The worst of the seasonal spike in wholesale spot gas prices on the east coast appears to have passed. Having seen gas prices surge by 500% to above $50/GJ, many might be tempted to jump from wholesale to fixed-price contracts. We explore whether this is the right option and what other strategies can be considered.
The competitiveness of some East Coast manufacturers and other large gas consumers that are exposed to wholesale spot prices was threatened by a surge in gas prices this winter. Both domestic and international supply and demand factors push spot prices to an intraday record high of $56/GJ.
- Unseasonably cold weather across many Australian capital cities increased heating demand.
- Increased gas-fired generation due to baseload outages at Callide following an explosion and fire in May and flooding at the Yallourn generator in June
- Unplanned maintenance at the Esso/BHP Longford gas plant
- Rapidly falling reserves at the Iona gas storage plant (due to Longford maintenance)
- Export demand for LNG remains unexpectedly high as many Asian energy consumers rebuild inventories after running them down in 2020 at the height of the COVID-19 crisis.
Relief on the horizon
The issues at Longford, Yallourn and Callide’s generation units (other than the restoration of unit 4, which is scheduled for December 2022) have been resolved, and winter will shortly give way to spring. Some retracing of spot prices in Queensland and New South Wales was evident in July, and prices are beginning to settle around $10/GJ.
We regularly see negative pricing in the electricity market. This suggests that demand for gas-fired generation is already falling. High water storage levels at the Tasmanian and Snow Mountains hydroelectricity stations mean they can take the place of gas-fired generation. Barring any further disruption, both hub and contract gas pricing should decrease further in Q4 2021.
While some large gas users will have faced above-budget invoices of late, the year-to-date average spot price is $7.70/GJ, and some significant users would have paid average rates closer to $5/GJ this year. This suggests wholesale gas customers are no worse off than those on fixed-price contracts from the beginning of the year.
Given our target for a year-end price of $7/GJ, we would therefore caution customers considering reacting to the market ructions by switching to fixed-price contracts that are currently being offered.
Instead, load shifting is one potential way to manage temporary price spikes. This will not work for businesses where the costs of deferring a shift or closing down production during peak gas pricing outweigh the gas savings.
Another option is to enter wholesale contracts with a price cap, whereby gas users pay a premium to ensure the price paid doesn’t exceed $8/GJ, for example. There are also hybrid contracts. These offer exposure to wholesale pricing while including a fixed price arrangement to provide more stable gas price outcomes. It is like fixing a portion of your home loan and leaving the balance on variable rates.
The long-term uptrend in electricity prices
The recent bout of volatility highlights the risks inherent in the wholesale market. Prices can quickly move up but take much longer to come down and rarely return to where they were previously. All the research we have seen, and our own modelling, underpins our belief that electricity prices remain in an upward trend.
Renewable generation remains the critical long-term influence over the spot electricity market amid continuing risk of further rationalisation in the baseload generation sector. Renewable generation projects will eventually need to recover their long-run marginal costs to ensure viable returns on equity and capital. This will place more significant upward pressure on electricity prices. Therefore, we continue to advocate that large users contract their electricity purchases to 2024 and consider 2025 pricing.
To discuss the best energy procurement strategy for your business, contact Energy Action on 1300 553 551 or contact us by clicking here.