By Benedict De Meulemeester on 13/08/2010
This morning a worried client called us to ask why the Dutch Cal 12 peakload had shot up by 3% yesterday whereas all other prices in the Dutch electricity market were down. The answer to that question is stupefying.
Somewhere last year, the members of the Dutch power exchange Endex started to complain that it is annoying in their international power trades that the peak hour definitions in the Netherlands are different than in Germany. Not strange, if you consider the amount of Dutch - German power trades. In the Netherlands peakload runs from 7:00 in the morning till 23:00 in the evening, whereas the German peakload runs from 8:00 to 20:00. Annoying, I can imagine, if you want to stage a Dutch - German cross-border peakload deal. So Endex listened to its members and introduced the Dutch "super-peak", running from eight till eight like the German peakload.
However, the retail market departments of those members remarked that they had a few thousand contracts running with industrial clients that have pricing mechanisms where the price is built based on the old seven to eleven peak. So, Endex decided to continue publishing the old, normal peak. The Netherlands became the only country I know with three instead of two energy contract types: baseload, peakload and super-peakload.
And then the story takes the stupefying twist. Trading three contracts per time-period, that would be of course a difficult task in a market that isn't really excelling in terms of liquidity. Multiplying the number of tradable contracts on an exchange where volumes on many products are already extremely thin is indeed not a very good idea. So Endex decided that trading would be limited to the new eight-to-eight peakload products and that the old seven-to-eleven peak would be 'calculated'. So, if you have recently fixed a peakload price in the Netherlands, your price was not based on an a value coming from real market trades but rather from some sort of calculation. As such, all peakload prices clicked since the 29th of April 2009, when the super peak was introduced, were calculated prices.
Of course, the calculated price is derived from real traded prices, so you could claim its reliability. However, an important factor has been added to that reliability-question: the reliability of your calculation methodology. I haven't taken the trouble of analyzing the arithmetic of the formula, but however, this is asking for trouble. Any formula, and this one also, will have some constant factors. The formula looks sophisticated, but it basically comes down to a simple principle. You take the twelve hour peak price and the baseload price and you multiply them with something. By doing that, you make the relationship between different market prices constant, whereas in practice it changes every day. So you can seriously question the practice of applying 'calculated' market prices.
What is even more absurd is that the formula sometimes turns out an unexpected result, namely a calculated seven-to-eleven peak that is higher than the eight-to-eight peak. As a proof that the formula is cranky, that one can count. How could it be possible that demand for electricity would be higher in the evening between eight and ten? We are not in Southern Europe, most Dutch people have stopped working and are sitting in their house with a small lamp on by eight o'clock. Many industries work on a nine-to-five schedule. Demand for electricity goes down in the evening in the Netherlands.
So Endex decided to 'remedy' that. They made an extra rule that whenever the price for the seven-to-eleven is higher than the eight-to-eight peak, they will reduce it by 3 euro per MWh. And that's exactly what happened in the past weeks with the Cal 12 contract. The formula gave higher prices for the old peak, so it was reduced by 3 euro's. Yesterday, the formula gave a normal result again and the minus three euro rule was no longer applied. The result was that the price jumped up by 2,22 euro's. So, we now have peakload prices that shoot up and down by some euro's, not due to the underlying economics, but due to the versatility of an ill-shapen calculus.
It would be funny if less money was involved. Just imagine that you are an owner of a CHP and that you have made a deal two days ago for selling Cal 12 seven-to-eleven peakload to the grid based on the Endex-price (a common practice). Yesterday, all of sudden, you could sell at a price that is more than two euro's higher. Or an even more common practice. Power markets have come down in the past weeks. Let's say that as a buyer you told your boss yesterday that you recommended not to buy the peakload because it was in a downtrend. How are you going to explain to him that it shot up by 2,22 euro per MWh due to some incomprehensible calculation?
This whole story raises two big questions:
1. This problem points to a larger problem regarding the continental European energy market. End consumers have fixed contracts with their suppliers where they use the power exchanges such as Endex as the benchmarks to set prices. That is quite logic, as the exchanges are a very transparent mechanism of price revelation. However, most of these exchanges so far, have failed in developing a liquid future market. Therefore, you can seriously question the reliability of their prices. This peak - superpeak farce is a sad illustration of that. How can we find a reliable price benchmark for retail contracts?
2. How is it possible that Endex and its members have manufactured this cranky solution, obviously without much consideration for its consequences for the end consumer of energy? Are they even aware of their huge responsibility as provider of price benchmarks for end consumer power contracts? How is it possible that inside power companies the trading departments ask for the creation of the superpeak, when this obviously creates a problem for their sales departments?
(Numbers of trades and trading volumes at the Endex NL power futures exchange have hardly changed in the past five years. In the first seven months of 2010 the average traded volume was a little bit more than 2,2 TWh. That is far too small to speak about a liquid exchange.)