Understanding today’s
rapidly evolving energy market
Gas Markets & Purchasing Options
22nd July 2004
Understanding today’s
rapidly evolving energy market
Agenda
Gas market high level overview
Introduction to Vaÿu and the Irish Energy
Co-operative Society Limited
Overview of gas purchasing and options
Understanding today’s
rapidly evolving energy market
Irish Gas Market
Threshold for eligibility was set at 5.3 GWh per annum
Natural gas users consuming above this threshold were eligible to choose
their gas Supplier
Equates to 230 eligible customers across 250 sites
Threshold dropped further on the 1st July, 2004 to include all those using
in excess of 73k kWh (All Non-Domestic)
Opens up approximately 19,000 smaller industrial & commercial and SME
customers
Understanding today’s
rapidly evolving energy market
Introducing Vaÿu
Understanding today’s
rapidly evolving energy market
Vaÿu – A new player
Vaÿu is a new Irish energy supply company; Licensed as a supplier
and shipper of natural gas in the Irish marketplace by the
Commission of Energy Regulation (CER) in December 2003.
Vaÿu Spearheaded, established and now manages the energy and
supply requirements for members of the Irish Energy Co-operative
(IEC)
IEC is an independent grouping of large industrial and commercial
organisations from a range of industry sectors in Ireland
Understanding today’s
rapidly evolving energy market
Why the Co-op?
Address escalating Energy costs in Ireland with a fresh approach to
pricing.
Bring competition and choice of options to the deregulating gas market.
Proactively and collectively address the issues of increasing energy prices
and there effect on Ireland Inc.
Make liberalisation ‘relevant’ to end-users, impacting the bottom line
through competitive pricing
Become the de facto voice for Industrial, commercial and SME’s in Ireland
over the coming years
Understanding today’s
rapidly evolving energy market
How does it work?
Understanding today’s
rapidly evolving energy market
How does it work?
Flexible procurement model
Vaÿu ships and supplies gas, utilising a UK trading partner
Competitive price offering, facilitated by:
•PPurchasing power of IEC members
•UUK counterparty trades over 27 billion therms of gas a year
•EEconomies of scale
•OOperational Efficiencies Passing the benefits of liberalisation to
the customer
Understanding today’s
rapidly evolving energy market
Overview of Gas
Purchasing and Options
Understanding today’s
rapidly evolving energy market
The market is as much dependent
on economists, as weather on
meteorologists.
H.G. Wells
Understanding today’s
rapidly evolving energy market
• Exploring Your Needs
• Hedging
• Choices and Their Pros and Cons
• Vayu Portfolio & Risk Management
• Recommendations
Understanding today’s
rapidly evolving energy market
What are your companies needs?
Price Management
Price
Surveillance
Asset
Management
Natural Gas Services
Energy
Accounting
Regulatory
Surveillance
Total Cost
Service
Optimisation
Understanding today’s
rapidly evolving energy market
The strategies/products that follow have the potential to reduce price vs.
fixed price purchases by [3-10%] - however, there is always the risk that
opportunities do not arise, are missed or actual market conditions are not as
predicted
The tools and methods described in the following slides are some of the things
that can be done to create the “Vayu Portfolio Price”
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It is assumed in the following slides that the standard transaction is a fixed price
purchase - this could be offered by any supplier - the price will always be at or close
to the IPE price (plus transportation) at the time the sale/purchase commitment is
made
This document describes some of the things Vayu can do in pursuit of a better risk
managed price for End-Users
Products described on the following slides apply to portfolio based transactions by
Vaÿu at in the UK and at Moffat – Vaÿu translate these wholesale products into
services for end user customers
All the examples in this document rely on sufficient market conditions, including
liquidity and opportunity
Understanding today’s
rapidly evolving energy market
What are your companies needs?
Each Company is Unique
• Corporate Situation
– culture and philosophy
– policies and practices
– how does your company manage risk?
• At The Plant Level
– budget process
– relative importance to end product
• Resource Strength
– in-house pool of resources to use
Understanding today’s
rapidly evolving energy market
Understanding today’s
rapidly evolving energy market
What are your companies needs?
If it is Price Management...
– IPE, index risks
– basis risks
– currency risks
Does Your Supplier Meet Your Needs?
– Market outlook, tracking fundamentals, technicals
– role in developing customer hedging strategy
– 2 way communication, formal/informal, relationship building
– trigger and hedging capability
– supply flexibility, spot gas
– information; right amount, right time
Understanding today’s
rapidly evolving energy market
What are your companies needs?
If it is Asset Management...
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Facilities Management
CHP ??
upstream transportation / Interruptible Contracts
storage
balance accounts
Does Your Supplier Meet Your Needs?
– provide notice of opportunities
– extract value from excess / mitigation capability
– work well with Transmission / Distribution Operator
– trading capability
– daily nominations
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If it is Regulatory Surveillance...
