The Sutton Bridge Power Plant case was discussed as an illustration for innovative contracting mechanisms. We also learned about the difference in the market structure for Electricity between developed and developing countries; while electricity is in perennial shortage in the developing countries, there is competition among generators, which resulted in “Pool Pricing Mechanism” for pricing the power in UK in 48 half hourly rates for each day. There is also restriction on distributors from having a monopolistic hold on generating capacity so that the pool prices are not rigged.
In order to circumvent this regulatory provision, an innovative contractual mechanism was evolved between Eastern, which is a distributor of electricity and which also has interests in gas supply, and Enron, a predominantly US based company but with expertise in risk management.
The mechanism involved setting up of two concurrent Capacity & tolling Agreements. The first was between Eastern and Enron Europe, where Enron Europe would supply electricity at pool prices to eastern on demand upto a certain specified capacity. In return. Eastern would supply the requisite gas. As Enron Europe was not a generator, this was a “virtual plant” which operated on the wishes of Eastern. This CTA was supported by another CTA between Enron Europe and Sutton Bridge Power ( a real power plant set up by Enron as a project company) which supplied electricity to Enron Europe as per demand and on supply of the required gas.
The advantage to Eastern was that it could take advantage of the differential price of gas and electricity. For Enron, the advantage was that it could arbitrage between a contractual heat rate (in the first CTA) and a real heat rate (in the second CTA). Also all capacity related costs were covered by Eastern.
Contractual innovations are one of the methods for risk management. There are various contracts which are signed to manage the greatest risk to an infrastructure sector – the revenue risks. For power plants, there are power purchase agreements which are signed through take or pay or take and pay contract. For the roads sector, there are annuity models which are available for mitigating the revenue risks. Other risks like supply risk can also be mitigated by take or pay, take and pay, or tolling contract (where the supplier decides when the plant should function). The main risks for a project can be found by plotting a probability x impact matrix (heat map). The risks in the red areas are critical, while risks in amber area is to be monitored so that they don’t enter the red areas. It is not possible to address all the risks in an infrastructure project. A heat map allows the project owners to mitigate the most influential risks. There are various insurances which help mitigate risks like construction all risks insurance (physical damage for assets), marine cargo insurance (covering damage during transportation). Political risk is another risk which is very important in construction projects. For this there are Political insurance covers available
The major portion of this module has already been explained by others. So i would like to give a brief description on my learnings from this case study. The Sutton Bridge Project was discussed in this module. An innovative contract (Capacity and Tolling agreement) is developed between Enron Europe and the Eastern Group whereby Eastern Group would arbitrage between gas and electric prices and Enron’s profit margin depends on the difference between actual performance and contracted performance of the Sutton Bridge power plant. The tentative NPV of Eastern was found to be 17.3 million pounds and Enron’s was 125 million pounds. I personally feel that Eastern Group, a REC should have proposed the contract in an even profitable way keeping in view of the Enron’s profit margin from the operation of actual CCGT plant. Key Learning: There are profits out there waiting to enter the assets side of a company’s balance sheet who possess appropriate strategies and expertise to manage risk and exploit the arbitrage options available in its range.
Risk management for infrastructure projects is organized in four parts: identification, assessment, mitigation and allocation of risk. Project risk can be assessed by the factors probability of occurence and economic consequences of bad events. The strategies for risk management are firstly determined by the sort of risk, which can either be market risk or project specific risk. Secondly, the strategies depend on the ability to control risk. Combining these two risk categories we are left with different risk scenarios in which specific risk management tools should be applied. For the scenario of market risk and low ability to control it either bearing or hedging the risk are suitable risk management strategies.
A very successful example of allocating market risk by designing a hedge strategy in the energy and power sector is the case "Contractual Innovation in UK Energy Markets", which is about Sutton Bridge Power Plant and Enron's contractual innovations for funding this project. At the time of constructing Sutton Bridge Power Plant Enron implemented a significant change in its corporate strategy. It started to sell risk management solutions for the energy market rather than just doing the traditional energy business. In the wake of deregulation of energy markets in Europe the strategy prooved to be highly successful.
