The National Electricity Market (NEM) contains a wholesale spot market where generators are paid for the electricity they produce, and retailers pay for the electricity their customers consume.

All energy traded through the NEM must be settled through the spot market.Generators make offers to supply and are dispatched on a rolling five minute dispatch interval basis while financial settlements (and the spot price) are based on a 30 minute trading interval. Variability of demand and supply conditions can result in significant fluctuations of the spot price over the 30 minute trading period. Prices in the current spot market can range from the Market Price Cap (MPC) of $14,500/MWh to the Market Floor Price (MFP) of -$1,000/MWh. The MPC is adjusted annually in line with changes in the consumer price index.

Retailers and generators use electricity contracts as a form of insurance against these fluctuating spot prices enabling them to lock in long term revenues or costs at a fixed rate.

Contracts ensure retailers know the price that they will pay for electricity, which in turn allows them to write longer-term contracts with consumers, and therefore offer stable retail prices.

For generators, contracts provide a revenue certainty which is critical when seeking finance for new investments.

While the contract market is distinct from the spot market, the prices of contracts are based on forecast spot market outcomes.

Broadly, the spot market and contract market work together to support the financial integrity of the market and to provide signals for investment in new generation and demand-side technologies.

Forms of contracting in the NEM

Contracts in the NEM are currently traded either on the Australian Securities Exchange or bilaterally.

Swaps and caps are two examples of core contract types.

Thumbnail

Swaps

Under a swap contract:

  • A swap contract trades a given volume of energy during a fixed period for a fixed price (normally 1 MW for either a one month or three month period at the strike price).
  • The variable wholesale market spot price is, in effect, swapped for the fixed strike price.
  • The contract is settled through payment between the counterparties based on the difference between the spot price and the strike price.

Caps

Under a cap contract:

  • A cap contract trades a fixed volume of energy for a fixed price when the spot price exceeds a specified price.
  • It provides electricity purchasers with insurance against high prices.
  • The standard contract traded in the market is a “$300 cap”. This means the seller of a cap is required to pay to the buyer the difference between the spot price and $300/MWh every time the spot price exceeds $300/MWh during the specified contract period.
  • As a result of the one-sided payment obligations arising under a cap, caps are normally sold for a positive up-front premium.
  • The current premium for cap contracts in 2017 range from $13 to $56/MWh.