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Transportation Tariffs / Codes of Operation
Entry Exit, Storage, Interconnection
Regulation of Retail Tariffs
PSO’s
Does Your Supplier Meet Your Needs?
– Tracking of key issues important to you
– sharing of info and views
– work with industry & Co-op members towards resolution
– passive or active
Understanding today’s
rapidly evolving energy market
If it is Total Cost Service Optimisation...
– Capacity & Transportation Management
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firm vs interruptible
bundled vs unbundled
Customer Nominations
Penalties
Does Your Supplier Meet Your Needs?
– Experience / knowledge level
– delivery capabilities
– daily nominations capability
– financial security
– long term commitment
Understanding today’s
rapidly evolving energy market
If it is Total Cost Service Optimization...
– Capacity Management
• Peak Day Management
– Energy audits behind the meter
– capital investment with payback based on sharing of
energy savings
– detailed review of Capacity Charges
– customer operating reports (customised)
Understanding today’s
rapidly evolving energy market
If it is Price Surveillance...
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Commodity, transportation
Ability to instruct procurement
varying terms
varying delivery points (Aggregated portfolio)
What benefit can be delivered on you own portfolio of
meter points.
Does Your Supplier Meet Your Needs?
– Significant pool of upstream shippers / options traders
– Offered strategy tailored to your portfolio
– sharing of info and views
– may or may not take title
Understanding today’s
rapidly evolving energy market
Consider Multi-Year Terms
– most buyers:
• Are unable to hedge long term with their current
supplier
• can’t fix a price unless gas is purchased
• Under the RTF don’t know the actual price in the
contract until 2 days before term
– allows for:
• better strategic planning
• achieving budget targets
Understanding today’s
rapidly evolving energy market
Recommendations
• take the time to discover/change your corporate boundaries;
re-affirm or identify your natural gas service needs
• Understand your utilisation vs. procurement strategy
• Understand the impact of MDQ on your total bill
• opportunity to look at gas cost big picture daily forecast of gas
consumption is critical
• get more familiar with IPE natural gas futures to manage your
risk
• Understand the longer term outlook for gas commodity prices
Understanding today’s
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PREPARING FOR PRICE VOLATILITY/ UNCERTAINTY
Developing a Hedge Plan
Plan Ahead
Define Specific Program Objectives
Purchasing Objectives
BUY Under Budget
Develop a Quantifiable Hedging Strategy
Maintain Structure and Discipline
BUY to Protect Against Major Price
Increases
BUY Lower than Competition
BUY as Low as Possible
Practice Proper Interpretation of Hedge Results
Understanding today’s
rapidly evolving energy market
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Fundamental analysis include supply/demand, weather, storage, and economic drivers
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Technical analysis include charting, moving averages, and market concentration
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Historical analysis is an anchor to define “value” over a long period of time
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Most companies will utilise a combination of quantitative analysis and a qualitative
analysis (current fundamental and technical features) that are affecting price
Fundamental
Analysis
Technical
Analysis
MARKET
VIEW
Historical
Analysis
Understanding today’s
rapidly evolving energy market
ASSESS
RISKS
IDENTIFY
NEEDS
&
RISK
TOLERANCE
LEVELS
EVALUATE
Vayu believes that the methodical assessment
and design of a risk management program
can help an organisations achieve its stated
goals and objectives through the
Co-op.
POLICIES,
PROCEDURES
&
CORPORATE DEVELOP &
APPLY
STRUCTURE
INTERNAL
CONTROLS
GAS TRADING
& RISK MANAGEMENT
DEVELOPMENT
SOFTWARE
HEDGE PLAN
DEVELOPMENT
BROKERAGE / TRADING
PRESENT NEW
DOCUMENTS
TO CO-OP
ADDRESS
STEERING
DEAL TRACKING,
GROUP
VAR,
STRESS TESTING,
CREDIT
ANALYSIS
APPLY
KNOW-RISK
DEAL
TRACKING
SYSTEM
DEVELOP
HEDGE
PRICING
STRATEGY
PROVIDE
EDUCATIONAL
WORKSHOPS
FOR
ASSIST WITH
ALL CO-OP
ON-GOING
MEMBERS
APPLICATION OF
HEDGE PROGRAM &
PORTFOLIO
MANAGEMENT
Understanding today’s
rapidly evolving energy market
NATURAL GAS PRICE DISTRIBUTION
When prices rally to historically
high levels, the high prices
encourage more production and
discourage demand, eventually
driving prices lower.
ENERGY PRICE PLAN PHILOSOPHY
42 p stg
PRICE
Low Supply/High Prices
Discouraging Demand
Conversely, when prices are
historically low, production and
exploration are curtailed and
usage of gas tends to increase,
ultimately supporting a price
rally.
