Tohoku Electric to Start Coal Swaps to Hedge Price Swing Risks

Tohoku Electric Power Co., Japan’s third-biggest coal user, will start trading coal swaps for the first time to manage price volatility risk as it prepares for the liberalization of the country’s electricity market.

The Sendai-based utility plans to begin using swap contracts against the Newcastle coal index price published by globalCOAL as early as this fiscal year, said Kaoru Hijikata, a deputy general manager of the company’s planning department. Hijikata, who has worked at companies including Enron Corp., UBS Securities Japan Co. and Sumitomo Corp., joined Tohoku Electric in April to help expand the use of derivatives and help prepare for the government’s planned deregulation.

During 2018-2020, Japan plans to abolish the current power-tariff regulation that allows utilities to pass on high supply costs. The measures pose a major challenge to the country’s power industry, Hijikata said.

“It’s called the electricity system reform, meaning it would fundamentally change the industry’s structure,” Hijikata said in an Aug. 27 interview. Tohoku Electric’s executives “have a sense of urgency that the company could be swallowed up by another” if they fail to properly prepare, he said.

Bigger Japanese coal buyers are ahead of Tohoku Electric. Electric Power Development Co. (9513), Japan’s biggest thermal coal user, started coal-trading in fiscal 2004 and swaps in fiscal 2006, spokesman Junichiro Hoshino said Sept. 3 by phone. The Tokyo-based company, known as J-Power, also owns a minority stake in Global Coal Ltd., a provider of a coal trading platform, Hoshino said.

Power Traders

Chubu Electric Power Co. (9502), Japan’s second-largest consumer of the fuel, is using coal swaps and other derivatives to mitigate risks, spokesman Ryo Tanikawa said Sept. 3 by phone, declining to say when it started such operations. The Nagoya-based utility began a coal-trading venture with Electricite de France SA in 2008.

“When the power market is liberalized, electricity may not be sold as expected. That means power companies would have surplus coal and gas and have to sell them in market,” said Hijikata, who helped develop commodity derivative products at Japanese trading house Sumitomo Corp. (8053) “Every power company will build a trading function.”

Power utilities can also hedge against market swings by using the wholesale power exchange market and a futures market planned by the government as part of the reform, Hijikata said. Weather derivatives would be another hedging option for Tohoku and other power companies, said Hijikata, who pioneered such products in Japan before he joined Enron, a Houston-based giant in the derivatives business, which collapsed in 2001.

Among the three instruments, “we can pick the cheapest and most effective one,” Hijikata said. “That’s what’s interesting about derivatives for the electricity business.”

To contact the reporters on this story: Tsuyoshi Inajima in Tokyo at tinajima@bloomberg.net; Emi Urabe in Tokyo at eurabe@bloomberg.net; Yuji Okada in Tokyo at yokada6@bloomberg.net

To contact the editors responsible for this story: Pratish Narayanan at pnarayanan9@bloomberg.net Peter Langan

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