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Date: Tue, 23 Oct 2001 09:39:42 -0700 (PDT)
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Subject:      U.S. Power Firms Plunge Into Europe's Trading Market; U.K.'s
 NETA             Rules May Set Continental Standard
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October 23, 2001=20


U.S. Power Firms Plunge Into Europe's Trading Market;=20
U.K.'s NETA Rules May Set Continental Standard=20



By Will McNamara
Director, Electric Industry Analysis=20


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[News item from Reuters] U.S.-owned Entergy-Koch Trading (NYSE: EKT) is boo=
sting its European electricity and weather trading business with expansion =
in Germany and the Netherlands. "After a successful start, we plan to subst=
antially increase our volume of European power, power options and weather t=
rading next year," said Uday Narang, managing director of European trading.=
 EKT also completed the paperwork needed to start trading electricity in Fr=
ance and Austria, although its immediate focus would be Germany and the Net=
herlands.=20

Analysis: The announcement from Entergy-Koch Trading that it will significa=
ntly increase its European power trading business is by no means unique. In=
 fact, a recent scan of announcements from U.S. power firms tells a similar=
 story. Dynegy announced last week that it is seeking acquisitions to stren=
gthen its European operations, in an effort to "replicate its strong U.S. e=
nergy trading platform in Europe." TXU said that it expects "sharply higher=
 profits this year" from European energy trading as its electricity trading=
 volumes have soared across the Continent. For the first nine months of 200=
1, TXU reportedly traded 211 terawatt hours of wholesale electricity in con=
tinental Europe, mostly in Germany, which compared to 97 terawatt hours in =
all of 2000. Further still, UtiliCorp just announced that it and an unnamed=
 financial partner will be purchasing Midlands Electricity, the fourth-larg=
est regional electric utility in the United Kingdom, which in addition to 3=
8,000 miles of electric distribution lines owns a 1,875-MW power plant. The=
 unrelated announcements have a common denominator: U.S. power firms are pl=
unging into the European energy trading market in droves, despite some inhe=
rent governmental challenges and resistance toward embracing electric compe=
tition among some European countries. A new model in the United Kingdom, kn=
own as the new energy trading agreement (NETA) rules, appear to be facilita=
ting more efficient trade in that country and could become the standard acr=
oss the Continent.=20

The appeal of Europe's power market for U.S. energy companies is perhaps ob=
vious. According to a Financial Times Energy report from late last year, de=
mand growth for electricity in European countries over the next five years =
may prompt the need for an additional 69,000 MW of generating capacity to b=
e built (an amount roughly equivalent to the generating capacity of ERCOT i=
n Texas). In addition, like other developed areas of the world, Europe's en=
ergy consumption has grown over the last two years. U.S. power firms, who p=
erhaps see their competitive opportunities as being rather limited in this =
country, have expanded operations in Europe, where electric privatization i=
s occurring on a country-by-country basis. Consequently, the companies ment=
ioned above join Williams, Enron, Duke, AEP, and Mirant (to name a few), wh=
ich have established London trading offices.=20

Moreover, many of the U.S. power firms that expand into Europe start by acc=
umulating generation assets in the United Kingdom, as represented by the Ut=
iliCorp and Dynegy announcements. Much of this has to do with the fact that=
 the United Kingdom began privatizing its electric market in the early 1990=
s and completed the process in May 1999 (after Norway, but well ahead of ot=
her European countries). However, there is a more important reason why U.S.=
 energy firms may be drawn to U.K. power trading, and that is related to th=
e area's unique rules for energy transactions, which were outlined in NETA =
and took effect in March of this year.=20

To appreciate the significance of the new NETA rules, it is important to fi=
rst understand the context of the European market as a whole and the tradin=
g system that had been in place in the United Kingdom until earlier this ye=
ar. The European Union has directed countries across the Continent to open =
their electric markets to competition. Toward this end, the commencement of=
 competition in various European countries has included the following three=
 approaches: 1) allowing end-users the right to select an alternative provi=
der; 2) giving generation companies the right to use an incumbent power sup=
plier's transmission and distribution network, otherwise known as third-par=
ty access; and 3) the introduction of energy trading, which has allowed an =
incumbent supplier to buy power on the wholesale market. This last point is=
 significant, because some of the European countries have dismantled previo=
usly integrated, state-owned utilities and mandated the divestiture of gene=
ration assets.=20

