Andrew sutherland erm power

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Information about Andrew sutherland erm power

Published on March 12, 2014

Author: informaoz


Our perspective on market reforms 8th WAPower&GasConference 12 March 2014

Important notice - disclaimer. 2 Disclaimer This presentation contains certain statements with respect to the Wholesale Electricity Market in Western Australia, the operations and business of ERM Power Limited (ERM Power) and certain plans and objectives of the management of ERM Power. It should be read in conjunction with ERM Power’s other periodic and continuous disclosure announcements to the Australian Securities Exchange (ASX) available at: Such statements may involve both known and unknown risks, uncertainties, assumptions and other important factors which are beyond the control of ERM Power and could cause the actual outcomes to be materially different from the events or results expressed or implied by such statements. None of ERM Power, its officers, advisers or any other person makes any representation, assurance or guarantee as to the accuracy or likelihood of fulfilment of any statements or any outcomes expressed or implied by any statements. The information contained in this presentation does not take into account investors investment objectives, financial situation or particular needs. Before making an investment decision, investors should consider their own needs and situation and, if necessary, seek professional advice. To the maximum extent permitted by law, none of ERM Power, its directors, employees or agents, nor any other person accepts any liability for any loss arising from the use of this presentation or its contents or otherwise arising out of, or in connection with it.

Presentation outline. • Who is ERM Power and how is it involved in markets? • At a broader level - key elements of market reform - WA status - WA future • At a WEM level - WA Energy Market - WA Capacity Mechanism • Conclusion • WA gas spot market 3 WA market reform – our perspective

Who is ERM Power and how is it involved in markets?

Our business in a snapshot. 5 Australia's 4th largest electricity retailer, with significant generation development and operating expertise • Ownership interest in, and operator of, two low emission gas-fired peaking power stations Oakey (100%) in Queensland Neerabup (50%) in Western Australia • Operator of the 320MW Kwinana baseload power station in Western Australia • Australia's 4th largest electricity retailer, licenced to sell electricity in all Australian states and the ACT and Northern Territory • Electricity supply exposure is hedged by using owned or contracted generation capacity and derivative contracts • Targeting business customer market Large businesses Small businesses • Conventional and unconventional exploration and production tenements in Western Australia and New South Wales • Exploring options for the business, including potential demerger • Since inception, ERM Power has developed >2,600MW of generation and has a further >2,000MW approved for development

Embraced by large business. 6 0 5 10 15 20 25 FY2009A FY2010A FY2011A FY2012A FY2013A FY2014F FY2015F AGL FY2013A ORG FY2013A TWh Electricity Sales – Large Business Segment Synergy ERM Power Source: ERM Power, Origin Energy and AGL Energy FY2013 annual reports and ERM Power forecasts ERM Power is among Australia's largest and most successful large business electricity retailers AGL FY2013

Capability in generation. 7 ERM Power has developed six power stations, representing ~5% of Australia's generation capacity Neerabup, WA (2009) Kwinana, WA (2008) Uranquinty, NSW (2008) Oakey, Qld (1999) Braemar, 1 Qld (2006) Braemar, 2 Qld (2009)

Generation development. 8 Lead managed development of 29% of all new scheduled generation commissioned across Australia over the five years to end of FY2010 997 757 744 724 460 416 340 300 208 166 140 135 120 88 86 49 2,337 0 500 1000 1500 2000 2500 ERMPower AlintaEnergy OriginEnergy CSEnergy Delta TRUenergy GriffinEnergy SnowyHydro Transfield Services AuroraEnergy RioTinto AGL QGC/ANZ WesternEnergy PowerandWater ATCOPower InfratilEnergy MW Scheduled generation capacity commissioned by lead developer since 2005 Source: AEMO - Winter Aggregate Scheduled and Semi Scheduled Generation Capacity (for Qld, NSW, Vic, Tas and SA) and ESAA 2010 (for WA) Note: Scheduled capacity (MW) figures do not relate to historical or current ownership interests in the commissioned generation capacity

