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Integration of Physical and Financial risk in Australia

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Integration of Physical and Financial risk in Australia s National Electricity Market Les Hosking Managing Director and CEO NEMMCO * Presentation Overview NEM ... – PowerPoint PPT presentation

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Title: Integration of Physical and Financial risk in Australia


1
Integration of Physical and Financial riskin
Australias National Electricity Market
Les Hosking Managing Director and CEO NEMMCO

2
Presentation Overview
  • NEM design- gross pool and contract market
  • Settlement inefficiencies
  • Risk management processes
  • Reallocation- offset spot with
  • contract payments
  • Futures payments
  • Central clearing- Objectives/Issues

3
NEM Design Gross Pool
  • All prices via pool
  • Compulsory
  • Competing generators
  • Energy only
  • Marginal price setting
  • Volatile -1k to 10k
  • Competing retail

G
G
G
G
Pool
R
R
4
NEM Design Contract Market
  • Risk management for Retailers requires
  • Contracting around compulsory gross pool spot
    market
  • Direct generation investment (vertical
    integration - gentailer)
  • Demand side control
  • Contracts can take the form of contracts for
    differences, hedges, swaps or futures
  • Via bilateral, brokers and exchange traded
    futures
  • Concerns over financial market liquidity
  • Vertical integration (gentailers)
  • Beyond Q2 2010 climate change uncertainty
  • Futures contracts strong but not in all locations

5
Gross Pool / Contract Market- Settlements
NEMMCO Retailer buys 100MWh Generator supplies
100MWh Spot price determined as
100/MWh Settlement 100x100 10,000 per
hour via NEMMCO

Contract at 40/MWh (100 40) x 100MW
6,000 per hour
Banking System
6
Gross Pool financial inefficiencies
  • NEMMCO
  • Circular cash flows
  • Volatile cash flows
  • 33 day settlement
  • High prudential requirements
  • Credit default risks
  • One retailer has failed

Banking System
7
Prudential Management
  • Risks from large volatility in price
  • Risks from rapid payment obligations
  • Largest retailer (20 of NEM) with spot price at
    10,000/MWh will increase exposure to NEMMCO at
    1Million per minute
  • Risk of non payment covered by bank guarantees
    with NEMMCO
  • NEMMCO typically holds 1.5Billion to 3.5Billion
    in bank guarantees
  • Level of guarantee (Max Credit Limit) driven by
    energy traded, average price and price volatility
  • Daily review of participant exposures
  • Rapid payment requirements when near limits
  • Default then suspend if obligation not met
  • Rapid retailer of last resort required

8
NEM Outstandings History
9
Reallocation- Offset spot with contract payments
  • Option to offset the credit from one party
    (generator) in MW or against the debit from
    another (Retailer) - in line with their financial
    contract position
  • Slow to be taken up by participants
  • Confidentially concerns
  • Counterparty credit issues

10
Mechanics of Reallocation
Reallocation of 100MW between Generator and
Retailer which is valued at 10,000
Retailer buys 100MWh Generator supplies
100MWh Spot price determined as
100/MWh Settlement 100x100 10,000 per
hour via NEMMCO
NEMMCO
NEMMCO
Reallocate 10,000
Reallocate 10,000
Banking System
11
Growth in Reallocations - MWh
12
Reallocation by Formula
  • NEMMCO is moving towards reallocation by formula
  • Effectively allows parties to settle derivatives
    via NEMMCO and net against physical spot
    settlement
  • Requires licence/exemption from Securities
    Regulator ASIC

13
Reallocation by Formula
Retailer buys 100MWh Generator supplies
100MWh Spot price determined as
100/MWh Settlement 100x100 10,000 per
hour via NEMMCO
Reallocation of 100MW swap between Generator and
Retailer which is valued at 6,000
NEMMCO
Reallocate 6,000
Reallocate 6,000
Retailer
Generator
Contract at 40/MWh (100 40) x 100MW
6,000 per hour
14
Futures Offset Arrangement
  • Investigations into using positive margins from
    futures contracts flowing to NEMMCO
  • Has strong upside price stablising effect for
    retailers
  • Risks need to be understood
  • Complex under insolvency
  • Complex in segregation of accounts in clearing
    participant and potentially clearing house

15
Futures Offset Arrangement
Positive margins
Futures Exchange
NEMMCO
Clearing Participant
6,000
Futures Contract
Generator
Retailer
16
Central Clearing Objectives/Issues
  • Shorten settlement cycle in the NEM
  • Align settlement times of all products
  • Data on amounts owing and to be paid fed to
    Central Clearer
  • A single party takes responsibility to clear all
    products
  • All payments made to Central Clearer
  • Prudential regime managed by Central Clearer
  • Central Clearer to be responsible to address
    defaults and remove defaulting parties
  • Synergy with market operation functions
  • Acceptance of compulsory central clearer by
    participants

17
Conclusion
  • ISSUES
  • Gross Pool Challenges
  • vertical integration
  • liquid Financial markets
  • Settlement Inefficiencies
  • offset spot/forward difficulties
  • protracted settlement cycle
  • credit squeeze
  • Central Clearing
  • outsourcing issues
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