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Aggregator: Gas Drives Texas Power Volatility

The general counsel for two aggregators of Texas municipal electric consumers blames the natural gas futures market for high and volatile power prices in the state. While speculators can be blamed for some of the most recent run-up in gas prices, a globalizing gas market also gives him reason for concern, as gas is expected to be the marginal fuel for Texas power generation for some time.

Because it was struck at a time when power prices are relatively low, a five-year contract just put together by Cities Aggregation Power Project (CAPP) and South Texas Aggregation Project (STAP) with Direct Energy and FPL Energy will save 150 Texas communities and political subdivisions more than $30 million compared to 2008 power prices, the groups said last week.

"It's the Nymex [New York Mercantile Exchange] futures market that determines all the [power] pricing, and when pricing is fluctuating as often as it does and as volatile as it is, it is very difficult to get comfortable and to make the right guess. Even for my clients working in the wholesale arena who have the ability to go long and to take that and to hopefully twist some arms at generator level and say, 'Give us some pricing that breaks away from this gas-driven model,' even those guys are still struggling with the tremendous uncertainty," said Geoffrey Gay, a lawyer with the Austin, TX, firm of Lloyd Gosselink and general counsel for CAPP and STAP.

The contract took effect Jan. 1. CAPP and STAP members are able to take advantage of a dip in energy prices that occurred in the latter half of 2008. CAPP was able to lock in low prices until 2014. "The five-year contract provides much-needed stability for city budgets in the volatile energy market, which saw double-digit increases [last] year," CAPP said.

CAPP has 101 members participating in the contract and STAP has 49. Contract is to meet their full requirements of 1.2 to 1.3 billion kWh per year. Peak load is estimated at about 150 MW. Pricing will be discrete per zone in the Electric Reliability Council of Texas (ERCOT). STAP represents members in southern ERCOT only.

FPL Energy will provide all of the power, and Direct Energy will provide customer and billing services.

Gay told NGI the groups had never signed a supply contract for longer than two years before. Prior to the five-year deal, the aggregators were about to sign a 24-year contract for supply with Luminant, but the global financial crisis scotched the deal.

"When we finished the contract work in the May-June time frame of last year, the price of power was about 14 cents per kWh. And by the time we got the contract out there to be approved by the cities, the price of power had dropped in half," Gay said. "So the economic turmoil in this country sank that deal. But at the same time the fact that we were pursuing long-term efforts led us to the five-year deal, and we're very comfortable with that because we do think the price of natural gas, the Nymex futures market and the price of electricity are all going to go back up to levels where they were this past summer.

"So we think we've gotten a great deal, not only because the price is right at the moment but because we've got known pricing for the next five years. And virtually everybody that's doing deals today cannot find anyone who will extend the term beyond two years. The uncertainty is just too great. For political subdivisions who work off of budgets and manage the budgets, this is a great thing."

CAPP Chairman Jay Doegey said, "The decision to focus on the five-year agreement reflects CAPP's ability to remain flexible to take maximum advantage of changing market conditions. CAPP members are guaranteed significant savings for the next five years while we continue to seek opportunities to lower energy costs for the future."

CAPP has been a critic of the deregulated Texas power market, alleging that deregulation has driven up prices that consumers pay for power. "Since lawmakers deregulated the state's retail electricity market in 1999, Texas has suffered some of the steepest residential price increases in the nation," CAPP said in a recent white paper. "Even compared with prices in other deregulated states, the Texas model fares poorly...[S]ince 1999, no state with retail competition has seen residential prices increase by a larger percentage than has Texas."

Gay said he expects Texas wholesale electricity prices to remain volatile, and he blames this to swings in the Nymex gas futures market, caused largely of late by speculative interests in the market.

While Gay said speculators contributed to the most recent Nymex gas price run-up, he said he also sees gas entering a global market. "And I do fear that even if you take the speculative part out of it that we're still going to see a tremendous demand for natural gas globally...and that from basic supply-demand fundamental economics, we're going to have continued volatility and an upward trend in the price of natural gas," he said, adding that natural gas will remain the marginal fuel for power generation in Texas "for some time into the future."

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