ERM Energetics Exchange

Episode 10: Electricity retail contracting 101

• Season 1 • Episode 10

Share episode

 After considering the impact of COVID-19 on Ausrtalia's energy markets, we now turn to the economic downturn and the need to keep energy costs low. Mark and Gilles discuss the range of options available to businesses when looking to secure the most advantageous retail electricity deal.

Featuring: Gilles Walgenwitz, General Manager, Energy and Carbon Markets and Mark Asbjerg, Principal Consultant

Our host: Helen Wetherell, General Manager, Marketing and Communications

Note: The information and commentary in this podcast is of a general nature only and does not take into account the objectives, financial situation or needs of any particular individual or business. Listeners should not rely upon the content in this podcast without first seeking advice from a professional.

Speaker 1:

[inaudible]

Introduction:

Please note that the information and commentary in this podcast is of a general nature only, and does not take into account the objectives, financial situation, or needs of any particular individual or business.

Helen:

Welcome everyone to the energetics exchange, energetics podcast series, featuring energy and climate experts. I am Helen Weatherall, energetics, general manager of marketing and communications. And I'll be your host for today's discussion. Our topic is retail, electricity contracting one Oh one, the fundamentals of risk manage procurement for large energy users. Uh, and for this, I am joined by shields with alphabets, our general manager of energy and carbon markets and Mark iceberg, who is a principal consultant whose clients include some of Australia's largest energy users. And he's also been a key commercial advisor to a number of high profile, renewable power purchase agreements. Thank you both for your time today. So Mark and Jill in previous conversations, we've discussed the impact of COVID-19 on our energy markets and on Australia's renewable energy industry. And today there's a lot of attention being given to Australia's ability to recover wealth from the COVID-19 upheaval and minimize the impact of the economic downturn and Australian businesses are naturally very anxious to keep their energy costs low. And certainly we are seeing low prices in the market right now. So Mark, if I could start with you, what are some of the options available to businesses when looking to secure the most advantageous retail electricity deal?

Mark:

Thanks, Helen. I think it's important before we discuss this, just to take a few steps back and look at what costs actually contribute to your overall electricity spend. So around 40% of the average bill, and this is just a rule of thumb, it's different for everyone, but around 40% is actually made up a regulated charges, network charges and demand charges. This is essentially the cost of developing and maintaining the infrastructure to get electricity to each site. The remaining let's say 60% is a what we call contestable costs. So around 10% of these, this, so 10% of the total bill is made up of a number of environmental schemes. So this is the federal renewable energy target, and also a number of state based efficiency targets. These are all different in every state, the last 50% and the bulk of the overall spend is this retail, electricity, the cost of the actual electricity. So when you were looking at retail contracting options, it's only this retail spend that we can really manage with different contracting options. And before I guess, to get a better understanding of what options are available, I think it's important that we, I understand that there's two fundamental different markets for electricity that rates highly has access to price the electricity for each end user. The first market here is essentially the spot market in this market prices change on a 30 minute basis, depending on demand and the cost of the marginal generator to meet demand at every single price interval. For example, a overnight, you would have a base load demand, which is quite low, and you'd typically have a coal-fired generator to meet that demand, which is priced at a lower price point and conversely, on a hot summer's day when everyone gets home from work and the afternoon switches on their air conditioning, that's when you need a gas peaking generator to meet demand when, when that demand spikes and that taking generator typically comes at a, at a higher price point. So the second market, and this is the wholesale futures market, and it's this market that most retail contracts reference phase contracts are tried it over the ISX. So it's all publicly listed and they essentially re represent the average expected cost of electricity at the time it's going to be delivered at that point in the future. And this is based on the known supply and demand drivers we have today. So I think the best example to paint a picture of this would be looking back at the 2017 contract in Victoria when the Hazelwood power station was announced that it would close. So if I go back and look at prices in September for the next year 2017 on the 23rd of September, 2016, the average expected price for electricity in Victoria for the 2017 delivery period, was it$54? That same day we had newspapers announcing that Hazelwood power station was expected to close the following year. The following day, the market had a very different view of what the average cost of electricity would be for 2017. Would that generation taken out of the market and the implications were that gas generators would likely be needed more and more. And we actually sold the average price of electricity of that contract jump by 15%. So it jumped from$54, a megawatt hour to$62. It's this market that retailers are using to price electricity. And this is coming back to you, your question, Helen typically end users have bought fixed price contracts, and essentially the, the price of the peak and the off peak rates that they pay is based on what that underlying futures market is doing on the day that they could receive that offer. So in this example, back from, from 2016, if I was to contract one day before the announcement of Hazelwood versus one day after my peak and my off peak, right, there would been a likely a 15% difference between the two, if I'm a customer using a hundred gigawatt hours a year that jump on its own represents about$800,000 overnight. So that is your fixed price. Contracting is essentially exposing you to that, to that risk. And I think what we're saying, a lot of other uses look for a lot of other customers look to over the last few years, there's a number of alternative contracting methods, and this is where you have something called progressive, which is to become more of a viable option for smaller customers. And then there's also a level of a block and some managed a spot market exposure for other customers as well.