For the Sutton Bridge Power Plant Enron implemented a contractual design in the first contractual relation between the end user Eastern and Enron Europe and in the second contractual relation between Enron Europe and Sutton Power Bridge. Both contracts included alligned capacity and tolling agreements for the use of the power plant. Overall, the contractual set-up stipulated the transformation of gas into electricity for both the contractual relations.
The project was pofitable for both Enron and Eastern. Enron could earn the toll spread for the power plant and Eastern implemented an arbitrage strategy, which exploited the price difference between gas and electricity. Actually, Enron had created a hedged business opportunity that could give them unbounded return while only having a risk of limited loss. This opportunity was also created by the right of Enron to control the power plant after the expiration of the capacity and tolling agreement. This right gave them an unrestricted upside potential for profits in the merchant phase of the power plant. Moreover, Enron strenghtened its reputation as the innovator of the energy sector. Besides the profit for both parties, the Sutton Bridge was the first power plant that obtained an investment grade credit raiting without an existing Power Purchase Agreement.
To sum up, Enron did not only use the idea of a virtual power plant to manage its own risk. They also sold a risk management solution for other energy businesses like Eastern. Additionally, Enron's business partner Eastern was able to overcome increased regulation, which limited their business opportunities. Sutton Bridge Power Plant was a very innovative risk management approach that really worked at that time.
CE11B073: The Sutton-Bridge Project case is an example of how innovative project structuring can be used to exploit loopholes in the system. 1. Eastern with its natural gas reserves and power production capacity wanted to arbitrage between the price of natural gas and energy. But they had already maxed out (exceeded in fact) their allowed power production capacity. 2. Enron owned the Sutton Bridge plant. If the plant was run like a conventional IPP, the returns would not be high enough. Also Enron would not get the opportunity to capitalize their trading and risk management services. The beauty of the project structure was that after the agreement both Enron and Eastern were able to exercise their strengths. The energy production capacity of Eastern was in effect increased, Enron was provided with the O/M costs and natural gas to maintain the plant and Enron could now provide its services risk management services to Eastern. The most interesting part in this module was the screening of the documentary, Enron: The Smartest Guys in the Room. It opens your eyes to what large corrupt infrastructure companies with monopolistic capabilities can do to a country. Enron single-handedly brought the entire state of California (along with its illustrious Silicon Valley) to its knees with rolling blackouts. Despite having surplus energy production capacity even during peak demand, the blackouts occurred in winter when the power consumption is much less.
The “World of Practice” Session included in the Module 5 enlightened us with the challenges faced by the private companies like L&T IDPL in the PPP model. Some of these are:
• Lack of alignment between the private sector and the Concessioning authorities. • Little accountability from the Government side. • For successful implementation of the projects, trust and mutual respect is needed between the two parties which is mostly absent. • Land clearances require permits from multiple agencies which eat up ample time, which might jeopardize the risks on equity investor returns. • Lack of design freedom
In the “Contractual Innovation in UK Energy Markets” Case study we also came to know about forward contracts in which the price is decided now and the delivery is in the future. These contracts cannot be for more than 4 years as it will difficult to forecast the price whereas PPA (Power Purchase Agreements) can be of longer duration (15 years).
The UK Power market was deregulated, had 40 generators, 12 Regional Electrical Companies and varying gas prices. Gas price was volatile whereas the electricity price was not. Challenge is to use this volatility arbitrage. SPARK spread was a helpful indicator. It is the difference between the cost of electricity and the cost of gas required to generate that electricity. If the SPARK spread is positive, then electricity should be sold. In a nutshell, the Eastern group supplies gas to Enron which is bought by the Sutton Bridge. The Pool price is given to the Eastern via Enron. The arbitrage between contracted and the actual supply of gas is the source of profit for Enron
This module stresses on contractual innovations that help in risk management. In the Sutton Bridge plant, Eastern bypasses the regulatory prohibition of not having power generation concentrated (to prevent rigging of pool prices) by bringing in Enron and a virtual power plant. The electricity market in UK offered reasonable profits to those who set up efficient power plants and Eastern wanted to take advantage of that but was prohibited to do so because of the regulatory environment. So it brought in Enron which itself didn’t want to get into the business of power generation and wanted to enter the market as a company that helps others in risk management. They set up a virtual power plant through which Eastern is arbitraging on the differential between gas prices and energy prices without tripping up in regulatory process and for Eastern which wants to grow its business in the UK energy markets, the contract delivers what it wants.
