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How an independent power producer uses a weather swap linked to a commodity to manage power prices
X Power Co. is a large independent power producer in the southwestern United States. If temperatures in any month of the peak cooling season (June through August) rise above normal, load and production costs also increase. Under such conditions, the company would like to receive a higher price for its power. On the other hand, should the weather be cooler than normal, when load and production costs are lower and power prices are likely to be depressed, the company is prepared to accept a lower price for its power. X Power Co. therefore enters into a weather-indexed swap transaction with Enron.
Enron agrees to purchase from X Power Co. 50MW during weekday peak hours in the months of June, July, and August at a base price of $20 per MW. Having considered historical weather conditions, both parties agree on a trigger number of cooling degree days per day (CDDs/d) of 25. CDDs/d are calculated as the cumulative number of CDDs for the three-month period, as measured by a National Weather Service Weather Station in X Power Co.'s service territory, divided by the number of weekdays in the period.
For every COD/d above 25, to a limit of 28, Enron agrees to pay X Power Co. $1.50/MW over the base price. For every CDD/d below 25, to a limit of 22, Enron will pay X Power Co. $1.50/MW under the base price.
Should the underlying weather conditions be warmer than the trigger, X Power Co. is now assured of receiving a higher price for its power. For example, if the cumulative number of CDDs for June through August is 1,800, or 27.27 CDDs/d, the company will receive $23.41/MW ($20 + $1.50 x [27.27 - 25]).
X Power Co. is also assured of receiving a minimum price of $15.50/MW, which, although lower than the base price, will occur only when weather conditions are cooler than the trigger and when the company's production costs should be less and lower market power prices would be anticipated.
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