Gilles:

Maybe I can add a layer to that. It's probably worthwhile splitting further. The components that we tell us we'll consider when quantifying the, we tell the risk premium or the compact premium that they apply at the top of the underlying futures that you mentioned, cause they are all the divers that can explain the price that our customer will have compared to another one for, uh, you know, a set conditions of, of on, on the, on the futures market. Um, so they, we tell us, apply compact premiums at the top of the underlying world sell forward or futures contract pies. And as I mentioned by Mark, and these premiums will differ relatively significantly, according to the shape of the customer load. So typically a would say PQA customers loads, uh, willing cure, higher compact premiums because of the absurd relationship. If there is one between high electricity load and high Pisces. So I could have I load that he's positively correlated with high Pisces, but I could well have customers like in the water sector or whatever distribution sector where typically it's could be opposite. It depends on the type of assets you're dealing with and you can have a productive work call, negative correlation between high price events and Peaky load. So these premium will value a lot, um, depending on the load shape of the customer and all the factors to consider would be the term of the contact, the liquidity of the market, for which the contact is required. The credit was in S of the customer. And we know for some, in some instances we have issues with multiple ABN, multiple customers, and another customer acting as an agent that can be a nightmare for retailers. And you will probably see this in the credit rating provide, Oh, by the way, teller when, when challenging or were developing their premium. And there are other consideration like the attractiveness of the overall load shape to the portfolio of generating assets that the Jen Taylor may have. Well, what I wanted to flag before we move to something else is, um, customers need to understand these, uh, these factors, um, that constitute, uh, the compact premiums and understand how they can potentially influence them when going to market. Um, so for example, you could set an internal approval process such that you have the white level of delegation of authority to, uh, use the value of the retailer. So if you are able to lock in a contact with a short value D period, it means you Weta is less exposed to volatile market conditions as mentioned by Mark, and you could potentially use your validity premium there. Another example is, um, if you can all find you estimates of the annual compacted volume and what quests are lower and flexibility at once on volume. Um, so other than asking for plus, or minus 20%, because it's convenient for you. If you can have some confidence in your future load requirements, you could potentially use this[inaudible] plus or minus 10. And this will mean that when they will calculate the exposure to sport through the calculation of the covariance between your shape and your spot pies, they will probably come with a sharper and leaner a compact premium. So they are, there is this component of time to market. They're the other components that built the avoid contact payment that the customers is or deep our clients need to understand.

Helen:

And certainly a number of our clients have think purchasing their electricity progressively. And can you tell us some more about, um, progressive purchasing and what it offers?

