The Cost of Maintaining Grid Integrity Ancillary Services

Transcription

1 AMEREXENERGYUPDATE ELECTRICITY / NATURAL GAS / PETROLEUM / COAL MARCH 2008 / VOLUME 4, ISSUE 7 IN THIS ISSUE: TWO SO WHAT S THE GOOD NEWS? SIX Natural Gas Outlook Crude Outlook The Power Connection SEVEN Gas Storage Outlook Electricity & Coal Outlook EIGHT ERCOT Energy Prices The Cost of Maintaining Grid Integrity Ancillary Services One of the costs of your power is the result of the Independent System Operator (ISO) securing operations that affect grid integrity and reliability. The ISO in Texas is ERCOT (others include PJM, NYISO, CAISO, NE- POOL, MISO, SPP). The operations covered include paying generation assets to have spinning generation spinning reserve - (but not booted onto the grid unless required), idled generation ready to kick in on short notice non-spinning reserve, generation kicked in to regulated the frequency of transmission reg up & reg down, and other related tasks. All of these are termed "ancillary services. These services are priced competitively and have market volatility, most often driven by those forces you might expect, namely availability and demand. As the forward curve of pricing for these services is to be decided, Retail Electric Providers approach their pricing in various manners. Generation-rich entities may opt to utilize in-house assets while others may elect to make a guess as to costs and set same in retail adder values. A third course of action is to treat these costs as pass throughs and the customer will float from billing cycle to billing cycle, paying what the ISO charges without mark up from their provider. What s the right answer? We suggest that it is a subjective one, the proffered cost guiding how to choose which way to go. The chart of historical costs in ERCOT, below, leads us to recommend to lock ancillaries when they re $2.00ish and to float them when they approach the $4.00 area One could argue that since the average of the daily costs is $1.63, anything above this number is pricey. We are of the opinion that, unless the number is in the upper tier of prices, the cost of accounting to true up prices would negate any advantage. At the end of the day, this is your decision (Whatever this decision is, you will most likely depend on some benchmark such as this chart to base decisions).

2 ENERGYUPDATE... So What s the Good News?... The march to higher numbers for anything dollar denominated has not given any indication of turning around. There are plateaus where profit taking ensues (an example that comes to mind is $1000 for an ounce of gold), but to call these areas a top implies and assumes so many things that have yet to be identified (much less completely understood) is, at a minimum, wishful thinking. The world of energy belongs to this confusing and unsettled mix, something that will most likely lead to uncertainty for the foreseeable future. Today s metrics provide executables that can put these uncertainties to bed albeit at a price that would have been considered unthinkable in the not so distant past. So what does one do? The answer for one facility isn t necessarily the same for other similar facilities because of the lack of predictability and the breath of unpleasant consequences. We cannot, as your good counsel, make decisions that are based on too rosy OR too pessimistic of a scenario that will unfold over the next several months, the particulars of which just can t be determined today. The one thing we do believe prudent is to feed hand to mouth as long as it takes to weather the storm of uncertainty. The real question is to determine what is the optimum pricing structure to accommodate this marking time period? The candidates we will discuss going forward have been those we feel the most comfortable with, primarily because of our familiarity, history, and comfort of the mechanics and the providers that we have worked with (we feel that this is not a time to add uncertainties such as new structures nor new providers). After listing the options of pricing venues, we will then plug in three possible scenarios, three that we fell will cover the most likely pluses and minuses for you to make a decision (but by no means a list of everything that might happen). Step One - create a hypothetical customer (load). This customer, ABC, Inc. (ABC) will have a May 2008 start date, a medium load factor, a fairly constant monthly usage of 1,000,000 kwh, and willing to commit to a 20 month term. ABC is located in Houston Zone, has distribution level delivery, and while usually risk adverse, feels that current pricing is so high that they are willing to consider reasonable alternatives. Step Two - decide what pricing venues are available (these will be placed in a spread sheet along with the three what ifs for comparisons the natural gas curve and the Heat Rate curve will be as of close of business, March 3 rd, 2008) : Fixed Pricing - the current forward curve of natural gas, May 2008 through December 2009, X the forward curve of Heat Rates, same term, + the cost of shape, notionally $4/MWh for their load, + cost of line losses, notionally 5.75% of the energy charge for distribution delivery in Houston, + the cost of the ERCOT bucket, inclusive of ancillary services + those other ERCOT fees and things such as transition fees, nuclear decommissioning, etc., passed through without market up + the provision for the cost of imbalances + the REP s margin + the broker/consultant margin if applicable + sales and gross receipt taxes, if applicable Heat Rate - the forward curve of Heat Rates, same term, + the cost of shape, notionally $4/ MWh for their load, + cost of line losses, notionally 5.75% of the energy charge for distribution delivery in Houston, + the cost of the ERCOT bucket, inclusive of ancillary services + those other ERCOT fees and things such as transition fees, nuclear decommissioning, etc., passed through without market up + the provision for the cost of imbalances + the REP s margin + the broker/consultant margin if applicable + sales and gross receipt taxes, if applicable, all fixed with the values for natural gas yet to be determined.

