R. Patrick Thompson

    We have seen them in movies and on television. When financial markets become turbulent, the business sections of newspapers routinely feature pictures of them. They are those wide-eyed and overactive traders throwing finger and hand signals at one another and then scribbling frantically. They make the Energizer Bunny look like a tone deaf, worn out rabbit.

    You can imagine my disorientation when a calm lawyer-like P. Patrick Thompson, President of the New York Mercantile Exchange, begins an insightful tutorial on the "how's", "why's" and "where to's" of electricity contracts. He wants to make sure that professionals in the electricity sector understand the potential benefits of electricity contracts. In a possibly more important, although longer-term vision, he wants them to grasp how electricity contracts may work to enhance institutional changes taking place.

    First though it is necessary to understand the parameters of an electricity contract. The NYMEX trades two electricity contracts, one for physical electricity exchange at specific point on the Oregon-California border and another at an interchange point in Arizona. Each contract represents an agreement between a buyer and seller to exchange 736 MWH (2 MW between 6AM and 10PM for 23 consecutive business days). Today's price of the future physical exchange is what the traders on the floor buy and sell with one another-thus futures.

    We asked Mr. Thompson why two places in western states were chosen for contracts. He explained "Basically when we at NYMEX started looking at electricity as a commodity, electricity producers and consumers in the west specifically had greater experience with deregulation. Deregulation of western utilities into distribution, transmission and generating companies had progressed further than in the other states. In addition independent power producers had come to the market place. Essentially there was a larger and more diverse pool of competitors. Moreover, the western power pool had standardized its business practices and made the underlying product, in this case electricity, more fungible." He further elaborated "Since we wanted to try to get to the marketplace as soon as feasible, the western states seemed to us as the most feasible locale. Now, the pace of deregulation has accelerated in the east and we expect to add contracts here as well."

    For those familiar with the detailed pricing schemes of power pools, such as The PJM (Pennsylvania, New Jersey and Maryland), just two contracts at present and anticipating only a few more in the future would seem to contradict these sophisticated electricity dispatch schemes. Mr. Thompson did not feel that any inherent conflict exists and if it did, futures pricing will eventually serve as an indicator for a broader market. His major objection was that unique prices at 1,500 different points, for example, on a power grid did not adequately support the notion of fungibility-an essential component of a futures market.

    "We think the way that will evolve that is that the market itself will begin to create an aggregation of interest at another one or two (additional) points," said Thompson. This is because those coming to the market will prefer fewer contracts and the resulting increased liquidity to more contracts representing more physical interchange points.

    "Because the industry is changing from one of engineering to one of marketplace solutions, the economic role of power grids may diminish considerably over time. I think you will see the rise of marketing and economics types over the operating engineer types. You will find over time that the operating philosophy will change. This makes changes that you thought were impossible, possible if not likely. The PJM, as we know it, will probably not exist seven years from now. Hard to believe but it will happen."