Mark:

So coming back before a fixed price contract is essentially locking in all your volume, all your requirements on a single date, single point in time, and the price therefore is driven by the view of the market on that day. What progressive does is it essentially allows you to not put all your eggs in one basket, really. So you're buying different portions or percentages of your load at different points in time, your end contract price, your final peak and off peak rates, but based on the volume weighted average of your purchases. So if I were to look at the example I used before, when Hazelwood closed so overnight, you had a jump from 54 to$62. If I had bought half before and half later, my contract price would have ended up right in the middle of that at$58. So I would have been able to somewhat offset that price increase and not being fully exposed to the budget implications of that increase. And depending on the size of your load and different retailers, you can break up your, your volume requirements that as many little chunks as you, as you need, it could be a down at 5%, or it could be a single megawatt or five megawatts. There's different retailers are offering different levels of granularity to purchase your requirements, but it is ultimately a way of spreading your risk. What that does mean is customers who are buying this way, having to more actively monitor the market as it gives them also the flexibility to buy more volume when the opportunity presents itself. So when, when market prices are low, they can purchase more. Or when they see market prices increasing, for whatever reason, they can then choose to buy more volume upfront. So manage the risk of being exposed to those higher prices and in a few months time. So ultimately this, this gives customers a more flexible approach to buying their electricity that better enables them to adapt to market conditions, which are constantly changing the importance though, or what, what customers really need to look at then is making sure that not caught out, making sure that they're more actively engaged in the market and following market trends. And we typically find when we're assisting clients with this sort of purchasing option there, we will set up a, a risk management framework, for example, to help guide those purchases for that contract over the coming years. And this framework will incorporate factors like delegations of authority, a time to maturity, the price of the contract minimum volumes to be bought at different different times a stop loss mechanisms, or there may be other risk management tools such as volume at risk, et cetera, that you might worry that they might include in that. Um, but I think it's with that approach as well. Um, it's important that customers are able to, um, benchmark the pricing that they get from retailers with, with what they say on the market.

Gilles:

Yes, yes. Yeah, absolutely. I agree. It's, it's, it's important. We know that, uh, different, we tell us may propose, um, different benchmarks in the pacing formula. So our listeners need to understand the advantage of progressive purchasing is you have supposedly a transparent pricing methodology there. And so you agree on the factors that will be used to the hive, uh, the peak of peak Heights for the twisty, uh, uh, based on an underlying, um, we'll sell futures or the benchmark pace, uh, you need to understand what the baby benchmark will be. And, um, and so some retailers will be using a publicly available benchmark, or they could use a benchmark that they develop themselves. And that includes already potentially some of their risks like[inaudible] and could somewhat be different than what is available on Lasix. So our clients or the listeners, if they consider, uh, PON spot on pricing methodology with a price benchmarking approach for policy purchasing needs to understand which benchmark we are talking about. The other thing to consider as well when you're purchasing is, um, consider how attractive the offer from the retailer is. So if I say today, I want to buy 50% of my a hundred gigawatt hours, a load that you mentioned before. Mark, I need to understand the, how I talk if it's a place today. And so I need to understand how to position these pies against the beat of his plan on the market. And, um, would there be options for me to actually negotiate our pies? Also? I think, I don't know if it's relevant to this question, but, um, there are some limitations in the progressive purchasing that, um, and users need to be aware of. One of them is the possible lack of liquidity in the market. Um, the, uh, national electricity market is not a very deep market and we have, um, especially for long dated instruments, we have alternatively low liquidity. So I could well say today that it's worthwhile for my client to consider buying, um, FYI Twinkie, sweetie, um, safe. Um, the problem that I may face is that I may not have lots of, um, sellers, uh, for this specific instrument and that we tell our may argue that well, so that's supplies in the market, but currently there is no offer. So I Contactually, um, buy these for you. So when, um, I would say you, you, uh, you consider, um, are we tailor for progressive purchasing? You probably need to consider this question of lack of liquidity and, um, and, and especially for, you know, complex that you would like to buy two years in advance or so, or otherwise agreed and protocol for buying off-market. So if there is limited liquidity on the futures, what could be the alternative option for you to potentially find buyers or sellers, or should I say, in this case for the retailer to one or somewhat the willingness that you have to look in some volume, um, and, um, finally I think what is important to understand when you go into a progressive purchasing arrangement is important to understand how, um, the Ohio Piscean middle you would walk, how would the, of the Heights based on the underlying world sell futures or index pies and, and this load shape or premium of the factors that they apply to derive a Pico peak, very important, especially if you are, let's say, you know, you will have to, um, willingness to implement to behind the Minnesota generation or, you know, that you will Lord shape would change over the contact term. Um, well, uh, the load shape factors or these pretty factors that the retailers will apply to the[inaudible] will have a different outcome depending on how you look shape, will change

Speaker 6:

At that point. Um, can I ask you to describe these load shape factors?

