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A little [ price volatility ] goes a long way

The year of 2020 is slowly ending which means that summer has well and truly arrived. However, for those with some connection to the NEM, this is a period where speculation peaks in terms of what summer has in store for us – and with good reason! Of all parts of the year, the March Quarter tends to feature the warmest temperatures which feed peak demand days as well as the potential risks of plant failure and environmental factors such as bushfires. These factors come together to make the next three months some of the most tense of the year for some.

To put the March Quarter into context, roughly 30-40% of the total yearly cost of electricity occurs in these months. In fact, for the last two years, ~19% of the yearly value was in the month of January. In dollar terms, ~$4-6 billion dollars traded in each of these two years in January.

Given the scale of the financial impacts, the expectation of prices in the quarter are front-of-mind for all in the market, particularly around risk management and hedging. The ASX futures can provide a view of market sentiment based on the prevailing strike prices for listed products – two in particular; swaps and caps. Swaps represent a flat profile at an average price across the period while caps are essentially a volatility product which reduces the exposure to intervals above $300/MWh for the purchaser.

The swap product indirectly captures the price volatility component therefore by subtracting the cap value from the swap we arrive at an underlying price for the period. The ASX futures as of COB yesterday are charted in Figure 1 including the actuals of previous March Quarters. Base Futures in most regions are currently around $70-76/MWh except for QLD lower at $56/MWh. Cap components of these prices are relatively large with caps trading around $20-27/MWh. This translates to expected underlying prices of around $45-50 in all NEM regions.

The current values for the coming period seem to align with the actual outcomes of Q1 20 – where prices were comparatively low on average however, a handful of extreme price events drove a significant rise in the averages.

Our Q3 2020 update of the Benchmark Power Curve (BPC) price forecast has a similar expectation for upcoming March Quarter in terms of the underlying price albeit slightly higher. Our modelling suggests that the ASX value for caps is likely capturing some speculation to the impact of unforeseen failures like those in Q1 20 (NSW transmission line outage due to bushfires and SA islanding event). We also ran a sensitivity for Victoria where we forced an outage of a single brown coal unit for a twelve-hour period during a system peak day which led to multiple periods of price at the market price cap (MPC). This led to an increase in the average price for the quarter of more than $6/MWh from a single event. For context, a single interval of MPC prices increases average prices by ~$2.60/MWh for a quarter.

In our upcoming Q4 2020 update of our Benchmark Power Curve, we will be providing a clearer picture of our expectations for the upcoming quarter as well as the impact that the significant pipeline of renewable and storage projects coming online will have on price outcomes in the long term. To learn more or get a copy when we release (shortly), please drop me an email or send one to enquiries@cornwaill-insight.com.au