LuthINformed- Issue 4, Power Supply Options & Fixed Price Supply Agreement

Published to LuthINformed, Issue 4 (June 3, 2016)

This is the last of four issues in which we present a broad overview of power and natural gas markets and deal structures. Going forward, we will delve much deeper into the nuances of the energy issues affecting us all. We hope to provide our readers with guidance and actionable information that will be both valuable and useful. As always, your feedback is welcome…


Power Supply Options…

As you probably know, deregulation has not provided price stability. Many retail energy customers are exposed to market fluctuations. For example, any Con Edison full-service customer with a demand over 500kW is subject to Mandatory Hourly Pricing, or MHP (NYISO Day Ahead hourly pricing). So retail customers seeking price protection, or budget certainty, turn to an Energy Supply Company (ESCO) that can offer some form of “price insurance”. Generally speaking, the less risk, the higher the premium. And while ESCOs typically offer many various supply options, the three most common structures our clients use are Fixed Price, Indexed Price, or a Hybrid of the two.

Supply agreements are initially presented as “boilerplates”, but should be negotiated to meet your specific requirements. Be sure to understand any scenarios under which your supplier may be allowed “pass throughs”, since these will affect your final cost. Also, the more complex the structure, the more “active management’ and monitoring is required. An analysis of your Load Profile and Load Factor (below) is essential to determining the product most likely to minimize risk and maximize savings. Load analysis can also be used to apply your historical, hourly profile to historical index prices to establish a cost baseline and benchmark against future performance.

Fixed Price Supply Agreement…

The simplest, and most common, supply agreement is a Fixed Price contract. In this type of agreement, the customer agrees to a fixed price per KWh for an agreed period of time – typically one to three years. This product best suits a customer with a low tolerance for risk because it places most of the risk on the supplier. It also satisfies an organization’s need for budget certainty. However, most fixed price supply contracts carry a certain level of “load risk” since they typically contain usage bandwidths. These bandwidths can be thought of as “buffer zones” which provide a cushion for unexpected usage variations. For example, if your contract allows suppliers to pass on weather related fluctuations, extremely hot weather may push usage outside the buffer, allowing the supplier to charge market prices for the differential – often at a time when prices are highest. A Fixed Price offers protection from upward price swings – but it will also keep you from fully participating in any downward price movement. The benefit of a sustained downward price trend can be partially realized for Fixed Price contracts through a “Blend and Extend” process.

A Blend and Extend agreement is a contract that most suppliers will offer to their clients. If the market moves lower, after you have already agreed to a higher fixed price, the supplier may extend your contract out another year or two allowing you to take advantage of the lower prices. To accomplish this, the ESCO blends the cheaper future rates with your current rate for a new contract that reflects an overall lower price.

Next time we will continue our discussion of supply options with an Indexed Price agreement and Hybrid Product.


DISCLAIMER

Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

LuthINformed- Issue 3, ICAP and Ancillary Services

Published to LuthINformed, Issue 3 (May 20, 2016)

Previously, we discussed the New York power market design in terms of regulations and policy. Additionally, we review the concept of transmission and delivery. To conclude our discussion of market design, we will discuss New York City Installed Capacity (ICAP) and ancillary services.

ICAP

NYC ICAP Cost vs. Rest Of State

NYC customers must purchase 83.5% of their capacity from NYC. Therefore a 100 kW customer would pay 83.5 kW x $15.99 or $1,335. The rest of their capacity, 33.5 kW (i.e. to meet their 117% requirement) can be purchased in the Rest of State (ROS) market at $10.99 or $368. The total cost would be $1,703. An upstate customer that purchases all of their capacity at the ROS rate would purchase 117 kW at $10.99 for a capacity cost of $1,286. The NYC customer would pay 32% more to meet their capacity requirements – expensive –  but also a good opportunity to be in a demand response program.

Other than energy, the second largest price component is Installed Generation Capacity, or ICAP. To ensure power reliability and availability, the NYISO requires that Con Edison and retail marketers have reserve sources of ICAP available as protection against generation outages. Each supplier must procure sufficient ICAP to equal 117% of its peak day load, purchasing 83.5% of peak load from in-city sources. As the example in the box above illustrates, NYC ICAP costs are significantly higher than the rest of the state.

What Are Ancillary Services?

It’s important to understand the various components that make up your supply price. The NYISO requires that various ancillary services be provided at either fixed rates or market prices. Ancillary services is a catch-all term that many don’t really understand – so here we go:

Voltage Support – These services must be purchased from the ISO and will be priced at a fixed rate. Voltage support services are closely coordinated with the individual Transmission Operators who are responsible for determining the means by which additional voltage support services will be provided when asked to do so by the NYISO.

