CHUBU Energy Trading

June 2009

Introduction

I am Katsuji Noda and I am the Executive Managing Director of Chubu Electric Power Company where I am responsible for Chubu’s fuel procurement activities.  I am also the CEO of Chubu Energy Trading, which is a new company that has been established by Chubu to procure coal more flexibly and more reliably in the Asia/Pacific market.  Today I would like to address you as the CEO of Chubu Energy Trading, and to make things simpler, I would like to refer to this new company as CET for the rest of my presentation.

CET was established in December 2007 as a coal trading joint venture between Chubu Electric Power, the 3rd largest power utility in Japan, and EDF Trading, which is the energy trading subsidiary of EDF of France.   Since February 2008, CET has had procurement responsibility for about half of Chubu’s coal portfolio and, in addition, the shipping and logistics responsibilities for Chubu’s entire portfolio of about 10 million MT per year.

CET commenced coal deliveries to Chubu in April 2008, and since then has delivered more than 70 cargos from many sources in Australia, Indonesia, Russia, and China.

Why Chubu started trading coal

I would like to give a brief explanation as to why Chubu decided to establish a trading company to procure and trade coal in the first place.

As you know, Japanese power utilities typically buy coal under long-term contracts. These are usually large-volume, take-or-pay contracts and the delivery price is fixed annually by a negotiated process.  This traditional type of fuel procurement has provided Japanese Power Utilities with security of supply in the past, but in recent years this has lead to new risks, which Chubu needed to address.

In the past, annual contract prices were negotiated with reference to the supply and demand situation and also to production costs. But in recent years there has increased spot trading and the development of the financial swap market.  This means that the Newcastle Index has a greater influence today.

The volatility of the Newcastle index and the inflexibility of traditional procurement has become a real concern because:

•    Firstly, the market prices fluctuate during the annual price negotiations, leading to a long and difficult process.
•    Secondly, there are cases where the index price falls immediately after reaching agreement, leaving the buyer with a price which is far higher than its competitors.  In a market where the price is volatile, the act of buying coal at a fixed price is itself a large risk for a power utility.
•    Thirdly, it can be said that fixed-price coal deliveries are not always secure.  In our experience, we were not able to enjoy the merit of fixed-price coal because of delivery delays when the index price rises above the fixed price.  When this happens, we had to purchase unplanned spot cargoes exactly when the market supply is most scarce and prices are highest.
•    And finally, take-or-pay obligations are a particular concern when a utility faces unplanned outages or steep decreases in electricity demand, which are beyond its control.

Traditional coal procurement worked well in the past when coal prices were fairly stable, but the same practices have become more risky in recent years.  So Chubu decided that, in addition to long-term contract security, it also needs short-term contracts and procurement flexibility that the traditional procurement model does not provide.

Chubu recognized that European utilities have faced this situation for some years and have developed practices to manage price volatility and market risks.  And as a result, Chubu decided to establish CET together with EDF Trading.  The goal was to establish a utility trading business in the Far East using the procurement trading model which is used by major utilities in Europe.

Through CET, Chubu is implementing new methods to manage the price volatility and market risks of fuel procurement.

How is the new business different from the traditional JPU procurement model

CET’s asset-backed trading model is different to the traditional procurement function.  This is why Chubu established CET as a separate company and allowed it to employ business practices that are different to those of the traditional fuels department.  With experience and know-how from EDF Trading, CET takes a different approach to the “traditional” power utility fuels department.

To give a few examples;
•    CET transacts with many counterparties, whereas “traditional” power utilities transact huge volumes with a limited number of counterparties;
•    CET transacts throughout the year, not just in March and October.
•    CET transacts directly with suppliers, not through agents;
•    CET transacts in financial and physical products. CET can accommodate fixed-price or index-linked contracts, based on what Chubu or the supplier requests.
•    CET can act as buyer or seller.  If Chubu has a plant outage, CET can resell coal to address over-supply and take-or-pay.
•    CET can transact quickly and without a lengthy approval process.  This allows us to capture opportunities that others cannot.
•    CET measures its success against wholesale market prices.  CET’s benchmark price for FOB Newcastle is the Newcastle index price.

These differences have helped Chubu to manage the risks of procurement and to be more flexible.

But of course, some people wonder if the Atlantic model, which has been successful in Europe, can also work in the Asia/Pacific market.   Last year, the coal and freight markets experienced the highest volatility ever.  And although this was a difficult environment to start up, CET was able to deliver coal reliably and according to the orders placed by Chubu and, at the same time, to generate a satisfactory profit.

This success, I believe, is strong proof that the business model is valid in the Asia/Pacific market.

The future of CET

Lastly, I would like to talk about the future of CET.

CET’s activities have brought many positive changes to Chubu Electric Power and, therefore, we will continue to support this new business in the future.  Chubu is still evaluating the business model, and we see two possibilities for future expansion of CET.

Firstly, Chubu is considering combining the long-term and short-term coal procurement activities within the CET platform.  Chubu sees benefits in managing its procurement, long-term and short-term, as a single portfolio and within the business structure provided by CET.

And, secondly, Chubu may expand the CET business beyond coal and to combine procurement and trading in other types of fuels as well.

As CET has now entered its second year of business, and we look forward to strengthening our business relationship with many of you in the audience.

Thank you very much for your kind attention.