Information on the Market #12 - Hedge market update: how prices reflect market information
The Authority's objective for the hedge market is for it to provide a robust and transparently determined forward price curve.
This means that forward prices should reflect the best available information about future prices at any point in time, while the futures themselves provide a mechanism for locking in these prices.
A demonstration of this can be seen by charting the ASX forward price at Benmore against South Island hydro storage which shows how the forward price curve is reflecting storage. As storage falls, the forward prices rise reflecting the market's judgements about the possibility of fuel shortage in the South Island leading to high spot prices.
Figure 1: forward price at Benmore for September 2012 and South Island hydro storage as a % of average
There has been another recent demonstration of forward prices responding to new information. On the 5th of September New Zealand Aluminium Smelters (NZAS) announced that it would be cutting 100 jobs at the Tiwai smelter by November, bringing forward a year old plan to shed these jobs over the next five years. The same release said that 35 jobs had already been shed through attrition. This information is on top of recent news that Rio Tinto””part owner of NZAS””is considering shutting uneconomic smelters (New Zealand Herald 10 August).
Tiwai uses fourteen percent of New Zealand's electricity and Meridian Energy's chief executive Mark Binns has stated that hydro-electricity from the Manapouri scheme, which effectively feeds the smelter, would be the cheapest available: "it's 5,000 Gigawatt hours of New Zealand's most efficient plant, with the HVDC unleashed (with the new Cook Strait cable in place). There are some constraints in Southland, but those can be resolved," Binns is reported to have said by the New Zealand Herald on August 13.
It seems that the combination of the possibility of the smelter reducing production and Meridian's confidence that Manapouri power could be available for the grid without significant constraint has been reflected in the forward price for energy at Benmore for the next three winters which dropped sharply on heavy trading on the 5th and 6th of September. Typical is the price for the June 2014 quarter at Benmore which dropped from $116.00 on the 4th to $106.70 on the 6th. Figure 2 shows forward prices for the next two winter quarters alongside two summer quarters. This shows that the Tiwai news has affected future winter prices while summer prices have remained relatively steady.
Figure 2: selected forward prices at Benmore as at August and September 2012
This pattern of forward prices reflecting physical circumstances””both over long time frames for hydro storage and short time frames for the Tiwai announcements””is very encouraging and suggests that these prices are being determined robustly and represent the market's best estimate of future spot prices.
For more information on how the hedge market operates see i on the market #7.