For Enron, it showcased its ability to deliver innovative Risk Management solutions and it also earned huge profits along the way. Enron used the contract to make profits by arbitraging on the difference between the contracted and the actual performance. Thus both the parties have used the contract to bypass the regulations (which can be seen as a risk) and make profits.
Infrastructure Finance (through Project Finance) uses contracts to manage risks and this module and case study demonstrated how the innovations in contracts can deliver value for all the parties concerned.
CE11B070 B. Pavan Kumar The final module is about the importance of contractual innovations for making more money. The contractual innovations in UK markets case was discussed. The case showed us the enormously high rate of returns obtained by the Enron organization for their innovative deal and risk mitigation strategies where a virtual power plant is created. The returns for Enron was close to about 125 million pounds which signifies, the amount of money they made out of an innovative deal. Also, eastern has got very high NPV, close to about 17 million in this project. Later in the film screened, the way enron tried to obtain monopoly in the state of California power sector was seen.
CE11B070 B. Pavan Kumar The final module is about the importance of contractual innovations for making more money. The contractual innovations in UK markets case was discussed. The case showed us the enormously high rate of returns obtained by the Enron organization for their innovative deal and risk mitigation strategies where a virtual power plant is created. The returns for Enron was close to about 125 million pounds which signifies, the amount of money they made out of an innovative deal. Also, eastern has got very high NPV, close to about 17 million in this project. Later in the film screened, the way enron tried to obtain monopoly in the state of California power sector was seen.
Apart from project structuring, the key element in risk management is the way the contracts are developed. As an example the futures contract or a forward contract eliminates the revenue risk. In a forwards contract the deal is done and is agreed to be implemented irrespective of the market conditions in a future time. Similarly a Power Purchasing Agreement also ensures fixed returns eliminating the revenue risk. The Sutton Bridge case is one such case study where the opportunity to get a large pool of money lying in the form of arbitrage is captured effectively through the contractual innovation. Through the innovative contractual agreement between Enron and Eastern, market risk has been hedged successfully in energy sector.Enron gained upon the spread between the payments received for the agreed performance of the plant generation and the cost incurred for the actual generation. Eastern gained from the PPA agreements, which proved to be credible as the contract has “minimum 15000 half hr periods” which shows that there is definitely a rise in the future.
Adding to what Harish said, “Contractual Innovation in UK Energy Markets” Case study involves Eastern Group, Enron and the Sutton Bridge. Enron earns from the difference between the actual performance and the contractual performance. Eastern will operate only when the SPARK is positive. From Exhibit 8, SPARK is positive most of the time. So Eastern is confident that the plant will be operational for most of the time. Also, Eastern agreed to pay for 15000 half hour periods as maintenance charges which implies plant will be definitely operational for 86% of the time (15000/17250). This indication in contract made Eastern certain about the operation of the plant. Although the life of the plant is 40 years, Eastern will pay only upto 15 years. After 15 years, the plant is fully depreciated which means that the profit margin will be infinite!