Operating Reserve – There are three types of reserves: 10-minute spinning reserve, 10-minute non-spinning reserve, and 30-minute reserve. Operating reserves insure that there will be sufficient capacity in the event of the loss of the largest supply source on the system, and are auction priced. Recently, the NYISO has begun allowing demand side resource aggregations to provide operating reserves.
Regulation and Frequency Response – This is the real-time, second-to-second operation of the bulk power system. It includes balancing of load with generation and the maintenance of a constant system frequency of 60 Hz. This service must be paid for by all internal New York loads (exports and wheel-throughs are exempt) and cannot be self-provided. They are priced by auction.
Black Start – The NYISO purchases “black start” capability at fixed cost rates from those generators with the ability to start up without the benefit of an outside power source. These resources would be used in the event of a total or partial system collapse to bring the grid back up one piece at a time.

Black Start

Outlook

The latest inventory report (above) shows a net increase of 73 Bcf vs. the previous week. Stocks were 791 Bcf higher than last year at this time and 795 Bcf above the five-year average. Immediately following the release of the report, the futures curve moved lower. Traders considered the report bullish for short term prices and the 12 month strip rose 6.5 cents to close at $2.60.

12 month strip = $2.535

24 month strip = $2.709

Cal Year 2017 = $2.836

Cal Year 2018 = $2.884

(all prices NYMEX only; A/O 5/18/16)

Storage levels remain high – as is domestic production. Natural gas inventories continue to set year-over-year highs. Overall, market prices remain near recent lows with CY’17 and CY’18 back under $3. Against this backdrop, a long term fixed price supply agreement is certainly attractive. The following market charts illustrate trends.

More…

Graph 1Graph 2Graph 3Graph 6

For an in-depth discussion on markets, purchasing strategies and other topics, call us here at Luthin Associates. We offer our clients regular market updates and our Energy Procurement Group is staffed with certified experts on energy market conditions.

Luthin Associates

732-774-0005

DISCLAIMER
Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

LuthINformed- Issue 3, Power Market Structure…

Published to LuthINformed, Issue 3 (May 20, 2016)

In this issue we look at power fundamentals. In it, we present an overview of New York power markets and offer insight into the various factors that impact power prices.


There are two main bodies which influence NY power market design, regulations and policy:

The New York State Department of Public Service (PSC):

Promotes competitive power markets and stimulates infrastructure investment. Where competition is not present or viable, the PSC exercises its regulatory authority to ensure equitable rates and high-quality service.

The New York Independent System Operator (NYISO):

Ensures the reliable, safe and efficient operation of New York State’s major power transmission system and administers an open, competitive and nondiscriminatory wholesale market for electricity in the State.

New York City is a “load pocket”, meaning that transmission lines cannot carry enough energy into the City to meet its peak load. By regulation, 83.5% of demand must be supplied by generation inside the city. For the balance, New York is connected to upstate New York, northern New Jersey and Long Island.

Transmission capacity to the City has not been increased since the 1980s and pricing is influenced by transmission congestion at these various bottleneck points. To accommodate regional price differences, eleven separate pricing zones have been defined. New York City is known as Zone J, and historically, has the highest rates.

While load management, conservation and distributed generation are all positives, these measures provide only marginal improvements in reliability and competitive prices. High demand, transmission congestion, loss of generation or extreme weather can all negatively impact prices.

More…

Components of Electric Supply
The two largest cost components of delivered electricity are Transmission and Distribution (T&D) and Supply. T&D is the cost paid to the Utility to deliver energy to the point of use. Supply, also known as energy or commodity, is the cost paid for the actual electricity. However, Energy, Transmission, Installed Capacity (ICAP), and various Ancillary Services are all required to deliver power to the end user’s meter.

How Pricing is Determined

Under the NYISO’s guidance, energy is sold in hourly day-ahead and real-time auctions, as well as in negotiated bilateral transactions. A bilateral transaction is negotiated outside the NYISO’s marketplace and many Energy Supply Companies (ESCOs) use them to set forward pricing curves. Transmission costs are driven by regional constraints. Installed Capacity prices are set in a regulated bidding process. Ancillary services including regulation, voltage support and operating reserves are set at either fixed rates or market prices. If a customer is interested in locking in a fixed price, an ESCO will enter into long-term bilateral agreements on their behalf. In recent years, given the down turn in electric prices, a long-term fixed price contract (two to three years) has been, by far, the most popular product for those customers who are seeking budget certainty.

T&D

Transmission and Distribution…

Transmission and Distribution, or T&D, includes Con Ed transmission, distribution, market adjustments and ancillary services. T&D is the mechanism by which power is routed to a customer’s on-premise meter.

