Wednesday, 28 January 2009

Pain for Utilities in 2009

As you know, we don’t do financial advice here, but we do take an interest! The first of CU’s predictions for 2009 was this:

Oil will be the investment opportunity, with never to be seen again low valuations in oil companies.

And later he had a look at what’s going on in the sector – which, as Alphaville also reports, includes some crazy happenings.

So what about gas and power utilities, then ? Aren’t they just middlemen, who make a healthy turn irrespective of whether energy prices are going up or down ?

Putting aside the fact that several of them have upstream assets as well as utility operations, we could say that in ‘normal’ times they can indeed insulate themselves from energy price risk, just taking a margin. But these are not normal times, and they are badly exposed to the huge downturn in industrial energy demand. This is because, perhaps surprisingly, even the very largest industrials mostly buy energy like you and I do – we may agree the price, but how much actual gas and leccy we are going to use is a matter of educated guesswork based on historical data, and the supplier takes the full risk that we don’t use the amount he expects us to.

Often, his concern is an unexpected peak in demand: but not in 2009! The utilities have bought gas and power forward, in amounts that reflect past consumption – and they are on the hook for these quantities. But most industrial buyers are not.

This is causing agonies for several of the big suppliers right now, and until the collapsing industrial demand (20% down by some estimates) works through the system, taking at least 6 – 12 months, they will have a very uncomfortable time of it.

It won’t be a happy sector in 2009 - particularly for any of them that haven't diversified into upstream assets.

ND

6 comments:

Blue Eyes said...

So does that mean the lights won't go out, after all?

Perhaps BG and Npower will be next in line for a bailout...

not an economist said...

"The utilities have bought gas and power forward, in amounts that reflect past consumption – and they are on the hook for these quantities."

May I ask sthg please ...

Does this mean that these companies are committed to both the quantities they ordered AND the prevailing prices at that time, such that if prices fall during the year they will not get the benefits of those falls?

Steven_L said...

The price depends on the terms of the forward contract they entered into and whether they locked in to any particular price by hedging.

Nick Drew said...

BE - best guess must be that the lights will stay on (no politician can survive rolling blackouts, as has been seen worldwide), but at the expense of (a) ditching green policies and (b) lots of panicky last-minute new power-plant building

Steven has it nailed, NAE: they sign contracts with agreed price formulae (not usually fixed prices - they tend to be indexed to the price of oil) and fixed minumum quantities. They may indeed have hedged the oil-indexed prices: but it's mostly the quantities that will stuff them.

Continental contracts tend also to have 're-opener' clauses which allow key terms to be renegotiated periodically (e.g. every 3 years)if market conditions have changed since the last review (!!). Some of these clauses allow both price and volume to be renegotiated, within limits: but some only allow price.

Failure to agree can then result in arbitration, or recourse to the courts. (This doesn't really work under English law, so UK purchase contracts don't generally operate these provisions)

One cannot imagine the Russians being particularly understanding in such renegotiations, which tend to be pure win-lose affairs.

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