue to introduce and refine the variety of products and services they offer in response to what the market demands and also based on the profit margins associated with these services. As the business becomes more competitive and profit margins in the standardized services are squeezed, more emphasis will be placed on higher value-added (and therefore higher profit margin) products. For illustration purposes, however, the services most commonly offered are categorized as follows: Facilities management — Many utilities and customers can benefit from improvements in the utilization, maintenance, and operation of their existing assets, plants, infrastructure, and personnel. This is particularly true for some of the smaller utilities that may not have adequate in-house or internal resources for such services and outsource them to others. A number of power marketers have specialized in such work and are highly successful at it. These services are usually provided in addition to more traditional power marketing functions such as selling the excess output of the plant (eg, what is not needed to serve the utility’s native load) to the highest bidders outside the utility’s immediate service area. The savings resulting from the improved operations and maintenance practices are usually shared among the two parties under pre-arranged terms. In some cases, the power marketer may assume a significant portion of the up-front investments and/or may assume the risks associated with the poor performance of the proposed scheme in exchange for a higher percentage of any resulting savings. The power marketer’s willingness to manage certain critical O&M functions, assume risks, and arrange financing makes such schemes highly attractive to many clients who do not have the internal resources or expertise to engage in such functions. Since no up-front investment may be needed, and no risk is borne if there are no improvements in performance of the plants, there is no risk to engage in such deals with power marketers. Risk Management—Offering a variety of services to provide price stability and risk hedging is among the most sought-after services provided by power marketers. Since many customers and smaller utilities are not familiar with and do not have the necessary skills and capabilities to manage the risks internally, they rely on power marketers for such services. ¹otal energy services, solutions, maintenance, etc — By combining many types of input fuels (eg natural gas, coal, oil) and end-use energy and/or services (eg electricity, natural gas, steam, hot water, and other) it may be possible to reduce a customer’s overall energy costs while at the same time providing an improved level of service. For example, by switching from natural gas to coal on the fuel side, and/or by switching from electricity to natural gas on the end-use side, a customer can take advantage of lower price opportunities. Some power marketers specialize in providing these types of services, usually with little or no costs imposed on the customer and little or no risks on the customer’s operations. Through their broad knowledge of the markets and prices, the power marketer may assume the role of the fuel procurement for the unsophisticated customer, managing the risks and sharing in the resulting cost savings. ¹olling Services — The power marketers’ ability and willingness to buy raw energy at low prices in one location or time and to deliver a portfolio of desirable energy services and customized products at another location or time is highly attractive. Although customers can, in principle, perform these functions on their own, many do not have the market reach or the risk management capabilities of the power marketers. Moreover, power marketers, by virtue of having many offsetting tolling transactions, can balance the risks of market price fluctuations through pooling and other arrangements, thus reducing the risks to the individual customers. Structured/customized products — Structured or customized products are increasingly emerging to meet the specific needs of sophisticated customers. Another reason for their increased popularity among power marketers is that customers are willing to pay significant premiums for these types of services. Offering a package of customized goods and financial services that meet specific customer needs, their financial resources, and risk tolerance, however, tends to be time and resource intensive, hence the higher premiums. These types of services cannot, by their nature, be standardized. They require extensive effort to negotiate and consummate. But the results could be worth the extra effort. For example, a power marketer may be able to structure a tolling arrangement among a coal mine operator, a natural gas pipeline distributor, a generator with multiple plants, and a large customer. If carefully structured, such an arrangement could, over a period of time, make all parties better off by switching from one fuel to another as market prices fluctuate. The end-use customer would, in effect, get the benefit of the lower fuel costs depending on the prevailing market conditions.
