Australia’s electricity and gas markets during COVID-19: know your contract terms, look for opportunities

Author Gilles Walgenwitz, Alister Alford

Date April 2020

In Energetics’ first podcast, energy markets experts Gilles Walgenwitz and Alister Alford discussed the impact COVID-19 is having on Australia’s electricity and gas markets. They not only shared their views on the trends and issues to watch but provided advice on the approach that large energy users should take to managing their energy portfolios during this time of upheaval and uncertainty[1].

Summary of recommendations

  • Monitor your demand to understand your risks and opportunities. What is your predicted electricity usage over the next six to 18 months? Could anything change? Undertake modelling to understand the variables that can influence your load shape and use this information to manage electricity market risks.
  • Know the details of your contracting arrangements. Know the level of flexibility and specific terms and conditions to minimise the risk of penalties, especially if your electricity demand is changing markedly.
  • Prices are falling, can you seize the opportunity to engage directly in the market? Are your decision-making processes fit for managing volatility? While trading desks have mandates and decision-making tools that enable a speedy response, most corporates are not set up that way. Businesses considering trading should determine delegations of authority, triggers for entering the market and know their appetite for risk.
  • To capture low electricity spot prices and reduce costs quickly, businesses can investigate a “blend and extend” contract. Key questions include, when is my contract set to end? At what price do I see worthwhile cost reductions? Does a long-term contract suit my circumstances?
  • Understand whether progressive purchasing works for your business. Well executed progressive purchasing strategies can be a highly successful risk management approach in a falling market.
  • Consider purchasing on the short-term gas market. Large gas users should assess current contract end dates and understand any risks associated with switching to a spot-based purchasing arrangement.

Issues as raised in discussion

Demand for electricity has dropped and prices are falling

With the implementation of social distancing and stay at home measures, a 5-7% reduction in electricity demand in NSW and Victoria has been observed based on a few weeks of data; although this information was not corrected for the seasonal effect of temperature. With the economic upheaval, there are also expected changes in the daily pattern of energy usage.

For energy users, the shifts in demand are different across the three broad market categories: SMEs (40-50%), large industrials/aggregated loads (around 20%) with the balance being residential (between 30 and 40%)[2]. Amongst large users, retailers, accommodation providers, clubs and other businesses with severely curtailed operations due to the social distancing requirements, will have lower electricity requirements. No impact has yet been seen in some of the very large industrials such as metals smelting.

What are the implications? For those whose electricity usage has fallen sharply, a sustained pattern of low consumption may lead to breaches of minimum annual volume conditions in their retail contract. However, as we are weeks, not months into our nation’s response to COVID-19, it is too early to determine what action should be taken, and at this point is an issue for business to monitor.

There are also actions businesses can take to proactively manage their electricity contracts. The most important is knowing the details of your contracting arrangements: the level of flexibility available and specific terms and conditions that minimise the risk of penalties.

Gas markets impacted by global LNG glut

Before the outbreak started, the Australian gas markets were affected by the glut in LNG supply worldwide, which pushed Asian spot prices towards the record low of US$3 BTU. The glut was a result of factors such as increased supply, high inventory levels, and a warm winter in the northern hemisphere. The situation was further compounded by the reduction in demand due to COVID-19. LNG buyers in north Asia are reducing the quantity that they are buying now and are trying to shift the delivery of LNG. Sellers are offering unsold term volumes to the spot market, which exaggerate supply/demand imbalance, making it harder for local Australian exporters to find a good price in the Asian spot markets. As a consequence, Australia is seeing downward price pressure and fewer arbitrage opportunities to export the non-contracted volume.

Gas prices in the Short Term Trading Market (STTM) hub over last few months saw Brisbane at sub-$4/GJ and Sydney below $5/GJ. The effects are flowing through to the marginal cost of gas-powered generators and businesses with large gas intensive processes, which now have more opportunities to purchase gas on the STTM. Energetics recommends considering such alternative arrangements. As an action, large gas users should assess current contract end dates and the appetite for switching to a spot-based purchasing arrangement.

What could be the long-term impact on electricity markets?

The longer-term impact will depend on the length of the lock down response to the pandemic, the speed of a global economic bounce back and the level of support given locally by federal and state governments. We have seen Goldman Sachs estimate a 6% contraction in GDP in Australia in 2020 compared to 2019[3]; a figure similar to OECD estimates[4] based on three months of lock down. Should the COVID-19 response extend for six months or more, the GDP impact is likely to be much higher.

If you applied the typical elasticities between GDP variation and electricity demand, you could see a 3.5% contraction in annual volume which could also impact 2021, depending on whether Australia is still in recession. While not very large figures, such a reduction in annual volume contracted and the economic challenges ahead, could create a compounding impact above other deflationary price drivers.

Also, over the previous six months we saw a change in the bidding behaviour of some coal fired power generators, offering volume at lower prices particularly in quarters falling outside the typical Q1 summer period. This, together with the lower gas fuel costs for thermal power generators, could compound the impact of COVID-19 into the long term.

We have also seen a drastic reduction in prices in exchange traded futures contracts. In NSW futures contracts for delivery in calendar years 2021 and 2022 have experienced a fall of 23% in price between 1 November 2019 and 3 April 2020. For large businesses with, for example, a usage in the order of 100GWh pa, could see a drop in budget required of $1.6-1.7 million. Not an insignificant fall. This is particularly good news for those who haven’t yet bought for FY21 or Cal21, or those who can back end their purchasing under progressive arrangements.

Also, for those consumers with a contract in place for a number of years at prices well above where the market is trading that were determined say 12-18 months ago, the opportunity exists to “blend and extend” – you don’t have to wait until your contract reaches maturity. Your retailer may be able to lock in for another 18 months to two years on top of the existing term of contract. The market rate therefore becomes immediately applicable. There are advantages on both sides, retailer and purchaser. Retailers value the certainty gained over the term of the contract. For businesses which need immediate relief, cash flow pressure can be alleviated. There are some caveats as a view on the market is being taken over next 12-18 months. If your business is not struggling now, it might not be the strategy to pursue. Certainly, the current circumstances illustrate the importance of “time-to-market” and the benefits of progressive purchasing in a downward trending market.

References and Footnotes

[1] We note that the information in this article was current at the time of the podcast (8 April), circumstances have changed since then and not all data will be up to date.

[2] these percentages are the typical spread across Australia’s more populous states

[3] Scott, M: “Goldman Sees Deepest Australian Downturn Since Great Depression”, Bloomberg

[4] OECD Economic Outlook, Interim Report March 2020, “Coronavirus: the world economy at risk”

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