Options Paper examines potential measures to improve financial resilience of the National Electricity Market (NEM)

The Australian Energy Market Commission today called for public submissions on whether there is a need to introduce measures that aim to reduce the risk of financial distress of one electricity company spreading to other companies.

Last year the Standing Council on Energy and Resources (SCER) asked the Commission to provide ministers with advice on the resilience of financial relationships between electricity companies and the risks of financial contagion occurring in the national electricity market.

Financial contagion occurs when the financial distress or failure of one business has a cascading effect in the market.

This options paper commences the second stage of our advice to the Standing Council on Energy and Resources (SCER). The first stage of our review focused on the risk of financial contagion arising from the failure of a large retailer and associated retailer of last resort event. We published draft recommendations in relation to this issue on 4 June 2013 in our first interim report.

The second stage of the review considers other possible risks of financial contagion in the NEM. It highlights the important role played by financial contracts - known as derivatives - that are used by generators and retailers to manage their exposure to the wholesale spot price for electricity.

These contracts reflect active risk management by participants. However, they also have the potential to transmit financial distress from one participant to another, if a business defaults on its contracts.

AEMC Chairman, John Pierce, said today that while the NEM has operated effectively to date, with companies entering and exiting the market without causing widespread financial distress, it is important to assess the resilience of current arrangements given the widespread consequences of multiple companies failing.

“While highly unlikely, the failure of a large retailer could have significant consequences for market participants, customers and ultimately the Australian economy,” Mr Pierce said.

“The Commission is keen to listen to stakeholder views on the costs and benefits of introducing various measures to protect the market from financial distress spreading across participants and how such measures could complement existing arrangements ” Mr Pierce said.

The options paper discusses the nature and management of risk in the electricity sector and how electricity companies attempt to manage the financial consequences of unexpected events. It seeks views on the transmission of financial contagion in the NEM and how best to address the risk.

The paper also sets out a number of measures to address financial contagion in the NEM.

These measures include the reforms to the regulation of over-the-counter derivatives agreed by the ‘group of 20’ countries following the global financial crisis.  These G2O reforms are currently being implemented in Australia for other categories of financial derivatives.

The Treasury has indicated that the Australian Government will consider whether it is appropriate to impose any G20 requirements in relation to electricity derivatives after the completion of the AEMC's NEM financial market resilience advice.