Market reform at a broader level

Key elements of market reform. • Objective of market reform - Deliver lowest cost to the customer (electricity or gas); whilst not compromising - Security and reliability of supply • Goals of market reform - Encouraging competition in wholesale and retail sectors of the market - Minimising government involvement and increase private sector investment - Setting cost effective reliability standards • Requirements of reforming a market - Independence - from political interference - Transparency - best possible information - Efficiency - optimal use of resources - Liquidity - physical or financial markets 10 ERM Power a success story in transparent, efficient and liquid markets

WA status. • Poorly, according to the ESAA - Strategic Energy Initiative didn’t deliver - Re-merger viewed as a backwards step - Tariffs not cost reflective with GOCs propped up by state tax subsidies - Contestable customers (50 – 160kWh) can still have access to regulated tariffs - Tariffs often set against the advice of the regulator - Strong government involvement (generation, retail and networks) 11 How does WA score?

WA future. • Expect that it will improve - Well informed and proactive Energy Minister; readily accessible and knowledgeable advisors - Timely broad ranging market review - No-one supportive of the merger, however - Encouraged by regulations regarding the merger which should result in increased retail competition. Verve/Synergy hasn’t just been put back together - Standardised products will result in forward price discovery and competition - Jury is still out on the merger - > headed in the right direction but still uncertainty on how the entity will behave - WEM energy market improving in efficiency and transparency. Strong recognition by the IMO for improvements - WEM capacity mechanism taking small step changes to more efficient outcome (although still requires tuning) - Governments making noises of lowering participation and encouraging private investment (generation and retail) 12 How does ERM Power view the future scoring?

Market reform at a WEM level

Customer cost structure. • Focus of reform – based on the cost structure - At a state level the Market Review needs to focus on the energy, capacity and network components - At a Federal level the review of the Renewable Energy Target is being carried out along with repeal of the Carbon Pricing Mechanism 14 Reducing costs to customer - elements making up the cost

Key design elements of WEM. • Energy Market - Financial -> day ahead Bilateral and STEM, with Physical -> on the day near real time gross dispatch of generation Financial -> to-date very limited derivative products by participants and none by financial institutions - Two Price Caps (Gas - $305/MWh [annual] and Liquid - $550/MWh [monthly]); as we have a • Capacity Mechanism - Designed as a regulation for risk mitigation – physical (security of supply) and financial (price volatility) 15 Energy market and capacity mechanism – what we currently have to work with

View of the Energy Market. • Investment efficiency - Top end -> affected by Reserve Capacity Mechanism, load growth over forecasting - Current surplus doesn’t appear to be efficient investment 16 Reform Requirements - Efficiency Lots of high SRMC plantSource: IMO

View of the Energy Market. • Investment efficiency - Bottom end -> current oversupply in the market with effect on overnight thermal plant cycling - Affected by Federal Government energy policy – RET Scheme - Affected by State Government investment Reform to balancing market has at least allowed wind farms to price turndown which it couldn’t previously 17 Reform Requirements - Efficiency Cockburn being run at very low capacity factor – yet most efficient in the Synergy fleet Frequent cycling of coal plant

View of the Energy Market. • Investment efficiency - Effect is a world wide issue - Falling demand decoupling from GDP growth - Government policies regarding renewables creating distortions - WA has the added influence of Capacity Mechanism 18 Reform Requirements - Efficiency

View of the Energy Market. • Operational Efficiency - Most efficient decisions are ones made with the most amount of information possible - Hence best decision is as close to real time as possible - Reform to Energy Market has been a huge positive step from day-ahead dispatch to near real time gross dispatch 19 Reform Requirements - Efficiency Plant production set day-ahead and not moving with on-the-day conditions Old Market – inefficient!!