Contracts are powerful tools for risky modern day investments and the UK Energy Market Case Study was a clear example of it. This case study exemplifies how companies come together by the contacts abiding them to bring in their expertise to together create a project beneficial to all of them. There were multiple levels of contracts to create this project. Eastern both a gas supply company and regional energy supplier saw the arbitrage opportunity arising between prices of Gas and Energy generated from it due to the varying prices of gas. The contract between Eastern and Enron provided Eastern an option to sell gas to Enron and receive payments at equal to the energy generated from the gas. Thus Eastern created a power plant virtually by contracts that they can operate only when it was profitable. The contract assumed an average efficiency of production, but Enron by using higher efficiency turbines could make profits from the revenue from the extra electricity they generate. The efficiency of the turbines had its own risk as it was new in the market and previous versions had issues, this was again mitigated with contracts with the manufacturers: GE which ensured Enron’s risk was mitigated. For GE, this was an option to promote their new design and could gain trust by using a contractual agreement ensuring efficiency. This project is a clear indication on how diverse parties can come together blending their strengths and do business by abiding to the contracts between them. Contracts can not only mitigate possible risks, but also create trust which otherwise is difficult between parties from different nations and sectors of interest.
In this module we see arbitrage which was the driving for this project. Enron recognized the opportunity present in the situation where eastern group had reached its capacity and there was a significant difference in pricing of electricity and gas and the volatility in their pricing. The scenario created a win –win situation, with eastern group earning through a virtual power plant and Enron profiting from arbitrage, efficiency of the technology and faster construction of the plant. The innovative strategy used by the Enron group to capture this opportunity is remarkable. In this session we have come across some contractual terms of forward contract and spot contract, PPA and IPP etc. This strategy shows immense profit but at the same time there are many risks involved, the price of gas and electricity may change or may even reverse, at that time electricity could not be stored but now that may not be the case and regulations may change. Every project pose certain risks, innovation is required to mitigate the risks and ceasing the opportunity at the right time gives an advantage, infrastructure sector has high scope for innovation to maximize profitability.
MS15D002 M R Aravindan
ReplyDeleteContractual Innovations and Risk Management
The Sutton Bridge Power Plant case was discussed as an illustration for innovative contracting mechanisms. We also learned about the difference in the market structure for Electricity between developed and developing countries; while electricity is in perennial shortage in the developing countries, there is competition among generators, which resulted in “Pool Pricing Mechanism” for pricing the power in UK in 48 half hourly rates for each day. There is also restriction on distributors from having a monopolistic hold on generating capacity so that the pool prices are not rigged.
In order to circumvent this regulatory provision, an innovative contractual mechanism was evolved between Eastern, which is a distributor of electricity and which also has interests in gas supply, and Enron, a predominantly US based company but with expertise in risk management.
The mechanism involved setting up of two concurrent Capacity & tolling Agreements. The first was between Eastern and Enron Europe, where Enron Europe would supply electricity at pool prices to eastern on demand upto a certain specified capacity. In return. Eastern would supply the requisite gas. As Enron Europe was not a generator, this was a “virtual plant” which operated on the wishes of Eastern. This CTA was supported by another CTA between Enron Europe and Sutton Bridge Power ( a real power plant set up by Enron as a project company) which supplied electricity to Enron Europe as per demand and on supply of the required gas.
The advantage to Eastern was that it could take advantage of the differential price of gas and electricity. For Enron, the advantage was that it could arbitrage between a contractual heat rate (in the first CTA) and a real heat rate (in the second CTA). Also all capacity related costs were covered by Eastern.
CE14D040
ReplyDeleteContractual innovations are one of the methods for risk management. There are various contracts which are signed to manage the greatest risk to an infrastructure sector – the revenue risks. For power plants, there are power purchase agreements which are signed through take or pay or take and pay contract. For the roads sector, there are annuity models which are available for mitigating the revenue risks. Other risks like supply risk can also be mitigated by take or pay, take and pay, or tolling contract (where the supplier decides when the plant should function).
The main risks for a project can be found by plotting a probability x impact matrix (heat map). The risks in the red areas are critical, while risks in amber area is to be monitored so that they don’t enter the red areas. It is not possible to address all the risks in an infrastructure project. A heat map allows the project owners to mitigate the most influential risks.
