A Brief Review of
New Institutions and Structures
in the Electricity Industry
GEMI Power Conference
Houston, Texas
29 June 2006
Agenda
• Overview
• Wholesale Markets
• Retail Markets
• Financial Institutions
• Energy Trading
• Conclusion
Private & Confidential
Overview
Key questions
• Who will develop an IGCC unit with a positive NPV over a
20-year horizon if investors have only a 5-year horizon?
• Where do you build a new transmission line if costs cannot
be recovered through regulated rates?
• What good are smart meters if you still have dumb prices?
• Why do we need new institutions and structures?
Private & Confidential
A structure defined
Structure (struk' chər)
1. Manner of building, constructing, or organizing
2. Something built or constructed, as a building or dam
3. The arrangement or interrelation of all the parts of a whole
4. Something composed of interrelated parts forming an
organism or an organization
Source: New World Dictionary
What
Whatorganizations
buildings are are
people
people
organizing?
building?
Private & Confidential
IGCC financing requires mitigation of uncertainty
10
Natural Gas Price Breakeven ($/MMBtu)
9
Coal prevails – PC
and IGCC are near
parity
8
IGCC with
sequestration prevails
7
6
Point where sequestration
becomes economic
5
IGCC Breakeven
4
NGCC Wins
3
2
1
0
0
5
10
15
20
25
30
Emissions Price ($/ton CO2)
35
40
Notes:
10% Cost of Equity
Gas Prices can move to $6.8/MMBtu if the cost of sequestration is ~$25/ton
We do not exactly hit $25 ton because IGCC must pay for 10% of CO2 it does not capture
Chart
not show “grey area” where site-specific factors determine the winner
Privatedoes
& Confidential
Assumes no value for the CO2 sequestered
45
50
Merchant Transcos (no rate base) are becoming bolder
Western Interconnect
Private & Confidential
Eastern Interconnect
Recent studies support TOU meters/dynamic prices
Energy Demand Under Variable Pricing
(California pilot program results)
0.90
0.80
Point where sequestration
becomes economic
Peak Price ($/kWh)
0.70
0.60
Average Critical Price = $0.58
IGCC Breakeven
0.50
NGCC Wins
0.40
0.30
Average Normal Weekday Price = $0.22
0.20
Average Control Price = $0.13
0.10
0.00
1.00
1.05
1.08
1.10
1.15
1.18
1.20
Peak Period (kWh/hour)
Source: Ahmad Faruqui and Robert Earle, “Demand Response and Advanced Metering,”
Regulation, Spring 2006.
Private & Confidential
1.22
1.25
Wholesale Markets
Growing realization energy-only markets may not suffice
DPeak
Clearing
Price
Capped &
Mitigated
Price
The “missing money” =
lost contributions to fixed
costs for every plant
Price set
by
demand
Price set
by supply
offer caps
Peaker
Intermediate
Baseload
Quantity
Private & Confidential
Out-of-Market
Actions
Resource adequacy solutions
• Proposed / Implemented Capacity Markets
–
–
–
–
–
New England
New York
PJM
Spain (structure similar to NE)
Netherlands (structure similar to NE)
• Some type of Resource Adequacy Construct under discussion
– Texas
– California
• Public Power Authorities
– California (proposed, established and retired)
– Ontario (proposed, established and operating)
– Connecticut (proposed)
• Other Market Designs
Private & Confidential
Retail Markets
State electricity restructuring appears to be stalled
Source: Energy Information Administration
Private & Confidential
Industrial and commercial customers continue to
purchase from energy-only providers
600
Transportation Sector *
Other Sector *
Commercial Sector
Industrial Sector
Residential Sector
Sales by Energy-Only Providers
(Million Megawatt-hours)
500
400
300
200
100
1996
1997
1998
1999
Source: EIA http://www.eia.doe.gov/cneaf/electricity/epa/sales_state.xls
Private & Confidential
2000
2001
2002
2003
2004
Utilities offer green products in addition to their
standard regulated offerings
Private & Confidential
New distribution channels for energy efficiency services
Private & Confidential
Financial Institutions
Financial services firms provide credit support
“I’d say we spend as much
time structuring credit as we
do structuring energy”
- Catherine Flax, JP Morgan
"There are investors in this
space, principally hedge
funds, that will happily take
the risk if the spread is
attractive enough and if
they're convinced that the
underlying story is
favourable."
- Elad Shraga, Deutsche Bank
Source: Duncan Wood, Risk Magazine, "Putting energy into credit," Dec. 2005 (Volume 18, No. 12).
Private & Confidential
Financial services firms dominate top-rated dealers
2005 Rankings of Top Dealers
Source: www.energyrisk.com, Rankings compiled by Glenn Leihner-Guarin, 2005
Data based on the results of a survey sent to more than 2,000 banks, brokers, energy users and
traders worldwide. Voters were asked to nominate their top three counterparty dealers and top two brokers
based on criteria that included keen pricing, flexibility, market making, reliability, integrity and speed of
transactions.
Private & Confidential
Private equity firms have more than $135 B in capital
Private
Equity
Private
Equity
Tenaska
Invenergy
KKR
American Securities
Riverstone
Company
ArcLight Capital Partners
First Reserve
One Equity
Fortress Group
Apollo Advisors
Blackstone
Madison Dearborn
Texas Pacific Group
Warburg Pincus
Private Energy Market Fund, L.P.
