Re: Bitten by NIMBY, CA power system goes socialist...

Date: Fri Jan 12 2001 - 09:45:50 MST

One thing I learned in reading a couple of the papers at is that futures markets
by themselves will probably not lead to significantly lower energy prices.

The future market price is basically an estimate of what the average spot
price will be over the contract period. Both buyer and seller have to
agree on the price to which they will be locked in, and they will try
to negotiate the best deal possible. Ultimately it will come down to
their guesses at what average prices are going to be.

As it happens, the high prices we have seen in the past year were not
anticipated by anyone. So futures contracts negotiated a year ago would
in fact have saved money for the utility companies who are buying power.

However, now that we have seen the high prices, futures contract prices
are going up. No seller wants to get locked into $50/MWh if he is going
to be making $500/MWh on the spot market. So any futures contracts
entered today are going to be at premium prices.

What will happen next summer? The spot market could shoot up as it did
last year, so that spot prices are higher than the long term futures
contract prices. Or we could have an economic slowdown and some cooler
weather, in which case the utilities would be locked into paying much
more than the spot price.

There's no way to predict. By locking in the price today, the utilities
insulate themselves from the risk of higher prices, at the cost of
being unable to take advantage if prices drop back to more historically
normal ranges.

In general, the market makes the best guess possible about the future.
It may be wrong either way, but on the average it will be as likely to be
wrong one way as the other. This means that using futures contracts will
lead to prices that are, on the average, the same as spot market prices.
It does not save money.

Now, there are some second-order effects which can lead to savings under
futures contracts. They take away some of the strategies and tricks which
power suppliers can use to exercise "market power" and get higher than
competitive prices. For example, suppliers are accused of holding plants
offline, falsely claiming they are under maintenance, and then when the
prices have risen high enough that day suddenly the plants are turned on.

This kind of "gaming" of the system appears to be happening in some cases,
and it can only work in the short term markets. Using futures markets
would eliminate some of these uncompetitive strategies and might lower
prices somewhat, depending on the extent to which high prices are due
to these kinds of tricks. It's not clear though how much of an effect
this would have.


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