Prudence:
Price Benchmarking and After-the-Fact Reviews

As a result of electricity deregulation, many local distribution companies (LDCs) now transact in wholesale markets to meet their obligation to serve.  Regulatory approval of wholesale purchases and their ensuing cost recovery require an affirmative showing of prudence.  Allegations of imprudence invite regulatory scrutiny and possible disapproval of an LDC’s proposed transaction, and can trigger cost disallowance of transactions already made.  Protracted litigation and large disallowances can financially ruin an otherwise financially healthy LDC (e.g., some utilities in California and Nevada).  E3 can assist an LDC to:

• Develop a procurement plan that embodies prudent management of cost and risk.

• Benchmark the price-reasonableness of a long-term forward contract or a tolling agreement, which may be an affiliate transaction.

• Make an affirmative showing in a before-the-fact prudence review by a regulator of an LDC’s proposed procurement plan and its underlying transactions.

• Make an affirmative showing in an LDC’s filing for an after-the-fact recovery of procurement costs of transactions already occurred.

E3 at Work

• Using the long-run marginal costing methodology, Dr. Orans demonstrated the price-reasonableness of a long-term power purchase agreement between a large California LDC and its affiliate.

• For a large Ontario generation owner and a Florida municipal utility, Dr. Woo applied cross-hedging to forecast electricity forward prices for benchmarking price reasonableness of contracts and managing procurement cost and risk.

• Dr. Woo’s testimony filed with the CPUC led to a favorable settlement for an LDC that signed a five-year fixed price contract at the height of the energy crisis.

Selected E3 Publications

• Woo, C.K., I. Horowitz, A. Olson, B. Horii and C. Baskette (2006) “Efficient Frontiers for Electricity Procurement by an LDC with Multiple Purchase Options,” OMEGA, 34:1, 70-80.
• Woo, C.K., D. Lloyd and W. Clayton (2006) “Did a Local Distribution Company Procure Prudently during the California Electricity Crisis?” Energy Policy, 34:16, 2552-2565.
• Woo, C.K., A. Olson and I. Horowitz (2006) “Market Efficiency, Cross Hedging and Price Forecasts: California’s Natural-Gas Markets,” Energy, 31, 1290-1304.
• Orans, R., C.K. Woo, and W. Clayton (2004) “Benchmarking the Price Reasonableness of a Long-Term Electricity Contract,” Energy Law Journal, 25:2, 357-383. (500 kB PDF)
• Woo, C.K., D. Lloyd, M. Borden, R. Warrington and C. Baskette(2004) “A Robust Internet-Based Auction to Procure Electricity Forwards,” Energy - The International Journal, 29:1, 1-11.
• Woo, C.K., R. Karimov and I. Horowitz (2004) “Managing Electricity Procurement Cost and Risk by a Local Distribution Company,” Energy Policy, 32:5, 635-645.
• Woo, C.K., I. Horowitz and K. Hoang (2001) “Cross Hedging and Forward-Contract Pricing of Electricity,” Energy Economics, 23: 1-15.
• Woo, C.K., I. Horowitz and K. Hoang (2001) “Cross Hedging and Value at Risk: Wholesale Electricity Forward Contracts,” Advances in Investment Analysis and Portfolio Management, 8, 283-301.