At the end of 2000, approximately 68.4 percent of the European Union (EU) e=
lectricity market was open to competition. Privatization has theoretically =
enabled European power companies to expand beyond their traditional service=
 territories and business lines into other countries (at least those that a=
re open). That is the good news. However, the basic problem with this appro=
ach is that the European Union did not put standardized deadlines for the t=
ransition to a fully competitive marketplace, and thus various countries in=
 Europe have developed their own timetables. For instance, Germany is fully=
 privatized, while France has been notoriously hesitant to provide third-pa=
rty access to competitors. In practice, this often means that one country m=
ay have an extremely complex system for transmission tariffs while its neig=
hboring country may have not developed any standards at all. The other prob=
lem is that physical interconnections between countries are often deficient=
, which makes it difficult to transport power across borders. As a result, =
wholesale competition across the Continent is considered rather heterogeneo=
us and lacking in comprehensive trading standards. The lack of standards is=
 particularly acute as it relates to rules and tariffs for third-party acce=
ss to the national grids on the Continent.=20

While these fundamental problems on the Continent are being resolved, the U=
nited Kingdom has moved ahead with what is generally perceived as a more ef=
ficient market because it offers one grid system, one balancing and settlem=
ent code, and one contract format. However, even the power trading market i=
n the United Kingdom did not get off to an easy start. Up until March of th=
is year, the U.K. power market operated under a pool / auction system. Unde=
r that model, generation companies offered electricity for sale, which was =
then pooled into an auction system where day-ahead bids were made and power=
 was sold in half-hour increments. The model was quite significant because =
it was one of the first attempts in the world to create a competitive marke=
t for generation and it operated outside of governmental oversight.=20

However, the pool model in the United Kingdom became fraught with problems,=
 mostly because observers believed that excessive opportunity existed for m=
arket manipulation. Given the concerns with the pool format, the United Kin=
gdom began to formulate new rules for power trading in October 1998, which =
culminated in the NETA model that started this year. The key tenets that ma=
ke NETA different from the previous pool model are:=20

Forwards and futures markets, which allow participants to form power sale d=
eals using standardized contracts either on-the-day or several years in adv=
ance (as opposed to only day-ahead bids).=20
More flexibility regarding the kinds of contracts that buyers and sellers c=
an negotiate (bilateral and multilateral contracts are allowed in the Unite=
d Kingdom).=20
A new balancing mechanism covering ancillary services overseen by National =
Grid Co. (operating in a role similar to an ISO), which facilitates the var=
ious transactions to ensure reliability.=20
The administration of contracts linking wholesale supplies with demand (rep=
resented by individual meters), and the threat of strict penalties for part=
icipants whose positions do not match their metered volumes of electricity.=
=20



In a nutshell, NETA essentially sharpened the rules surrounding power tradi=
ng in the United Kingdom to allow less opportunity for gaming. The system i=
mprovements have been successful, and more international power firms appare=
ntly believe that they stand a better chance of competing in the United Kin=
gdom due to the NETA rules. Installation of the NETA system reportedly has =
caused a 315-percent increase in the number of contracts traded, a 25-perce=
nt drop in wholesale prices and a six-fold increase in the variety of produ=
cts offered. As of early summer 2001, about 150 new participants had regist=
ered to participate under the NETA system, as compared with about 12 under =
the former model.=20

As noted, many believe that the NETA model will become a standard for the C=
ontinent as other European countries proceed with opening their wholesale m=
arkets to competition. In addition to the U.K.'s model, there are several a=
ctive trading exchanges in Europe presently, although more are expected to =
emerge as the market becomes more competitive. The Nord Pool, with about 60=
 members, organizes trade in standardized physical and financial contracts,=
 and provides current prices on electricity in both spot and futures market=
s. The Dutch Amsterdam Power Exchange has about 25 members and operates a s=
pot market for electrical power. Smaller European exchanges, offering both =
spot and futures contracts, include the Switzerland Exchange and Germany's =
Leipzig Power Exchange in Frankfurt. In the meantime, I think we will conti=
nue to see additional U.S. power firms expanding into the European trading =
market, and using the United Kingdom as their launch pad.=20


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