NGI The Weekly Gas Market Report
For those who would generate and sell electricity in thecompetitive marketplace, the future is one of many opportunitiesand at least as many challenges. “There’s no guaranteed costrecovery. You’re going to have to manage your fuel cost and youroperational excellence outside of the rate base mentality,” saidWilliam J. Grealis, chief strategic officer and vice president forcorporate services for Cinergy Corp. “You’re going to have tounderstand with your generation portfolio how many additionalmillion megawatt hours can you generate at what price to dispatchinto the market to make money.
“You’re going to have to have a commercial mindset in terms oflooking at future opportunities, whether they be plants thatsomeone wants to sell, whether they be sites that can be developedand whether it’s an understanding of the transmission grid tounderstand constraints and how to capitalize on those constraintswith merchant generation.”
Grealis made his remarks at Arthur Andersen’s 20th annual EnergySymposium Tuesday in Houston. And who better to expound upon thedangers and pitfalls of the power supply business than Cinergy. Powerprice spikes and contract defaults cost the company dearly lastJuly. Cinergy lost $73 million and was seriously considering quittingthe supply business altogether (see Daily GPI, Aug. 9, Aug.11, and Aug. 13). However, lastmonth the company’s board voted unanimously to stay in the supplybusiness as the industry moves toward competition (see Daily GPI, Nov. 4). More recently it came to lightthat Cinergy’s behavior last July prompted an investigation by theEast Central Area Reliability Coordination Agreement (ECAR). ECARconcluded that Cinergy broke certain ECAR and NERC (North AmericanElectric Reliability Council) rules when it drew between 1,500 and1,700 MW of power it did not own in six to eight different hoursduring the last week of July (see Daily GPI, Nov. 24).
Grealis predicted generation companies will take at least one oftwo forms, and both of them will be exposed to substantial risk.”Plain vanilla converters” will need to know how to leverage theirassets and be creative with financing. “You develop a commercialmindset in terms of identifying undervalued or inefficient assetsand you buy those cheaply, improve them, increase the output, lowerthe prices, make money. You look at transmission constraints andfind out how to capitalize on those transmission constraints. Andyou manage fuel. You manage not only the fuel itself in terms ofprices, for example, if you’re coal-fired, like we are for asignificant part of our capacity, you start driving those coalprices down because you’ve got to get the net-back pricing. Andyou’ve got to control fuel transportation costs.”
The other option is somewhat more ambitious and includes all ofthe above plus physical and financial trading. “You… try tomaximize the value of those plants by engaging in physical andfinancial trading around the commodity that you’re producing. Inmany respects that’s a much riskier business than just being aplain vanilla converter.
“First of all, not only do you have to sweat assets, but you’regoing to have to spend millions of dollars on systems and peoplewith origination, commercial risk management capabilities. Thepeople and the systems are critical, not just operationalexcellence. You’re going to have to manage an aggregated supplyload. You’re going to buy contracts, be the default provider.You’re going to manage load volatility, whether it’s due tocustomer switching or whether it’s due to weather. You’re going toneed assets and skill sets and products and services to manage therisk that you’re taking. It’s not just load volatility risk but itwill be price risk.”
Risks will not be alien to the transmission and distributionside of the business either, Grealis said. “It will be a regulatedbusiness, but going forward regulation will be different. It willnot be cost-based regulation. It will be incentive-basedregulation. You’ll make money by stripping costs out, not reducingreliability and dropping those dollars down to the shareholders.Your success will be based on having an even better regulatoryexpertise than you have today.” Companies playing in transmissionand distribution will need to have operational capabilities andcost-cutting expertise.
“From our perspective, we think transmission will be runseparately from distribution. You’ll have the creation of the RTOs,the regional transmission organizations. Those will become publiclytraded. Utilities will move their transmission assets into that inreturn for equity. They may become master limited partnerships,similar to gas pipelines. On the distribution side, you may be thedefault provider legally, and so therefore you’ll have a commodityservice risk, but unless you own generation, you’ll contract thatrisk out to a genco that has physical and financial tradingcapabilities.”
The competitive marketplace will bring additional threats aswell. Niche companies will come in to target billing, creditcollection, and call center operations. “You no longer have amonopoly right on those services.” Utilities can either choose tobecome competitive in these newly opened areas and minimize costsby growing market share, or they can choose to outsource theseoperations, Grealis said.
“You’ll also find competition for metering, line maintenance andsubstation maintenance. There’s no magic about this. Othercompanies that are outside the business can come in and do this. Soyou’ll either face competition and you’ll outsource those services,or you’ll create a business around those services.”
Also, look for distributed generation to make inroads, firstwith industrial and large commercial end users and, over time, withsmaller commercial and even residential customers.
“You can only sweat assets so much, so if you’re in thedistribution business and you really cut your costs to the bone,how can you grow? Well, you’re obviously going to have to continuethe consolidation trend. You’re going to have to become a regionalor a super-regional distribution company. You’ll do adjacentroll-ups. You’ll find cost savings by managing materials managementover a larger customer base or a larger asset base. You may look atnatural extensions and get into the water business.”
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