Andrew Sutherland, ERM Power - ERM Power’s perspectives on market reforms

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Information about Andrew Sutherland, ERM Power - ERM Power’s perspectives on market reforms
News & Politics

Published on March 12, 2014

Author: informaoz



Andrew Sutherland, General Manager WA Projects, ERM Power Ltd delivered this presentation at the 8th Annual WA Power & Gas Conference 2014.

The conference represents a timely meeting for the industry to hear about the current changes affecting the WA energy and electricity market.

For more information, visit

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  plant  Source:  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  producFon  set  day-­‐ahead  and  not  moving  with  on-­‐the-­‐day  condiFons   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 Month  balancing  cost 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  ConsumpFon  =  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  uplig  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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