Utility Asset Strategies in a High Price Environment

Content

• Datamonitor View
• Catalyst
• Summary
• Analysis
• Utilities Risk Price And Commodity Exposure As They Trade And Purchase The Energy They Need To Supply Their Customers
• Uk Gas And Power Prices Are Made Up Predominantly Of Commodity Costs And So Are Extremely Influenced By The Wholesale Cost Of Gas Or Power
• As Prices Fluctuate Prior To Delivery, It Can Be Either Detrimental Or Advantageous To Contract Energy In Advance
• To Avoid Commodity Exposure, A Utility Company Must Ensure That It Has Purchased Sufficient Energy To Cover Its Position
• The Wacog And Wacoe For A Utility Are Dependant On Prices Arranged For Power To Cover Its Position
• Due To Wholesale Market Fluctuations, When Utilities Establish A Contractual Position For A Delivery Date, They Risk Price Exposure
• The Difference Between The Weighted Average Price Of The Energy Bought By A Utility And The Market Spot Price Defines The Level Of Price Exposure
• High Wholesale Power Prices Have Continued To Be Passed On To Consumers, With Sharp Increases Seen In The Uk
• As Uk Wholesale Gas Prices Have Begun To Climb Once More, Retail Prices Have Been Increased To Accommodate Them
• As The Market Moves Into A High Price And Volatile Environment, The Potential Risk And Cost Of Exposure Increases
• Wholesale European Gas Prices Have Continued On An Upward Trajectory
• European Power Prices Dropped At The Beginning Of 2007, But Have Increased Significantly Over The Last 18 Months
• Coal Prices Have Seen A Dramatic Surge Over The Last 18 Months, But Generation From Coal Also Suffers From Associated High Carbon Costs
• Despite Rising Gas Prices, Potential Margins From Gas-Fired Generation Have Increased As Spark Spreads Increase
• Despite Rising Coal Prices, Potential Margins From Coal-Fired Generation Have Increased As Dark Spreads Increase
• Each Utility Has A Different Level Of Potential Commodity Exposure
• There Is A Significant Discrepancy Between Different Utilities' Exposure To European Wholesale Electricity Markets
• Most Utilities Use More Gas Than They Produce, A Very Different Picture To That Seen In Electricity, As Few Have Upstream Capacity
• The Volume Of Exposure Paints A Different Picture From The Percentage Of Exposure Due To The Difference In Size Of Utilities
• While Almost All Utilities Surveyed Show Considerable Wholesale Gas Exposure, The Actual Volumes Involved Vary Dramatically
• Datamonitor Assesses The Range Of Strategic Options Available To Reduce The Impact Of Gas Exposure
• Datamonitor Assesses Possible Strategies To Mitigate Price And Commodity Risk According To Six Criteria
• The 'Going Upstream' Strategy Entails Purchasing Gas Production Assets Or Even Exploration Acreage
• Although 'Going Upstream' Can Provide Guaranteed Cover From Wholesale Price Increases, It Is A Very Expensive And Complex Process
• 'Lng Procurement' Strategies Present An Alternative Source Of Gas To Wholesale Markets
• Procuring Lng To Feed Retail Portfolios Brings With It Certain Security Of Supply Advantages
• The "storage Capacity Build" Strategy Reduces Commodity Exposure And Also Presents Opportunities For Arbitrage
• Seasonality In Gas Prices Presents Opportunities For Arbitrage Through Storage
• The 'Storage Capacity Build' Strategy Reduces Commodity Exposure, Providing A Buffer To Spikes In The Wholesale Gas Market Price
• Utilities Have A Range Of Strategic Options Available To Reduce The Impact Of Power Exposure
• A 'Generation Capacity Expansion' Strategy Increases A Player's Existing Asset Portfolio, Thus Reducing Wholesale Market Exposure
• 'Generation Capacity Expansion' Is An Adaptable Strategy, But Can Take A Long Time To Yield Returns And May Adversely Affect Public Relations
