Hedging Strategy and Electricity Contract Engineering - IFOR
Hedging Strategy and Electricity Contract Engineering - IFOR
Hedging Strategy and Electricity Contract Engineering - IFOR
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3.3 The risks in the electricity market 47<br />
immature markets has put electricity firms under pressure. Because of the<br />
uncertainty that arose along with the deregulation a number of utilities have<br />
already been downgraded by rating institutes like St<strong>and</strong>ard & Poors. To mention<br />
a few European examples, the French incumbent, EdF <strong>and</strong> the Spanish<br />
incumbent, Endesa, were both downgraded in 1999. UNA in the Netherl<strong>and</strong>s<br />
<strong>and</strong> TXU in the UK were also downgraded that year, whereas United Utilities<br />
was downgraded in 2000. 2<br />
In the third week of June 1998, the spot price in the Midwest soared to more<br />
than 7000 US$/MWh, whereas it usually trades at about 30 to 40 US$/MWh.<br />
Some market players were not able to meet their obligations <strong>and</strong> went out of<br />
business, which created difficulties for all players that were doing business<br />
with them. A number of electricity firms lost a lot of money during this price<br />
spike <strong>and</strong> in the US a number of utilities have defaulted <strong>and</strong> went bankrupt<br />
since the deregulation process started. A few utilities in California have been<br />
badly injured by the deregulation process, where a disastrous retail cap was<br />
enforced in combination with unlimited wholesale prices. California’s largest<br />
utility, Pacific Gas & <strong>Electricity</strong> went bankrupt last year because of its inability<br />
to hedge against this odd one-sided price cap. 3 The bankruptcy of Pacific<br />
Gas & <strong>Electricity</strong> has raised concerns about the creditworthiness of other<br />
utilities in California, like Southern California Edison. Their counterparties<br />
have therefore increased their dem<strong>and</strong> on collateral to decrease their credit risk.<br />
The need for <strong>and</strong> importance of risk management in the electricity industry is<br />
thus indeed substantial.<br />
3.3. The risks in the electricity market<br />
The risks that players in the electricity market are facing can in our view be divided<br />
into two groups. The first part consists of the important risks that appear<br />
also in traditional financial markets. The second group is electricity- or at least<br />
commodity-specific risks in the sense that they do not play an important role in<br />
traditional financial markets.<br />
2 Source: Reuters, Dow Jones.<br />
3 RISK Magazine, Vol 15/No 5 May 2001.
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