 |
Snowbelt Power Company burns approximately 10 million tons of PRB coal per year at its merchant power plants. Fuel costs represent a significant portion of its total operating costs. To remain price competitive with other generators, Snowbelt must control the price it pays for coal.
To protect itself against a significant rise in coal prices, Snowbelt Power enters into a two-year cap agreement with Enron for all of its monthly consumption.
 Caps can provide users with full protection from rising prices, while allowing them to receive the benefits of decreasing prices.
In this agreement, the company is protected from the negative impacts of coal priced above $4.75/ton - a price level that Snowbelt has calculated as being a threat to its ability to compete. In exchange for this price protection, Snowbelt Power agrees to pay Enron an up-front "premium" of $0.15/ton for the protected coal volumes.
During the life of the cap agreement:
- Snowbelt Power continues to buy 10 million tons of coal from its normal sources at spot market prices.
- If the market price of coal rises above the cap price, Snowbelt has the right to buy its coal from Enron at $4.75/ton.
- In effect, Snowbelt has purchased ongoing protection against unusually high coal prices. For Snowbelt, the financial downside risks involved in paying more than $4.75/ton for its coal are greater than the cost involved in coal price protection.
|