All-In Price Components.jpg

Commodity…

The term “commodity” is used interchangeably with electricity, power, and energy. It includes Con Edison or ESCO supplied power, capacity, line losses and other minor ancillary services.

Next time we will continue our discussion of  power market structure with Installed Generation Capacity and ancillary services…


DISCLAIMER
Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

LuthINformed- Issue 2, More About Contracts…

Published to LuthINformed issue 2 (April 29, 2016)

Previously, we discussed active management as well as the concept of “blend and extend.” In this segment we will conclude our discussion of supply contracts.

More About Contracts…

The importance of understanding supply contract details and language cannot be overstated. Ideally, any contract is mutually beneficial. But remember – the laws and rules governing natural gas delivery, balancing and billing are complex – and can change. If each party is seeking to transfer or mitigate risk, ask yourself if you are assuming risk(s) you may not fully understand. Under what scenarios can your supplier pass through costs? If a price component changes, can that change be passed through? Are there change-in-law provisions? Do you benefit if a change in law decreases a cost component? It is clearly important that an experienced professional review all contractual terms and conditions.

Chart 5

Outlook

The latest inventory report (above) shows a net increase of 73 Bcf vs. the previous week. Stocks were 870 Bcf higher than last year at this time and 832 Bcf above the five-year average. Immediately following the release of the report, the futures curve moved lower. Traders considered the report bearish for short term prices and the prompt month dropped 7.5 cents to close at $2.078.

12 month strip = $2.704

24 month strip = $2.872

Cal Year 2017 = $3.009

Cal Year 2018 = $3.037

(all prices commodity only)

Storage levels are at record highs – as is domestic production. Natural gas inventories continue to set year-over-year highs. Overall, market prices remain near near recent lows – but have begun ticking up. Against this backdrop, a long term fixed price supply agreement is certainly attractive. The following market charts illustrate trends.

More…

Chart 6Chart 7.jpgChart 8.jpgChart 9.jpgChart 10.jpgChart 11

For an in-depth discussion on markets, purchasing strategies and other topics, call us here at Luthin Associates. We offer our clients regular market updates and our Energy Procurement Group is staffed with certified experts on energy market conditions.

Luthin Associates (732)-774-0005

Next time we will review power fundamentals…


DISCLAIMER

Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

LuthINformed- Issue 2, Active Management…

Published to LuthINformed issue 2 (April 29, 2016)

Previously, we discussed hedging and risk associated with energy supply contracts. To build upon this contract discussion, we will review active management as well as the concept of “blend and extend.”

Chart 2

Active Management…

An active management strategy is often employed when current fixed prices do not meet budget requirements. Typically requiring contracts of 3 to 5 years, the key to this strategy is allowing a long enough time horizon to take advantage of the cyclical nature of markets. Periodic, opportunistic purchases mitigates the well documented risks associated with market timing and allows cost averaging at attractive levels – without the pressure to buy.

A common strategy is to lock in basis and “float” commodity (i.e. buy at current market price) for the term of the contract. Typically, that same contract also allows price hedging at some point in the future. And there are many options – buying NYMEX monthly settlement; hedging at fixed intervals; buying when the prices reach pre-established price triggers and/or percentage drops.

Active management enables a buyer to, say, lock in attractive short term prices for the winter & summer while floating the shoulder months (paying NYMEX monthly settlement prices). Sophisticated strategies are primarily suited to large Commercial and Industrial clients. They require a substantial amount of monitoring which is not always attractive to energy managers with competing priorities.

Chart 3

Blend and Extend

Hedging minimizes, or eliminates, market risk – but only for the term of the supply agreement. The budget impact of rising prices cannot be avoided forever. Clients whose current supply contract doesn’t expire for some time – or who feel they did a “bad deal” because they are paying higher-than-market prices – may be well aware of this.

If you are facing this situation, it is possible to obtain a lower fixed price by hedging a longer term (i.e. beyond the current deal expiration). The cost of the new term is then blended into the cost of the existing supply contract and the expiration date is extended to include the new term – thus the term “blend and extend” (see above).

Think of this as analogous to trading in a leased car before the expiration in order to get a newer model. It is important to note that this type of arrangement can only be made with the existing supplier – the reasons should be obvious.

Remember, hindsight is 20/20. No one can consistently identify market low points. Rather, the goal is to meet budget objectives by making rational, defensible purchasing decisions based upon trend analysis and the likelihood of prices rising or falling beyond their current levels.

Chart 4

Budgeting for Reality…

It’s essential that budget projections reflect market conditions to the extent possible. Some managers have little input into the process and are simply handed budgets developed by finance people who think last years figures, marked up by a percent or two, should be just fine. This, of course, may make the job of purchasing energy at a price that meets the budget all but impossible. Prevent this scenario! Educate decision makers!