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
2003. If this prediction comes to bear, it will make electricity the country’s single largest traded commodity by a wide margin. More amazingly, the $2.5 trillion figure will amount to roughly 10 times the retail value of electricity trade in the US for 2003. How would this be physically possible? Many in the industry, including Mr. Lee, believe that the 10-fold multiple is not far fetched based on the experience of the deregulated natural gas industry. In that industry, the volume of trade is estimated around $600 billion, roughly 10 times the total retail value of natural gas sold nationwide. This is possible because of developments in financial trading instruments such as futures, forwards, swaps, and options which allow the same electrons to be bought and sold multiple times before they are actually generated and consumed. What explains the industry’s phenomenal growth, and how long will it continue? The growth may be explained by several factors, notably: — the emergence of exposed market risks due to market price volatility; — the emergence of new and small players who must rely on power marketers for many critical trading, brokering, and information services; — the existence of considerable locational, temporal, inter-, and intra-fuel price disparities which offer arbitrage opportunities that were previously unexplored; — the emergence of previously unattended customer demands for customized energy-related services; and — intense pressures to better control and manage costs, increase operational efficiency, and increase the performance and utilization of fixed assets and underutilized networks. These fundamental drivers of demand are not expected to be fully satisfied any time soon. Having said that, the phenomenal growth of the last couple of years cannot be expected to continue indefinitely. Once the basic (and finite) needs of the clients in the post- restructured energy industry are understood and satisfied, the industry’s growth rate will diminish. The mostlikely time horizon for continued growth is expected to stretch through 2003, when most of the retail electricity markets in the US are expected to become competitive.
What products and services do power marketers offer? The range of products and services offered by power marketers has been increasing as more players enter the field, as existing players refine and perfect their skills and competencies, and as new niche markets and services are identified and served. Table 2 provides
1103
a summary of the range of services currently provided by power marketers.
Is power marketing profitable? Figures on profitability of the industry are hard to come by because, in most cases, companies engaged in power marketing combine their revenues and costs with many other activities and only report their consolidate performance. This practice makes it frustratingly difficult to figure out the profitability associated with their power trading activities. Moreover, because of the rapid growth of the industry and equally rapid evolution of the power marketing business, many players are primarily focused in establishing market dominance. This objective is driving many a players to sacrifice short-term profitability to gain significant market share. Consequently, any current industry or company-specific profitability results would be of dubious value at best. Furthermore, any profitability (or lack thereof) trends experienced over the past several years would be a poor predictor of the longer-term trends in the industry.
Future growth prospects and long-term implications for power industry Although no industry can indefinitely sustain the exponential growth experienced in power marketing over the past several years, there are a number of indicators suggesting that power marketing still has plenty of room to grow. While the ultimate number of power marketers shows no signs of slowing down, the market is getting crowded and some consolidation and shake out is inevitable. But the volume of trade and the range and type of services provided can be expected to grow both in the retail and wholesale markets, for at least the next several years. More significantly, power marketers, like the independent power producers (IPPs) before them, are no longer merely marginal side players. As time goes on and more power marketers merge or form affiliations with traditional utilities — or vice versa — the distinction between a utility and a power marketer may become fuzzy. Many utilities already have significant wholesale power trading operations, competing head on with power marketers in critical markets and regions. Moreover, as a number of major integrated energy service companies with national (and global) aspirations emerge, the whole definition and makeup of the energy services business is dramatically changing. Ten years from now, it will be an entirely different industry with new market institutions, with new players, new risks, new customers, new expectations and standards of service. Looking back, it will be hard to say what
1104
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
was responsible for so much change in so few years. And as far as most customers are concerned, it will be irrelevant if it was the IPPs, the power marketers, the Federal Energy Regulatory Commission, or the individual state public utility commissions that initiated, facilitated, or caused the change. What will matter will be whether there is a more efficient industry with vigorous competition, offering increased and improved services at lower prices.
Acknowledgements This paper is based on a major report prepared for the Electric Power Research Institute (EPRI). The report, TR-111004, July 1998, is available from EPRI, Palo Alto, CA. The funding and support of EPRI, and the EPRI Project Manager, Mr Art Altman, is gratefully acknowledged.
