Understanding today’s rapidly evolving energy market Gas Markets & Purchasing Options 22 nd July...

Understanding today’s Understanding today’s rapidly evolving energy rapidly evolving energy marketmarket

Gas Markets & Purchasing Options22nd July 2004


Agenda

Gas market high level overview

Introduction to Vaÿu and the Irish Energy Co-operative Society Limited

Overview of gas purchasing and options


Irish Gas MarketThreshold 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


Introducing Vaÿu


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


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


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

How does it work?


Overview of Gas Purchasing and Options


The market is as much dependenton economists, as weather onmeteorologists.

H.G. Wells


• Exploring Your Needs

• Hedging

• Choices and Their Pros and Cons

• Vayu Portfolio & Risk Management

• Recommendations


Natural Gas Services

Natural Gas Services

Energy Accounting

Energy Accounting

Price Surveillance

Price Surveillance

Total Cost Service

Optimisation

Total Cost Service

Optimisation

Price Management Price Management

Regulatory

Surveillance

Regulatory

Surveillance

Asset Management

Asset Management

What are your companies needs?


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”

– 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


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




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



If it is Asset Management...– Facilities Management– CHP ?? – upstream transportation / Interruptible Contracts– storage – balance accounts


– provide notice of opportunities

– extract value from excess / mitigation capability

– work well with Transmission / Distribution Operator

– trading capability

– daily nominations



If it is Regulatory Surveillance...– 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


If it is Total Cost Service Optimisation...– Capacity & Transportation Management

• firm vs interruptible• bundled vs unbundled• Customer Nominations• Penalties


– Experience / knowledge level

– delivery capabilities

– daily nominations capability

– financial security

– long term commitment


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)


If it is Price Surveillance...– 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


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


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


Developing a Hedge PlanDeveloping a Hedge Plan

Plan Ahead

Define Specific Program Objectives

Develop a Quantifiable Hedging Strategy

Maintain Structure and Discipline

Practice Proper Interpretation of Hedge Results

Purchasing Objectives

BUY Under Budget

BUY to Protect Against Major Price Increases

BUY Lower than Competition

BUY as Low as Possible

PREPARING FOR PRICE VOLATILITY/ UNCERTAINTY


Fundamental analysis include supply/demand, weather, storage, and economic drivers

Technical analysis include charting, moving averages, and market concentration

Historical analysis is an anchor to define “value” over a long period of time

Most companies will utilise a combination of quantitative analysis and a qualitative analysis (current fundamental and technical features) that are affecting price

MARKETVIEW

FundamentalAnalysis

TechnicalAnalysis

HistoricalAnalysis


Vayu believes that the methodical assessment and design of a risk

management program can help an organisations achieve its stated goals

and objectives through theCo-op.

GAS TRADING & RISK MANAGEMENT DEVELOPMENT

SOFTWARE

HEDGE PLAN DEVELOPMENT

BROKERAGE / TRADING

ASSESS RISKS IDENTIFY

NEEDS & RISK TOLERANCE LEVELS

EVALUATE

POLICIES,PROCEDURES& CORPORATESTRUCTURE

DEVELOP &APPLYINTERNAL CONTROLS PRESENT NEW

DOCUMENTS TO CO-OP STEERINGGROUP

ADDRESSDEAL TRACKING, VAR,STRESS TESTING, CREDIT ANALYSIS

APPLYKNOW-RISKDEAL TRACKING SYSTEM DEVELOP

HEDGEPRICINGSTRATEGY

PROVIDE EDUCATIONAL WORKSHOPSFOR ALL CO-OPMEMBERS

ASSIST WITH ON-GOING APPLICATION OF HEDGE PROGRAM & PORTFOLIOMANAGEMENT


ENERGY PRICE PLAN PHILOSOPHY

42 p stg42 p stg

16 p stg16 p stg

High Supply/Low PricesHigh Supply/Low PricesEncouraging DemandEncouraging Demand

Low Supply/High PricesLow Supply/High Prices Discouraging DemandDiscouraging Demand

PR

ICE

PR

ICE

TIME/VALUETIME/VALUE

When prices rally to historically high levels, the high prices encourage more production and discourage demand, eventually driving prices lower.

Conversely, when prices are historically low, production and exploration are curtailed and usage of gas tends to increase, ultimately supporting a price rally.

NATURAL GAS PRICE DISTRIBUTION



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

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.

Collar: Buying a call and selling a put optionGives the buyer an obligation and an option at the outer range of two prices; paying a premium and collecting a premium

FIXED PRICING

FIXED PRICE

INDEX / ARBITRAGE STRATEGY

INDEX

CAPS

CAP (Strike + Premium)

COLLARS

FLOOR

COLLAR

CAP

PRICING ALTERNATIVES

CALL PUT

BUY BUYING THE RIGHT TO BUYPAY PREMIUM

BUYING RIGHT TO SELLPAY PREMIUM

SELL

SELLING RIGHT TO BUYIF OPTION IS EXCERCISED TAKE

ON OBLIGATION -

TO SELL FUTURE

COLLECT PREMIUM

SELLING RIGHT TO SELLIF OPTION IS EXCERCISED TAKE

ON OBLIGATION -

TO BUY FUTURE

COLLECT PREMIUM


– 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:– 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.

History of 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.

Reasons for Natural Gas Hedging


• 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.

Hedging IS NOT:


• 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’

Typical Objections to Hedging


Characteristics

•Agree the price now for future deliveries of gas

•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

Vayu offers this service and will share its views to help choose the optimal time to buy

Actual out-turn prices Fixed price

Illustration

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.

By reading the market correctly there is an opportunity achieve a better price than the fixed price available at the time of purchase.

J F M A M J J A S O N D

PriceFixed Price Gas


Characteristics

•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

Advantages

•Instead of depending on a fixed price buyers can choose to pay the market price close to the time of delivery

•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

Daily Prices vs. Month Ahead Prices

0

5

10

15

20

25

30

35

30/0

1/03

28/0

2/03

30/0

3/03

30/0

4/03

30/0

5/03

30/0

6/03

30/0

7/03

30/0

8/03

30/0

9/03

30/1

0/03

30/1

1/03

30/1

2/03

Pe

nc

e/T

he

rm

IPE Month Ahead 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.

Index Priced Gas


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

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

Actual forward prices

Fixed price

Illustration

Projected forward prices

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.

Price

Time

Fixed Price Gas - With a “Sell Back” Facility


Characteristics

•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

Advantages

•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

Vayu can provide this prudent buying mechanism

Fixed price

Illustration

Price cap


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.

Price

Time

Fixing the Maximum Price with a Price Cap


Fixing the Maximum & Minimum Price with “Costless Collar”

Characteristics

•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”)

Advantages

•Protection against price spikes - buyer can put a ceiling on future prices

•Price will only vary within a pre-determined band

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

Fixed price

Price cap


Price floor

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)

Price

Time

Illustration


• 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

Current Market Outlook

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Understanding today’s rapidly evolving energy market Gas Markets & Purchasing Options 22 nd July...

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