High Supply/Low Prices
Encouraging Demand
16 p stg
TIME/VALUE
Understanding today’s
rapidly evolving energy market
Understanding today’s
rapidly evolving energy market
PRICING ALTERNATIVES
INDEX / ARBITRAGE
STRATEGY
Index Pricing: Setting the price at a monthly/daily index based on the IPE price
Fixed Pricing: Locking in prices for multiple months up to several years
FIXED PRICING
Cap: Buying a call option
The buyer pays a premium to receive the right to buy energy at a predetermined
maximum strike level without the obligation of buying at that level.
FIXED
PRICE
Collar: Buying a call and selling a put option
Gives the buyer an obligation and an option at the outer range of two prices;
paying a premium and collecting a premium
CAPS
CAP
(Strike +
Premium)
BUY
SELL
CALL
PUT
BUYING THE RIGHT TO BUY
PAY PREMIUM
BUYING RIGHT TO SELL
PAY PREMIUM
SELLING RIGHT TO BUY
IF OPTION IS EXCERCISED TAKE ON
OBLIGATION -
SELLING RIGHT TO SELL
IF OPTION IS EXCERCISED TAKE ON
OBLIGATION -
TO SELL FUTURE
TO BUY FUTURE
COLLECT PREMIUM
COLLECT PREMIUM
COLLARS
CAP
COLLAR
FLOOR
Understanding today’s
rapidly evolving energy market
History of Hedging.
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Futures were originally crafted to allow, millers of flour and makers of
bread to “lock in” their costs/revenues, eliminating RISK from an
inherently risky business.
• Grain growers:
– Wanted to know the price they could sell grain when harvested.
• Millers were interested in:
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Knowing what they were going to spend on Grain.
Cost to process the grain.
What they could sell flour for after it was processed.
• Bread makers:
– Had a “known” sale price, which the public would pay for bread.
– Wanted to eliminate volatile swings in price in flour and the corresponding
affect on their cost to manufacture bread. Negatively affecting their
margin and profit.
– Through “forward contracts”, both bread makers and millers were
able to REDUCE the inherent risks of their respective businesses.
Middle to late 1800’s.
Understanding today’s
rapidly evolving energy market
Reasons for Natural Gas Hedging
• Hedging is implemented to reduce the effect fuel price
volatility will have on a business entity.
• Hedging is a management tool that is to project costs, net
revenues and net profit into the future.
• Hedging is putting a plan in place to control a cost, over
which, you have no control and can not influence.
• Hedging can be used to meet a target price or budget cost..
• Hedging can avoid the agony of having done everything else
correctly and then being “torpedoed” by a uncontrollable
event.(ESB Strikes, Enron,Field Outages, Weather, Refinery
meltdowns, IRAQ, Terrorist event)
• Hedging frees you to manage costs and events you can
influence.
Understanding today’s
rapidly evolving energy market
Hedging IS NOT:
• A way to “reduce” costs and outperform the market.
• An avenue to lock prices “before they go up”.
• A consistent way of “increasing” profit or “saving money”
though fuel purchasing.
• A way of using your, or an advisors, knowledge to lock in “good
prices”, better than the competition.
• Locking in prices and then evaluating the purchase with 20/20
hindsight, or evaluate not buying a fixed price in the same
manner.
• Implemented and designed to “make money” and evaluated as
a profit/loss item.
Understanding today’s
rapidly evolving energy market
Typical Objections to Hedging
• Our company is conservative.
• If I am “in the money” someone is getting hurt, and If I am “losing
money” someone is benefiting at my expense.
• I don’t understand and it’s difficult.
• We’re big enough to stand on our own two feet.
• I don’t really need to do anything, my company can “weather the
storm”.
• I have never done any in the past and we survived.
• I’m not really responsible if prices move up and we miss budget,
‘I can’t control world markets’
Understanding today’s
rapidly evolving energy market
Fixed Price Gas
Price
Illustration
Characteristics
•Agree the price now for future deliveries
of gas
Actual out-turn prices
Fixed price
•Probably the most usual way for
retailers to sell gas (low on effort and
creativity)
Advantages
•Certainty - cost of gas is fixed up front
•If gas prices subsequently rise you still
pay the original fixed price
Disadvantages
•picking the best day to fix price for (say)
a year in advance is difficult - highly
unlikely to achieve the best price
•If gas prices subsequently fall you still
pay the original fixed price and do not
have the opportunity to buy at the lower
prices
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In the above illustration the buyer of fixed price gas would lose
out vs. an index price buyer with the exception of periods during
Jan/Feb and Sep/Oct/Nov. The timing of the fixed price gas is
crucial - a buyer is relying on prices being low when he commits
to the purchase.
