April 28 report: Large-scale Generation Certificate (LGCs)
The slump continued in the LGC market across April with the spot and forward markets losing substantial ground, though again a concrete explanation for the diminishing buying interest remains elusive. Meanwhile the Prime Minister continued his focus on upgrading existing hydro power stations’ ability to act as a form of battery storage, with the Tasmanian plants now in the spot light.
For a scheme that appears set to be undersupplied in Cal 18, recent months have seen negative sentiment prevail. Such was the case in the LGC market across April with the spot and forward markets all losing significant ground. Having closed March at $85.00, it was all one way traffic in the spot market during April, opening at $84.70 and losing ground steadily on patchy liquidity. By mid month the market was at $82.70, by its close it had reached $78.25, a 12 month low and a drop of 8% on March’s close
While the spot lost considerable ground, the Cal 18 and Cal 19 vintages suffered even more across April. Having ended March at $82.50, the Cal 18 market opened at $82.25, traded sharply lower both early and late in the month to close at $71.90. The Cal 19 vintage – which is far less liquid – opened the month at $71.00 and gapped down late in the month to close t $64.50.
A solid explanation for the LGC market softness remains elusive, though there remain many theories. Amongst them are concerns over the potential for one (or more) of the major liable entities opting to pay the penalty on a large-scale, rather than surrender LGCs in 2017 or 2018. With some new generation coming online and several million extra LGCs being rolled over from 2016 due to penalty payment, the concern is that it is conceivable that this may substantially alter the supply/demand balance in Cal 18.
Against this position run two arguments. Firstly that given the current gap between generation and supply and the diminishing surplus of LGCs it is causing, it appears highly unlikely that Cal 18 will not be short. Secondly, the critics would say, the serious reputational risks associated with such a move would likely be sufficient to dissuade such an outcome and erode the potential financial benefit in undertaking it in the first place. Never the less the issue continues to feature as a talking point.
This issue also begs the question of if there are to be an insufficient number of LGCs available for surrender in Cal 18 then what is the difference if a liable entity with eligible tax losses pays the penalty for 100k LGCs or 1m LGCs?
Other theories include a drop in short term demand for LGCs owing to commercial and industrial customers holding off on entering into retail contracts in the hope that the dramatic increases in wholesale electricity prices will ease. Once these buyers eventually commit, the theory goes, that buying interest will emerge and bring with it support in the LGC market.
There is also the broader thesis that with the softening prices, whatever their cause, buyers have taken a breather to see how far things will go. Presumably at some point that will change and re-emerging buyers will see support returned to the market.
Whatever the explanation may be, with each reduction in price, for those who believe the LGC market will remain short in the years to come, the potential return on buying grows. For the Cal 18 vintage the months will likely prove an interesting period.
The Prime Minister has continued his contortionist act on renewable energy, caught between the need to act and the straight jacket that is the conservative arm of his party. As he did in March, Malcolm Turnbull has cunningly used the cloak of infrastructure and nation building to out manoeuvrer the naysayers with the Tasmania hydro system in the lime light this time around. As was the case with Snowy Hydro, Turnbull is proposing to upgrade existing facilities to increase their capacity to pump water to higher ground, currently the cheapest method of battery storage.
The proposal may ultimately require the addition of a second interconnector with the mainland, an issue that has long been mooted anyway. Should this scenario play out it will further assist in the stabilisation of the national electricity market and facilitate the rollout of larger proportions of renewable generation in the years to come.
Small-scale Technology Certificates (STCs)
April provided a glimpse of what is to come in the STC market with strong submission numbers continuing, a return to trade in the spot market, Clearing House surpluses and plenty of forward market activity. A nervy conclusion to the Q1 compliance period also had participants talking.
Things have changed in the STC market in 2017. Submissions are up and the target is down, yet the higher proportion of the total year’s surrender in Q1 (35%) combined with the deficit rolled over from 2016 have meant that the market was always going to be short in Q1. Despite this the Clearing House (CH) did return to surplus during April and with it spot market activity which, for the most part, took place at $39.90.
The forward market remained active across the month with trades for settlement in Q2 trading initially around $39.30-$39.40 and subsequently at $39.25. The market for Q3 and Q4 traded around the $38.00 mark.
While the CH was in surplus for 3 weeks across March and April, the final date for Q1 compliance (28 April) meant that a significant deficit was expected. Yet only matter of days before that deadline the CH surprisingly returned to surplus, causing much speculation as to whether or not an under surrender would take place. A return to surplus in late April was clearly not expected by the market and did cause some jitters amongst participants. Ultimately a major purchase did come through and the CH finished the month 1.4m in deficit.
Yet April (and Q1 in general) was really a prelude to the main event which will play out over the coming months as the market moves towards a surplus and the prospects for use of the Clearing House diminish. The current Clearing House deficit will provide an option for spot sellers that appears set to last until sometime in the second half of May. Once that deficit is eroded however, based on current creation rates it seems the CH may not be used again until April or July 2018, assuming the target for 2018 is accurately forecast.
With expectations of a growing and eventually very large STC surplus across 2017 (circa 6m by year’s end based on current trends) the question now is how low will prices go.
Some believe the second half of the year will yield spot prices well below the $38.00 currently implied by the market. Yet there are others that are hopeful that STC submissions will moderate and price falls will not be so dramatic. On that front there are many variables to ponder. Chief among them are the looming increases in the electricity bills owing to the dramatic uptick in the wholesale price of electricity as well as the ongoing reductions in the price of solar panels. Yet seasonality is also a factor with sales stronger in the summer months when compared to winter. The solar juggernaut rolls on.
Marco Stella is Senior Broker, Environmental Markets at TFS Green Australia. The TFS Green Australia team provides project and transactional environmental market brokerage and data services across all domestic and international renewable energy, energy efficiency and carbon markets.