The AEMC has proposed not to make a rule to introduce additional market making schemes in the national electricity market, in a draft determination released today. This is because a number of initiatives are already underway that should increase contract market liquidity – in particular the ASX’s voluntary market making scheme and the market liquidity obligation which is part of the Retailer Reliability Obligation

At the same time, the Commission has proposed a range of initiatives to improve transparency in the electricity contract market. This would improve price discovery for those seeking to buy and sell hedge contracts, and also make it easier for regulators to assess market performance including liquidity. 

Market making arrangements aim to increase the opportunities for market participants to trade in electricity hedge contracts and to have greater visibility of wholesale contract prices. They can be voluntary or compulsory.

The service is typically made available in less liquid markets so that retailers and other market participants always have an opportunity to buy and sell electricity futures contracts. This helps to increase market liquidity and support competition and confidence in the market as a whole.

There are a number of initiatives underway that should increase contract market liquidity in the national electricity market – in particular the ASX’s voluntary market making scheme and the market liquidity obligation (MLO) which is part of the Retailer Reliability Obligation, which are both due to start on 1 July 2019. 

In making its draft determination on a rule change request from ENGIE to establish a tender for voluntary market making services, the Commission found that additional market making arrangements beyond the ASX and MLO initiatives would ultimately add costs for consumers while being unlikely to provide any additional benefits.  

Key findings include:

  • Liquidity across the national electricity market is generally healthy, although liquidity in South Australia is much lower than in other regions.
  • The structural characteristics of the South Australian market contribute to lower liquidity. The characteristics include limited firm generating capacity, a heavy reliance on gas for firming capacity, high penetration of renewables, low levels of demand, limited interconnection and high levels of vertical and horizontal integration which can reduce the broader availability of contracts. 
  • The ASX and MLO schemes are expected to improve liquidity compared to the levels currently observable in the market. These improvements should be most notable in South Australia.
  • Independent analysis of the costs (NERA report) and benefits of the different types of market making arrangements by NERA found that if the ASX scheme delivers to its design, there would be no additional benefit from additional market making schemes. There would however be additional costs. 

The draft determination also sets out specific monitoring and reporting that the Commission considers should be undertaken by the Australian Energy Regulator. This includes monitoring the ASX voluntary scheme and implementation of the MLO/Retailer Reliability Obligation to see if these new market making arrangements provide the intended benefits to contract market liquidity. This function would be enabled by proposed law changes to expand the AER’s market monitoring function to include the contract market.

The draft determination also notes improvements are needed in relation to the reporting of OTC trades through the AFMA survey of market participants, particularly in relation to price, coverage and timeliness. This would address material information gaps in the contract market which undermine price discovery for participants, and also regulators’ ability to assess market conduct and performance. The Commission will work with the AER on these improvements, including whether large vertically integrated market participants should regularly report specific additional data to enable ongoing assessment of market conduct and performance.

Submissions on the draft determination are due by 8 August 2019.

Media: Prudence Anderson, Communication Director, 0404 829 935; 8296 7817

Background: Contracting in the national electricity market

Electricity retailers and large energy users enter into various wholesale hedging contracts to manage their financial risks and to have more certainty over wholesale energy costs. 

These contracts fix the wholesale price retailers pay for electricity over the course of a year, or several years. This reduces retailers’ exposure to the highs and lows of the spot market - which can go as low as minus $1,000 per MWh, and as high as $14,500 per MWh - and smooths their costs. Retailers can then offer their customers stable retail prices, which typically change only once a year.

For generators, entering into wholesale hedging contracts increases the certainty of their revenue streams, which allows them to get funding for their generation investments from banks or other financial institutions. 

Banks and some other types of financial institutions are also able to participate in the market and offer contracts without actually owning physical generation assets.

To work effectively, the contracts market needs to be liquid – that is, there must be enough contracts available for retailers and large users to manage their wholesale risk, and for generators to finance their investment.