In the relentless search for value in electricity procurement, risk products are being increasingly marketed to larger organisations to try and beat traditional electricity retailers’ term contracts. The challenge lies in dimensioning the risk-reward payoff and benchmarking outturn performance.
There are a couple of risk models out there – they typically involve an intermediary managing the portfolio within specified hedging parameters, and a licensed retailer acting as biller and provider of short term hedges. The buyer is usually large – 50GWh per year or more – with a balance sheet to match.
There are few main options to benchmarking performance:
Obtain Indicative Offers
This approach is problematic. If the retailers know that they are being asked for indicative pricing, or they learn that any firm pricing they provide will not be contracted, then there is a risk of bias in the quote.
Use Real Reference Pricing
Actual reference pricing may be obtained from an exchange like the Sydney Futures Exchange and then combined with settlement, billing and other retail costs to synthesize a reference retail price. However, the futures market is not deep and will not match the buyer’s load shape. Alternatively, pricing from retail contracts concluded in the market may be used, if available. This is arguably a more reliable benchmark, but needs to be reflective of size, shape and location. However, retailer pricing is typically treated as confidential, so the data has to be presented as an anonymous, but auditable, distribution.
Procure Term Contracts for Part of the Portfolio
This is the most reliable alternative and depending on size, need only be applied to a moderate portion of overall load. It must be of the same shape and composition of the at-risk load. Ideally the benchmark portfolio should be comprised of a mix of contract maturities, rather than just a single, say, 3 year term to reduce the timing impact on the benchmark rate
It is imperative to measure both the actual costs incurred as well as the amount of risk taken. Volume limits can be set on risk, but consideration needs to be given as to whether the limits apply to every half-hour or a longer period over which exposures can be averaged. However, even a theoretically 100% hedged risk portfolio carries convexity risk, which is usually temperature related. Whilst a standard term contract may carry residual volume risk, the Retailer’s margin includes VoLL1 risk. The low likelihood, but high cost, of an uncovered VoLL event needs to be included in the risk calculation.
1 The risk of the electricity spot market maxing out – currently $12,500/MWh
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