Futures exchange starts trading electricity contracts

Issue 5 and Volume 100.

Futures exchange starts tradingelectricity contracts

The New York Mercantile Exchange (NYMEX) began active trading of its new electricity futures contracts last month, signaling the start of large-scale, competitive wholesale electricity markets in the United States. “It`s the beginning of the end of over-regulation of electricity,” said Daniel Rappaport, NYMEX chairman. “Consumers will begin asking why they`re paying high prices when they see futures contract prices published daily.” The Wall Street Journal reported that the June contract for delivery of electricity at the California-Oregon border (COB) was valued at less than one cent/kWh in trading in early April.

California Public Utility Commission`s Jesse Knight, present at the opening day ceremonies, said, “This is one of the happiest days I`ve had as a regulator. All Californians are indebted to NYMEX. The finger is now out of the dike.” Knight has been a strong advocate of competitive electricity markets and a driver of deregulation in his state. “It will be a shock to the electric industry to find that the price of electricity has nothing to do with their production costs but everything to do with what people are willing to pay.”

Energy trading

NYMEX is the commodity futures exchange in the United States that specializes in energy contracts. Historically, it has launched futures contracts in specific energy sectors immediately after deregulation stimulated the formation of a competitive spot or “cash” market in those sectors.

The electricity contract is structured to cover delivery of 736 MWh of firm energy in the contract month at the rate of 2 MW/h, for 16 hours a day, on each business day of the month. Futures contracts are not intended to result in actual delivery. NYMEX reports that less than 1 percent of energy contracts result in delivery. However, a few do, which means that the prices of the futures contract and prices in the cash market converge at the delivery date. Rappaport said that a mature electricity futures market would see a few thousand contracts being traded daily with 50 to 100 traders in the “pit.”

Electricity market

The new contracts are designed to service the emerging competitive wholesale market in electricity. Much of the existing wholesale electricity market is not competitive because it takes place via closed negotiations. Operation of the new, competitive market can be seen, for example, in the transactions being made by the power marketing agencies, new electricity trading companies that have been recently licensed by the Federal Energy Regulatory Commission (FERC) to do business. Several dozen power marketers are now active and they are brokering several million MWh a month. That`s small compared to the entire electricity market, which is approximately 3 billion MWh retail annually plus another billion MWh in the wholesale market. The U.S. electricity market`s total value is approximately $200 billion a year.

NYMEX expects competitive wholesale electricity trading to increase substantially after the FERC publishes the final rule requiring transmission system owners to provide open access at market prices, which is due this spring. However, more than 50 utilities have already formally opened their transmission systems to outsiders by publishing tariffs that comply with the FERC`s proposed rule, the so-called “Mega-NOPR” (notice of proposed rulemaking). This is the watershed event in the creation of competitive electricity markets because with access to a “common carrier” non-transmission owners can now participate in the market.

Western markets

The first two electricity futures contracts are tied to spot market transactions at the California-Oregon border and at the switchyard of the Palo Verde nuclear power station in Arizona, both points where relatively large amounts of wholesale power flow.

There are three 500-kV transmission interties that flow through the COB, linking utilities in the Pacific Northwest and Canada with utilities in California and Arizona. The COB price, as it`s now called, is an average of pricing information received from 15 utility participants based on what they`re paying, or selling for, at that point. The Dow Jones COB price index is published daily in the commodities section of The Wall Street Journal. This index price has varied considerably with daily price swings of 25 percent being common. Over the past year the price has varied over a range of more than 200 percent. The NYMEX COB futures contract is based on prices in this spot market at varying points in the future. At the Palo Verde switchyard there is capacity to move 6,100 MW to the east and 2,500 MW to the west, and there is a lot of spot market activity through this point. The Palo Verde index price is also published daily in The Wall Street Journal.

Since April 1, the futures contract information has also been published daily. NYMEX officials hope to establish an east coast index price and an associated futures contract soon. Since there is no interconnection between the eastern and western United States, there is little interest in western index prices of electricity in the east. Officials also speculated that there could be an index price and a futures contract in Europe when open trading starts there.