A new hedge contract started trading in September 2020. It’s a cap product with strike price of $300/MWh. Over 320 of these contracts traded so far, but we still don’t know who is selling them.
The Energy Link electricity contract indexes are published monthly using data disclosed pursuant to the electricity Code, on the electricitycontract.co.nz website. The index uses disclosed prices on fixed price variable volume (FPVV) and hedge contracts (contracts for differences, or CFDs) to calculate an average price contract price, for contracts of six months or greater duration, referenced to the Haywards node just north of Wellington.
Early this year we noticed two new contracts listed on the site: C130 and C300. The C130s have never traded but the C300s started appearing from 2nd September 2020, and although we think we know what type of contract they are, we’re still trying to work out who is selling these contracts.
So, what exactly is a C300?
Well, it’s a Mercedes car model, and it’s also a Canon camera, but in the context of NZ electricity, we believe it is a type of option contract know as a ‘cap’, which could be purchased to protect the buyer from spot price spikes.
The ‘C’ probably refers to a cap. The 300 probably refers to $300/MWh, the fixed ‘strike’ price of the contract. (From here on I will just use $ for prices, not $/MWh).
The disclosed data also lists the date each contract was traded, which includes 2/09/2020, 18/09/2020, 19/10/2020, 17/11/2020, 17/12/2020, 22/01/2021, 19/02/2021, 18/03/2021, 20/04/2021, 19/05/2021, 21/06/2021, 12/08/2021, 17/09/2021. Now it may be that the seller only sells caps on these dates, about once each month, but it could be they’re just entering the data for all trades each month on one date (which could be in breach of the requirement to list within five business days).
The data includes the term of the contract, which is always one calendar month starting with the first contracts in October 2020 and the latest in March 2023.
The contract trade at either the Otahuhu node in Auckland or at the Benmore node in the centre of the South Is.
The data includes the volume and the price. The price is not the $300, which is the same for all of these contracts (assuming they always have a strike price of $300), but the premium (or option fee) paid to the seller by the buyer.
Let’s take an example: a C300 that traded on 17th September 2021 for all trading periods in the month of March 2023, with the prices referenced to the Otahuhu node. The price was $11.43 and the volume was 0.242 MW.
Most likely, the contract will be settled in cash on or about the 20th of April 2023. Let’s suppose the price at Otahuhu in the first trading period on 1st April 2023 is $60: this is less than the $300 strike price, so the buyer pays the seller 0.242 MW × 0.5 hours × $11.43 = $1.38.
For as long as the price remains below $300 in March 2023, the buyer just keeps paying the $1.38 in each trading period. But let’s suppose the price spikes to $350 for a trading period, then the payout to the buyer becomes 0.242 × 0.5 hours × (350 – 300) - 0.242 × 0.5 × 11.43 = $6.05 - $1.38 = $4.67.
It’s easy to show that the buyer receives a net payout in any trading period when the spot price at Otahuhu exceeds $311.43.
At settlement time, these calculations are repeated for all trading periods in March 2023 and the net amount, which could be positive for either the buyer or seller depending on how often the spot price spiked over $311.43, is paid by the party for who the net amount is a cash outflow.
In New Zealand, the price spikes that pose the greatest risk for spot purchasers are those that result from dry periods, and these can be up to several months long. Using a $300 cap to protect against these medium-term spikes is risky because dry period prices can be elevated for months, but seldom breach the $300 mark. However, one could imagine a purchaser who is 80% hedged, for example, might purchase some of these caps to provide a little protection for their unhedged 20%.
We’ve never managed to find out who is selling these caps, and it would be interesting to know. But there is one other mystery about them, and that is the quantities. In our example we used the quantity on an actual trade, 0.242 MW, which is only 242 kW or 121 2 kW electric heaters. It’s tiny! The range of quantities traded, if you can even believe this, is from 2 kW up to 10.3 MW. I could believe quantities from 0.1 MW and up, as these are the units that other hedges traded in (FTRs and futures for example), but 2 kW!!??
A total of 9.5% of the caps traded are less than 0.1 MW in size, ranging from 2 kW to 98 kW. Who would hedge their purchases on a 2 kW heater? That just does not make sense. Which begs the question: what is really going on here? I’m no conspiracy theorist, so there is probably a perfectly reasonable answer, I’d just like to know what it is.
But just for interest’s sake, we can plot the average premium (price) and volumes of the C300 caps traded each month, as shown below. The averages are taken over all C300 contracts traded in the month, so they include data for several months, not just the month they are traded in.
The two charts include the average monthly spot prices at Haywards through to September of last year, and it does appear to correlate with both price and quantity, which suggests that these tend to trade when prices rise, making it more likely that prices will spike over $300.
This post is not intended to be advice about whether or not to buy C300 contracts. If you are considering trading these hedge instruments, you should ensure that you understand how they work (don’t rely on this post because I am only making educated guesses), and the risks that you are hedging.
And if anyone out there knows who is selling these instruments, I’d like to know.