Gilles:

Yeah. We'll pick here the teller's perspective for me about how will they will, they will see this themselves. So, um, I think market explain, uh, before that are we telling is actually because it's a Goss pool market that we have in national QC market that we tell that is exposed to the spot market with your Lord as I, as a customer. And so what they want to do is to hedge their position by offsetting the sport exposure by buying fixed price contact for more or less the same load and the used expert exposure for that. So what they need to understand is a load for low cost, which is what we are talking about here. A lot, following an arrangement in jewel Baya, we Tana is just some of the pace. If we tied the interval, um, multiply by the hourly demand for this specific customer. Um, and, and, you know, that's, you can imagine all activity unpredictable. So that's why when you submit as a, let's say you are, and user, you want to have enough and form a waiter, a lot large CNI customer. They want to have an understanding of your load profile. They will match this load profile against spot Pisces, typically historical spot Pisces for tools for years, they will define which is the white hedging strategy for them considering a sort of a block cost at peak cost and considering as well, this covariance risk and whether or not they should cover themselves more because of these higher spots exposure doing HighSpot post by post event. So it's very important for us as advisors, but for any end user, when they negotiate with the retailer to assess to what extent they can align this load shape and the ability and cost to flex this shape and the most attractive contacting model that matches their whiskey story on. So if I have a very flat load, for example, and I do not have a duty to represent a significant twist for the retailer of HighSpot exporter beyond a flat swamp, there is relatively limited, at least for, for, for, for, for, for me in taking this risk and just asking for a block, just charge a block for me, I take the residual demand, a risk above this, the size of this block, or on the, of the opposite. If I have a very unpredictable and piggy profile, while I can be prepared to pay a high price because of these high locate factors that will apply from the retailer. But if I have physical hedges, then I could do something by shaping this, this load and I'll use my costs. If I can't do anything, then I put all the history on the retailers and I pay the price for that.

Helen:

So for end users looking to be proactive, um, what are some of the options available to them to, um, optimize their load shape?

Mark:

I think the fast point is around some sort of permanent demand reduction. So avoiding the times where the demand spikes, for example, that could be changing the operations of a building or a site so that not all the machinery is being switched on at the same time, also by potentially using some sort of onsite generation batteries or, or, uh, a backup generator to when you see those spikes switching on that generation or that battery. So the is not managing that risk. Um, the other thing you could look at doing is consolidating your portfolio. So if you have a number of different being able to pull them all together as sort of in a single contract, and you might have sites that are sort of operating in the opposite behavior, essentially. So having one on one type of sites, that's peeking in, in the morning and another that's peaking later in the afternoon, if you can sell it, eating it, then overall for a retailer, you're generally flattening out the load of both.

Gilles:

Otherwise. I think some of our listeners probably know already that there will be an implementation of award cell demand West ponds market. And that comes in line with what Mark said, if there is a lucrative market for demand response, and that's probably a good thing to, um, substantiate the business case for implementation of new hardware or software capabilities on demand response in your different, different assets. But there is a, uh, another benefits to consider because once you implemented the tested, you demand response capabilities, you will have some good understanding of your capacity and its availability and your confidence in the firmness of this demand response, capable capacity. And then you will be able to assess to what extent you could take some spot exposure with yourself from on your way, tell contact. So other than asking, give me your weight teller, give me a load following fixed pies for what contact or give me a load following Polglasie purchasing contact. You can say just, I want to buy a block of electricity on the forward market or the futures I could potentially buy another peak in addition to a, a flat swab, but then the rest, I will take myself despite exposure, and that will be using this demand response capacity that they have as a physical hedge. So you could see if this demand response market is speaking up more and more appetite, potentially, especially for large customers to an arrangement where they do not pay the retailers, the contact premium for a load for living arrangement. They go to the retailers with as touch upon it, what we call a structural problem that would be requesting that we tell us to buy, um, flat swaps, so, or buying, um, peak, uh, big swap contracts, and then using physical hedges that they have to reduce this post exposure[inaudible] exposure, and then buying potentially, especially in doing a quarter once every summer, uh, buying a district cap, compact or options to reduce further their sport exposure. So we could see potentially a, an appetite for that in the, in the coming is, which would just probably be a natural move into a former former market that used to be fully fixed to a moving progressive. And now moving potentially something more to arms towards structural products

Helen:

At this point, reflecting on the fact that, you know, we've, we've worked with a lot of clients we're in the market every day. What are the overall trends that you would both like to comment on?

Mark:

I think generally with COVID-19, we've seen a, a number of repercussions that have put downward pressure on, on market prices. So for those customers using a fixed price contracting, it looks like it's an ideal time at the moment to, to contract and to enter the market and look to extend or renew those contracts. But at the same time, progressive purchasing is increasingly being used as a contracting option that the customers can use over the longer term to manage this time to market risk. So anyone considering that or anyone currently progressively purchasing, I think it's important that they're very actively monitoring the market to make sure that they're maximizing this opportune time and reducing the risk of any potential shock if prices increase towards the back end of the year as, as restriction start to ease.

Gilles:

Yes, the, the, the other, I just mentioned before, um, the possible interests, uh, on, um, Stasha products, um, because of the likely take up off demand response capabilities that can support a contract arrangement with more or less on the end users and not all the load following on a retailer. Another diver that could be considered as well is a number of our clients have been entering into a renewable energy Palm purchase agreements, a number of them, and two in, into, uh, financial, uh, PPA. So I finished four, I would say cash settled contact for difference on the spot market. So somewhat, um, some not all does, um, clients necessary. What did you do that? But basically to poke cure, um, or to source on large scale generation certificates, into hedge, they're a position on the market. They decided to enter into a contract for difference. This means that these clients that potentially historically used to have an experience only on fixed buys for what contacts now I exposed to spot. And so it's a completely different game now. And we went through a number of large users and users explaining the difference between spot and futures and explaining, uh, how, um, eye contact for defense and the spot market is only a partial hedge against, uh, we can contact index for the futures. Uh, you could see then the natural discussion we have then with those customers or clients that are interested in a contact for difference is to talk about, um, how can they amend or change or shift their, we Del compacting model to improve the utility of the hedge they enter into. So I entered into a financial PPI contract for difference on the spot market, as I'm edging instrument, how can I improve its effectiveness by contacting differently? Uh, my hedged item, which is my way tell compact cost. And that naturally leads you to, um, that use somewhat the time lag between the time you are contacting and buying on the futures on the forward. And, uh, and the time you are getting a hold of the new from the spot, or it could lead you to take exposure to the sports so that you reduce the basis risk that we have, if you stay on the, for wild or the compact market. So there is a potential 10 to what, what spot more spot exposure and less compact market exposure for those fines and turn into financial PPI as a hedge to procure long term, large scale generation certificates.

Helen:

Thank you, Sheila. Thank you, Mark. Uh, so a lot of great insights today, and certainly there are a lot of options available to large energy users right now with the end goal of minimizing their risks and minimizing their energy costs. So if I reflecting on the conversation, uh, I guess there's a number of takeaways for our listeners. First of all, take control. You can proactively manage your purchasing and also to develop in Thermop your confidence in physical hedging opportunities and participating in the wholesale demand response market there further once that confidence is established to your point, Jael considered structured products and your development and the refinement of your overall hedging strategy. Again, thank you for your time today, Jill and Mark. And, um, thank you to our listeners, energetics exchange podcast conversations with energy and climate experts.

Speaker 1:

[inaudible].