PII: S0301-4215 (98) 00047-0
Communication Wholesale power marketing in restructured electricity markets
Fereidoon P. Sioshansi* and Art Altman Convector Consulting, Inc. (CCI), 750 Menlo Ave, Suite 200, Menlo Park, CA 94025, USA Electric Power Research Institute (EPRI), 3412 Hillview Ave, Palo Alto, CA 94304, USA
Prior to 1992, very few people had heard the term power marketing. Today, power marketing is wellrecognized, however, few people know what is behind the industry’s exponential growth. This communication, which is based on a major study recently completed for the Electric Power Research Institute (EPRI), explains what power marketing is, who the power marketers are, what they do, and what’s behind the industry’s explosive growth in the past few years. It also explains what types of products and services power marketers offer, and what are the fundamental drivers of this demand. Understanding the last item is particularly significant, namely the growth of power marketing in the context of the rapid restructuring of the wholesale — soon to be followed by the retail — electricity markets in the US. 1999 Published by Elsevier science Ltd. All rights reserved.
Introduction
Power marketing: definition
Prior to 1992, mentioning the term power marketing would produce a blank look for most people in the electric power industry. Today, owing to several years of exponential growth (Figure 1), nearly everyone would recognize the word. The industry’s volume of trade in 1997, for example, was 1.2 billion MWh; more than five times what it was in 1996. This paper explains what power marketing is, who power marketers are, what they do, why they do it, and what’s behind their explosive growth in the past few years. This paper also explains what types of products and services they offer, why these products and services are in demand, and what are the fundamental drivers for this demand. Understanding the last item is particularly significant: namely, the rapid restructuring of the wholesale — soon to be followed by the retail — electricity markets in the US. Another equally important impetus for the industry’s growth is the passage of the highly significant Energy Policy Act in 1992 and, more recently, the promulgation of the Federal Energy Regulatory Commission’s Order 888 and 889 in 1996, in the absences of which there would be no power marketing industry as we know it today.
The term power marketing refers to any number of financial and/or physical transactions associated with the ultimate delivery of a host of desirable energy-related services and products to wholesale — and increasingly retail — customers. Power marketers, those engaged in such trade, however, need not — and generally don’t — own any generation, transmission or distribution facilities or assets, but rely on others for the physical delivery of the underlying physical services. Moreover, power marketers operate primarily as contractual intermediaries. Power marketers provide a number of highly-valued products and value-added services designed to fit the individual needs of their clients. Some of these products and services are aimed at reducing the costs, improving the performance, increasing the revenues, or increasing the profits associated with the clients’ underlying energy generation, transmission, or delivery business. Other desired services are associated with reducing the clients’ risk exposure to price fluctuations or other market volatilities. For some clients, power marketers offer a measure of performance or security in an otherwise risky business environment. Some customized services are designed to address a particular concern, cover a menacing risk exposure, finance a complicated transaction, or facilitate risk
*Corresponding Author.
1099
1100
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
Figure 1 Power marketing’s phenomenal growth in recent past Source: Edison Times, March 1998, Edison Electric Institute
and profit sharing among a diverse group of parties who would not otherwise engage in the risky and/or complex transaction. Many of the products and services offered by power marketers have gained in significance in the last few years because of the introduction of price volatility — and considerable risks — in the competitive wholesale electricity markets. The underlying risks, which have always been there, have now become exposed and explicit. They must be understood, and properly managed. Risk management is one of the critical services offered by power marketers. As retail markets are opened to competition across the US over the next several years, similar pressures — as well as opportunities — will emerge in the competitive retail markets. The energy related services provided by power marketers typically include the actual physical delivery and/or a financial obligation or promise to do so. The products may include electricity, natural gas, or their energy-equivalent in a particular time, delivery point, and with a fixed or variable price. The delivery of the goods may be firm or non-firm, short-term or longterm, a one-time deal or an agreement stretching over time. If the price is variable, it may be indexed to any number of other commodities, or may be derived from a combination of underlying commodity prices, hence a derivative price. The services associated with the energy-related products typically include measures or features that provide some degree of price stability or offer some performance guarantee. The level or degree of firmness with which the goods are to be delivered, notably price
stability, firmness of physical delivery, and the time and place of delivery, can be adjusted to fit the client’s needs and risk tolerance. Providing such services becomes increasingly more significant as both wholesale and retail markets become competitive and subject to market price fluctuations, exposing both the buyers and sellers to risks they poorly understand and, in many cases, can ill afford. Moreover, many new generators, energy providers, and retailers entering competitive energy markets will not be able to properly function or provide the services their clients expect without the power marketers.
