United Power – Minimizing price risk in a volatile market

Forecasting the price of coal is dependent on many variables. These include; supply uncertainties, transportation inefficiencies, international coal demand, regulatory constraints, labor disruptions, natural gas and electricity have highlighted the need for an understanding of coal trading and risk management. Additionally the disappearance of the fuel adjustment clause is also forcing utilities to use risk-management tools to handle the generators’ inherent natural short fuel position. More volatile fuel prices, cap and trade emission programs in SOx and NOx, increased pressure to work with more efficient inventory levels, and potential alternative synfuel and feedstock uses for coal all contribute to a potentially more active and price sensitive market.

In response to these changes an active over-the-counter (OTC) market has developed in coal. Historically, coal buyers and sellers have relied on basic strategies of diversification in an attempt to spread their market risk. While helping to avert some types of risk, such as product delivery, these techniques fail to address basic price risk. Price risk in coal is dependent on so many factors that attempting to mitigate any one still leaves basic price risk untouched. The OTC coal market has developed to serve traders, producers, and consumers of coal with new instruments to hedge against the volatility of price exposure. This market provides both standardized physical coal products and financial hedging instruments, including calls, puts, collars, and swaps, to help manage the risk of price fluctuation.

Standardized OTC Products

A variety of coals trade in the OTC markets. However, the majority of the activity is based on the 12,500 Btu/lb Central Appalachia rail coals; 12,000 Btu/lb Nymex look-alike barge coal (having the same quality and delivery specifications criteria of the NYMEX futures contract); and the Powder River Basin 8,800 Btu/lb and 8,400 Btu/lb coals.

United has provided a downloadable trade Confirmations sample for the aforementioned standardized coal products.

One-off OTC Products and Structured Transactions

United has successfully matched buyers and sellers in a vast variety of coals that do not meet the quality, quantity and/or delivery specifications of standardized OTC products. These “off-market” coals, Northern Appalachia rail and barge, Illinois Basin and Western Bituminous, often lack the daily liquidity of the OTC market. Fortunately, United has the industry contacts in place to assure full market coverage. We understand complex and challenging transactions while preserving value for both buyers and sellers.

Standardize Contracts, Terms and Conditions

Our clients recognize the value of OTC transactions as a hedging tool for price volatility, delivery performance and credit guarantee. This “insurance” policy requires bilateral, general terms and condition (GTC) contract language and Master Agreements between the parties. These agreements expedite the trade confirmation process. United has conducted and published an independent summary reviewing numerous Master Coal Purchase and Sales Agreements (MCPSA). This practical guide summarizes ten (10) primary areas covered within the MCPSA and can be purchase for a nominal fee. Contact Dan Vaughn for more information.

As an additional service United also provides an example of an executable GTC and MCPSA, courtesy of DTE Coal Services.

General Terms and Conditions     Master Trade Agreement

Derivative Transactions

The Coal Trading Association continues to work toward the development of a swap market using Platts’s OTC Broker Indexes, of which United Power’s Coal Division is a contributing information source.

Currently, United provides to Platt’s four mark-to-market coal indexes on a daily basis: PRB 8800 Btu/lb, PRB 8400 Btu/lb, 12,000 Btu/lb Nymex look-alike CAPP barge coal and the CSX 12,500 Btu/lb less than 1% sulfur rail coal. These daily indexes are quoted for both prompt month and prompt quarter delivery. Financial settlement is based on the mean of the Platts’s posting for the prompt index. However, the industry’s acceptance of a swap market has been limited.

NYMEX Futures Contract

The New York Mercantile Exchange provides a Clearport Trading System for 'CAPP' contracts only. (CAPP stands for 'Central Appalachian' and represents a 12,000 Btu/lb, 1% Sulfur coal loaded in the barge on the Big Sandy River.) The CAPP contract is the futures contract traded electronically on the NYMEX. The contract trades in one-barge increments of 1550 tons. This contract was designed as a financial instrument to be settled on a monthly basis although it can be nominated for physical delivery. United Power is authorized to submit trades for Nymex clearing for those clients with Nymex Clearport accounts.

Fundamental Perspectives, Daily Analysis

While United’s primary focus is to close buy-sell transactions in a timely, ethical and professional manner, our business activities lead to an array of interaction with every facet of the energy market. Many of our clients desire to take advantage of our market knowledge and seek comprehensive, yet individualized consulting services. These services include assistance and review of sales/revenue projections, verification of market-based offers for internal audits, development of procurement strategies and bid preparation, and working as a buyer’s agent in real-time or traditional energy/coal procurement.