There are various insurances which help mitigate risks like construction all risks insurance (physical damage for assets), marine cargo insurance (covering damage during transportation). Political risk is another risk which is very important in construction projects. For this there are Political insurance covers available
CE11B096 Y V Sandeep
ReplyDeleteThe major portion of this module has already been explained by others. So i would like to give a brief description on my learnings from this case study.
The Sutton Bridge Project was discussed in this module. An innovative contract (Capacity and Tolling agreement) is developed between Enron Europe and the Eastern Group whereby Eastern Group would arbitrage between gas and electric prices and Enron’s profit margin depends on the difference between actual performance and contracted performance of the Sutton Bridge power plant. The tentative NPV of Eastern was found to be 17.3 million pounds and Enron’s was 125 million pounds. I personally feel that Eastern Group, a REC should have proposed the contract in an even profitable way keeping in view of the Enron’s profit margin from the operation of actual CCGT plant.
Key Learning: There are profits out there waiting to enter the assets side of a company’s balance sheet who possess appropriate strategies and expertise to manage risk and exploit the arbitrage options available in its range.
MS15F007 - Philip Baumgärtner
ReplyDeleteRisk management for infrastructure projects is organized in four parts: identification, assessment, mitigation and allocation of risk. Project risk can be assessed by the factors probability of occurence and economic consequences of bad events. The strategies for risk management are firstly determined by the sort of risk, which can either be market risk or project specific risk. Secondly, the strategies depend on the ability to control risk. Combining these two risk categories we are left with different risk scenarios in which specific risk management tools should be applied. For the scenario of market risk and low ability to control it either bearing or hedging the risk are suitable risk management strategies.
A very successful example of allocating market risk by designing a hedge strategy in the energy and power sector is the case "Contractual Innovation in UK Energy Markets", which is about Sutton Bridge Power Plant and Enron's contractual innovations for funding this project. At the time of constructing Sutton Bridge Power Plant Enron implemented a significant change in its corporate strategy. It started to sell risk management solutions for the energy market rather than just doing the traditional energy business. In the wake of deregulation of energy markets in Europe the strategy prooved to be highly successful.
For the Sutton Bridge Power Plant Enron implemented a contractual design in the first contractual relation between the end user Eastern and Enron Europe and in the second contractual relation between Enron Europe and Sutton Power Bridge. Both contracts included alligned capacity and tolling agreements for the use of the power plant. Overall, the contractual set-up stipulated the transformation of gas into electricity for both the contractual relations.
The project was pofitable for both Enron and Eastern. Enron could earn the toll spread for the power plant and Eastern implemented an arbitrage strategy, which exploited the price difference between gas and electricity. Actually, Enron had created a hedged business opportunity that could give them unbounded return while only having a risk of limited loss. This opportunity was also created by the right of Enron to control the power plant after the expiration of the capacity and tolling agreement. This right gave them an unrestricted upside potential for profits in the merchant phase of the power plant. Moreover, Enron strenghtened its reputation as the innovator of the energy sector. Besides the profit for both parties, the Sutton Bridge was the first power plant that obtained an investment grade credit raiting without an existing Power Purchase Agreement.
To sum up, Enron did not only use the idea of a virtual power plant to manage its own risk. They also sold a risk management solution for other energy businesses like Eastern. Additionally, Enron's business partner Eastern was able to overcome increased regulation, which limited their business opportunities. Sutton Bridge Power Plant was a very innovative risk management approach that really worked at that time.
CE11B073: The Sutton-Bridge Project case is an example of how innovative project structuring can be used to exploit loopholes in the system.
ReplyDelete1. Eastern with its natural gas reserves and power production capacity wanted to arbitrage between the price of natural gas and energy. But they had already maxed out (exceeded in fact) their allowed power production capacity.
2. Enron owned the Sutton Bridge plant. If the plant was run like a conventional IPP, the returns would not be high enough. Also Enron would not get the opportunity to capitalize their trading and risk management services.
