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Power-Gen: Entergy cuts consumption with call options

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ORLANDO, Fla., Nov. 15, 2000à‚–Entergy Inc. has learned something about pricing electricity from the airlines industry and applied it to the company’s new market-based load management program.

As a power buyer as well as a generator, “we wanted to make sure we are not in the market during the 15 highest price days from June through September,” said Peggy Soileau, senior analyst, at Power-Gen International.

For inspiration, Entergy turned to the airlines “oversold” model of offering incentives to customers to get off the plane. Airlines profit when they overbook a flight because the last tickets sold cost customers the most. Rather than not selling these tickets, the airlines make it worthwhile to some passengers take another flight.

Similarly, New Orleans-based Entergy is paying program participants to reduce energy consumption when the resources are needed, thereby displacing higher cost alternatives, Soileau said. The program was introduced this past summer.

Entergy offers three variations of the program: a market-valued call option, market-valued energy, and experimental energy reduction.

Under the market-valued call option, a customer sells Entergy the right, but not the obligation, to purchase a curtailment in the future at a specific energy price for a predetermined number of occurrences for each summer month.

In return for selling Entergy this right, the customer receives a call option premium for each of the 4 summer months and an energy payment tied to each curtailment. The total potential for 16 curtailments is 128 hours, but curtailments are for 8 hours only with a cap of 3 days/month in June and 5 days/month in July and August.

The program is organized so that interested parties submit bids in early spring, including site, call option premium, firm demand, and a estimate of curtailable load. If the bid is accepted, the customer receives the call option premium as a credit on their June-September bills. For instance, if the call option premium is $2,500/MW a month for a 5 MW load, the credit amounts to $12,500/month for the summer.

Call option credit
If Entergy calls a curtailment, the customer receives a credit multiplied times the energy strike price. If June and September strike prices are set at $100/MWh and July and August strike prices are set at $250/MWh, the customer’s total credit equals the call option premium and the sum of the credits from each 8-hour curtailment.

Soileau said the disadvantage of the call option variation is pricing is very difficult in an illiquid and highly volatile wholesale market and there is a lack of transparent hourly indexes in certain regions. She said two large industrial users are using this particular option.

Participants in the market-valued energy variation of the program do not have to sign a contract up-front to participate. But they do sign an enabling agreement that allows them to bid in the day-ahead market. Each week day of the summer, these customers decide if they want to bid between 8 a.m. and noon in the next day market for a curtailment to occur on the following day.

If Entergy accepts the bid, the customer receives notice to reduce load by the agreed upon amount. Participants receive a credit for each curtailment equal to the load curtailed by the energy price bid multiplied by 8 hours.

Compared to the market-valued call option program, Soileau said, the market value energy variation doesn’t require the customer to give up control to the utility. The decision to participate can be made daily.

Geared to smaller customers, the experimental energy reduction variation is similar to the shared savings approach, but the price is not tied to a wholesale index. Entergy posts day-ahead prices on a secure Internet site and the customer agrees to a demand reduction in return for a credit based on the amount of energy he had pledged to cut. Participants receive a credit tied to actual load relative to the prior day’s load multiplied by the preset energy price.

The net result of the program is Entergy expects it to improve the financial performance of the utility, lower cost to all regulated customers, maintain service to all customers, and provide a financial incentive to participants that exceeds their cost of curtailing energy use, said Soileau.

Even though Entergy is introducing the program in a regulated market, she predicted market-based load management pricing schemes will become the primary mechanism for differentiated pricing in a deregulated market.

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