1	Energy Contracts As Risk Management Instruments: What Are the Choices and the Consequences? Marty Blake The Prime Group, LLC 502-425-7882
2	Risk Concepts Risk - The chance or probability of loss Risk results from variability Risk can be borne by the individual or shifted contractually to another party The person that bears the risk is compensated for bearing the risk
3	Options for Managing Risk Whether or not to contractually shift risk to another party is a business decision Assume the risk yourself Shift risk to third party How much? Reduce risk (partial) Eliminate risk (all) What is the cost?
4	Pooled Risk vs. Individual Risk Pooled risk is easier to predict and is more manageable than individual risk Diversity of supply Diversity of use Law of Large Numbers
5	Energy Related Risk Elements Price variation Quantity variation Weather Operational characteristics/Load variability Delivery/Supply Risk Quality
6	Risk Assessment To properly assess risk, you must understand: The physical characteristics and economics of your production process The physical elements of an energy sale
7	Risk Assessment How large of an item is energy in your overall cost structure? Can your production process be interrupted? What is the cost of in terms of cleanup? What is the cost of in terms of lost production? Do power quality variations result in additional costs? How weather sensitive is your production process? How variable is your energy usage?
8	Physical Elements of an Electric Power Sale Distribution Transmission Generation Ancillary services
9	Combining Elements Bundled - combining elements for sale as a single product. The bundled electric product currently sold by most utilities combines generation, transmission, distribution and ancillary services. Unbundled - the customer arranges for and purchases each element separately.
10	Distribution System Sized to meet the non-coincident peak demand of the customers in a given area Cause of most outages currently experienced by customers Risk reduction underground vs. overhead multiple feeds
11	Transmission System Two types of electric transmission Within a utility’s service territory - sized to meet the coincident peak demand of the customers within the area Between utility service territories - sized for reliability purposes to meet certain specified contingencies The further that electric power is wheeled, the greater the chance of transmission constraints
12	Transmission System Types of Transmission Service Firm point-to-point Non-firm point-to-point Network service Risk reduction generation located closer to the point of usage
13	Generation Firm Power - Electric power intended to be available at all times during the period covered by the guaranteed commitment to deliver System firm Financially firm Non-Firm Power - Electric power supplied or available under a commitment having limited or no assured availability
14	Force Majeure An inevitable, unpredictable act of nature, not dependent on an act of man Used in insurance contracts to refer to acts of nature such as earthquakes or lightning Used in power and gas contracts to mean just about anything You need a clear understanding of what constitutes Force Majeure in a contract
15	Contractually Shifting Risk Risk reduction Financially firm Liquidated damages Tight definition of force majeure If it is more expensive for the supplier for the power not to show up, the power will probably be delivered Impact on price
16	Ancillary Services Necessary to support the transmission of electric energy between purchasing and selling entities while maintaining reliable operation Provided using generation capacity
17	Ancillary Services Scheduling, system control and dispatch Reactive supply and voltage control Regulation and frequency response Energy imbalance service Spinning reserves Supplemental reserves Backup supply service
18	1998 Daily Price Index of Spot Electricity MAPP On-Peak ($/MWh)
19	1999 Daily Price Index of Spot Electricity MAPP On-Peak ($/MWh)
20	Risk Management Tools Price Risk Contracts for future delivery Fixed price formula price Options Hedging Quantity Risk Weather futures (Chicago Mercantile Exchange)
21	Energy Contracts If energy is treated as a commodity, the contract is extremely important Everything needs to be specified Cannot make handshake deals in a commodity market The more value-added the relationship, the contract is less detailed Pricing tends to be higher Relationship can’t be captured easily in a contract