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Australian households battling spiralling costs of living are being warned to brace for more power price pain as a crisis in a key part of the electricity market threatens to send retailers to the wall.
Key points:
- Macquarie Bank and Bell Potter have stepped back from the so-called electricity hedging market amid record volatility
- The market allows power retailers and generators to effectively insure themselves from wholesale power prices
- Industry insiders say the exit of the two firms could force some providers to the wall and push prices still higher
Energy insiders say it is becoming alarmingly difficult for power retailers and generators to access a type of insurance through what is known as the hedging market, which is in virtual meltdown.
This month, investment banking giant Macquarie and brokerage firm Bell Potter stepped back from the market amid unprecedented levels of volatility in wholesale electricity prices.
Adrian Merrick, the founder and chief executive of Melbourne-based independent retailer Energy Locals, says the pair's exit from providing hedging services is a disaster for the industry.
Mr Merrick said Macquarie and Bell Potter were two of the biggest operators in the hedging market, and their decision to shut up shop to new clients could have potentially fatal consequences for some electricity companies.
He likened hedging, or futures, contracts to a form of insurance that provided vital cover to retailers and generators who would otherwise be exposed to wild price swings on the spot market.
"For companies of that magnitude to want to withdraw I think is the sign of a market that is, frankly, bust.
"Just like lots of other businesses will put in place insurance to protect their business from various types of financial shock, hedging is a way of doing that within the energy market.
"If you don't hedge then you're exposed to the spot price, which can go from minus $1000 a megawatt hour to plus $15,000 a megawatt hour.
"And that can change every five minutes.
"So, some extreme ranges in pricing.
"Most customers don't expect to be exposed to that type of volatility and nor do we because it could wipe out many businesses very quickly."
Middlemen 'shutting off the tap'
According to Mr Merrick, the turmoil in the hedging market would be enough to send some power companies broke, further diminishing competition already hit by a wave of retailer failures during the peak of the energy crisis in June.
Peter Kerr, a former financial markets trader and energy executive who runs ATA Consulting, said extreme volatility was to blame for the exit of Macquarie and Bell Potter.
Mr Kerr said the companies effectively acted as middlemen, allowing retailers and generators to insure themselves against fluctuations in the spot market.
In doing so, he noted that they took on some risk themselves, guaranteeing multimillion-dollar hedging deals every day until the contracts settled in the evening.
But Mr Kerr said the huge intra-day price movements so far this year had exposed Macquarie and Bell Potter to massive risks which they were no longer willing to take.
"What they require from their clients is either a bigger margin call — they (the retailer or generators) have to provide them with more collateral to continue to play in the market — or as is the case with the smaller players, they shut off the tap," Mr Kerr said.
"They say, 'You can't participate; it's just too risky and we're not comfortable taking on the extra risk from you, we've got enough thank you, our boots are full, so you'll have to sort out yourself some other way'.
"I think overall it's another sign that the electricity market as a whole is creaking at the edges, [it] is under stress."
With the hedging market seizing up, Mr Kerr said power providers had few other options to insure themselves and none was cheap.
He said companies could use the so-called over-the-counter market, where they could deal directly with parties such as the other side of the trade or a bank to thrash out individual deals.
But Mr Kerr says this market is invariably much more expensive and "clunky".
'Competition down, prices up'
Alternatively, he said retailers or generators could ride their luck on the spot market "and that's, at the moment, incredibly risky".
"When these investment bankers, the masters of the universe ... [are] starting to get nervous as well, it certainly tells you something about the broader market and how stressed it's become," he said.
"Probably long-term, it consolidates power in the hands of a few large players.
"The bigger end of town tends to gobble up the smaller end of town, if you like.
"So, it reduces competition over time."
Australian Energy Regulator chair Clare Savage acknowledged the problems in the hedging market were a big worry.
She says the watchdog is keeping a close eye on the situation, especially given the importance of the hedging market to the way in which benchmark electricity prices were set.
Sarah McNamara from the Australian Energy Council, which represents big electricity and gas firms, also voiced concern about the upheaval.
"Any exit from the market of organisations that are providing hedging facilities is not a positive development," she said.
"We definitely want to see retailers manage their risks over the coming years, especially as we know we're entering into a difficult period, pricewise.
"We don't want to see retailers fold because that is a very poor experience for customers and also, of course, for the people employed by those retailers."
Help urgently needed: retailer
Mr Merrick, whose Energy Local firm has about 100,000 customers across Australia's eastern States, echoes those fears.
He called on governments to help, saying they could push for more fuel supplies such as gas to be directed to the domestic market to relieve pressure on electricity prices.
They could also, he said, step into the hedging market by providing underwriting services.
"There are a range of things the government could go after if it has the appetite to probably have a fight with a few people in the industry but to do so with the best interests of consumers in mind," he said.
Mr Merrick said his company was effectively insured for this financial year and was hopeful it could cover its position until mid-2024 courtesy of its relative maturity.
But he warned that some other retailers might not be so lucky, and the absence of hedging providers could spell big trouble.
Ultimately, he said, that would leave consumers poorer.
"If the current market conditions continue I do think we'll see some other retailers start to struggle — there's no doubt about that," he said.
"We already saw a number of retailers go out of business over winter.
"I think we will see fewer retailers in the market."