0
5,000
10,000
15,000
Size ($ Million)
Source: CRA Research, best estimates of size as of June 2006
Private & Confidential
20,000
25,000
30,000
More than 300 hedge funds in energy provide liquidity
Selected Hedge Funds
Fund
Asset Size ($ Million)
Appaloosa
$4,000
Caxton-Iseman
$2,000
Cerberus
$16,000
Citadel Investment Group LLC
$12,000
DE Shaw
$20,000
MatlinPatterson
$4,000
Och-Ziff Capital
$15,000
Vega
$12,000
Source: CRA Research, best estimates of size as of June 2006
Private & Confidential
Energy Trading
Regulatory oversight focused on market manipulation
FERC and CFTC
Memorandum of Understanding (October 12, 2005) to
coordinate requests and share proprietary information
New CFTC focus
FERC
compliance
– Prohibition of
Market
Manipulation
refines Market
Behavior Rules
– New regulations
focused on fraud
and scienter
– Must maintain 5year trading
records
– Proposed legislation
- CEA Reauthorization
- Oil and Gas Traders
Oversight
– Natural Gas Price
Transparency
– Marketers must keep and
provide records, even for
exchanges exempt from
regulation
TRADER
Stiffer penalties
Private & Confidential
– Penalties: $1 million per day per violation
– Felony vs. misdemeanor
– Eliminates Principal/Agent defense
Existing trading structures drive compliance strategies
NonDiscretionary
Discretionary
Rational
Trader
Model
Process
Model
Rock
Star
Model
Benchmark
Model
Ad-Hoc
Private & Confidential
Systematic
Current compliance models cannot identify market
manipulation very easily
Typical Mid-Office Compliance Model
Define Acceptable
Trading /
Marketing
activities via
Corporate Policy
Execute
Trades
Review Trading /
Marketing results
for evidence of
non-compliance
Take appropriate
action as dictated
by policy
•
Costly: Tens of millions of dollars
•
Questionable: Most traders believe they can stay ahead of the game
-- this oversight does nothing to prevent them from executing an
improper trade and very little to detect one after the fact
•
Incentives: Sets up a contest between highly motivated traders vs.
intelligent mid-office staff
•
Potential for Failure: Most notable “blow-ups” have occurred in
organizations touting “best in class” capabilities in compliance
Private & Confidential
Alternative compliance models create a systematic
approach to trading to preclude market manipulation
“Systematic” Mid-Office Compliance Model
Define &
Analyze
possible
Trading
Protocols
“Acceptable
Basis for
Trading”
Guidelines
Capital / Risk
Allocation
Guidelines
Execution
Discretion
Guidelines
Approve
Trading
Protocols for
Execution
Generate
Trading
Guidance for
Execution
Execute
Trades
Compare Trades to
Execution Guidance /
Discretion Guidelines
Take appropriate
action as dictated by
policy
Private & Confidential
Large industry players are adopting systematic trading
Private & Confidential
Black box trading -- thinking inside the box
Silent dealers set deadly pace in derivatives trade
By Martin Waller
There is a phenomenon outside the industry called 'black box' trading, carried
out by computer programs devised by brilliant mathematic minds
TODAY marks the start of International Derivatives Week, at which
participants from exchanges all over the world will gather in London. Yet
traders accounting for more than half those markets’ volume will not be there.
They will be at their desks as usual. These are not the overpaid and
overworked dealers in derivatives. They are the algorithmic dealing programs
that clinch bargains on exchanges . . . without any human input whatsoever.
Source: Business Time Online, June 2006,
http://business.timesonline.co.uk/article/0%2C%2C8210-2231867%2C00.html
Private & Confidential
Conclusion
What’s Hot What’s Not – In Electricity
HOT
NOT
• IGCCs in regulated rates
• NGCCs on market rates
• Smart meters
• Dumb prices
• PPAs
(Public Power Authorities)
• PPAs
(Power Purchase Agreements)
• LICAPs
• Price caps
• Of course we do financing
• You need recourse financing
• Credit-rating renegades
• Credit-rating downgrades
• MOUs on data exchanges
• Unregulated exchanges
• Market Manipulation Tools
• Market Behavior Rules
Private & Confidential
One Final Caveat
“It must be remembered that there is nothing more difficult
to plan, more doubtful of success, nor more dangerous to
manage, than the creation of a new system. For the
initiator has the enmity of all who would profit by the
preservation of the old institutions and merely lukewarm
defenders in those who would gain by the new ones.”
– Machiavelli
Private & Confidential
Tanya Bodell’s consulting practice focuses on various aspects of
the energy industry, including the effects of government
regulation on profit opportunities, particularly in the areas of
competitive markets and environmental policy. Her work in
trading and risk management spans all energy-related
commodities, including tradebook valuation, portfolio
optimization, and regulatory compliance. Her work in electricity
includes design and implementation of competitive wholesale
and retail markets, as well as strategic advice to the participants
in those markets. She has also been extensively involved in the
analysis and determination of damages in liability cases
pertaining to the energy industry, including breach of contract,
product liability, fraudulent conveyance, and bankruptcy
proceedings. Ms. Bodell has a B.A. in Mathematical Economics
from Pomona College and an M.A. in Public Policy from the
University of Chicago.
Tanya Bodell
200 Clarendon Street, T-33
Boston, MA
617-425-3364
tbodell@crai.com