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Hedging

Purpose of hedging

future-financial-risk-management-in-the-nem-report-for-the-accc.pdf

  • help manage the revenue risks to generators

  • provide retailers with greater energy purchase cost certainty

  • allow welfare maximising price discrimination

  • lower entry and exit barriers

Ways of participants hedging their exposure to spot prices

  • Vertical integration: A retailer that owns a generator

  • Power purchase agreements (PPA) with a generator

  • Financial derivatives such as swap contracts and cap contracts

Financial Hedging

  • Futures Contracts: Retailers can use futures contracts to lock in the price of electricity for a future delivery date. By entering into a futures contract, retailers can protect themselves from potential price increases in the electricity market.

  • Options Contracts: Options give retailers the right, but not the obligation, to buy or sell electricity at a specified price (strike price) on or before a certain date. Retailers can use options to hedge against adverse price movements while retaining flexibility to benefit from favorable price changes.

  • Swaps: Electricity swaps involve exchanging cash flows based on the difference between fixed and floating electricity prices. Through swaps, retailers can manage their exposure to price fluctuations and reduce the impact of market volatility.

Volume Hedging

  • Baseload Contracts: Retailers can enter into baseload contracts to secure a fixed volume of electricity supply throughout the day. Baseload contracts provide certainty of supply, making it easier for retailers to plan their electricity needs accurately.

  • Peak Load Contracts: Peak load contracts provide additional electricity supply during peak demand periods, allowing retailers to meet their customers' increased electricity consumption during those hours. These contracts help manage capacity constraints and reduce reliance on the spot market.

Portfolio Diversification

  • Contract Types: Retailers can diversify their electricity supply portfolio by having a mix of contract types, such as spot market purchases, long-term contracts, and power purchase agreements (PPAs) with renewable energy sources. This diversity helps mitigate risks associated with market fluctuations and regulatory changes.

  • Energy Sources: Diversifying the sources of electricity supply is essential for managing risks and supporting sustainability goals. Incorporating a mix of conventional and renewable energy sources ensures a balanced and resilient energy portfolio.

  • Geographical Diversification: Retailers can source electricity from various regions to spread risk and reduce the impact of localized supply disruptions or extreme weather events.