In the wake of California’s latest round of electricity priceand supply shock concentrated in San Diego, some of the state’smajor energy industry participants have raised the level ofinterest in forward markets and hedging. San Diego Gas and ElectricCo., in particular, has been second guessed about why it did notuse available hedging instruments through the state’s nonprofitpower exchange to help ease the impact of recent wholesale pricespikes on its retail customers.

Interestingly, the debate has developed in the midst ofprojections this month that energy giants like Duke, El Paso andEnron who have major trading operations are looking at robustprofits for the second quarter because of the same extreme energyprice swings that are giving governmental officials, utilities andconsumer advocates fits. (El Paso has reported $152 million inprofits from its power trading and marketing operations in the pastthree months.)

If firms actively manage natural gas, power generation andtrading activities, “volatility is your friend,” said Jim Donnell,CEO of Duke Energy North America in an analysts’ call earlier thismonth (July 7). “If you are only a merchant generator or commoditytrader, you would be inordinately exposed to volatility, and itwould then be the enemy.” Without going into specifics, Donnelltold analysts that Duke Energy North America’s power generationportfolio is heavily hedged through next summer.

SDG&E in approaching this summer did not aggressively lookto the forward markets as a means of lessening the impact ofwholesale price volatility, and some consumer advocates arecriticizing the Sempra Energy utility subsidiary for not providingtheir retail customers more of a “safety net.” The utility gainedauthorization last summer from state regulators to participate inforward markets through the California Power Exchange (Cal-PX),from which the state’s 1996 electricity law requires investor-ownedutilities to buy all of their power supplies. The Cal-PX gainedfederal authority to offer expanded block-forward contracts thisyear, but SDG&E did not seek California Public UtilitiesCommission (CPUC) okays to participate in those markets, althoughthe state’s two other major electric utilities did. (SDG&E isnow on an expedited basis seeking CPUC authorization.)

“We have not elected to participate heavily in the block-forwardmarkets, although we have submitted bids into it,” said WayneSakarias, SDG&E’s director of fuel/power supplies, speaking atan emergency meeting of state energy participants last Wednesday inSan Diego. “No suppliers wanted to take us up on those bids. Thebids that we submitted for July that were not accepted were twicewhat the current average price for electricity is this month. Sothat explains why we are reluctant to accept those bids except on avery critical basis.”

In direct response to a question about whether San Diegoelectric customers would have been spared the recent doubling andtripling of their monthly bills by SDG&E using the samebloc-forward contracts the state’s other investor-owned utilitiesdid, Sakarias said it is unclear, but that it probably would nothave lowered consumer bills.

“The forward-markets are very thinly traded,” Sakarias said.”You can go day after day after day without striking any deals.We’ve experienced putting bid offers in that have not beenaccepted.

“We currently have a limitation of 400 MW we can put into theforward market which is roughly 10% to 15% of our load. Even if wehad participated in those (block-forward) markets it would not havehad a significant affect on prices even if we made a killing. Andin these types of markets, people typically don’t make killings. Inmy estimation, it is just shear speculation talking about whatmight have happened.”

Cal-PX sources, however, disagree with SDG&E, saying theutility in essence “blew it” by not doing what Pacific Gas andElectric Co. and Southern California Edison Co. did-hedging in thePX’s market. The source said that estimates place savings inwholesale power costs of about $160 million in May and Juneblock-forward hedging by the two other IOUs. “Was there money to besaved in the block-forward markets? Absolutely,” said the Cal-PXsource who asked to not be identified.

“Even if SDG&E had only 20 percent of its purchases (inJune) in the hedge market, it would have saved them a ton ofmoney,” said the Cal-PX source, who said the utility is notsufficiently incented to hedge because under the current stateregulatory rules, it can pass on all the costs to its customers.

State-certified, nonutility energy service providers (ESPs) arethe only hope longer term of providing mass retail customersprotection against the extreme price swings that are inevitable inderegulated markets. (The other option is re-regulation andfreezing retail rates.) And ESPs have been treading water inCalifornia’s retail electricity market among the residential andsmall business customers, losing customers steadily as they returnto the incumbent utilities. Sempra Energy and its SDG&E haspledged to turn that around as part of a strategy to promotecompetition in the state’s energy markets.

Ironically, when California’s largest ESP, Commonwealth Energy,offered a fixed rate, hedging-like option to customers last fall,customers didn’t go for it, according to Jay Goth, Commonwealth’smarketing vice president in Tustin, CA, who noted that since thefirst of year Commonwealth’s overall customer load in Californiahas dropped to 60,000 from figures approaching 100,000 last year.

“We haven’t been doing any aggressive marketing in Californiasince the first of the year,” Goth said. “We have turned out sightson other markets where we feel there is a better economic model forus, so Pennsylvania is where we have been concentrating ourefforts. And we have a provisional license in New Jersey and willget our permanent license in August, at which point we will startoperations there.”

Are you going to give up on California?

“San Diego is a good test of the market after the rate freeze islifted [statewide], Goth said. “I think some kind of hedgingstrategies will be employed by everyone to provide the consumerswith strong price fluctuations in the summer. They’ll offer somesort of flat rate that will go throughout the year, but customerswill have to sign up for some contract period and not just switchbetween summer and winter.

“I think that is what we’re going to end up looking at offering.I think we’ll see a lot of different offerings structured aroundmarket pricing, unless some people get their way and we go back toa regulated market.”

Current indications in the state legislature and with the twoGov. Gray Davis appointees at the CPUC are pointing in thedirection of some retrenchment toward more regulation, at least forthe rest of the transition period to full competitive markets.

Richard Nemec, Los Angeles

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