3 So What s the Good News? cont... ENERGYUPDATE... Real Time Marketing MCPE segueing into LMP, sometime the guesstimated value of the real time market, month by month, + cost of line losses, notionally 5.75% of the energy charge for distribution delivery in Houston, + the cost of the ERCOT bucket, inclusive of ancillary services + those other ERCOT fees and things such as transition fees, nuclear decommissioning, etc., passed through without mark up + the provision for the cost of imbalances + the REP s margin + the broker/consultant margin if applicable + sales and gross receipt taxes, if applicable. Step Three guess at three possible price cases for Heat Rate venue and Real Time venue Heat Rate: 1. The first will be natural gas pricing, increasing at a 5% rate per month through September The assumption will then be flat pricing from October 2008 through April 2009, then increasing at a 5% rate per month through December The second will be natural gas pricing, increasing at a 10% rate per month through September The assumption will then be flat pricing from October 2008 through April 2009, then increasing at a 10% rate per month through December The third will be natural gas pricing, increasing at a 10% rate per month through September 2008, and then a 10% decrease per month through December Real Time 1. The first (Base Assumption) will be $65 May 08 through July 08, $75 August 08 through October 08, $60 November 08 through July 09, $70 August 09 through October 09, and $60 November 09 through December The second will be $10 Higher from Base Assumption. 3. The third will be $15 Higher from Base Assumption. Results The results are interesting we even throw in the results for an abbreviated term, the first six months, something we ll discuss below (interesting doesn t equate to pleasing, unfortunately). The summary for the different 20 months pro formas is as follows (This is energy only pricing - The detailed spreadsheet was too cumbersome for this article, but if you would like a copy, please let us know and we ll send you one): FIXED PRICING: Unit Cost $ Total $ 2,210, Months $ 697,436.42

4 So What s the Good News? cont... ENERGYUPDATE... HEAT RATE - 5% Monthly Increase in Natural Gas Prices (BASE ASSUMPTION) Unit Cost $ Total $ 2,268, Months $ 722, HEAT RATE - 10% Monthly Increase in Natural Gas Prices Unit Cost $ Total $ 2,326, Months $ 746, HEAT RATE - 10% Monthly Increase in Natural Gas Prices through June 2008, Then Decrease 10% per Month for Balance Unit Cost $ Total $ 2,122, Months $ 736, Real Time Base Case - $65 May 08 through July 08, $75 August 08 through October 08, $60 November 08 through July 09, $70 August 09 through October 09, $60 November 09 through December 09 Unit Cost $ Total $ 1,743, Months $ 561, Real Time - $10 Higher from Base Assumption Unit Cost $ Total $ 1,963, Months $ 627, Real Time - $15 Higher from Base Assumption Unit Cost $ Total $ 2,074, Months $ 660,570.59

