Large-scale Generation Certificate (LGCs)
In contrast to the relentless negativity witnessed across 2018, 2019 has been characterised by stable/positive pricing outcomes across most of the forward curve, with trade activity having remained healthy across most of the year.
There is however a sense that some pressure may be building for a move in one direction or other, with much speculation surrounding the potential for penalty payments in the pivotal 2019 compliance year.
The growth in options market activity over this period may also reflect this, with the implied volatility of transactions climbing despite the historical volatility of the underlying contracts having been in mild decline.
While there have been some ups and downs, the LGC forward curve following the 2018 final compliance date in February has been generally stable.
The spot and Cal 19 contracts have experienced the greatest movements with both having traded between $35 and $45 in the subsequent period, with a far great level of stability seen across June and July.
The Cal 20 contracts range was between $20 and $26 since late Feb, yet it too saw a considerably tighter range develop since May of $22.50 to $24.50. Cal 21 and 22 have been even more stable across the period, yet with considerably lower liquidity.
With the Clean Energy Regulator (CER) continuing to assert that the 2020 Large-scale Renewable Energy Target will be met, and few people left arguing against it, most of the attention in recent times has been focused on how small the surplus of LGCs left over following Cal 19 compliance will be.
With over 7m LGCs ultimately carried forward from 2018 following a significant under-surrender, it is highly likely that the Cal 19 vintage will see the surplus fall to its smallest levels ever.
With a series of factors causing delays to projects, including connection agreements with AEMO, EPC contractor concerns and labour law and marginal loss factor changes, several forecasters have wound back their oversupply numbers for 2019 to sit in the 2-3m range.
Ordinarily such a small surplus, given the size of the 2019 target (32.1m), would likely result in a sharp increase in prices for the relevant period. Yet so far it has not.
The reason for this appears to be uncertainty surrounding the potential for under-surrender in 2019.
With the CER essentially having moved away from its previous ‘name and shame’ approach to penalty payments following the 2018 compliance year, to one of open encouragement, there has never been less at stake for liable entities looking to adopt this strategy.
Indeed when a major federal government owned corporation paid the penalty last year, most assumed all bets were off.
Should there be even one or two of the major liable parties who adopt this strategy in a meaningful volume, then the 2-3m forecast surplus could quickly become 4-5m and dramatically reduce the risks of a squeeze.
Whatever happens in Cal 19 is important because it may have a flow on affect into later vintages, with a spike in prices likely to spill over into at least the Cal 20 contract and possibly the Cal 21.
And while pricing across all of these vintages has been fairly stable following the 2018 compliance period, the activity in the options market in recent times has suggested something different.
Overall options trade volume has been on the rise, and with it has come an increase in the implied volatility of those transactions. With volatility having previously sat in the low to mid 30% range, recent weeks have seen the number climb to 40% and on occasion above.
As one of the prime determinants of options pricing, this increase in volatility has resulted in an increase in the cost of buying options, the upfront premium. In a period of considerable uncertainty, buying options provides a participant with flexibility, allowing them to hedge without necessarily locking them into the rigidity of a forward.
With the recent jump in volatility resulting in higher options premiums, options sellers are now being better rewarded for taking the plunge, which seems reasonable given they are taking on the risk. And the higher premiums have brought out more sellers, which has in turn helped liquidity.
Small-scale Technology Certificates (STCs)
Stability has also been the order of the day in the STC market in recent months, with a reduction in supply in the period since Easter easing what had been a rapidly growing surplus. The principal reason for this decline sits with the Victorian Government’s decision to cap its rebate which has turned it from a stimulus of installation activity into a barrier to it.
The spot STC market has traded between $36.25 and $37.75 across 2019, with multiple periods of price oscillation within that range as outlined in the chart below. With very large quarterly obligations to be met in April (13.1m) and July (9.37m), there was always going to be solid demand for STCs.
Yet until April, as in the previous two years, STC supply was comfortably exceeding the 569k weekly run rate required to meet the 2019 target, implying another large surplus for 2019. After Easter however, this trend moderated.
When Victorian solar installers saw the Andrews’ Government returned in 2018, they knew they were set for a massive year ahead, with a new $2225 subsidy on the table for eligible householders.
And for the first 4 months of 2019 that’s exactly what they got, with Victoria overcoming its lower rates of solar radiation (and hence fewer STCs per install) to become the largest source of residential STC creation in the country.
With the funding for this policy rapidly disappearing, the Andrews’ Government abruptly announced in late April it had reached its quota for the financial year and closed the scheme until 1stJuly.
Consumer perception is always hazy with these types of schemes, but if they feel they are missing out on something, consumers will wait to ensure they don’t.
And as such, Victorian residential solar installation activity ground to a halt and the STC submission figures have been softer ever since.
Having regularly sat above 700k per week before Easter, the period since has produced an average of 643k per week. Whilst still comfortably above the 569k required by the run rate, the reduction in supply has implied a significant retreat in the likely 2018 surplus from something north of 7m to something south of 5m.
And while the return of spring and the prospect of a reduced deeming period from 1 January will likely yield further growth in the second half of the year, the recent slow down was enough to ensure Q2 compliance was tighter than it otherwise would have been.
The Victorian rebate was eventually reopened on 1stJuly, but with the introduction of a monthly cap of 3333 systems, a figure that is less than what was being installed before the scheme commenced and circa half the rate of installations seen earlier in the year.
Perversely, the scheme has come to represent a major barrier to installation activity and that is why there are now calls from both the major solar industry groups to redesign the scheme, either by biting the bullet and bringing forward money from next financial year, or by halving the grant and doubling the monthly cap.
For the moment the Andrew’s Government has dug in, refusing to make any changes lest it risk an electoral backlash for breaking an election promise.
With ongoing pressure being applied it may yet concede on this matter and reinvigorate the state’s residential sector, but spring will likely yield a boost to STC supply in other states anyway.
The other major issue which had a significant impact on STC prices in 2018 but has, as yet, failed to rear its head in 2019 is, ironically, a push from within the federal government to reduce the subsidies available to solar.
While the ACCC called for a reduction of solar rebates in its energy market report last year, noting the potential to reduce the STC clearing house price, and many members of the government voiced their support for such a move, the Turnbull/Morrison Governments ultimately shied away from any changes, likely fearing electoral demise.
Following its stunning victory, the Morrison Government has since been silent on the issue, though a number of prominent economists and industry thought leaders have continued to call for a reduction or the complete elimination of solar subsidises.
Should the prospect of a Clearing House price reduction loom, it may not matter what happens to STC supply in the short term for there to be significant impact on price.
Marco Stellais 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.