Finance Professionals Seminar
Financing the Domestic Energy Markets
– A Changing Risk Landscape
Simon Schwarz
Financing the Domestic Energy Markets
• Introduction
• Basics
• Typology of Risks
• Putting it All Together
Introduction
• National Electricity Market
(NEM) inter-connecting the
Eastern Australian States.
• World’s longest interconnected AC power system.
• Relatively simple and large
market, few firms, relatively
few assets – easy to model.
• We will focus on the
wholesale generation market
within the NEM.
Source:
Australian Electricity Market Operator, “Pivotal to Australia’s Energy Future”, August 2012
Basics
• Value of a firm or asset is the discounted value
of future net cash flows expected to be
received by that firm or asset.
• Revenue streams are the value of electricity
generated and sold (plus LGCs for renewable
generation, minus carbon price for fossil fuel
generation).
• Spot prices are determined by SRMC.
• Future price paths are determined by LRMC.
Wholesale Price of Electricity
• The transport of electricity from generators to
consumers is facilitated through a ‘pool’ or spot
market, where the output from all generators is
aggregated and scheduled at regular intervals
through the day to meet demand.
• All generators bid capacity into the pool at these
intervals. The clearing price of electricity is set at
the level where aggregate bid capacity at that
price exactly meets demand for that interval.
Short Run Marginal Cost
• Generation portfolios enter into electricity
derivative contracts to hedge wholesale revenues
in order to reduce earnings risk.
• Thus, generators are considered indifferent to
spot price movements across the volume of these
contracts except where the spot price falls below
its Short Run Marginal Cost (STMC).
• Optimal strategy: for a generator is therefore to
offer all contracted generation at SRMC.
Long Run Marginal Cost
• Basic premise: if market prices are significantly
and persistently above Long Run Marginal Cost
(LRMC) then this should, given time, prompt new
generation investment that restores prices to
those levels.
• Classic definition of the LRMC of generation: the
levelised cost of meeting an increase in demand
over an extended period of time.
• LRMC =
Sources:
Δ NPV of costs
Δ NPV of load
NERA Economic Consulting, “Estimating LRMC in the National Electricity Market”, December 2011
Intelligent Energy Systems, “The Long Run Marginal Cost of Electricity in NSW”, February 2004
Long Run Marginal Cost (cont.)
• Theoretical generation program utilises
existing generation, committed developments,
and the most efficient new generation entry.
• Relies on accurate forecasts of levelised costs
of entry (LCOE) of different generation
technologies over time.
• LRMC calculation relies on accurate forecasts
of future load profile (demand) – both volume
and shape.
Typology of Risks – Market Risk
• Market Risk: the risk that changes in market
prices will reduce the value of a firm or asset.
• The value of firms or assets operating in the
NEM is primarily affected by the long run price
path of electricity, which determines the value
of their long run revenue streams.
• Mitigants – hedging, fixed price power
purchase agreements, vertical integration, low
gearing.
Market Risk Mitigants
• Hedging – fine in theory, but in practice: both
OTC and exchange traded hedging features
basis risk, limited tenors, limited liquidity.
Source:
ASX Electricity Base Load Quarterly Futures NSW, www.sfe.com.au/content/prices/rtp15sfBN.html ,
accessed on 15th August 2014
Market Risk Mitigants
• PPAs – Fine in theory, but in practice: limited
universe of creditworthy counterparties, high
bargaining power of suppliers, leading to low
prices, short-medium tenors, if available at all.
• Also introduces legal risk, eg. on existence and
nature of clean energy frameworks such as
carbon price, renewable energy certificates.
Who takes the repeal risk?
Market Risk Mitigants
• Vertical Integration – using a retail business to
on-sell to consumers under essentially fixedprice retail tariffs, as an internal hedge.
• This is the mechanism chosen by the large
incumbents, all 3 of whom have become
vertically integrated “Gentailers”.
• Has been touted by other major generators
such as Pacific Hydro.
Market Risk Mitigants
• Low gearing – occasionally a generation asset can
be financed on a merchant basis, ie. without long
term hedging or power purchase agreement.
• Typically this is done using project finance at low
gearing levels so the project maintains robust
debt serviceability ratios even under strong
downside scenarios in power price, eg. Westpac
project finance of Woodlawn windfarm in 2011.
