Do Trading and Power Operations Mix?

9 Pages Posted: 23 Dec 2013

See all articles by John E. Parsons

John E. Parsons

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: Fall 2013

Abstract

The author uses the case of Constellation Energy to show the challenges, and pitfalls, of running an energy and power trading unit as a profit center within a large power company. Sophisticated trading and risk management operations do play important supporting roles in power companies that face competitive wholesale markets. The complicated dynamics of power prices and the complex operations of generation assets and supply obligations require careful assessment of risks and returns. Trading operations can help extract more value from physical assets and supply obligations. But problems are bound to arise when companies attempt to manage the trading function as a stand‐alone profit center. Determining the amount of capital required for proprietary trading portfolios and other elements of trading businesses is complicated. It is easy to underestimate the capital required and so exaggerate the profitability of trading. When profit center trading operations share a balance sheet with other business units - especially units with physical assets like generation - the natural tendency is for the trading operation to piggyback on the capital of the other units. The actual amount of capital consumed becomes apparent only in times of crisis. We have seen this mistake made repeatedly in the short history of trading operations in U.S. power companies. Only truly independent trading operations, with their own balance sheets, can be evaluated clearly and held accountable.

Suggested Citation

Parsons, John E., Do Trading and Power Operations Mix? (Fall 2013). Journal of Applied Corporate Finance, Vol. 25, Issue 4, pp. 30-36, 2013, Available at SSRN: https://ssrn.com/abstract=2371488 or http://dx.doi.org/10.1111/jacf.12039

John E. Parsons (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~jparsons/

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