5 So What s the Good News? cont... ENERGYUPDATE... First, The Generic Analysis (One that doesn t assume any biases) The conclusion we reach is primarily based on term. Why would you lock in prices for anything longer than summer 08 unless you have a very solid feeling about how things will unfold? The search to capture Heat Rates and hope for better than current natural gas prices seems to us the wishful thinking approach. The outlook for prices has an upside bias (there s no indication of any toppy action). The most threatening time line appears to be between now and end of summer, and the differentials between fixed pricing, HRs, and real time market even given worst cases presented lead us to a real time pricing choice. Its virtues are highlighted by wide latitude of action and its vices are marked by a new limit of $2500 per 15 minute interval, something that could be troublesome in periods of stress (or should some generators decide to game the market, something not unheard of in the past). Given extraordinarily high real time prices, you can still move to one of the other two venues. If you elect to lock in the longer term now, our comment would be that these terms are driven by ugly or innuendo of ugly. Second, Our Biased Analysis We believe that the troublesome times are not over but neither are they without end. The prospects for finding some solution would seem to us to be between now and the presidential elections (or from now to summer + a usually benign early fall). One might argue that anyone new to the scene will bring with them hope of improved circumstances. It is arguable that a new administration could pour fuel to the fire and have bad things go even worse, but we believe this not a high percentage scenario. The economy is cooling. Industrial activity does not appear to be ramping up for increased demand for energy, but rather quite the contrary. The one value we believe accessible is the capture of a Heat Rate (HR) that is depressed due to high natural gas values (among other things). Even if immediately after capturing a longer term HR you elected to resell the immediate term and go into the real time market, we suspect that you will have teed up opportunities that will outlive the current period of pain. Some of the particulars to executing this ploy would be to avoid the cost of shape (buy blocks) and insure that the provider is accommodative of reselling the HRs on acceptable terms. The possibility of seeing this as a contradiction versus the generic suggestion (taking the six month term) is understandable. By way of explaining this seeming contradiction, we explain that it is directed to our accounts currently under management (or those familiar enough with the way we do things to appreciate how we can move from one venue to another). History has taught us to be patient, avoid making absolute, irreversible decisions, and keep emotion at bay. So what s the good news? It s the alternatives presented above. We believe that one should deal with reasonable expectations and make plans accordingly. That is what has been attempted here. We could have painted a picture that has natural gas prices going lower from tomorrow s opening through January Likewise, we could predict a catastrophic summer weather experience and have prices reaching mid-teens without respite. Both extremes appear to us, at this juncture, distant possibilities. We will modify views as time, circumstances, and analysis guide. We encourage you to find a middle ground that s comfortable for you and follow a similar path of discovery.

6 ENERGYUPDATE... On an annual basis, the Henry Hub spot price is expected to average about $8.18 per Mcf in 2008 and $7.95 per Mcf in $3.50 per gallon this spring, while diesel prices are expected to average around $3.70 per gallon in March and April. At the onset of the peak driving season (April 1), total gasoline stocks are projected to be 224 million barrels, 22.3 million barrels above last year and 18.6 million barrels above the 5- year average. Although distillate fuel (diesel fuel and heating oil) inventories ended February about 6 million barrels below the same time last year, they are at the 5-year average and are projected to stay close to the average over the forecast period. Natural Gas Outlook On February 29, 2008, working natural gas in storage was 1,484 Bcf. Current inventories are now 63 Bcf above the 5-year average ( ) and 169 Bcf below the level during the corresponding week last year. The Henry Hub spot price averaged $8.76 per Mcf in February, $0.51 per Mcf more than the average January spot price. Cold weather so far in the first quarter has kept pressure on prices, which are expected to decline as space heating demand begins to wane in April. On an annual basis, the Henry Hub spot price is expected to average about $8.18 per Mcf in 2008 and $7.95 per Mcf in Natural gas consumption in the electric power sector, which makes up about 30 percent of total natural gas consumption, grew by over 10 percent in 2007 but is expected to decline slightly in 2008 because of the projected milder summer temperatures. Natural gas consumption in the industrial sector is also projected to decline by 0.2 percent in 2008 because of slowing economic growth. WTI crude oil prices, which averaged $72.32 per barrel in 2007, are projected to average $94.11 and $85.92 per barrel, respectively, in 2008 and Crude Outlook WTI crude oil prices, which averaged $72.32 per barrel in 2007, are projected to average $94.11 and $85.92 per barrel, respectively, in 2008 and Regular grade gasoline retail prices, which averaged $2.81 per gallon in 2007, are projected to average $3.21 and $3.06 per gallon, respectively, in 2008 and Diesel fuel prices, which averaged $2.88 per gallon last year, are projected to average $3.45 and $3.22 per gallon, respectively, in 2008 and The monthly average gasoline price is projected to peak at just under

