The hedge market is the electricity futures market. Generators and buyers can enter financial hedge contracts with other participants to manage the risk of future price movements in the spot market.
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About the hedge market
The hedge market is a key part of the wholesale market. It provides transparent and robust forward price signals and enables participants to manage their exposure to the spot market.
If a party purchases a contract that reduces their financial risk, this is called hedging. If a party sells a contract that increases their financial risk, this is known as speculating.
There are the following three key markets in the New Zealand hedge market:
1. Futures and options exchange (currently ASX only)
The Australian Securities Exchange (ASX) electricity futures and options are standardised contracts structured as cash-settled contracts for difference against two grid reference nodes - Ōtāhuhu in the North Island and Benmore in the South Island.
Electricity futures market hedges are always settled directly with the ASX. The ASX also has separate prudential requirements for traders in this market.
The approved exchange platform for trading New Zealand electricity base load futures contracts is the ASX electricity futures market.
2. Over-the-counter (OTC) market
Over-the-counter hedges are where buyers negotiate directly with sellers to agree on a price. These contracts can be customised and provide flexibility for both parties.
There are several over-the-counter hedges to manage different types of risk:
- contracts for difference
- fixed price fixed volume
- fixed price variable volume
- other bespoke arrangements.
The majority of hedges are contracts for difference that are cash-settled each month based on differences between spot prices and the hedge's fixed hedge price.
Over-the-counter hedges can be settled directly between parties, or lodged with the clearing manager and settled at the same time as the parties’ electricity market transactions.
Over-the-counter hedges that are lodged with the clearing manager can also be used to reduce a party’s prudential requirement. It can be used to offset their purchases in the wholesale market.
3. Financial transmission rights (FTR) market
Financial transmission rights (FTR) hedges help parties manage risk from large and unpredictable differences in spot prices between two locations, or nodes, on the national grid. This is known as location price risk.
The FTR market enhances competition in the retail and hedge markets by allowing generator-retailers to compete for customers on a national basis, rather than just in regions near where they own generation assets. It also allows other retailers to compete in areas away from where they purchase the hedges.
What is an FTR?
A financial transmission right is the right to the difference in price between two hubs or dedicated locations. The hub from which the energy originates is called the source, and the hub where the energy exits is called the sink.
Energy can flow in either direction, so for each pair of hubs there are two potential financial transmission rights. One where the first hub is the source and the other where the second hub is the source. Each financial transmission right is further split into two products – options and obligations.
How the FTR market works
The FTR manager publishes the FTR allocation plan containing the auction rules and grid design. Auctions are held twice monthly. Before and during each auction, the FTR manager checks with the clearing manager that each party holds sufficient security to validate their bids. (View FTR market disclaimer.)
The clearing manager manages the prudential security and settlement of FTR. They also publish the FTR prudential security assessment methodology.
Participants can trade exchange-traded or OTC contracts, but FTRs are bought through an auction process that is managed by the FTR manager.
The FTR market helps parties manage risk from the differences in spot prices between locations. This is referred to as locational price risk.
Information for industry participants
To be a participant in the hedge market, you are required under Part 13 of the Code to:
1. Disclose risk management contracts
Industry participants need to disclose risk management contract information using the electricity hedge disclosure system website.
Industry participants can use the hedge disclosure system website to:
- view and compare hedge contract details
- produce historic contract curves to better understand the market
- view historic contracts which may assist when negotiating new hedge contracts.
Disclosures are anonymised to protect commercially sensitive information.
2. Submit an annual declaration certificate
Every participant who submits hedge information must certify they have disclosed information accurately. A hedge disclosure certification form must be completed and submitted by 30 June (as per clause 13.230 of the Code).