Financial Management - Enron Case

Financial Management

-Contractual Innovation in the U.K. Energy Markets: Enron Europe, the Eastern Group, and the Sutton Bridge Project-

Q1. Why is Eastern interested in getting additional generating capacity?

1. Diversification strategy adopted by the company is to combine gas supply with gas-fired electricity generation to arbitrage between the two markets (gas market and electricity market) depending on price.

2. Because The Eastern’s operation profit decreased from £ 195 million to £ 43 million, the company expects to get a greater the sales and increase profits through additional generating capacity.

3. As the gas and electricity markets in the UK, regulators allowed a full and open completion in both gas and electricity. Therefore, additional generating capacity was than meant a larger production which in turns meant economies of scale.

Q2: How would you characterize Eastern’s option under the Capacity Tolling Agreement (CTA)? When is this option valuable? For example, what happens when gas is priced at £1.25 per MMBtu and electricity is priced at £25.00 per MWh? What happens when gas is priced at £2.50 per MMBtu and electricity is priced at £15.00 per MWh?

Indeed a nice agreement for Eastern. Since Eastern has no obligations and can choose electricity pool proceeds when it is economical it is less dependent on fuel price volatility. Furthermore does the physical plant still belong to Enron and Eastern has no risk of ownership.

The option is valuable in case:

- Eastern receives electricity when gas prices are low relative to electricity prices.

- Eastern sells gas when gas prices are high relative to electricity prices

In Scenario 1 (Gas Price=£1.25/MMBtu, Electricity Price=£25/MWh) Eastern would make a profit of approx. £9700.

In Scenario 2 (Gas Price=£2.5/MMBtu, Electricity Price=£15/MWh) Eastern would lose £4390. Under this situation, Eastern Group will not exercise the option.

Scenario 1 Scenario 2

Gas Price 1.25 2.5...