It’s no secret traders yearn for volatility. But after UK electricity prices ricocheted from a negative hundreds of dollars to thousands of dollars earlier this year, Entergy Wholesale Operations CEO Geoff Roberts figured risk taking had its limits.
Signaling its dissatisfaction with a change in UK market rules, the power plant development arm of Entergy Corp., New Orleans, last month cut a deal to sell its 1200 Mw gas-fired Saltend power plant in the UK to Calpine Corp., San Jose, Calif.
The sale will reduce by 60 per cent Entergy’s exposure to the England and Wales electricity pool. Entergy kept the 800 Mw Damhead Creek plant. The decision reflected the company’s belief selling Saltend was preferable to warehousing risk that couldn’t be hedged or controlled.
The shift to a physical bilateral contract market called the New Electricity Trading Arrangements (NETA) reduced liquidity and raised volatility when the new market first opened in the UK, Roberts says. Volatility in the UK imbalance market has since declined. Prices in today’s “buy” market average about $50/Mw-hr, and about $16.50/Mw-hr in the “sell” market. But they occasionally spike much higher.
Roberts says the Damhead unit is more suited to the company’s needs. It is strategically located, and flexible contracts make the unit more attractive for trading, he says. At the same time, Entergy is unwinding positions in Pakistan, India, China, and Latin America, where the company was often a passive investor in projects, and boosting investment in Europe, especially Spain, Italy, and Bulgaria, and also in the US.
Entergy’s departure from many once promising regions for the relative safety of the US and Europe shows up how large the challenge is to create competitive electricity markets that work. The UK was one of the first countries to embrace electricity deregulation, drawing a wave of US investors, but many have since sold their holdings, complaining of the shift to NETA.
“We want to go where we have the most tools in the toolbox to manage and limit risk,” Roberts says. Worldwide, Entergy expects to spend about $3.6 billion in the next 2 years on independent power development projects, but much of it will be invested close to home.
“Two years ago Entergy was everywhere else but the US,” says Roberts. Today, the company is evaluating about 40 US sites based on current market and price assumptions and taking a conservative approach about which projects to pursue in light of the 70-80% decline in the spark spread since last summer.
Three or more power plant sites are competing for each set of turbines the company has committed to buying, Roberts says. Entergy has ordered 5,000 Mw of turbines to be delivered over the next 4 years and is in negotiations to complete contracts with customers for more than half its new turbine capacity. None of the projects under consideration will be pure merchant plants and most are targeted for startup in 2004, giving the company time to complete contract negotiations and determine where to put iron on the ground.
Having multiple potential customers and multiple sites competing for turbines allows the company to make the most of its turbines and remain flexible, Roberts says. Sites are under evaluation based on markets by delivery points, hedging strategy, and potential for sale to third parties. Ità¯¿½s a strategy that will help insure the company doesn’t have more turbines than it needs in an uncertain market.
“We want to be long permitted dirt,” says Roberts, not turbines.
He says sites that don’t fit Entergy’s risk vs. reward profile often can be turned for a profit. The impact of unfavorable UK market conditions during the second quarter was partially offset by a gain on the sale of the DeSoto development site in Florida.
Entergy wholesale unit has four plants in operation or under construction in the US, including the 2,544 Mw Ritchie Unit 2 and the 14%-owned Independent Unit 2, both in Arkansas; the 50%-owned 425 Mw Riverside plant in Lake Charles, La.; and the 300 Mw Warren plant in Vicksburg, Miss.
Entergy is building a block of “core assets” for its trading and marketing partnership with Koch Industries Inc. to trade around, Roberts says. In January, Entergy contributed its power marketing and trading business to a new limited partnership, Entergy Koch Trading LP.
The joint venture markets and trades electricity, gas, and weather derivatives. Koch Industries Inc., Wichita, Kan., contributed its 9,000-mile Koch Gateway Pipeline, gas storage facilities, and Koch Energy Trading.
Linking gas to electricity
Even though US gas prices have come down substantially from winter highs, “at the end of the day, new gas demand has been added to the market” because of gas-fired power projects, Roberts says. “There are producers who have asked to link gas prices to electricity prices, increasing their exposure to electricity synthetically.”
He says Entergy is open to these type arrangements and expects the trend to continue.
While reducing its exposure in many parts of the world, Entergy is taking a position in central Europe in Bulgaria, where the company recently won a contract to rehabilitate the 840 Mw Maritza East III power plant. Roberts says the investment in the strategically located formerly communist nation is not as risky as it might sound.
The Overseas Private Investment Corp. has already approved $200 million in political risk insurance, the prelude to completing the $470 million financing needed to complete the project. Roberts estimates the it can be completed for about two-thirds the cost of building a new power plant, while reducing air emissions.
Despite Bulgaria’s reputation for being isolated, Roberts says, Greece and Bulgaria have long sold electricity to each other. And with a new government in power he expects Bulgaria to reach out to the West.
Former King Simeon II, who was recently appointed prime minister, has made full membership in the European Union, a principal goal for Bulgaria. Simeon also has brought in a western educated team to handle the country’s finances. A former Merrill Lynch executive and external debt restructuring specialist is expected to become Bulgaria’s new finance minister, and a US-educated markets analyst is due to be deputy prime minister.
“They know what it takes to attract foreign investment,” Roberts says.
Like many US companies who went into Asia, Entergy is now backtracking. Roberts says the company expects to have disposed of its investments there by yearend with the exception of Pakistan, where it holds a 5% interest in the 1,200 Mw Hub River plant. Owners of the largest private power producer in Pakistan have been engaged in a long-running dispute with the government over rates charged by the plant.
Entergy also is disposing of its holdings in Argentina, Chile, and Peru, where the company was a minority owner in four power plants. “These were passive investments that didn’t lead into something,” Roberts says. “If we had good operating positions, I’d have a different answer.”