View of the Energy Market. • Operational Efficiency 20 Reform Requirements - Efficiency Source: Sapere CBA Report October 2013

View of the Energy Market. • Operational Efficiency - Sapere estimated $3.2M p.a. benefit in lower cost plant dispatch; and - $10.2M p.a. benefit in greater generation offered at dispatchable prices/reduced price spread 21 Reform Requirements - Efficiency Source: Sapere CBA Report October 2013 $- $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000 $5,000,000 Monthbalancingcost Comparison of actual and predicted balancing costs Actual Without competitive balancing Introduction of competitive balancing

View of the Energy Market. • Operational Efficiency - There is still work to be done and room for improvement - Issues already undergoing review under the market development program 22 Reform Requirements - Efficiency Requirements • Improve load and wind forecasting • Reduce 2hr Gate Closure to 1/2hr • Reduce 6hr LFAS Gate Closure to 1hr • Increase transparency e.g. updated wind forecast and wind generation in the BMO • Cost benefit analysis of Synergy portfolio bidding moving to facility bidding

View of the Energy Market. • Synergy Merger ― Majority of energy is held by Synergy either directly or through PPAs -> creates liquidity problem ― Wholesale obligations of non-discrimination appear encouraging ― Standardised products should provide greater opportunity for retailers to hedge their contractual positions ― Headed in the right direction and should result in increased competition • Product Diversity ― Spot Market -> near real time market has opened up the opportunity for electricity derivatives which wasn’t previously practical by any other participant other than Verve as default balancer. ― Forward Market -> Synergy standardised products provides price discovery and the potential for other supplies to provide forward prices ― Potential for entry of financial institutions -> market needs to be set up to move away from being exclusively trading based on physical delivery of product. 23 Reform requirements - Liquidity

View of the Energy Market. 24 Reform requirements – liquidity comparison to the NEM FY13: OTC + ASX = 633TWH Underlying Consumption = 184TWh 3.4 x underlying is traded

View of the Energy Market. • Informed decision making improved by access to information ― Plant dispatch. IMO has done a great job improving transparency 25 Reform requirements - Transparency

View of the Energy Market. • Informed evaluation ― Synergy Standardised Products -> Forward price curve will provide price discovery for customers and regulators. 26 Reform requirements - Transparency

View of the Capacity Mechanism. • Key decision in the design - are you confident that the market can find a solution? • Open market vs regulated mechanism – conflict between markets and security of supply • Reserve Capacity Mechanism – regulation to ensure security of supply or adequate Reserve 27 Capacity Mechanism not a market

View of the Capacity Mechanism. • Comparison to NEM – Let the market find a solution vs regulated price 28 Capacity Mechanism, not a market NEM WEM Energy Price Limit $13,000/MWh $305/MWh gas; $550/MWh liquid Cap Strike Price $300/MWh Cap on Energy Prices Cap Premium Price Three to two year forward price Strong response to supply/demand Range $21 to $0/MWh Regulated - two year forward price based on 160MW OCGT Weak response to supply/demand Paid even if not required Range $21 to $11/MWh Cap Volume Retailer decides – it’s a risk management tool. Either buy short term financial product or underwrite peaker Regulated - based on 12 Trading Intervals in a year with uplift factors covering the oversupply

View of the Capacity Mechanism. - NEM cap market -> price and value moves rapidly with supply situation 29 NEM – manages risk via letting the market find a solution

View of the Capacity Mechanism. - NEM forward energy price -> falling Cal 13 to Cal 16 do to oversupply (reducing demand and RET) 30 NEM – Manages risk via letting the market find a solution Reducing Forward Energy Price (SFE – Sydney Futures Exchange)

View of the Capacity Mechanism. - NEM cap market -> price and value moves with supply situation. 31 NEM – Manages risk via letting the market find a solution. Cap price at new entrant level. Risk for merchant Cap suppliers

