On May 22, 2018, our experts discussed the financial hedges that deliver set pricing outcomes for businesses’ bottom lines. They also shared some valuable advice on how businesses can keep electricity contracts flexible to best take advantage of the lows in the power market.
The Australian power market
Trades in the electricity market are published on ASX energy futures market. This is where you can see the actual price that power is being traded at. It works in exactly the same way that other commodities, such as gold, soybeans or even corn are traded.
Everyone buys their power from the wholesale market but you can be smart about how you do it – without getting involved in trades directly. Our customers don’t need to sign onto fixed-rate contracts for price certainty. Instead, we can achieve set prices on the wholesale market.
Accessing the upside of the spot market
The spot market, also called the wholesale market, gives pricing transparency and allows energy users to access low-cost dips in the market. In contrast, fixed-rate contracts carry a built in risk premium, meaning that you pay for risks that may or may not occur. You get the benefit of price certainty but don’t miss out on the savings that the wholesale market can give.
Businesses that are tapped into the wholesale market secure savings when the market performs better than predicted.
Price certainty on lockdown
You can achieve price security on the wholesale market. At Flow Power, we can secure price certainty for your business by understanding how you use power and what your requirements are.
Price certainty can be achieved in three ways:
- Physically responding to price signals.
- Buying and selling financial hedges
- Locking in long-term prices with Renewable Corporate Power Purchase Agreements (PPAs)
Businesses are diverse so standardised fixed-rates don’t often yield the best outcomes, especially if a business uses energy differently. For example, a winery will have very different needs to a manufacturer as it uses more energy in summer months whereas, the manufacturer has consistent energy use throughout the year.
Delivering set outcomes
Utilising the Ceiling Power Tool will set a limit to what you pay. This tool is set every quarter and works with your business’s evolving needs. It gives the benefit of fixed-rates but still lets you access the lows of the market.
It allows businesses to pay interval by interval wholesale prices but removes the risk of high-cost peaks.
Better than fixed-rate
Buy a ‘swap’ when the market is peaking and avoid paying higher spot prices. A swap is a contract of difference that allows you to trade the half-hourly spot price for a pre-arranged rate. Swaps give price certainty with the added benefit of greater risk management.
If you want your business to have the option of a swap in the future, take out a ‘swaption’. This hedge doesn’t lock you into a swap so if the market changes, you have the flexibility to decide if you want to use it or not. It’s the perfect solution for businesses that need to forecast further into the future.
If your business had been on the wholesale market in Q1 you would have come out on top.
Question & answer:
Q. What is the cost of a swaption?
A. It is not a significant cost given the potential upside of this strategy. In cost per MWh it’s no more than a couple of dollars. In c/kWh it works out to be 0.1c. For example, if you can buy a contract at 10c, adding a swaption would turn your price into 10.2 or 10.3 cents.
Q. What is the best time of year to take a financial hedge?
A. The best time to buy a hedge is when you need one but there are certain times in the market when contracts are generally cheaper than others. For example, coming into the summer period may not be the best time to look at contracts. Last year was a good example of that, we saw a lot of premium prices in the market and then prices dropped at the start of January.
There is some strategy needed. Our job is to guide our customers through this process.
If you consider that most customers will sign a retail contract at a specific point in time and either lock in a high or a low price, this is an important point to make. Timing is a factor but the right strategy can also deliver price certainty.
Q. What is the typical amount of price variation you would expect to see over a three-year contract?
A. It depends on the strategy you use. If you are looking at swaps, you could lock in a very high degree of price certainty. Depending on your load profile and energy strategy, it could be within 1-2%.
If a customer wants access to potentially lower market prices, should a dip occur, they would need to look into a ceiling or a swaption. These give price certainty for the future and also, offer an opportunity to pick up some value when the market is lower.
Q. What is the difference between a Wind VGA and a Solar VGA?
A. The contracts are the same, the only difference is the source of the generation – either wind or solar. While they can be signed separately, we recommend using both generation sources. This gives businesses better coverage.
Wind and solar have different generation profiles and blending them together can be beneficial for customers. It all comes down to how each customer uses power.
Q. How can we integrate financial hedges with demand response?
A. It actually integrates superbly. Demand response outside of a wholesale strategy doesn’t make a lot of sense because customers need the ability to respond to price signals occurring in the spot market. Ultimately, this is what makes demand response work.
Businesses can still be on a swap contract or a ceiling contract under a wholesale strategy. If it manages its load during a high price event, this is usually when demand response occurs.
You would get paid during the periods you reduce load. In addition to this, you could also participate in the AEMO RERT program and get the full benefit from the market. It is a very logical way to participate in demand response. Hedges often provide the opportunity for demand response without any obligation. It’s a great way for a customer to explore demand response in their organisation while ensuring set pricing outcomes.