Vayu offers this service and will share its
views to help choose the optimal time to
buy
By reading the market correctly there is an opportunity achieve
a better price than the fixed price available at the time of
purchase.
Understanding today’s
rapidly evolving energy market
Index Priced Gas
Daily Prices vs. Month Ahead Prices
Characteristics
35
30
Pence/Therm
•Price is set according to an index - for
example, the IPE month ahead index is
set according to the price of gas (for any
given month) in the month immediately
preceding delivery - I.e. May gas is
priced at spot market prices (for May
gas) quoted during April
25
20
15
10
5
•If prices are expected to fall, buying gas
close to the time of delivery may result in
lower prices
•Price changes each month so spot
market volatility might be “smoothed out”
Disadvantages
•Cost of gas is not known until nearer the
time of delivery - prices might rise
Vayu can provide index priced gas
IPE Month Ahead
30/12/03
30/11/03
30/10/03
30/09/03
30/08/03
30/07/03
30/06/03
30/05/03
30/04/03
30/03/03
28/02/03
•Instead of depending on a fixed price
buyers can choose to pay the market
price close to the time of delivery
0
30/01/03
Advantages
IPE Year 2003 (on Dec 2, 02)
This chart shows the actual fixed price that could have been achieved on
Dec 2, 2002 for the whole of 2003 and the IPE month ahead prices for
2003.
A successful strategy would have been to float with the month ahead
index price for the first half of the year and commit to fixed price for the
second half of the year.
There was the opportunity to save over 2 p/therm for anyone predicting
this situation correctly - that’s in the region of 10% of the annual gas bill.
Understanding today’s
rapidly evolving energy market
Fixed Price Gas - With a “Sell Back” Facility
Price
Illustration
Characteristics
•If, after committing to a fixed price gas
purchase market conditions indicate
prices will fall, the buyer can sell back
gas with the aim of buying later at lower
prices
Actual forward prices
Fixed price
Advantages
•Provides flexibility if a fixed price
purchase appears to have been a bad
decision
•Allows the buyer to realise gains from
short lived price spikes
Disadvantages
•Gas could be sold back but prices still
move higher exposing the buyer to even
higher prices
Vayu can provide this service along with
views on future market prices - this
approach can be very risky
Projected forward prices
Time
In this illustration a buyer of fixed price forward gas (e.g. for 4th quarter
2004) may consider selling back some gas following a rise in the value of
forward contracts in the hope of being able to buy back later at a lower
price.
While this may be a real opportunity, given certain market conditions,
there is the risk that, following a sell back, prices will not fall and the
buyer’s cost of gas will rise.
Understanding today’s
rapidly evolving energy market
Fixing the Maximum Price with a Price Cap
Price
Illustration
Characteristics
Price cap
•A buyer can set a maximum price
(cap) for a fixed quantity of gas.
There will be a fee, payable up front,
for each unit of gas included in the
price cap
Fixed price
Advantages
Time
•Certainty - the buyer knows the
maximum price that will apply
•Flexibility - the buyer could wait to
buy gas closer to the time of delivery
and choose between a fixed price
from the spot market or the price cap
price
Disadvantages
•There is a fee
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In this illustration a buyer sets a price cap just above the current quote
for fixed price gas (no commitment to buy fixed price gas is required).
Just before the start of each month the buyer can choose to buy either at
market prices or at the level of the price cap.
In this example there would be savings in Jan/Feb and Sep/Oct/Nov from
buying at the level of the price cap.
Vayu can provide this prudent buying
mechanism
Understanding today’s
rapidly evolving energy market
Fixing the Maximum & Minimum Price
with “Costless Collar”
Characteristics
Illustration
Price
Price cap
•Similar to a price cap except the
buyer pays no fee in return for giving
up the benefits when prices fall below
a pre-determined level (the “floor”)
Price floor
Advantages
Fixed price
•Protection against price spikes buyer can put a ceiling on future
prices
•Price will only vary within a predetermined band
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Disadvantages
•The buyer will only benefit from price
reductions down to the floor price, not
beyond
Vayu can provide costless collars as
a way of limiting price fluctuations
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Time
This illustration is similar to the previous “price cap” slide with two
differences:
•there is also a price floor under the buyer’s price
•the floor is set at a level such that the cost of the collar can be set at
zero (buyer escapes some downside but gives up some upside)
Understanding today’s
rapidly evolving energy market
Current Market Outlook
• Generally prices will remain firm.
• Will have a opportunity to secure values
• Monday Oil futures closed at 7 week high of $42, gas
prices rallying on the back of it
• Impact of Field / Storage outages
• House of Lord’s / Ofgem Price manipulation
• Major events will have to move the market.
• Any major move lower on oil (below $36) will be
caused by a major geo-political event.
• UK LNG Facilities coming on stream ‘06
• ‘06 gas prices currently soft