• Equity is still exposed to substantial market risk,
now leveraged!
Typology of Risks – Model Risk
• Model Risk: risk that a model used to measure
value or risk of investments and financial
positions is wrong. May be due to internal error,
misapplication, incorrect assumptions or
misinterpretation of results.
How Many Modelling Firms Does it
Take to Change a RET Lightglobe?
• Renewable Energy Target modelling 2012-2014
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ACIL Allen for RET Review Panel
Frontier Economics for Australian Energy Market Commission
ROAM Consulting for Clean Energy Council
Sinclair Knight Mertz for Climate Change Authority
Jacobs SKM for the Climate Institute, the Australian Conservation
Federation and WWF Australia
Centre for International Economics for the Australian Industry
Greenhouse Network
Deloitte for Australian Chamber of Commerce and Industry, Business
Council of Australia, Minerals Council of Australia
BAEconomics for APPEA
Intelligent Energy Systems, public newsletter
Schneider Electric, public white paper
Generation Capacity Increased even as
Demand Declined (NEM 2007-14)
Source:
AEMO and Energy Australia presentation in RenewEconomy, 8th August 2014
Continual Demand Over-Forecasting
Source:
AEMO, “February Update: Supply-Demand Snapshot for the NEM”, March 2014
Continual Demand Over-Forecasting
Source:
AGL Energy presentation 2013 and AEMO in Citi Research, “Energy Darwinism in Australian
Utilities”, 10th February 2014
Solar PV Changes Load Profile
Source:
Energy Networks Association, “The Road to Fairer Prices”, April 2014
LCOE by Technology as at Dec 2013
Source:
BREE, Australian Energy Technology Assessment 2013 Model Update
Large changes in 2050 LCOE forecasts
Source:
BREE, Australian Energy Technology Assessment 2013 Model Update
Rapid Decline in Price of Solar PV
Source:
Bloomberg New Energy Finance in Citi Research, “Energy Darwinism in Australian Utilities, 10th
February 2014
Typology of Risks –
Reputation Risk and Operational Risk
• Reputation Risk: potential loss resulting from a
decrease in a firm’s standing in public opinion.
• Operational Risk: the risk of loss resulting from
inadequate or failed processes, people and
systems or from external events.
• Often these risks go hand-in-hand
Loss of Stakeholder Trust
Source:
Sydney Morning Herald, 11th August 2014
Costs of Reputation Risk
Source:
Thomas, T., Schermerhorn, J.R., Dienhart, J.W., “Strategic leadership of ethical behaviour in
business”, Academy of Managemenr Executive, 2004, in Heslin, P., AGSM, SM2 presentation, 2014
Typology of Risks – Political Risk
• Political Risk: risk that an investment's returns
could suffer as a result of political changes.
Source:
The Australian Financial Review, 18th August 2014
Carbon Tax Repeal
Source:
ASX & Media Release, AGL, 17th July 2014
LGC prices buffeted by political winds
Source:
Pacific Hydro data, 15th July 2014
Typology of Risks – Strategic Risk
• Strategic Risk: potential loss due to a decrease
in the competitive position of a firm.
• This risk is a function of a firm’s chosen
strategy, those of its competitors, and the
(changing) nature of the market and value
chain in which it operates.
Loss in Value of German Utilities
Sources: Thomson Reuters in The Economist, 7th June 2014
The Economist, 12th October 2013
Value Chain in Transformation
Source: IBM Institute for Business Value in Eurelectric, “Utilities: Powerhouses of Innovation”, 8th May 2013
New Market Models
Source: AGL Energy Limited, FY Full Year Results Presentation, 30th June 2014
Changing Business Models
Source: CSIRO, Future Grid Forum report: “Change and choice”, December 2013
Putting It All Together
• Investing in a stable market
• Investing in a disrupted market
Risk
Investing in a Stable Market
Technology
R&D
Growth
Business
Utility
Company
Investment Class
Generation
Asset
Investing in a Disrupted Market
Stranded assets
Risk
Portfolio
approach
Broken business
models
Riding the
disruption
Technology
R&D
Growth
Business
Utility
Company
Investment Class
Generation
Asset
Thank you
• Questions?