The beauty of the project structure was that after the agreement both Enron and Eastern were able to exercise their strengths. The energy production capacity of Eastern was in effect increased, Enron was provided with the O/M costs and natural gas to maintain the plant and Enron could now provide its services risk management services to Eastern.
The most interesting part in this module was the screening of the documentary, Enron: The Smartest Guys in the Room. It opens your eyes to what large corrupt infrastructure companies with monopolistic capabilities can do to a country. Enron single-handedly brought the entire state of California (along with its illustrious Silicon Valley) to its knees with rolling blackouts. Despite having surplus energy production capacity even during peak demand, the blackouts occurred in winter when the power consumption is much less.
This comment has been removed by the author.
ReplyDeleteCE11B074, Harishchandra Meena
ReplyDeleteThe “World of Practice” Session included in the Module 5 enlightened us with the challenges faced by the private companies like L&T IDPL in the PPP model. Some of these are:
• Lack of alignment between the private sector and the Concessioning authorities.
• Little accountability from the Government side.
• For successful implementation of the projects, trust and mutual respect is needed between the two parties which is mostly absent.
• Land clearances require permits from multiple agencies which eat up ample time, which might jeopardize the risks on equity investor returns.
• Lack of design freedom
In the “Contractual Innovation in UK Energy Markets” Case study we also came to know about forward contracts in which the price is decided now and the delivery is in the future. These contracts cannot be for more than 4 years as it will difficult to forecast the price whereas PPA (Power Purchase Agreements) can be of longer duration (15 years).
The UK Power market was deregulated, had 40 generators, 12 Regional Electrical Companies and varying gas prices. Gas price was volatile whereas the electricity price was not. Challenge is to use this volatility arbitrage. SPARK spread was a helpful indicator. It is the difference between the cost of electricity and the cost of gas required to generate that electricity. If the SPARK spread is positive, then electricity should be sold. In a nutshell, the Eastern group supplies gas to Enron which is bought by the Sutton Bridge. The Pool price is given to the Eastern via Enron. The arbitrage between contracted and the actual supply of gas is the source of profit for Enron
Zubin Nayak MS14S018
ReplyDeleteThis module stresses on contractual innovations that help in risk management. In the Sutton Bridge plant, Eastern bypasses the regulatory prohibition of not having power generation concentrated (to prevent rigging of pool prices) by bringing in Enron and a virtual power plant. The electricity market in UK offered reasonable profits to those who set up efficient power plants and Eastern wanted to take advantage of that but was prohibited to do so because of the regulatory environment. So it brought in Enron which itself didn’t want to get into the business of power generation and wanted to enter the market as a company that helps others in risk management. They set up a virtual power plant through which Eastern is arbitraging on the differential between gas prices and energy prices without tripping up in regulatory process and for Eastern which wants to grow its business in the UK energy markets, the contract delivers what it wants.
For Enron, it showcased its ability to deliver innovative Risk Management solutions and it also earned huge profits along the way. Enron used the contract to make profits by arbitraging on the difference between the contracted and the actual performance. Thus both the parties have used the contract to bypass the regulations (which can be seen as a risk) and make profits.
Infrastructure Finance (through Project Finance) uses contracts to manage risks and this module and case study demonstrated how the innovations in contracts can deliver value for all the parties concerned.
CE11B070 B. Pavan Kumar
ReplyDeleteThe final module is about the importance of contractual innovations for making more money. The contractual innovations in UK markets case was discussed. The case showed us the enormously high rate of returns obtained by the Enron organization for their innovative deal and risk mitigation strategies where a virtual power plant is created. The returns for Enron was close to about 125 million pounds which signifies, the amount of money they made out of an innovative deal. Also, eastern has got very high NPV, close to about 17 million in this project. Later in the film screened, the way enron tried to obtain monopoly in the state of California power sector was seen.
