On 27 July 2010 the Commission published its Stage 1 final report on the Review into the role of hedging contracts in the existing NEM prudential framework.

The Commission has also provided the final report to the Ministerial Council on Energy (MCE).  Subject to a policy response from the MCE, Stage 2 of the project will involve development of the Rules to implement the recommendations in the Stage 1 report.

In summary, the Commission has recommended that:

• existing and proposed reallocation offset arrangements be continued with some enhancements through changes to the Rules and AEMO's procedures and that an appropriate prudential margin be maintained where load is offset by internal generation;
• FOAs be integrated in the NEM prudential framework, subject to AEMO establishing an appropriate prudential margin and undertaking further assessment of benefits and impact on the prudential quality of the NEM following its broader review of the NEM prudential framework; and
• AEMO investigate options to improve the MCL methodology as part of its review of the prudential framework.

Background

The Commission considered a Rule change proposal on Futures Offset Arrangements (FOAs) proposed by three National Electricity Market (NEM) participants: Australian Power & Gas, Infratil Energy Australia and Momentum Energy (Proponents). The Rule change proposal sought to modify the Maximum Credit Limit (MCL) calculation methodology, and define and accommodate FOAs within the National Electricity Rules (Rules).

Under the Rule change proposal:

• the Proponents proposed to modify the MCL calculation methodology in the Rules. Rather than the MCL methodology using a backward looking price observation as a basis for predicting future pool prices, it would utilise Sydney Futures Exchange (SFE) electricity futures prices as the key inputs of the model, representing a forward looking view of future pool price outcomes; and
• the Proponents proposed to define and accommodate FOAs within the Rules. An FOA would be a commitment entered into by an SFE Clearing Participant on behalf of a NEM participant to redirect positive cash flows associated with the NEM participant's futures position to the Australian Energy Market Operator, (AEMO) to protect against the default of the NEM participant. The positive cash flows are to be held in a Security Deposit Account. In return, the NEM participant would only provide bank guarantee support to AEMO up to a level equivalent to the futures price at which the FOA was initiated and beyond which cash payment obligations from the SFE Clearing Participant to AEMO would arise under the FOA.

On 22 January 2009, the Commission published a draft Rule determination which did not make a draft Rule due to the risks associated with the proposed Rule.  This was confirmed in the final Rule determination made by the Commission on 16 April 2009

The Commission noted that an option to address the issues raised by the Rule change proposal was to make a more preferable Rule under section 91A of the NEL. The Commission, however, decided not to make a preferable Rule under this section of the NEL due to the complexity of the issues and the need for detailed consultation and expert advice.

The Commission considered that there were elements of the proposed Rule which had merit and warranted investigation. In particular:

• the futures price information could be valuable in providing a forward looking view to determine an adequate MCL level; and
• a robust FOA model could potentially reduce prudential costs of NEM participants.

To develop a feasible solution to address the risks associated with the Rule change proposal (if it is possible), the Commission decided to conduct a Review under section 45 of the National Electricity Law (NEL). Section 45 enables the Commission to carry out the extensive consultation and establish working groups and offers:

• appropriate flexibility to consider a broader set of issues than those raised by the Rule change proposal; and
• opportunities for rigorous investigation and in-depth discussion and consultation over a longer time period.

The Commission commenced this Review in January 2009.

This Review sought to develop a robust model to offset the prudential requirement of a NEM market participant using its futures and other contract positions. In addition, the Review examined ways in which the calculation of the MCL may be improved.

The Commission established a working group to provide expert advice relating to this Review.

On 26 March 2009, the Commission published a Framework and Issues Paper for the Review. This paper set out issues requiring consideration as part of the Review and highlighted a series of questions on which the Commission sought stakeholders' views.

On 16 April 2009, the Commission held a public forum on the Framework and Issues Paper. Submissions on this Framework and Issues Paper closed on 24 April 2009.

On 1 July 2009, the Commission published a revised timetable for this Review.  The Commission considered it necessary to revise the timetable for the Review to take into account the time taken to:

• develop FOA models for assessment; and
• finalise a detailed Request for Proposal for consultants.

In addition, due to the impact this Review was likely to have on the NEM, the Commission allowed for consultation on the consultants' draft report prior to it being finalised. 

On 23 July 2009, the Commission engaged consultancy firm PricewaterhouseCooper's (PwC) to undertake analyses and make recommendations on:

• the risks associated with the existing reallocation arrangements in the NEM prudential framework and options to enhance these arrangements;
• the risks associated with the proposed models for futures offset arrangements and options to enhance these arrangements; and
• the maximum credit limit methodology. 

On 14 October 2009, the Commission published a draft risk assessment report by consultants PwC for public consultation.  Working examples of futures offset arrangements models, developed in consultation with the working group and provided to PwC for risk assessment, were also published.

Submissions on PwC's draft risk assessment report closed on 4 November 2009. 

On 5 March 2010, the Commission published the final risk assessment report by PwC.

Stakeholders raised some substantive and complex issues in relation to PwC's draft risk assessment report, which  PwC took into account when finalising its report.  The final PwC report on risk assessment was be an input to the Commission's Review. 

On 19 March 2010, the Commission published  a draft report on the Review for public consultation.   On 12 April 2010, the Commission held a public forum on the draft report. Submissions on the draft report closed on 30 April 2010. 

On 20 April 2010 the Commission published papers related to the public forum and, at the request of stakeholders, published legal advice from Allens Arthur Robinson referred to in the draft report.

Submissions on the Commission's draft report required the Commission to obtain supplementary legal advice and to undertake further assessment.

On 27 July 2010 the Commission published its Stage 1 final report on the Review. The Commission has also provided the final report to the MCE.  In summary, the Commission has recommended that:

• existing and proposed reallocation offset arrangements be continued with some enhancements through changes to the Rules and AEMO's procedures and that an appropriate prudential margin be maintained where load is offset by internal generation;
• FOAs be integrated in the NEM prudential framework, subject to AEMO establishing an appropriate prudential margin and undertaking further assessment of benefits and impact on the prudential quality of the NEM following its broader review of the NEM prudential framework; and
• AEMO investigate options to improve the MCL methodology as part of its review of the prudential framework.

Subject to a policy response from the MCE, Stage 2 of the project will involve development of the Rules to implement the recommendations in the Stage 1 report.