Contractual Innovation in UK Energy Markets

Enron Europe, the Eastern Group ,and the Sutton Bridge Project

Agenda
Case Background The Eastern Group Enron Corporation Rationale behind Easterns Interest Sutton Bridge an Alternative Proposal The Deal Structure Easterns option under CTA Option Valuation with Scenarios (Calculations)

Case Background: The UK Power & Gas Market

Deregulation in both power and gas markets Transfer of electricity carried out by the National Grid Company Sale of electricity done by RECs : Eastern ,largest of the 12 RECs UK Electricity Sales 280,000(GWh) in 1995 :Growing at 1% Price of electricity determined by Auction Mechanism Transco managed National Transmisison System for gas transportation Short-run correlations between gas & electricity prices low but expected to be higher in future

The Eastern Group

Acquired by Hanson Group PLC for GBP 2.5 billion. Expanded into gas in early 90s : Diversification strategy was to combine gas supply with gas fired electricity generation. Expanded capacity in 1996 by acquiring 6,000MW of coal-fired generating capacity from National Power and PowerGen. With capacity expansion Eastern became 3rd largest fossil-fuel generator and 4th largest power generator in U.K.

Enron Corporation
One of the worlds largest integrated natural gas and electricity companies. Organized into six units: - Enron oil - Enron Gas pipeline group - Enron ventures - Enron International - Enron Renewable energy corp - Enron capital and Trade Resources Firms Asset Development Group had the expertise of tackling complex power projects globally.

Rationale of Eastern being interested in additional generation capacity

Transformation into an integrated energy company competing in deregulated environment : to provide the entire value chain for electricity. Sensed opportunities for rapidly changing gas markets: to create a diversified energy company. Consistent with its desire to arbitrage between gas and electricity markets on a daily basis.

Sutton Bridge Project

Traditional IPP Contractual bundle of 4 contracts to mitigate risks:
Engineering,procurement and construction contract (EPC) Operating and maintenance contract Gas supply agreement Power purchase contract (PPC)

Alternative Proposal CTA term of 15yrs followed by indefinite merchant phase Involved two independent economically linked CTAs between Eastern & Enron and Enron & Sutton Bridge Power (SPV) Eastern has the right and not the obligation. Enron could enter into an offsetting CTA with another party or construct a hedge using the physical plant at Sutton. Could capitalise on their respective strengths.

Extensive risk mitigation could be a low risk /low return investment. Utilities reluctant to sign PPA due to previous losses and demanded equity ownership. Did not capitalise on Enrons expertise in risk management.

Eastern-Enron-Sutton Bridge CTAs

Upfront payments Annual fixed payments Variable Payments Delivery of gas Upfront payments Annual fixed payments Variable Payments Delivery of gas

Eastern Group

PPPxNominated Capacity

Enron Europe (ECT)

PPP x Nominated Capacity

Sutton Bridge Power

PPP

Power
CTA(EASTERN-ENRON)

CTA (ENRON-SUTTON BRIDGE)

Electricity Pool

Easterns Option under CTA

Has the right and not the obligation to deliver natural gas and receive cash payments equal to the market value of a certain amount of electricity. Can decide whether to exercise its option to exchange gas for pool proceeds over 48 half hour period for the day. Contract will allow to receive electricity proceeds only when it is economical. Gas requirement depends on no. of megawatts generation and heat rate. Offtaker (Eastern) will pay the Owner(Enron) fixed payment, variable payments and other operating, maintenance and transportation expenses.

Easterns Option under CTA

Risk mitigation technique
Construction risk : transferred to Enron (Virtual plant ,so no direct or indirect legal ownership ) Fuel price risk : receive electricity proceeds only when it is economical
Gas prices were low relative to Electricity prices , then Eastern would exercise its option to receive electricity. If Gas prices were High relative to Electricity prices,then Eastern could sell the Gas in the Market

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