(D.) Mississippi Power Company Example

In the Spring of 1999, the Southern Company's emissions forecasts indicated that one of its subsidiary operating companies, Mississippi Power Company, would not have sufficient allowances for compliance in the year 2000. This was due to a number of factors, but the bottom line was that the revised SO₂ emissions for the company's power plants were higher than projected. Hence, it would be approximately 10,600 allowances short the following year. Southern's environmental compliance personnel ran a quantitative analysis to determine the best course to ensure Mississippi Power's continued compliance. After running through scenarios involving plant dispatch, fuel switching, and the application of emissions reductions technology, the company determined that picking up allowances in the emissions trading market would be the most cost-effective short-term strategy.

But how would Southern participate in the market? The company could seek out bilateral trades with other market participants, including utilities and traders. Southern, the largest electricity generator in the U.S., feels it does not always get the best over-the-counter prices from traders who may price deals with Southern's deep pockets in mind. As a result, Southern turned to a market broker, Natsource, LLC, allowing it to benefit from detailed market information and to maintain its anonymity in the marketplace.

Structure
The broker first worked with Southern to investigate different structures for its allowance purchase, factoring in Mississippi Power's allowances needs and a consideration of its cash flow situation. Mississippi Power did not require the allowances until the end of 2000, but the company wanted to lock in the purchase price immediately. Cash flow considerations stipulated that the company wanted to match its outlay of funds to the delivery of the allowances. The broker and Southern determined a forward settlement structure was the best course of action.

Sourcing
Before Southern could take its bid to market, however, the broker would have to determine whether the market could absorb it. The trading market for SO₂ is still thin relative to more established commodity markets. Major block trades, which at times cannot be accommodated by active buyers or sellers, could disrupt the market. Instead, large trades are often placed in multiple small blocks. After taking a look at the prevailing offer depth, current volume of the market, and the size of recent deals, the broker counseled that the 10,600-allowance bid by Southern could be readily placed in one block. The only preparatory step left was to determine pricing.

Next