• 'Contractual Purchase' Strategies Allow Utilities To Boost Supply Portfolios Without Paying For New Assets Or Increasing Exposure To Wholesale Prices
• The 'Contractual Purchase' Strategy Offers Long-Term Security Of Supply And Is Sufficiently Flexible To Suit Utilities Of All Sizes
• The 'Tolling Agreement' Strategy Sees The Utility Hire A Power Generation Asset From Another Player In Order To Increase Its Own Portfolio
• 'Tolling Agreement' Strategies Are Easy To Implement, But In A Changing Market Can Increase Or Reduce Commodity Exposure
• Utilities' Previous Strategic Choices To Mitigate Against Exposure Have Been Diverse
• Centrica's Recent Activity Exemplifies A Utility Aggressively Pursuing The 'Going Upstream' Strategy
• Centrica Has Been One Of The Few European Utilities To Pursue The 'Lng Procurement' Strategy, Although It Has Since Been Retrenched
• Edf Is Constructing New Plants And Regenerating Much Of Its Existing Asset Portfolio, Thus Reducing Wholesale Market Exposure
• E.On Recently Established A Pan-European Subsidiary To Focus Exclusively On Increasing Storage Capacity
• Smaller Utilities Such As Statkraft Have Used Ppas And Gpas To Expand, Minimizing Exposure And Investment
• Centrica's Deal With Drax Demonstrates The Benefits That A 'Tolling Agreement' Strategy Can Bring To Both Parties
• Appendix
  • Appendix 1: Wacog And Wacoe
  • Appendix 2: Price Exposure
  • Appendix 3: Consolidated Scores For Each Strategy
• Ask The Analyst
• Datamonitor Consulting
• Disclaimer
• List Of Tables
  • Table 1: Each Strategy Is Rated Against Six Criteria On A Range From 0 (Most Detrimental) To 3 (Most Beneficial)
• List Of Figures
  • Figure 1: A Breakdown Of Gas And Electricity Bills Normalized To Percentages Of The Average Uk Bill Shows The Commodity Element Of Gas Is 68% And Electricity 66%
  • Figure 2: Commodity Markets Experience Either Backwardation Or Contango, Making It Essential That Utilities Anticipate Market Movements And Purchase Appropriately
  • Figure 3: Example Exposure For A Given Gas Position
  • Figure 4: Example Of How A Wacog Position Is Calculated
  • Figure 5: Example Of How A Utility Can Become Positively Price Exposed Or Negatively Price Exposed
  • Figure 6: Rising Wholesale Power Costs Are Passed On Into Retail Costs, With A Lag To Account For Hedged Positions
  • Figure 7: Rising Wholesale Gas Costs Are Passed On Into Retail Costs, With A Lag To Account For Hedged Positions
  • Figure 8: European Wholesale Gas Prices
  • Figure 9: European Wholesale Power Prices
  • Figure 10: European Wholesale Coal Prices
  • Figure 11: The Spark Spread Is The Difference In Price Between The Power Generated And The Gas Required To Generate It
  • Figure 12: The Dark Spread Is The Difference In Price Between The Power Generated And The Coal Required To Generate It
  • Figure 13: Wholesale Gas Exposure Measures Production Against Supplied Volume And Highlights How Few Utilities Have Any Upstream Position
  • Figure 14: Wholesale Gas Exposure Measures Production Against Supplied Volume And Highlights How Few Utilities Have Any Upstream Position
  • Figure 15: Wholesale Electricity Exposure Measures Generation Against Supplied Volume, Here Shown As Absolutes Compared With Percentiles
  • Figure 16: Wholesale Gas Exposure Measures Production Against Supplied Volume And Shows The Dramatically Different Positions Between Utilities
  • Figure 17: Datamonitor Scoring Categories
  • Figure 18: Analysis Of The 'Going Upstream' Strategy
  • Figure 19: Analysis Of 'Lpg Procurement' Strategy
  • Figure 20: Month Ahead Uk Gas Price Against Mean Uk Temperature
  • Figure 21: Analysis Of The 'Storage Capacity Build' Strategy
  • Figure 22: Analysis Of The 'Generation Capacity Expansion' Strategy
  • Figure 23: Analysis Of The 'Contractual Purchase' Strategy
  • Figure 24: Analysis Of The 'Tolling Agreement' Strategy