Electricity contract prices retraced during the past fortnight from what has been a strong uptrend since early May. Most of the supply disruptions in the electricity and gas markets have been addressed and we remain cautious of the affect from Covid Beta and state lockdowns in relation to consumer electricity demand. The next fortnight will be critical in determining whether prices are able to break the strong uptrend or whether prices will resume the upward rate of increase.
Prices have dropped by approximately 5% from recent highs and represent a short window of opportunity for corporates to secure fixed price contracting, particularly for calendar year 2022.
Calendar year contracts for 2023 and 2024, continue to offer reasonable value relative to historical pricing, however, we continue to see price indicators signaling the likelihood of higher pricing – at least to the end of the current quarter - subject to understanding the impact from Covid lockdowns.
The Covid effect on electricity pricing has been hard to isolate, along with the trailing impact the Beta strain will have on future economic activity. Many economist are now suggesting the possibility of an Australian recession if vaccination rates don’t increase significantly by October. We’re also seeing the cost of renewable energy prices increase rapidly on the back of corporate demand. The price of 2024 LGC futures have doubled since March this year.
We have updated the following charts which show ‘flat’ electricity pricing by State. Since our previous update, the gradient (or rate of price increase) across all states remains extremely high. The rate of increase for VIC and SA has “caught-up” with NSW and QLD. In fact, NSW, QLD and VIC all share the same rate of increase in pricing, while SA has the highest rate of price growth for calendar year 2023 electricity prices.
While the August month-to-date period consists of 2 days, spot prices have dropped significantly since the extraordinarily high price levels set over the past few months. June, and to a lesser extent July, were impacted by significant supply disruptions which saw prices increase significantly in QLD and NSW - clearly visible in the Electricity Spot Price Trend chart below.
Plant outages during June and July demonstrate the underlying risks associated with electricity (and gas) and the cost associated with firming renewable generation. These experiences remind us that the costs associated with different fuel sources have a very different impact on the cost of electricity and will have a very different impact on the future level of industrial competitiveness, employment and economic growth.
While we are strong advocates for renewable fuel sources, the reality remains that Australia must adopt a diverse mix of fuels in order to generate low-cost electricity. The fundamental factors driving spot price increases relate to the level of gas-fired generation directly associated with outages in base-load coal generators in QLD and Victoria.
While we recognise the opportunistic pricing associated with recent gas-fired generation, Australia’s energy solution requires a mix of fuel sources to deliver a secure outcome. It’s not clear whether this would include the federal government’s $600m Hunter Valley gas-fired generator. What is clear, renewables have a key role but won’t offer a complete solution relative to rationalisation of the baseload generation sector. We believe AGL’s recently announced demerger recognised this.
Wholesale gas prices have settled since the all-time highs set during June. With the majority of factors now addressed, gas hub prices averaged below $15/GJ for July and $7.70/GJ for calendar year 2021.
The combined effect of compounding factors sent gas prices to unprecedented levels. However, Longford has since returned to full production, Yallourn is back on-line, the cold weather will eventually pass and Asian gas demand will revert to prior levels once storage levels are restored.
We expect gas prices to continue stabilising and suggest that now is not the ideal time to switch from wholesale to a fixed-price retail contract. We consider other mitigations are preferable if an immediate solution is sought. One such option is a hybrid contact. A hybrid contract offers exposure to wholesale pricing and combines with a fixed price arrangement to provide more stable gas price outcomes. This product is analogous to fixing a portion of your home loan and leaving the residual on variable rates. Another alternative available to gas customers is purchasing a price cap, which limits the maximum wholesale price. Our analysis shows wholesale customer that switched from January this year remain better-off than current retail rates, which have risen to between $8.00/GJ to $8.50/GJ, depending on usage, for calendar year 2022 contracts.
We consider contract rates will decline in-line with continued stabilisation in the wholesale market. The following charts show the short-term outlook for gas, with all hubs currently trading around $10/GJ or below:
The LGC forward curve continues to show price backwardation with the cost of 2024 LGCs currently trading at $24 certificate. While 2025 certificates are trading at $14.00 /certificate. Outyear pricing remains in uptrend as corporates continue to place greater demand on future certificate purchases to deliver their Net Zero and environmental strategies. 2024 LGC prices have more than doubled during the past 3 months from $10/certificate to $25/certificate.
ACCU’s (Australian Carbon Credit Units) have also increased significantly. These certificates are seen as a lower cost alternative to renewables in order to offset carbon for corporates seeking to decarbonise. While this approach is not considered a renewable energy strategy, it does satisfy Net Zero targets.
ACCU’s are currently trading well below the LGC price at $22/certificate compared to the LGC spot price of $34.75/certificate.