Posted on February 18, 2010

Earlier this week I presented a workshop on Hedging Electricity Price Risk, and participated in a panel discussion on developments in the wholesale electricity market, both of these taking place at Terrapinn’s Power and Electricity World conference at the SkyCity in Auckland.

In the sessions that I participated in the hottest topics were the development, potential and limitations of the new hedge market (in the form of an electricity futures market) that is included in the market reform package and required to be in place by June 2010. The market is intended to be a liquid hedge market and the test for this stated in the reform package is that a minimum volume is tading through the market by June 2011.

However, this in itself is not a sufficient test of liquidity: the primary test is that the ’spread’ (the gap) between bids to buy hedges and offers to sell hedges is small, i.e. of the order of 1% or less. The opposite, a large bid/offer spread (a.k.a bid/ask spread), is a sure sign that buyers and sellers are less than very willing to trade in the market. Unless buyers and sellers are in close agreement on price, the market will not be liquid.

The second key test is that new players have entered the hedge market, including new-entrant retailers and generators. More pertinent still, is the entry of financial intermediaries (banks and financial institutions) that will create further liquidity and look to use the hedge market as a mechanism with which to hedge new offerings into the wider electricity market.

But we do have to be realistic: putting large volumes through the new hedge market will require a major culture change at some of the large, vertically integrated gentailers. The hedge market will also be a small proportion of the total market, at least initially. The development of liquidity in a market tends to be a chicken and egg story: liquidity begets more interest in the market form more players, which begets more liquidity, which begets more interest, which . . . and so on. A concerted effort by existing market participants will be required to kick-start the new market into life and this will probably take more than just one year.

From Greg Sise, Managing Director