View of the Capacity Mechanism. - NEM cap market -> implied ex-post value directly linked to price volatility 32 NEM – Manages risk via letting the market find a solution % Time

View of the Capacity Mechanism. - Price based mechanism with certification not linked to requirement - Two year forward price set on regulated methodology - Develop bankable project and you’re certified for payment if built - Price moves with under/over supply but very slowly compared to market based NEM forward cap price - Price above new entrant incentivises build even if not needed - Arguable that it was only ever intended as a safety mechanism in event of shortfall 33 WEM has Capacity Mechanism, not a market

View of the Capacity Mechanism. - Regulated price has contributed to capacity oversupply in the short term not energy oversupply - Merchant capacity plays where new entrant cost was less than regulated cost 34 WEM has Capacity Mechanism, not a market Price influenced by estimated network costs Source: IMO

View of the Capacity Mechanism. Supply side - Major contribution from DSM and liquid peakers with fixed costs below the Reserve Capacity Price - Small contribution from energy producing or high utilisation plant 35 WEM has Capacity Mechanism, not a market Source: IMO

View of the Capacity Mechanism. Customer Side - Oversupply is shared by all retailers regardless of whether contracted bilaterally for capacity credit supply - Retailers bilaterally contracted bear the cost of oversupply - Retailers not bilaterally contracted don’t bear the cost as price is proportionately decreased with oversupply - Outcome is no retailer contracts bilaterally for capacity credits unless linked to energy producing plant PPA - There isn’t an appropriate risk profile to encourage bilateral contracting for capacity 36 WEM has Capacity Mechanism, not a market

View of the Capacity Mechanism. Customer Side - Method for allocating capacity to customer sites makes it difficult for retailers to provide bundled deals • Volume is uncertain during 12 half hour peak intervals • Uplift factors uncertain • Complexity = higher prices to the customer 37 WEM has Capacity Mechanism, not a market

View of the Capacity Mechanism. 38 WEM Capacity Mechanism Reform Reform - Lengthy pricing review was carried out by IMO with a number of recommendations Pricing - The pricing clearly doesn’t respond in an appropriate manner to supply/demand conditions NEM price responds, WEM doesn’t

View of the Capacity Mechanism. - Implied ex-post value of the liquid cap is very close to $0/MWh (never hits the $550/MWh “strike price”) yet; - is paid a premium > $20/MWh 39 WEM Capacity Mechanism Reform (Summer only)

View of the Capacity Mechanism. Rule Change on price mechanism – price formula more response to excess 40 WEM Capacity Mechanism Reform Source: The Lantau Group

View of the Capacity Mechanism. Rule Change on Price Mechanism - The proposed change is an improvement and is a good start - Arguable that its not steep enough to discourage low capital based capacity credits (e.g. DSM) - Also may not provide adequate risk profile to incentivise bilateral contracting - Balancing many factors and future tuning is likely to be required 41 WEM Capacity Mechanism Reform

Conclusion. 42 WA Market Reform - Synergy merger wasn’t supported but has at least been done in a way that should increase competition – but the jury is still out regarding behaviour against Wholesale Obligations - Government appears to be signalling reduced involvement which is good - Energy market • is oversupplied and affected by Government policies • IMO has done a great job with near real time dispatch and increased transparency - Capacity Mechanism • It’s not perfect but never will be • To remove it will be a huge change • Rather it should be tuned to better provide build signals and incentives for bilateral contracting • It should not incentivise build when it’s not needed

Gas spot market

WA gas spot market. 44 Gas market - WA now has a far better functioning electricity market - To complement this we would encourage a review of a live gas spot market that provides: • transparency of daily bid/offer spread • more efficient use of resources including transport • the correct level of independence and governance to attract major suppliers and users – hence greater liquidity

45 More Information: Andrew Sutherland General Manager WA Projects Email: Direct: +61 8 6318 6410 Mobile: +61 400 237 367 Website:

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