Who are the power marketers? The number of entities with FERC-approved marketbased rates, who can engage in power marketing, has seen a steady growth in recent years (Figure 2). The industry’s top ten players (Table 1) currently account for the lion’s share of the business, as defined by the volume of trade handled. As time goes on, however, the concentration of trade handled by the top players is expected to shrink (Figure 3). In the fourth quarter of 1996, for example, the top ten accounted for 74.5% of the industry’s total volume of trade. By the fourth quarter 1997, this figure had dropped to 56.5%. The volume of trade, however, may be a poor indicator of business profitability. The ranking and composition of the top ten players changes over time. Enron Power Marketing Inc. has been the top contender for some time now, reporting
1101
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
nearly twice the volume of the second-ranked Electric Clearinghouse. Despite its continued dominance, Enron’s market share for 1997 stands at 15.6%, considerably below 35.7% in the first quarter of 1996. Duke
Energy ¹rading and Marketing (formerly PanEnergy Trading and Market Services) in combination with Duke/¸ouis Dreyfus ranks as the third major player.
Figure 2 Growth of power marketers, 1993—1997 Number of power marketers entering business in a given quarter Source: Federal Energy Regulatory Commission
Table 1 Top ten US power marketers; for full year 1997 Top ten marketers Rank (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Marketer Enron Power Marketing, Inc. Electric Clearinghouse, Inc. Duke Energy Trading and Marketing (formerly PanEnergy) Vitol Gas & Electric LLC Southern Energy Trading and Marketing, Inc. Aquila Power Corporation PacifiCorp Power Marketing, Inc. LG&E Power Marketing, Inc. Ilinova Energy Partners Engage Energy US, LP
Includes pre-merger sales by Duke/Louis Dreyfus, LLC. Source: Edison ¹imes, March 1998, ¹he Edison Electric Institute.
Figure 3 Market share of power marketers; 1997
Sales (Million MWh) Market share; (%)
Change; old rank (From first quarter)
72.0 (16.0%) 38.1 (8.4%) 36.1 (8.0%)
#94.1% 1 #133.7% 2 #101.7% 4
29.5 28.3 24.6 19.9 19.9 14.5 12.9
#136.0% #167.0% #110.3% #521.9% #105.2% #81.3% #72.0%
(6.5%) (6.5%) (5.5%) (4.4%) (4.4%) (3.2%) (2.9)
3 6 5 21 7 8 9
1102
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
What business are they in and what’s driving their exponential growth? The fast evolving power marketing business is part hard work, part hard science, and part old fashioned marketing, product packaging and deal making. The hard work is to figure out what the clients need and want, and the best way to offer it to them at prices they can afford. The hard science is understanding the considerable risks, and managing them through mitigating and/or offsetting hedging strategies. Small, uncorrelated risks may simply be managed through risk pooling. The marketing and deal making is particularly important in packaging and offering the so-called structured (ie, non-standard) products.