Monthly Usage x All-in $/Dth = New Budget

Next time we will conclude our discussion regarding contract strategies…


DISCLAIMER
Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

LuthINformed- Issue 2, Hedging and Risk

Published to LuthINformed issue 2 (April 29, 2016)

In our last issue, we discussed fundamentals of natural gas supply, pricing and markets. In this issue we look at competitive supply options. You may ask “what makes a good supply agreement?” Simply put, a good agreement is one that allows a buyer to meet budget expectations without paying too high a premium for price insurance.


Hedging and Risk

Many institutions look to reduce, or eliminate, the risk that energy cost volatility will negatively impact their operating budget. The most common way to do this is to conduct a competitive purchase RFP, and enter into a supply agreement with the lowest priced supplier. The premise of this process, of course, is that competition drives down prices. Remember that the price being offered is the Citygate price (below) – not the burnertip price.

Chart 1

The vast majority of buyers hedge volatility risk by means of a fixed price supply contract. But many fixed price contracts still contain risk because they contain usage bandwidths. A fixed price, full requirements contract eliminates this additional risk. Full requirements means the supplier will charge the agreed price, no matter how much gas your facility uses. Such a supply structure meets the needs of a client with a low risk tolerance profile.  In order for your supplier to offer you a price, they must first know how much, and when, you use gas. Typically, data from the past 12 months is used. Either your supplier or consultant may use a technique known as weather normalization to adjust your usage data to reflect “normal”, rather than actual weather conditions.

Full requirements, fixed price contracts provide budgetary certainty, however, they may also include a hefty “risk premium” because the supplier cannot know, for example, exactly how much, or how little, gas your facility will actually use. An ESCO charges this premium to protect themselves against potential penalties and to cover the cost of unknown variables such as fixing cost components which may change in the future. So generally speaking, fixed price, full requirements contracts are among the most expensive contract options.

Understanding this, it’s not surprising that a supplier will offer a lower price if the buyer accepts usage “bandwidths”. This means that any usage above, or below, a certain threshold will be “marked to market”. Under certain circumstances you may be charged current market prices for any usage outside those pre-defined limits. For example, if your facility burns too little gas to satisfy the contract, perhaps because of unusual weather or an operational issue, the excess gas will be sold into the market. And chances are, under those circumstances, the unused gas will be sold at a loss – a loss that can be passed on to you. The opposite scenario also holds true. In January 2014, the polar vortex created unprecedented demand and delivery constraints – and NYC natgas spot prices reached $120/Dth. There were numerous anecdotes regarding dramatic pass-through’s as a result. With respect to futures pricing, the rules of supply and demand always apply.

More…

Next time we will continue our discussion of supply contracts and active management strategies…


DISCLAIMER
Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, Luthin Associates, Inc. (Luthin) assumes no responsibility therefore. The user of the information agrees that the information is subject to change without notice. Luthin assumes no responsibility for the consequences of use of such information, nor for any infringement of third party intellectual property rights which may result from its use. In no event shall Luthin be liable for any direct, indirect, special or incidental damage resulting from, arising out of or in connection with the use of the information.

 

On a Personal Note…

Published to LA Confidential, Summer 2016

Many of us, in our youth, held jobs that may surprise our colleagues. I was a blackjack dealer at Trump Plaza in Atlantic City. At that time, I had to shuffle eight decks into the shoe to start the game. Mastering the eight deck shuffle was not an easy feat.

The logic behind using the eight decks was that increasing the number of cards would make it more difficult for someone to count cards during the game. Difficult, but not impossible. Management continued to ban customers that they suspected were card counting.

I was just the blackjack dealer. Behind me was a floor person who would be watching four games, a pit boss that watched all the games within the pit I was dealing, and a shift boss that would oversee all games for the entire shift. In addition, there was the eye in the sky that could be turned on to observe any game at any given time. Any possible sleight of hand or unbelievable amount of luck could have all the folks and a camera trained on you.

It seemed like magic was always in the air. Whether it was the magic of the card counter or the magician in the showroom, some amazing things were going on around me. Fast forward to 2016 and I feel like magic is in the air again, along with its associated tricks.

This issue of LA Confidential looks at the illusion of magic surrounding the energy world. Whether we are using batteries to supplement the sun or encircling whole neighborhoods so that they may be self-reliant of grid based electric production, new technologies are being deployed to enhance what we thought was a new technology only a few years ago. It is possible that by 2050, when NY hopes to be 80% reliable on renewables, we will look back on the beginning of the 21st Century and marvel at how we replaced all of those hydrocarbons with a clean, resilient, flexible and reliable energy infrastructure.

-Catherine Luthin