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Power Shock Sends CA Players Running for Risk Management

Power Shock Sends CA Players Running for Risk Management

In the wake of California's latest round of electricity price and supply shock concentrated in San Diego, some of the state's major energy industry participants have raised the level of interest in forward markets and hedging. San Diego Gas and Electric Co., in particular, has been second guessed about why it did not use available hedging instruments through the state's nonprofit power exchange to help ease the impact of recent wholesale price spikes on its retail customers.

Interestingly, the debate has developed in the midst of projections this month that energy giants like Duke, El Paso and Enron who have major trading operations are looking at robust profits for the second quarter because of the same extreme energy price swings that are giving governmental officials, utilities and consumer advocates fits. (El Paso has reported $152 million in profits from its power trading and marketing operations in the past three months.)

If firms actively manage natural gas, power generation and trading activities, "volatility is your friend," said Jim Donnell, CEO of Duke Energy North America in an analysts' call earlier this month (July 7). "If you are only a merchant generator or commodity trader, you would be inordinately exposed to volatility, and it would then be the enemy." Without going into specifics, Donnell told analysts that Duke Energy North America's power generation portfolio is heavily hedged through next summer.

SDG&E in approaching this summer did not aggressively look to the forward markets as a means of lessening the impact of wholesale price volatility, and some consumer advocates are criticizing the Sempra Energy utility subsidiary for not providing their retail customers more of a "safety net." The utility gained authorization last summer from state regulators to participate in forward markets through the California Power Exchange (Cal-PX), from which the state's 1996 electricity law requires investor-owned utilities to buy all of their power supplies. The Cal-PX gained federal authority to offer expanded block-forward contracts this year, but SDG&E did not seek California Public Utilities Commission (CPUC) okays to participate in those markets, although the state's two other major electric utilities did. (SDG&E is now on an expedited basis seeking CPUC authorization.)

"We have not elected to participate heavily in the block-forward markets, although we have submitted bids into it," said Wayne Sakarias, SDG&E's director of fuel/power supplies, speaking at an emergency meeting of state energy participants last Wednesday in San Diego. "No suppliers wanted to take us up on those bids. The bids that we submitted for July that were not accepted were twice what the current average price for electricity is this month. So that explains why we are reluctant to accept those bids except on a very critical basis."

In direct response to a question about whether San Diego electric customers would have been spared the recent doubling and tripling of their monthly bills by SDG&E using the same bloc-forward contracts the state's other investor-owned utilities did, Sakarias said it is unclear, but that it probably would not have 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 been accepted.

"We currently have a limitation of 400 MW we can put into the forward market which is roughly 10% to 15% of our load. Even if we had participated in those (block-forward) markets it would not have had a significant affect on prices even if we made a killing. And in these types of markets, people typically don't make killings. In my estimation, it is just shear speculation talking about what might have happened."

Cal-PX sources, however, disagree with SDG&E, saying the utility in essence "blew it" by not doing what Pacific Gas and Electric Co. and Southern California Edison Co. did-hedging in the PX's market. The source said that estimates place savings in wholesale power costs of about $160 million in May and June block-forward hedging by the two other IOUs. "Was there money to be saved in the block-forward markets? Absolutely," said the Cal-PX source who asked to not be identified.

"Even if SDG&E had only 20 percent of its purchases (in June) in the hedge market, it would have saved them a ton of money," said the Cal-PX source, who said the utility is not sufficiently incented to hedge because under the current state regulatory rules, it can pass on all the costs to its customers.

State-certified, nonutility energy service providers (ESPs) are the only hope longer term of providing mass retail customers protection against the extreme price swings that are inevitable in deregulated markets. (The other option is re-regulation and freezing retail rates.) And ESPs have been treading water in California's retail electricity market among the residential and small business customers, losing customers steadily as they return to the incumbent utilities. Sempra Energy and its SDG&E has pledged to turn that around as part of a strategy to promote competition 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's marketing vice president in Tustin, CA, who noted that since the first of year Commonwealth's overall customer load in California has dropped to 60,000 from figures approaching 100,000 last year.

"We haven't been doing any aggressive marketing in California since the first of the year," Goth said. "We have turned out sights on other markets where we feel there is a better economic model for us, so Pennsylvania is where we have been concentrating our efforts. And we have a provisional license in New Jersey and will get our permanent license in August, at which point we will start operations there."

Are you going to give up on California?

"San Diego is a good test of the market after the rate freeze is lifted [statewide], Goth said. "I think some kind of hedging strategies will be employed by everyone to provide the consumers with strong price fluctuations in the summer. They'll offer some sort of flat rate that will go throughout the year, but customers will have to sign up for some contract period and not just switch between 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 around market pricing, unless some people get their way and we go back to a regulated market."

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

Richard Nemec, Los Angeles

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