How to select a wholesale power supplier in today's market.

• Author: Martin, Edward P.

Introduction

The success of an electric distribution cooperative in meeting its goal of service to its members depends on the critical decisions made by its board of directors. Clearly the most critical decision is the selection of the CEO of the cooperative. In the turbulent times of wholesale power deregulation, the next critical decision is the selection of a power supplier.

While the success of the distribution cooperative hinges on the soundness of both decisions, it is the power supply decision that has changed the most over the past few years. Throughout this article, it is our intention to review the power supply changes that have occurred in the market and to highlight some of the key factors that must be considered when choosing a wholesale power provider. Additionally, we will compare and contrast the different wholesale supplier options that are available in today's market and finally, provide you with an example of a decision-making tool that can be used to help evaluate such complex issues as power supplier selection.

WHOLESALE MARKET CHANGES

As the electric utility world continues its metamorphosis, cooperatives are addressing power supply issues that were unheard of as little as three years ago. Questions such as:

* Are we credit-worthy enough to buy power?

* Can we absorb the financial impact of a margin call?

* Does the power supply contract include liquidated damages?

* Are we adequately hedged against natural gas spikes?

These questions are rapidly becoming the business norm and not the exception. The choices our cooperatives must make have become increasingly complex ... leaving us searching for business partners we can trust to promote the well being of our cooperative membership.

From the mid-1930s until the mid-1990s the market price was regulated by a federal agency, initially the Federal Power Commission and more recently the Federal Energy Regulatory Commission (FERC). The basis for the market price that came from this regulation derived from an analysis of the cost of production and transmission, plus a fair return on investment. In other words, the price was cost-based, with a reasonable adder. Today, the standard for comparing prices is quite different, it is the market price of electricity at the wholesale market level.

In the mid-1990s the 1992 Federal Energy Act took effect. The new regulations placed in effect by the FERC under this Act allowed regulated public utilities to charge a price the wholesale market would bear. In other words, the price was no longer cost-based, but rather market-based. It appears that the market price for wholesale electricity will vary against the long-run marginal cost of the product. When the supply of generating capacity is high relative to market demand, the price is less than the long-run marginal cost to produce it. When the supply of generating capacity is low relative to demand, the price is greater than the long-run marginal cost of production. The variations on an hourly basis have been volatile, ranging from a low price of $15/mWh to as much as $5,000/mWh. For long-term contracts of three years or more, prices have less volatility, but still vary significantly depending on the contract's start date. The past five years have seen variations in longer-term contracts from $30/mWh to $5 0/mWh. Today, the standard for price comparison for these types of contracts is a combined cycle gas-fired generating unit.

The complexity of power supply that has come about since the Federal Energy Act of 1992 requires continuous study and increased expertise. The wholesale power market no longer contains the certainty of regulation. As a result, the rules change as quickly as the participants can find some competitive advantage. Small utilities and distribution cooperatives are hard pressed to hire and retain personnel with the wholesale market expertise that is needed to sort through the complexity of the new power supply decision.

The days of Federal Energy Regulatory Commission tariffs are gone. To determine the price for wholesale electricity purchases, a distribution cooperative has to go to the market and request pricing and contract alternatives through Requests for Proposals (RFPs). A major problem with the RFP process arises from the fast changing pace of pricing. Indicative price quotes from power suppliers seem to last as long as it takes to hang up the telephone. Consequently, wholesale market expertise provides the only workable answer to this time-sensitive circumstance. The wholesale power buying organization must be in the market 24 hours a day to understand the nuances of this evolving marketplace.

Another major problem faced by cooperative wholesale power buyers comes in the form of credit worthiness of the seller. When sellers consisted exclusively of traditional regulated utilities, the credit worthiness of the seller held little concern. The regulators would not let their utilities fail; they merely raised the price to the captive customers. Today, power marketers do not have that regulatory backstop, and complete corporate failures happen all too often. While Enron is the most visible example, there have been several other bankruptcies of power marketers since deregulated markets came into being. The buyer must beware, but more importantly, the buyer must be knowledgeable of the credit worthiness of the counterparties with which it proposes to do business--obtaining this knowledge becomes a constant research project.

Consultants provide a viable alternative for power supply procurement. Of course, one must be confident that the consultant has the necessary market expertise to complete an effective business transaction. Very few consultants are participating in the wholesale market on a daily basis. However, when the deal is gone, so is the consultant, so who holds responsibility if the supply deal not go as well as expected - the distribution system board and management.

To increase the odds of decision-making success, co-ops need a partner to interface with the wholesale power supply market. Currently, there are four available options to this need for wholesale market expertise:

1) A long-term relationship with the investor owned utility (IOU) in the area

2) Affiliation with a power marketing organization, such as ACES Power Marketing or Williams Energy

3) Purchases from federal power suppliers, such as TVA

4) Affiliation with related distribution cooperatives through a co-op-owned G&T.

Any of these options provide a viable answer to distribution system power supply needs.

While construction of generating facilities by the distribution cooperative is another option that exists, it is often so uneconomical that it falls out of consideration after closer inspection. New small units cannot compete in today's open market. Distributed generation, through the use of fuel cells, became of interest recently, but the technical challenges and the economics of fuel cell operation have caused that option to be uneconomical and commercially impractical for the time being.

So the question then comes down to which is the best option for your co-op's situation? What is the best power supply choice for the consumer owners of your distribution cooperative?

CHOOSING A WHOLESALE POWER PROVIDER

In choosing a power provider, the job of the distribution system manager and board now comes down to evaluating the alternatives. That evaluation requires a detailed review of a variety of factors.

Price of the supply relative to the wholesale market price in the specific geographic area of the distribution cooperative probably ranks as the most important factor that distribution systems consider...