Futures trading proves a consistent bright spot in the clouded U.S. electricity picture

The electrical system that interconnects nearly 150 million residential, commercial and industrial customers throughout the United States would be enormously complex even in the best of times, and these are not the best of times. Every part of the U.S. electrical system – generation, transmission, delivery and marketing – is in some kind of transition, flux, or just plain trouble.

The future shape of the industry is uncertain and unpredictable. Given that, it would be natural to think that trading in electricity futures had slowed. In fact, the opposite is true. The volume and open interest in electricity futures on the exchange are growing dramatically, the number of contracts being offered is increasing, and the geographical territory in which futures are offered is expanding. In 2008, renewables accounted for almost 80 percent of new generating capacity announcements. Wind energy added almost 700 megawatts (MW) of capacity per month in 2008, and represented more than 40 percent of the electricity industry's additions. The recession has stalled growth in electricity demand and temporarily lessened the need for new generating capacity. If and when the economy recovers, and new capacity is needed, the Obama administration is determined to see that much of it comes from renewable sources.

Establishing renewables

One problem with expansion of renewable generating capacity is that areas where there is enough wind and/or sun to generate electricity are generally far from major population centers. Building the transmission lines to get this green power where it is needed will be a major undertaking. Local opposition, based both on environmental sensitivities and cost, is a perennial problem as high-powered transmission lines are needed to interconnect electrical systems across regions. New power plants are coming on line at twice the pace of transmission development, and both system reliability and the ability to integrate renewables could be threatened.

As of now, the decisions on transmission are divided between state regulators – subject both to not–in–my–backyard sentiment and financing concerns on the part of residents – and the Federal Energy Regulatory Commission (FERC). The Energy Policy Act of 2005 increased FERC's authority to allow or require transmission lines to be built if they are needed to increase system reliability, but that authority has met with criticism and legal challenge.

The electricity industry believes that the United States will not be able to establish a true national transmission grid until FERC and the federal government makes money available for projects that may be locally objectionable, but in the national interest. The uncertainties surrounding transmission, integration of renewables and many others are exacerbated by the fact that, as M.I.T. Professor Paul L. Joskow explains, "We have a system that is one-third reformed and two-thirds stuck in the structural and regulatory paradigm of the 1930s or somewhere in between."

The electricity deregulation process began in the 1990s, as FERC permitted open access to utility transmission systems. States began adopting restructuring plans aimed at extending competition to the retail level and at requiring utilities to divest themselves of generating capacity.

The first state to announce a restructuring plan was California in 1994, and many more states, primarily Eastern and Midwestern states with higher electricity costs, followed. Flaws in California's plan led to soaring prices and rolling blackouts. That, coupled with the spectacular implosion of Enron, essentially put the brakes on deregulation. Today, customers in 23 states and the District of Columbia see some level of deregulation, usually allowing them to choose generation providers, but no other states are joining them.

FERC has set up, and regulates, two forms of electricity dispatching systems in the deregulated portion of the electricity marketplace; independent system operators (ISOs) and regional transmission operators (RTOs). ISOs coordinate, control, and monitor the operation of the electrical power system within a state. RTOs have the same functions, but operate in more than one state. ISOs and RTOs act as marketplaces in wholesale power. Where deregulation has taken hold, electricity futures have taken off, despite the uncertainty of the economy and all of the other elements of the electricity marketplace that are in flux.

The largest RTO in the country is the PJM Interconnection, founded in 1997. PJM originally meant Pennsylvania-Jersey-Maryland, but it now operates in all or part of 13 states, plus the District of Columbia. Other major deregulated markets are ISO-New England, which operates throughout the New England states; NYISO, in New York State; ERCOT, in Texas; the Southwest Power Pool; the Midwest Independent System Operator; and California's CAISO.

Electricity futures and options

NYMEX, now part of CME Group, launched its first electricity futures contract in the late 1990s, to initial success. Futures trading stalled after the troubles of California and Enron, but the effect was only temporary, since the need to hedge was great, and constant in the ever-flowing electricity marketplace. Today, NYMEX offers electricity futures and options contracts that settle on real-time and day-ahead prices provided by the ISOs. NYMEX ISO-based electricity futures and options are expanding volumetrically and geographically. Futures swaps are cleared through CME ClearPort, a service that substantially mitigates counterparty credit risk and provides neutral settlement prices.

The exchange has launched more than 100 power products since December of last year. The 5MW product design helps to capture transactions of varied sizes. The futures products are helping not only to hedge risk but to create liquidity in a tough market. Volume has significantly increased, with volume at nearly 646 million MW-hours for the first half of 2009, representing an increase of more than 60 percent over 402 million MW-hours for the same period in 2008.

"We trade all these products," says Michael DeSousa, director of trading for PSEG, one of the largest electric companies in the United States. "And, with the credit problems that the market is encountering, these new cleared products have helped us with our hedging and proprietary trading. The markets have a limited amount of good credit counter-parties and these products definitely help. I would estimate we do at least 20 trades a week on these new products."

In addition to the PJM market, futures swap contract products have been launched in the Midwest and New England. In late April, California re-launched its daily electricity auction, nine years after it fell victim to the state's energy shortage and its own design flaws. CME Group has initiated 16 new contracts, subject to NYMEX rules and regulations, in the brand new market.

In May, another addition to the product portfolio, a PJM Western Hub 50MW peak calendar month real-time LMP swap futures contract began trading on the CME Globex electronic trading platform. The exchange also began offering 16 new products in the Electric Reliability Council of Texas RTO, in June 2009. Clearly, whatever the future of the U.S. electricity marketplace, the futures of the electricity marketplace are doing just fine.

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