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In June of 1998, a combination of factors - including a prolonged hot spell and both planned and unplanned power outages - caused the price of power in the mid-western USA to skyrocket from its typical level of $30/MWh to the astounding level of $7500/MWh. A company called Federal Energy Sales defaulted on its obligations to supply power to several other energy companies, including Power Company of America (PCA). As a result, PCA also defaulted on some of its power supply contracts and was ultimately forced to declare bankruptcy, after $236 million in claims were filed against it. |
On June 24 1998, power prices in the Midwest skyrocketed from their typical level of $30/MWh to the astounding level of $7500/MWh. What caused this staggering price increase? An investigation by the Federal Energy Regulatory Commission wrote off the price surge as a fluke convergence of high demand (due to a prolonged hot spell) and severely reduced output (due to both planned and unplanned plant outages) and stated that this combination of events was unlikely to happen again.
The immediate chain of events was as follows: first, power marketer Federal Energy Sales defaulted on obligations to several companies, including Power Company of America (PCA), a power-trading company largely owned by principals of Barr Devlin SG, a New York investment bank specialising in energy.
This left PCA no option but to default on its obligations as well. On August 17 1998, three of PCA's creditors (the utilities Southern Co. and Entergy, and the power-marketing firm American Energy Solutions) filed a Chapter 11 bankruptcy petition against PCA. PCA had been planning to declare bankruptcy in any case, given that it was responsible for $236 million in outstanding claims under provisions in the contracts on which it defaulted. To date, electric utilities have attributed losses exceeding $500 million to market volatility in the second quarter.
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Early June 1998: PCA realises that its exposure to fellow power marketer Federal Energy Sales is dangerously high and attempts to mitigate risk by buying and selling forward power to create matching positions.
24 June 1998: Midwestern power prices skyrocket from their typical level of $30/MWh to $7500/MWh in the Midwest.
Late June 1998: Federal defaults on its supply obligations to PCA and to a number of other companies, forcing PCA to default itself. PCA becomes liable for claims from its own counterparties, who had to buy power at an inflated price following its default.
17 August 98: Three of PCA's creditors (the utilities Southern Co. and Entergy and the power-marketing firm American Energy Solutions) file a joint Chapter 11 bankruptcy petition again PCA.
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Lessons to be learned:
Pay attention to early warning signs
By the second quarter of 1998, many companies had stopped doing business with Federal, citing credit risk concerns. However, PCA waited until it was too late before attempting to reduce exposure to the company.
Understand the business
It appears that inadequate preparation was made for the possibility of default by a supplier
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