The Australian Competition and Consumer Commission (ACCC) is continuing its inquiry into the electricity supply market within the National Electricity Market (NEM). As part of their latest Electricity Market Inquiry Report, Frontier Economics was asked to explore the evolving contracts market in this sector. This is particularly important given the rapid push towards renewable energy and associated changes in government policy.
Utilising interviews with key industry stakeholders, and our own analysis, the report is focused on how the electricity hedging market might evolve over the next 10-15 years. This is a period the electricity market will be in transition. A particular emphasis is placed on how retailers, especially those without generation assets, will be able to manage risk.
Key findings: Electricity risk management and market evolution
The report outlines several key findings.
Firstly, an efficient hedging market is crucial for risk management, reducing energy costs, and ensuring a competitive retail market that benefits consumers. There are several tools that retailers can use to manage the risk of fixed consumer prices with the more volatile wholesale electricity market. These tools include financial contracting, vertical integration, or demand response strategies.
Secondly, the energy market transition, driven by government policy for a low carbon economy, is affecting electricity markets in complex ways. It is expected to reduce dispatchable capacity, such as thermal generation. The replacement to this will be renewable generation, where most of this output is dependent on whether conditions. This impacts on the ability for this supply to offer the firm base load swap contracts that have traditionally been sold by baseload coalfired generators, or cap contracts sold by gas peaking plants.
We have also identified several potential challenges for retailer risk management evolving from the transition to more intermittent generation. These include:
- Increased spot price volatility, which could challenge the ability for independent retailers to manage risk.
- Traditional contracts and futures may not meet the evolving risk profile of retailers, with a likelihood that more bespoke contracting will become increasingly necessary. This may have implications for trading exchanges, such as the ASX, to offer products that retailers need.
- The availability of financially firm contracts is expected to reduce, making it harder for retailers to rely on contracting to source efficiently priced financially firm contracts. Drivers for this include the retirement of dispatchable generation sources, but also the potential that government supported generators have a reduced incentive to make contracts available to the market.
- If vertical integration becomes necessary to effectively manage risk, this may foreclose on opportunities for smaller new entrant retailers.
Strategies and options to assist future retailer risk management
Our report sets out several strategies for the ACCC and Government to explore to improve outcomes for retailers in the future given the expected challenges they will face. These are:
- Given governments currently fund the majority of new supply technologies in one form or another, we consider the ACCC, and the Government should identify if there are ways that these government funded generation/storage projects could be used to support qualifying small retailers with access to a quantity of hedges.
- The Government may wish to also investigate underwriting new products on futures exchanges. The intent being to support the development and availability of these products until sufficient liquidity emerges.
Importantly, our report advocates against market interventions, such as market design changes, to manage risk for retailers. Reducing risk through market mechanisms, such as reducing the market price cap, would likely reduce the incentive for retailers to contract, and in doing so, reduce the incentive for new investment in essential dispatchable capacity.
Read further by downloading the report below, or on the ACCC website. The ACCC’s Electricity Market Enquiry can be found here.
More information about our work in the energy and renewables sector is found here.