7 Gas Storage Outlook ENERGYUPDATE... Working gas in storage was 1,398 Bcf as of Friday, March 7, 2008, according to EIA estimates. This represents a net decline of 86 Bcf from the previous week. Stocks were 151 Bcf less than last year at this time and 57 Bcf above the 5-year average of 1,341 Bcf. In the East Region, stocks were 30 Bcf above the 5-year average following net withdrawals of 54 Bcf. Stocks in the Producing Region were 52 Bcf above the 5-year average of 460 Bcf after a net withdrawal of 23 Bcf. Stocks in the West Region were 24 Bcf below the 5-year average after a net drawdown of 9 Bcf. At 1,398 Bcf, total working gas is within the 5-year historical range. Working Gas in Underground Storage Compared with 5-Year Range Note: The shaded area indicates the range between the historical minimum and maximum values for the weekly series from 2003 through Source: Form EIA-912, "Weekly Underground Natural Gas Storage Report." The dashed vertical lines indicate current and year -ago weekly periods. Electricity & Coal Outlook Growth in natural-gasfired generation is expected to be relatively flat this year due to the assumption that summer temperatures will fall back to nearnormal levels. Total electricity consumption is expected to grow by only 0.4 percent in 2008, then return to a growth rate of 1.5 percent in Growth in natural-gasfired generation is expected to be relatively flat this year due to the assumption that summer temperatures will fall back to near-normal levels. On the other hand, generation by wind power is expected to grow by 37 percent in Power generators have responded to renewable portfolio standards by rapidly installing wind turbines, which accounted for 25 percent of new electric generating capacity in Residential electricity prices are expected to increase by 2.4 percent this year, slightly higher than the 2008 growth projection in last month s Outlook, and then grow by 2.9 percent in Electric-power-sector coal consumption grew by 1.9 percent in Slow growth in electricity consumption, combined with increases in hydroelectric generation, will dampen growth in electric-power-sector coal consumption to 0.3 percent in Electricpower-sector coal consumption is projected to increase by an additional 0.4 percent in U.S. coal production is estimated to have fallen by 1.3 percent in Projected weak demand for coal in 2008 and 2009 will result in only a 0.1-percent increase in coal production in 2008 followed by 0.2- percent growth in In the Western region, the Nation s largest coal-producing region, production is expected to increase by 0.7 percent in 2008, but decrease by 0.6 percent in Total coal stocks are estimated to have grown by 1.6 percent in 2007 to 190 million short tons. Total coal stocks are expected to rise by 1.1 percent in 2008 and remain at that level (192 million short tons) in 2009.

8 ERCOT Energy Prices YEAR Balance of (Peak - 5X16; All - 7X24) 5X16 7X24 5X16 7X24 5X16 7X24 5X16 7X24 5X16 7X24 ERCOT Heat Rate X Gas Strip* Heat Rate 10.10x x X X X X X X X X8.10 NAT GAS STRIP DATE 3/10/2008 *Heat Rate X Gas Strip - Provided as an indication of price levels only; Calculated using median of STP HR Bid/Offer This data consists of purely indicative bid/offer market prices, and calculated heat rates where noted, and no warranty that the data represents or indicates prices at which transactions may be or were affected at any time is given by Amerex. Any opinion expressed or assumption made in association with the data is a reflection of the judgment of Amerex or any person who supplies all or part of the data to Amerex at the time of compiling the data and is subject to change without notice. Amerex Energy Services One Sugar Creek Center Blvd. Suite 700 Sugar Land, Texas (t) (f) (toll free) info@amerexenergy.com Notice of Proprietary Rights The information contained in this document is provided as a courtesy by Amerex Brokers LLC ( Amerex ). As a condition of receiving this information, you and any other recipient are deemed by Amerex to have acknowledged and agreed that (a) Amerex has exclusive and valuable property rights in this information, (b) Amerex is making this information available to a restricted group of recipients including certain of its employees, customers and business partners, and you may not distribute it in any form to any other person or entity without the express written consent of Amerex, and (c) you may make use of this information only for your internal business purposes and not for the benefit of any third party. Amerex does not make any representations or warranties, express or implied, with respect to any information contained herein, including without limitation any representation or warranty that the data set forth herein is accurate, complete or timely. Amerex reserves the right to terminate the distribution of this information at any time at its sole discretion.