Here is your conversation with my revisions marked (deletions struck through, 
insertions in bold).  Hope this helps but feel free to call or write with any 
questions or comments:

A:   The CFTC regulates futures contracts and certain kinds of option 
contracts.  
SP:  What's a futures contract?
A:  It is a contract for the sale of a certain kind of  commodity through a 
regulated  exchange.
SP:  How is the contract different than a non-futures contract?
A:  Ahem,   just for your information, we call the non-futures contracts 
forward or over the counter contracts.  The big difference is that the 
forward contract does not must go to delivery while futures contracts do not.
SP:  I though the futures contracts went to delivery.  I remember getting all 
messed up on the gas side with delivery of NYMEX futures gas at the Henry 
Hub, and what about those stories of a guys getting a load of soy beans 
dumped in their front yards?
A:  Well, er,  yes they do sometimes  go to delivery, but they are not really 
supposed to relatively few of them go to delivery.  They are supposed to  
more frequently (actually the vast majority of the time) net out as financial 
transactions.  It's that option of settling financially that distinguishes 
the futures contract.
SP:  Well lets get to the point,  why are physical buy sells so bad?
A:  That's easy.  Because they look like futures contracts.  They are not 
intended to go to delivery.  And if you are trading in futures contracts you 
are supposed to be doing it on a CFTC regulated exchange. 
SP:  So what you are saying is that if we deliberately net out our physical 
deals and never intend to even try to schedule delivery under them we are 
trading in futures contracts and could be subject to regulation by the CFTC?
A:  You've got it.  But it's even worse than that - federal law says that a 
futures contract which is not traded on a regulated exchange is illegal: not 
only could the CFTC come after you but your counterparties could use that law 
against you to get out of performing.  So you can think of each contract like 
that as having written a free option.
SP:  Well how much physicality do we have to have to make it a forward 
contract?
A:  What do you mean?
SP:  Well, if we settled physically one day a month but financially the other 
29 days, would we have a futures contract?
A:  Oh for Christ's sake I've had it.   I'm telling you once and for all that 
physical buy sells are futures contracts and you can't do them now get the 
hell out of my office!--

Is this the basic idea and if so,  how much can we blend physical into it to 
cross the line into the domain of the forward contract?  --Christian 

Basically, yes.  A lot has to do with the look and feel of the thing but also 
the parties' intentions.  If we do not intend to make and take delivery, if 
we intend to settle financially - or even intend to just have the option to 
settle financially, we have a problem.  The closest thing we have to an 
exception to this is the provision for cover damages when one party fails to 
deliver.  That is a provision in the contract that might be argued gives one 
party the right to settle financially just by failing to perform.  We argue 
that this is still a forward and not a future because the parties in good 
faith intend initially that delivery will be made and a default occurs when 
there is a failure to make or take delivery.  Unfortunately, in the power 
world a large percentage of contracts may in fact get booked out.  However, 
each party enters into those contracts knowing that they have an obligation 
to make or take delivery and the book-outs may or may not happen - we do not 
enter into those contracts knowing that they will be booked out.  The 
book-outs occur after the fact by mutual agreement at the time of the 
book-out.  In fact, if we didn't want to book them out, we could stand on our 
legal rights and require all of our counterparties to make and take delivery 
(although I assume this might not go over well with many of them or with our 
scheduling desk if a book-out would be more convenient at the time).