Developers and large energy users engaged directly in the market: what can you do to mitigate the risks of the energy transition’s “messy middle”?

 

In this blog we look particularly at the issues for developers and large corporates directly engaged in the market and explain how a portfolio approach can help mitigate those risks.  

It’s easy to see why the industry is talking about being in the messy middle of the energy transition. There is a lot of uncertainty. In a recent webinar run by the Business Renewables Centre Australia, “Take control: Renewable energy contracting strategies to manage uncertainty to 2030 and beyond” Smartestenergy’s Dan Smith shared his insights on the drivers of market uncertainty.

A shifting landscape – high and volatile prices are set to continue  

The forces that have created a “messy” midpoint in the energy transition are broad: regulatory changes, insufficient generation, greater complexity in contracts, financial markets yet to adapt to the transition and difficulties in securing talented people with the qualifications and experience necessary for managing through this period of uncertainty. More specifically, the drivers that are creating uncertainties and must be bridged through to and beyond 2030 include:

• Extensions to the operating life of poorly performing coal fired generation assets, and with that, the prospect of future supply failures.
• The end of the Renewable Energy Target (RET) in 2030 and the cessation of Large-scale Generation Certificate (LGC) creation. In its place, a new market will form and trade certificates called REGOs (Renewable Electricity Guarantee of Origin). Unlike the creation of LGCs, REGOs will be entirely voluntary.
• The impacts of the Capacity Investment Scheme and Long-Term Energy Supply Agreements in supporting the build out of new renewable and firming capacity.
• The outcomes of the Nelson Review of the National Electricity Market (NEM) and the possible changes that could be implemented. The final report is due before the end of 2025. Note that SmartestEnergy will provide immediate comment following the report’s release and, in the new year, a more detailed view of the Review’s recommendations.

Another aspect – and a big question for those engaging directly in the market – is, will there be good quality generation projects in the period leading up to 2030? Given the prevailing conditions, good quality projects are likely to be scarce.

We also expect to see an increasing complexity of contracts. Today, most PPAs in the market are standard run of plant. However, in the next phase of the energy transition, where currently buyers and sellers are far apart on price expectation, the gap will be bridged by more complex contracting structures such as hybrid solar and Battery Energy Storage System (BESS) contracts.

Is the market evolving to provide large energy users with greater options to manage their energy transition risk exposure?  Yes, but not enough. There are a number of issues:

• The derivatives market isn't keeping pace with the physical market transformation. We still have financial products that work for vertically integrated gentailers with fossil fuel generation with chunky baseload contracts.
• The types and granularity of energy products. We are seeing some progress with time-of-day and fixed shape products being developed. There are more battery contracts which are particularly interesting for how they can be used by corporates as a hedge against the price volatility caused by the increasing percentage of renewables. However, battery contracts are still in their infancy with options like physical tolling, virtual tolling and revenue swaps. The market appears to be tending towards virtual tolling, but there isn’t a standard form. For corporates the simplest approach is a revenue swap, where a fixed fee is paid for a share of the revenue generated by the battery. In doing that a corporate is trusting and taking the risk of the asset owner’s ability to optimise the battery, especially against the competition as that asset class starts to saturate. In summary, there is still a lot of work to be done before a standard product structure emerges.

Finally, and arguably one of the greatest challenges, is the problem of people resources and finding qualified and experienced people at time of increased competition. 

How do these challenging market conditions impact different stakeholders across the energy value chain?

Amongst the different energy players, the responses are similar:  

• Developers are increasingly required to take on market and operational risk. Such pressure may see more developers reassess what kind of business they need to be and where they sit in the energy value chain.
• For very large corporates which manage their energy with inhouse expertise, assessing the risks through this period may also lead them to decide the amount of risk they are prepared to take on and manage.
• Retailers need to evolve to create solutions that integrate their active participation in the energy markets. There is a greater choice, and customers don’t just want to “shop in the one store” for the next 5-10 years.  We need to think more like the Amazon business model, and facilitate buyers and sellers, regardless of whether a product is the retailer’s or not. Retailers could choose to make developer’s projects accessible through their own products and provide the capabilities that are better suited to an energy retailer, such as managing settlements and smoothing cashflows.  

What can energy users do to mitigate their energy transition risk exposure – recognising that organisational size, risk tolerance, operational capability all play a role?   

For corporates that are large energy users and have a commitment to renewable energy, taking some risk and directly engaging in the market, may be worth considering - even with the amount of uncertainty ahead. The opportunities include:

• Creating a portfolio of hedges: The thinking is similar to that used with an investment portfolio where diversity is built across hedges. This can be across technology, tenor, structure, and geography (if it is in the same state as where demand is located). The bigger the corporate demand, the more diversity is warranted.
• Using different types of technology: Looking at combining wind and solar to reduce the basis risk created in the gap between supply and the demand profile.
• Tenor: Varying the contract term between long term for core load, and shorter term to mitigate operational flexibility and capture changes in technology.

While there is the issue of size and complexity of contracting and managing multiple contracts, it may be better to incur those costs and be proactive, rather than run the risk of doing nothing through this period of investment value uncertainty.

Final thoughts and an example of proactive risk management – retailer vs financial PPAs

At SmartestEnergy we have a customer who we worked with to help address the risks created by uncertainty. They chose to take a wholesale PPA directly. However, they didn’t want to deal with the settlements and overall contract management of a financial PPA themselves. Instead, SmartestEnergy acts as their settlement agent with the developer, and we have incorporated the PPA in a retail contract for them as a hedge. From there they can add additional PPAs or buy at market when suits them.

Such a strategy isn’t unique to SmartestEnergy as a capability, but the message is that you don’t need to wait to understand the complete package of supply agreements and hedges and find it all in one place. Instead, look at hedging some exposure now and consider starting to develop a portfolio with diversity built across it.

View the webinar in full on YouTube.

You can also read more about our support and guidance for large energy using corporates and developers in our article, “Perfect storm for corporate buyers seeking PPAs is building in the lead up to 2030 - don't get caught!”  

Disclaimer: The information enclosed is general information only; it cannot be relied upon as legal or financial advice. No consideration has been given or will be given to the individual investment objectives, financial situation or needs of any particular person or entity.