CE11B070 B. Pavan Kumar
ReplyDeleteThe final module is about the importance of contractual innovations for making more money. The contractual innovations in UK markets case was discussed. The case showed us the enormously high rate of returns obtained by the Enron organization for their innovative deal and risk mitigation strategies where a virtual power plant is created. The returns for Enron was close to about 125 million pounds which signifies, the amount of money they made out of an innovative deal. Also, eastern has got very high NPV, close to about 17 million in this project. Later in the film screened, the way enron tried to obtain monopoly in the state of California power sector was seen.
Apart from project structuring, the key element in risk management is the way the contracts are developed. As an example the futures contract or a forward contract eliminates the revenue risk. In a forwards contract the deal is done and is agreed to be implemented irrespective of the market conditions in a future time. Similarly a Power Purchasing Agreement also ensures fixed returns eliminating the revenue risk. The Sutton Bridge case is one such case study where the opportunity to get a large pool of money lying in the form of arbitrage is captured effectively through the contractual innovation. Through the innovative contractual agreement between Enron and Eastern, market risk has been hedged successfully in energy sector.Enron gained upon the spread between the payments received for the agreed performance of the plant generation and the cost incurred for the actual generation. Eastern gained from the PPA agreements, which proved to be credible as the contract has “minimum 15000 half hr periods” which shows that there is definitely a rise in the future.
ReplyDeleteCE11B045, Pooja Battagani
ReplyDeleteAdding to what Harish said, “Contractual Innovation in UK Energy Markets” Case study involves Eastern Group, Enron and the Sutton Bridge. Enron earns from the difference between the actual performance and the contractual performance. Eastern will operate only when the SPARK is positive. From Exhibit 8, SPARK is positive most of the time. So Eastern is confident that the plant will be operational for most of the time. Also, Eastern agreed to pay for 15000 half hour periods as maintenance charges which implies plant will be definitely operational for 86% of the time (15000/17250). This indication in contract made Eastern certain about the operation of the plant. Although the life of the plant is 40 years, Eastern will pay only upto 15 years. After 15 years, the plant is fully depreciated which means that the profit margin will be infinite!
Contracts are powerful tools for risky modern day investments and the UK Energy Market Case Study was a clear example of it. This case study exemplifies how companies come together by the contacts abiding them to bring in their expertise to together create a project beneficial to all of them. There were multiple levels of contracts to create this project. Eastern both a gas supply company and regional energy supplier saw the arbitrage opportunity arising between prices of Gas and Energy generated from it due to the varying prices of gas. The contract between Eastern and Enron provided Eastern an option to sell gas to Enron and receive payments at equal to the energy generated from the gas. Thus Eastern created a power plant virtually by contracts that they can operate only when it was profitable. The contract assumed an average efficiency of production, but Enron by using higher efficiency turbines could make profits from the revenue from the extra electricity they generate. The efficiency of the turbines had its own risk as it was new in the market and previous versions had issues, this was again mitigated with contracts with the manufacturers: GE which ensured Enron’s risk was mitigated. For GE, this was an option to promote their new design and could gain trust by using a contractual agreement ensuring efficiency.
ReplyDeleteThis project is a clear indication on how diverse parties can come together blending their strengths and do business by abiding to the contracts between them. Contracts can not only mitigate possible risks, but also create trust which otherwise is difficult between parties from different nations and sectors of interest.
In this module we see arbitrage which was the driving for this project. Enron recognized the opportunity present in the situation where eastern group had reached its capacity and there was a significant difference in pricing of electricity and gas and the volatility in their pricing. The scenario created a win –win situation, with eastern group earning through a virtual power plant and Enron profiting from arbitrage, efficiency of the technology and faster construction of the plant. The innovative strategy used by the Enron group to capture this opportunity is remarkable. In this session we have come across some contractual terms of forward contract and spot contract, PPA and IPP etc. This strategy shows immense profit but at the same time there are many risks involved, the price of gas and electricity may change or may even reverse, at that time electricity could not be stored but now that may not be the case and regulations may change.
ReplyDeleteEvery project pose certain risks, innovation is required to mitigate the risks and ceasing the opportunity at the right time gives an advantage, infrastructure sector has high scope for innovation to maximize profitability.