In this update, Andrew Hines, Grant Shannon and Lasanthi Weerasekara look at the volatility of energy markets globally and domestically, resulting in unprecedented spot prices across all nodes of the National Electricity Market. The team provide insights into what’s behind this significant change.
Welcome to Shell Energy’s wholesale market update. Incredible volatility around the markets globally and domestically and over to the trading team to take you through the analysis.
Hello, and welcome to the latest Shell Energy Australia market review. I’m Andrew Hines, senior energy trader. The month of April has seen unprecedented spot prices across all nodes of the NEM, with prices averaging over $140 a megawatt hour, with Queensland setting a new monthly record of almost $220 a megawatt hour.
Coming off a relative low point of Q1-21, on average spot prices have been on a continuing upward trend, culminating the extreme prices we saw in April. Our first chart compares the monthly average spot prices over the first four months of 2021 and 2022. The 2022 outcomes are demonstrably higher. In most cases, spot price average is doubling and in the case of Queensland, almost tripling for the same month. Prices which are all averaging under $50 a megawatt hour in 2021, were all pushing into the hundreds and beyond in 2022.
So what’s behind this significant change? These two charts compare the average electricity demand on the left and the average available capacity on the right across the whole NEM. Looking at the demand first, we can see that in general, the first four months are largely the same year on year. There were no extreme weather events driving higher demand and in turn, prices higher. Similarly, the NEM wide average availability is not dramatically different year on year. What has changed is the price that generators are offering their power into the market. To explain this further, I’ll now hand you over to Lasanthi.
Thanks Andrew. Hi, my name’s Lasanthi and I’m a trader analyst in the forward trading team at Shell Energy Australia. In the following slides, we’ll be looking at how coal, gas and hydro generators have changed their bidding behavior since January 2021. These charts show the average volumes bid into the spot market by generators in different price ranges for each month. Beginning with coal, which supplies the majority of power in the NEM, we can see how these generators have progressively shifted their volume into higher price bands between January 2021 and April 2022.
Early in 2021, most of the volume was under $50 per megawatt hour. However, by the start of 2022, most of this volume was now being offered in price bands between $50 and $300 per megawatt hour. Looking on a state by state basis, we can see that the biggest bid band changes were in New South Wales and Queensland. These coal generators exclusively use black coal as an input and are therefore exposed to global thermal coal prices. Scarcity in global energy has seen energy commodity prices skyrocket across the globe. This includes Australian black coal and natural gas as these are export commodities. Higher commodity prices have driven up fuel costs and therefore running costs for exposed generators. That is for coal generators that are exposed to export prices, the volume of coal which they require that is above the level they have secured through fixed long term supply contracts, must be bought at higher prices.
In turn, these higher fuel costs have been managed by lowering operating levels and by passing on these costs through higher price bid bands in the electricity market. Victorian brown coal generators have seen a much less dramatic change in their bid band. Brown coal is locally mined and is not exported. As such, it is not exposed to international prices and is very cheap compared to black coal. Given these factors, the underlying fuel costs for Victorian coal generators have not changed as much as they have for black units. This has allowed Victorian bid bands to remain relatively unchanged throughout the year, with adjustments largely due to outages. Gas and hydro units generally provide additional generation during periods of high demand or to replace the base load power provided by coal units when they are unavailable.
Looking at gas across the NEM, the start of 2022 has seen an increase in volumes being offered under $500 per megawatt hour. This reflects the higher operating level of gas generation in the NEM. However, despite higher coal prices, high gas prices have meant that gas generation has remained more expensive than coal on a short run marginal basis. As such, gas generators have not been able to put downward pressure on electricity prices.
Hydro generation on the other hand has limited input cost relative to coal and gas and have therefore been able to generate at competitive prices. However, looking at hydro bid bands, we have seen more volume bid between $100 and $300 per megawatt hour, but less under $50 per megawatt hour. This is despite reservoir levels being high due to persistent wet weather conditions driven by the La Niña weather system over the past year. High rainfall means dam releases for operation are limited due to the already high water levels downstream and to limit the exacerbation of other environmental issues such as water turbidity. This accordingly limits the electricity that hydro generators can provide into the NEM, which in turn limits their ability to put downward pressure on electricity prices.
Overall, the bid stack changes seen across the NEM demonstrate that it is not just a few extreme price events, but sustained consistent high prices that have created very strong spot outcomes. To discuss how this impacts future’s electricity pricing. Here’s Andrew.
Thanks, Lasanthi. As spot prices have continued to increase, so have the electricity futures contracts. Looking at the financial year 2023 contracts in Queensland, New South Wales and Victoria, we can see that at the end of March 2021, Queensland and Victoria were averaging in the thirties while New South Wales were close to 50. Following the outcomes of Q122 and the extremes of April, by the end of the month the Queensland contract had doubled again and the New South Wales and Victoria contracts had followed suit.
