Update on stakeholder feedback on market making arrangements in the national electricity market

Stakeholders have shared a range of views to help inform the AEMC’s assessment of a rule change request to establish voluntary market making services in the national electricity market.

Through submissions to our consultation paper, a public workshop held last month, and discussions with the project team, stakeholders have outlined the benefits and challenges of various schemes to increase trading in electricity hedge contracts, as well as how to provide greater visibility over the wide range of risk management products now used in the market.

We received 14 submissions to our December consultation paper, which can be viewed on the AEMC’s website. The public workshop, held in Melbourne last month, was attended by around 40 stakeholders including representatives from major energy users, generators, electricity retailers, demand response and gas industry groups, financial institutions, governments, AEMO, AER and ACCC.

Stakeholder feedback has broadly focussed on three main themes:

Whether there is a problem with contract market liquidity in South Australia, or more broadly across the national electricity market

There were diverse views on the level of liquidity. Large generators, integrated gentailers and larger retailers generally felt liquidity is, on the whole, not an issue. While liquidity in South Australia is lower than the rest of the market, this was attributed to the physical characteristics of the market including the small size of the market, limited firm capacity, limited interconnection, a high penetration of renewables, and a reliance on mostly gas generation for firming capacity.

Some stakeholders also suggested that illiquidity may be temporary, drawing attention to increases in liquidity seen in the current financial year. Contracting, according to participants, can vary with the level of underlying volatility, with participants contracting on longer timeframes through periods of higher volatility. Further, participants argued that risk profiles change over time, as well as the nature of the products needed to manage that risk. For example, a ‘peakier’ demand curve in South Australia means more bespoke products will be developed to be able to cover actual peak demand. It was also felt that the current tight demand and supply balance in the national electricity market is naturally being reflected in contract markets. Long term changes to the market should be made with caution as more generation will enter, increasing contract liquidity with it.

Other stakeholders, including the ACCC, stated there is a liquidity problem, particularly in South Australia, which needs to be addressed now. Advisors to large energy users said the difficulty in getting contracts is encouraging businesses to look at behind-the-meter solutions. Generators also commented that the lack of liquidity and the impact on their ability to trade in good time can limit their ability to sell products, change their overall position and interact with the market as dynamically as they would like.

Whether voluntary or compulsory market making arrangements are preferable

In terms of the range of solutions proposed, most stakeholders favoured a voluntary approach to market making. Large retailers and the ASX supported either the ASX process currently underway - a “no regulatory action” approach – or a tender for voluntary market making in line with the rule change request.

Stakeholders also suggested that, given the amount of activity in relation to the contract market currently underway, it might be advisable to wait for the outcomes of the ASX’s voluntary market making scheme, which starts in April 2019, and the Retailer Reliability Obligation, which is proposed to start in July 2019, before introducing any additional compulsory market making mechanisms.

There was less support from stakeholders for a triggered obligation than for voluntary solutions. Some participants felt this option could lead to less liquidity in the market due to the withholding of capacity by participants in anticipation of future obligations.

Compulsory market making in general drew broad opposition from industry and was seen to be overly onerous on obligated parties, with incentives also for non-obligated parties to "free ride" and benefit from the obligations faced by other market participants.

The ACCC, however, is supportive of compulsory market making given the concerns expressed in the Retail Electricity Pricing Inquiry around the impact of contract market liquidity on retail competition. The ACCC has strong concerns about the ability of voluntary market making to resolve the issues in the contract market.

Some stakeholders concluded that, although a lack of market liquidity is a problem, market making arrangements won’t solve the problem in South Australia as they don’t address the physical factors of the market – that is, small demand, high variable renewable energy-based generation, low interconnection – which make the market riskier, more volatile and as a result less liquid for contracts.

Stakeholders also noted the limitations of market making in respect of other factors – for example, that it won’t change the high prudential requirements that a smaller retailer must meet to be able to trade on the ASX, or the size of lots traded on the ASX which are currently barriers for small retailers.

Whether increasing transparency in the contract market is a solution

There was a lot of support at the workshop for the view that information around contracting in general could be improved, particularly on products that are not traded on an exchange, such as bespoke risk management tools (for example weather derivatives, load following hedges), and also Over-The-Counter (OTC) traded products, internal hedges and Power Purchase Agreements. Making this information available to the whole market, not just policy makers, would allow participants greater access to information that can assist them in their contracting decisions.

The project team advised participants it would develop a voluntary industry product survey and circulate to participants. The survey is intended to improve visibility on the overall level of contracting using products that are not traded on an exchange.

NEXT STEPS

The AEMC will continue to consult with stakeholders in developing the draft determination and will advise details shortly on the voluntary industry product survey which is open to both workshop participants and other interested industry stakeholders.

Stakeholders are welcome to contact Russell Pendlebury, 02 8296 0620 or James Hyatt, 02 8296 0628.

Media: Prudence Anderson, Communication Director, 02 8296 7817; 0404 821 935

BACKGROUND: CONTRACTING IN THE NATIONAL ELECTRICITY MARKET

Electricity retailers and large energy users enter into various wholesale hedging contracts to manage their financial risks and to have more certainty over wholesale energy costs.

These contracts fix the wholesale price retailers pay for electricity over the course of a year, or several years. This reduces retailers’ exposure to the highs and lows of the spot market, where prices can vary between -$1,000/MWh and $14,500/MWh, and helps to provide greater certainty over their cost of energy. Retailers can then offer their customers stable retail prices, which typically change only once a year.

For generators, entering into wholesale hedging contracts increases the certainty of their revenue streams, which lowers the financial risk of their operations and allows them to fund their ongoing operations and generation investments via banks and other financial institutions.
Banks and other financial institutions are also able to participate in the market and offer contracts without actually owning physical generation assets.

To work effectively, the contract market needs to be liquid – that is, there must be an ability to trade a sufficient volume of contracts in any timeframe such that retailers, large users and generators are able to manage their wholesale price risk.