How to survive Australia’s energy market bull run

The Australian energy market is sky high at the moment. Consumers of energy in Australia are in for a real scare if they ask suppliers for quotes for delivery of energy in the next months and years. The forward wholesale price for delivery of electric power in 2018 has quadrupled in Victoria and tripled in other regions since the start of a bull run in the second half of 2015. An extreme bullishness reminding us of what we saw in Europe in 2005 – 2008. The Australian electricity price is now among the highest on the planet, which is weird in a country so richly endowed in coal and natural gas. What’s causing the high prices and how should you react to it?

What are the bull factors?

 Before going into the details of events leading to this spectacular bull run, we should make a remark on the unique character of Australia’s energy market, caused by the extreme geography. The enormous distances to be covered by power lines and gas pipelines, makes the Australian energy market a set of regional markets rather than one national market place.

 In 2015, the Australians consumed 253,6 TWh of electricity. That is less than a mid-sized European electricity market like Spain (278,5 TWh). If you know that Australia is more than 15 times bigger than Spain, you understand the difficulties of bringing this electricity together in one market. The consequence is that Australia is comprised of a set of regional, poorly interconnected markets.

 In itself, each of these markets are relatively small. This causes them to be highly perceptive to:

1. Price changes as soon as something changes in the supply and demand equilibrium.
2. Lack of liquidity in the wholesale markets.
3. Lack of competition in the retail markets.

 Whereas the demand in the Australian energy market has remained quite stable, supply has seen some remarkable changes in the last years, with the closure of many old coal-fired power stations. The marginal power stations are now more and more often gas-fired, with the electricity prices influenced by natural gas prices rather than coal.

 So wait a minute, you might say now, isn’t Australia sitting on massive reserves of natural gas? Yes, it is, and in the period 2000 – 2015 gas production more than doubled. But surprisingly, this natural gas isn’t finding its way to the inland market.

 Again, we have to look at Australia’s geography. The largest natural gas fields are to be found in the West, and currently there are no pipelines connecting them to the zones of consumption in the East. (The Northern Gas Pipeline should make that connection as of 2018.)

 Australia has chosen to use its natural gas resources for export as LNG. With energy-hungry Asia at its doorstep, Australia has wild dreams of becoming a new Qatar. It is going through a rapid expansion of its LNG export capabilities. However, the new export terminals in the East have been finalized much more rapidly than the terminals in the West. Due to this, the Eastern gas production, already under pressure from increasing demand for power production, now sees a lot of extra demand for export as LNG as well.

 This extra natural gas was supposed to come from the coalbed seams that are so richly endowed with methane in Eastern Australia. But production from this new source has failed to meet expectations. As such, Australians face the insane situation that inland gas prices are skyrocketing while exports increase rapidly. The Australian gas market is very opaque. Deals are bilateral and there are no market places such as Henry Hub or TTF that give a clear indication of prices paid. However, several sources cite prices as high as 12,5 Australian Dollars per GJ. That is a staggering 9 US Dollars per MMBTU or 30 euros per MWh.

 That is at times more than the prices at which Australian gas companies sell LNG in the spot markets in e.g. Japan, leading to accusations of oligopoly and market power abuse. It’s always difficult to judge such claims. Australian gas companies are struggling for market share in Asia, competing with e.g. newcomer US. It is therefore understandable that they might prefer to export to Asia even when prices in their own country are higher. Nevertheless, the Australian government has reacted to this and issued regulation that allows them to curb exports (read the article here).

 In a country so richly endowed in energy sources, there are many reasons why electricity prices could drop again:

1. Government interventions such as the curb on exports could prove effective.
2. Interconnection with Western Australia could bring more gas to the East.
3. Increasing LNG export capacity in the West could relieve pressure on the Eastern natural gas markets.
4. Developing a market of locational swaps could overcome the interconnection restrictions.
5. Australia could fix its renewable energy policy so that it can finally tap into its rich wind and solar resources. This could move the marginal MWh’s away from expensive gas-fired power stations.

 Whether these bearish factors will materialize is impossible to predict, especially as a lot of them depend on politics. For the time being, Australian energy consumers need to face the reality of high energy prices and figure out how to deal with them.

 What should you do?

When going into the market to ask for an offer for electricity pricing in the next years, Australians are in for a shock. If they fixed prices for the current period more than two years ago, they might receive an offer up to three times more expensive than what they are currently paying. How can you face such a situation?

The first advice is: don’t think the market will come down because you want it to. You can be the best energy buyer or consultant in the world, but you cannot determine whether markets move down or up. So don’t be tempted to develop a strong belief that “it has to fall again” and don’t do anything. Yes, you are too late, but if you don’t do anything, you might be even more so.

Be careful of rationalization in that context. I have cited some reasons above of why the Australian energy price could fall again. Maybe you’re already in that state-of-mind where they have reassured you. But neither me nor anyone can predict whether those factors will materialize. Moreover, no one can say what their exact impact on price will be. And it’s impossible to know whether other factors will not materialize that turn the market bullish again.

Second advice: don’t panic. We don’t know whether bearish factors will pop up, but we also don’t know for sure that they will not. Therefore, it could very well be that this is the highest moment, the exact peak. So, don’t let yourself be talked into a long term fix price deal because you think that if you don’t do anything now, it can only get worse. Many European consumers walked straight into that panic buying trap in the first half 2008, with lots of frustration when markets came down again.

Third advice: spread the risk. Moments like these are clearly showing why contracts where you can forward fix prices in different tranches are so valuable. If you had had such a contract in place, you would have probably done fixings in the rising market, making the situation less grave. Well, at least you would have had the possibility to do it. But OK, if you haven’t had such a flexible contract or you didn’t use it well, now is a good moment to do it.

This is a plan of action to deal with the current situation in the Australian market:

1. Analyze the current situation, even if it hurts to do so. By how much will your price increase if you fix now?
2. Set up a short term strategy based on two elements: 1. A stop loss that is higher than the current price level. 2. A spreading scheme based on the day by which you need to have a contract in place. E.g., if you need to have a new contract by 1/1/2018 and you want a fix price in 2018, you could go for a flexible contract with six tranches and then fix a tranche in each of the next six months. If the markets continue to run up, speed up the fixings to keep your price below the stop loss levels.
3. If your consumption is too low to obtain such contracts with price fixing flexibility, you can think about varying the duration of the fix price contracts that you sign. E.g. sign a contract for the first six months of 2018. Next, monitor the market for what happens to the remaining six months and keep the overall price for the year below your stop loss level. Signing the next fix price contract then for one year and going on with one year contracts starting on the 1^st of July, brings the advantage that you’re always fixing the price for half the volume of two years at the same level, which brings price stability.
4. Take your time to define a long term strategy that will make sure that you will never be in this situation again in the future.

Australia’s recent energy price history shows that volatility remains a reality in energy markets and that strong price increases can always occur, anywhere, even in a country with a lot of coal and natural gas. It shows the importance of having a solid strategy in place and monitoring your portfolio in all corners. Many of you reading this article will now realize that as far as their Australian activities are concerned, they are too late. Don’t let that lure you into bad decision-making.

If you want to discuss your situation in Australia and get some first-hand advice on what to do, please contact our business developer Belén Goméz Abad: belen@eecc.eu or +34 618 081 322