Such dramatic moves are reflected in the export benchmarked futures contract pricing for both gas and coal. That’s Newcastle coal futures and the Japanese Korea Marker or the JKM. The charts on the right show the forward curve at the start of April 2021 and the same curve at the end of April 2022, highlighting the huge movements in the pricing of coal and gas on the global market. The final chart on the left shows the backwardation in the forward curve for electricity futures. Contract prices are decreasing as we move to later years. This is somewhat driven by similar backwardation in the coal curve, meaning cheaper fuel costs are expected in the future.
As well, there’s an expectation of additional renewable energy generation entering the market, putting further downward pressure on prices. The continuation of higher spot price outcomes are in turn putting upward pressure on forward contract prices. These higher spot prices are not driven by transitory factors like extreme weather events driving up demand or planned outages or the like, but instead represent an underlying shift in the fuel costs for generators, which are driven by global energy commodity prices.
Hi, I’m Grant, gas trader with Shell Energy. For today’s gas seasonal market update is the differences between gas spot and forward prices. Starting with spot prices, participants are only exposed to spot prices if they have not procured enough energy ahead of time. This is often referred to as not been fully hedged. Spot prices on a day are dictated by marginal supply and demand in the market, often dependent on physical constraints, gas demand for heating and gas required for power generation. Spot prices move daily, often with much greater variation and volatility than forward prices. There can also be significant intraday volatility in spot prices. A very small percentage of all gas transacted in the market is at the spot price. This is typically traded through market exchanges, bilaterally, or through the various balancing markets.
Moving now to gas forward prices, which are typically defined as any purchase of gas today for a future period of time. If enough gas is procured for a future period of time, participants can effectively hedge against the spot price, which provides more certainty around gas cost and also reduces the volatility of pricing outcomes that would otherwise be exposed to in the spot market. Forward prices are driven more by longer term supply and demand fundamentals, and typically move with much less variation and volatility than spot prices. Finally, forward gas is typically procured via bilateral transactions. There is also growing liquidity in the ASX Victorian gas futures and over the counter gas derivatives, which can provide more flexibility and more bespoke hedging solutions.
Now to illustrate some of the key differences between spot and forward gas prices, we will now compare the Victorian spot price, Victorian forward price for 2022 and the ACCC LNG netback price as they varied between the 1st of January 2021 and the 14th of May 2022. The yellow line on the graph represents the 6:00 AM Victorian declared wholesale gas market price, which is a good proxy for the Victorian spot price. The dark blue line on the graph represents the ASX gas futures settle price for the 2022 calendar year, which gives an indication as to where the market is pricing gas for 2022. Finally, the light blue line on the graph represents the ACCC LNG netback price.
I would like to now highlight three key observations from this chart. Firstly, spot prices vary more and experience higher volatility than forward prices. Spot prices exceeded forward prices over three periods of time as highlighted in the shaded areas, otherwise they were slightly below the forward price. The periods of higher spot prices were largely driven by higher demand from gas fired generation, heating load in winter in Victoria and high LNG demands typically in the fourth quarter of 2021. Secondly, for all of 2021, the forward price to purchase gas for calendar year 2022 was multiple dollars below the average spot price to date for calendar year 2022. Finally, from August 2021, the LNG netback price gradually increased to all time highs. This is largely driven by European energy market dynamics resulting in extremely high demand for gas and LNG and the rise in global commodity prices due to the ongoing conflict in Ukraine.
Despite this rallying LNG netback prices, Australian domestic market spot and forward prices have remained mostly below LNG netback over the time. There have been some exceptions occurring over short durations, which typically coincide with the Australian winter when there is insufficient, local Victorian gas supply and Queensland supply needs to be sent south. This demonstrates that over the period, domestic market spot and forward prices were influenced mainly by domestic market fundamentals. More recently in May this year, spot prices have increased sharply to above the LNG netback price. One contributing factor is the large increase in gas fired power generation due to the low availability of coal generation and also low renewable generation output.
In summary, spot and forward gas prices reflect gas purchased for different periods of time. Spot prices can be above or below the forward price, depending on the relationship between short and long term market fundamentals. Consumers who procure gas in advance can hedge against short term price fluctuations and volatility, which has the added benefit of providing certainty around energy cost. Finally, from August 2021, LNG netback prices gradually increased to all time highs, largely driven by European energy market dynamics, which have resulted in higher demand for gas and LNG. This has also been underpinned by the rise in global commodity prices due to sanctions on supply and demand.
Great analysis there by the team. We look forward to bringing you future additions and of course, in the meantime, reach out either to your energy broker or to your Shell Energy account manager for further information.
This video has been prepared for information and explanatory purposes only and is not intended to be relied upon by any person. Customers should seek independent advice before making any decisions about electricity contracting arrangements.
If you have any questions, comments, or suggestions for any topics for future updates, please leave us a message and we’ll get back to you.
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