Non-standard products have higher profit margins — but also higher risks, and higher costs — and add considerable value to an otherwise mundane transaction. As previously reported, US power marketers reported sales of over 1.2 billion MWh in 1997. More amazing is the fact that power marketers have experienced continued growth in quarterly sales in every quarter since the fourth quarter of 1994 with the exception of the fourth quarter of 1997 (recall Figure 1). This, however, may be the tip of the iceberg. According to Jim Lee, an industry analyst and Vice President of ¹he Power Company of America ¸P, an energy marketing firm based in Greenwich, CT, the annual volume of wholesale electricity commodity trading may reach $2.5 trillion by the year
Table 2 Services offered by power marketers Services offered by power marketers Power marketers continue to introduce and refine the variety of products and services they offer in response to what the market demands and also based on the profit margins associated with these services. As the business becomes more competitive and profit margins in the standardized services are squeezed, more emphasis will be placed on higher value-added (and therefore higher profit margin) products. For illustration purposes, however, the services most commonly offered are categorized as follows: Facilities management — Many utilities and customers can benefit from improvements in the utilization, maintenance, and operation of their existing assets, plants, infrastructure, and personnel. This is particularly true for some of the smaller utilities that may not have adequate in-house or internal resources for such services and outsource them to others. A number of power marketers have specialized in such work and are highly successful at it. These services are usually provided in addition to more traditional power marketing functions such as selling the excess output of the plant (eg, what is not needed to serve the utility’s native load) to the highest bidders outside the utility’s immediate service area. The savings resulting from the improved operations and maintenance practices are usually shared among the two parties under pre-arranged terms. In some cases, the power marketer may assume a significant portion of the up-front investments and/or may assume the risks associated with the poor performance of the proposed scheme in exchange for a higher percentage of any resulting savings. The power marketer’s willingness to manage certain critical O&M functions, assume risks, and arrange financing makes such schemes highly attractive to many clients who do not have the internal resources or expertise to engage in such functions. Since no up-front investment may be needed, and no risk is borne if there are no improvements in performance of the plants, there is no risk to engage in such deals with power marketers. Risk Management—Offering a variety of services to provide price stability and risk hedging is among the most sought-after services provided by power marketers. Since many customers and smaller utilities are not familiar with and do not have the necessary skills and capabilities to manage the risks internally, they rely on power marketers for such services. ¹otal energy services, solutions, maintenance, etc — By combining many types of input fuels (eg natural gas, coal, oil) and end-use energy and/or services (eg electricity, natural gas, steam, hot water, and other) it may be possible to reduce a customer’s overall energy costs while at the same time providing an improved level of service. For example, by switching from natural gas to coal on the fuel side, and/or by switching from electricity to natural gas on the end-use side, a customer can take advantage of lower price opportunities. Some power marketers specialize in providing these types of services, usually with little or no costs imposed on the customer and little or no risks on the customer’s operations. Through their broad knowledge of the markets and prices, the power marketer may assume the role of the fuel procurement for the unsophisticated customer, managing the risks and sharing in the resulting cost savings. ¹olling Services — The power marketers’ ability and willingness to buy raw energy at low prices in one location or time and to deliver a portfolio of desirable energy services and customized products at another location or time is highly attractive. Although customers can, in principle, perform these functions on their own, many do not have the market reach or the risk management capabilities of the power marketers. Moreover, power marketers, by virtue of having many offsetting tolling transactions, can balance the risks of market price fluctuations through pooling and other arrangements, thus reducing the risks to the individual customers. Structured/customized products — Structured or customized products are increasingly emerging to meet the specific needs of sophisticated customers. Another reason for their increased popularity among power marketers is that customers are willing to pay significant premiums for these types of services. Offering a package of customized goods and financial services that meet specific customer needs, their financial resources, and risk tolerance, however, tends to be time and resource intensive, hence the higher premiums. These types of services cannot, by their nature, be standardized. They require extensive effort to negotiate and consummate. But the results could be worth the extra effort. For example, a power marketer may be able to structure a tolling arrangement among a coal mine operator, a natural gas pipeline distributor, a generator with multiple plants, and a large customer. If carefully structured, such an arrangement could, over a period of time, make all parties better off by switching from one fuel to another as market prices fluctuate. The end-use customer would, in effect, get the benefit of the lower fuel costs depending on the prevailing market conditions.
Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
2003. If this prediction comes to bear, it will make electricity the country’s single largest traded commodity by a wide margin. More amazingly, the $2.5 trillion figure will amount to roughly 10 times the retail value of electricity trade in the US for 2003. How would this be physically possible? Many in the industry, including Mr. Lee, believe that the 10-fold multiple is not far fetched based on the experience of the deregulated natural gas industry. In that industry, the volume of trade is estimated around $600 billion, roughly 10 times the total retail value of natural gas sold nationwide. This is possible because of developments in financial trading instruments such as futures, forwards, swaps, and options which allow the same electrons to be bought and sold multiple times before they are actually generated and consumed. What explains the industry’s phenomenal growth, and how long will it continue? The growth may be explained by several factors, notably: — the emergence of exposed market risks due to market price volatility; — the emergence of new and small players who must rely on power marketers for many critical trading, brokering, and information services; — the existence of considerable locational, temporal, inter-, and intra-fuel price disparities which offer arbitrage opportunities that were previously unexplored; — the emergence of previously unattended customer demands for customized energy-related services; and — intense pressures to better control and manage costs, increase operational efficiency, and increase the performance and utilization of fixed assets and underutilized networks. These fundamental drivers of demand are not expected to be fully satisfied any time soon. Having said that, the phenomenal growth of the last couple of years cannot be expected to continue indefinitely. Once the basic (and finite) needs of the clients in the post- restructured energy industry are understood and satisfied, the industry’s growth rate will diminish. The mostlikely time horizon for continued growth is expected to stretch through 2003, when most of the retail electricity markets in the US are expected to become competitive.
What products and services do power marketers offer? The range of products and services offered by power marketers has been increasing as more players enter the field, as existing players refine and perfect their skills and competencies, and as new niche markets and services are identified and served. Table 2 provides
1103
a summary of the range of services currently provided by power marketers.
Is power marketing profitable? Figures on profitability of the industry are hard to come by because, in most cases, companies engaged in power marketing combine their revenues and costs with many other activities and only report their consolidate performance. This practice makes it frustratingly difficult to figure out the profitability associated with their power trading activities. Moreover, because of the rapid growth of the industry and equally rapid evolution of the power marketing business, many players are primarily focused in establishing market dominance. This objective is driving many a players to sacrifice short-term profitability to gain significant market share. Consequently, any current industry or company-specific profitability results would be of dubious value at best. Furthermore, any profitability (or lack thereof) trends experienced over the past several years would be a poor predictor of the longer-term trends in the industry.
Future growth prospects and long-term implications for power industry Although no industry can indefinitely sustain the exponential growth experienced in power marketing over the past several years, there are a number of indicators suggesting that power marketing still has plenty of room to grow. While the ultimate number of power marketers shows no signs of slowing down, the market is getting crowded and some consolidation and shake out is inevitable. But the volume of trade and the range and type of services provided can be expected to grow both in the retail and wholesale markets, for at least the next several years. More significantly, power marketers, like the independent power producers (IPPs) before them, are no longer merely marginal side players. As time goes on and more power marketers merge or form affiliations with traditional utilities — or vice versa — the distinction between a utility and a power marketer may become fuzzy. Many utilities already have significant wholesale power trading operations, competing head on with power marketers in critical markets and regions. Moreover, as a number of major integrated energy service companies with national (and global) aspirations emerge, the whole definition and makeup of the energy services business is dramatically changing. Ten years from now, it will be an entirely different industry with new market institutions, with new players, new risks, new customers, new expectations and standards of service. Looking back, it will be hard to say what
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Wholesale power marketing in restructured electricity markets: F P Sioshansi and A Altman
was responsible for so much change in so few years. And as far as most customers are concerned, it will be irrelevant if it was the IPPs, the power marketers, the Federal Energy Regulatory Commission, or the individual state public utility commissions that initiated, facilitated, or caused the change. What will matter will be whether there is a more efficient industry with vigorous competition, offering increased and improved services at lower prices.
Acknowledgements This paper is based on a major report prepared for the Electric Power Research Institute (EPRI). The report, TR-111004, July 1998, is available from EPRI, Palo Alto, CA. The funding and support of EPRI, and the EPRI Project Manager, Mr Art Altman, is gratefully acknowledged.