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DWGM CPT REVIEW

PREPARED BY: Market Operations and Performance

DOCUMENT REF: DWGM CPT REVIEW – DRAFT REPORT

VERSION: 1.0

DATE: 2 July 2013

DRAFT

Australian Energy Market Operator Ltd ABN 94 072 010 327 www.aemo.com.au [email protected]

NEW SOUTH WALES QUEENSLAND SOUTH AUSTRALIA VICTORIA AUSTRALIAN CAPITAL TERRITORY TASMANIA

DWGM CPT REVIEW

Doc Ref: DWGM CPT REVIEW – DRAFT REPORT v1.0 2 July 2013 Page 2 of 59

Contents

1 INTRODUCTION .............................................................................................. 9

1.1 Structure of this report ................................................................................................ 9

2 BACKGROUND ..............................................................................................10

2.1 The CPT Mechanism ................................................................................................ 10

2.2 Decision to review the CPT Mechanism ................................................................... 10

2.3 Guiding Principles .................................................................................................... 11

3 APPROACH ....................................................................................................12

3.1 The operation of the CPT Mechanism ...................................................................... 12

3.2 The modelling tasks ................................................................................................. 12

3.2.1 CPT Event scenarios................................................................................................................. 12 3.2.2 LNG Revenue Sufficiency Model .............................................................................................. 14 3.2.3 Retailer Impact Model ............................................................................................................... 15 3.2.4 Comparative Market Analysis ................................................................................................... 16 3.2.5 Test parameters for the CPT mechanism ................................................................................. 16

3.3 Approach .................................................................................................................. 17

4 RESULTS OF ANALYSIS ...............................................................................18

4.1 Lower constraint value for the CPT .......................................................................... 18

4.2 CPT settings in the STTM and NEM –Retailer impact analysis ................................ 19

4.3 CPT settings in the DWGM -Retailer impact analysis ............................................... 20

4.3.1 CPT Event: 2 consecutive days with prices at VoLL ................................................................ 20 4.3.2 CPT Event: 3 consecutive days with prices at VoLL ................................................................ 25 4.3.3 CPT Event: 4 consecutive days with prices at VoLL ................................................................ 29 4.3.4 CPT Event: 5 consecutive days with prices at VoLL ................................................................ 33 4.3.5 Additional analysis requested by Lumo Energy ........................................................................ 37

5 RECOMMENDATIONS ...................................................................................39

5.1 Summary of findings ................................................................................................. 39

5.2 Excessive or unmanageable Risk ............................................................................. 39

5.3 Combinations of CPT settings that satisfy the risk threshold .................................... 40

5.4 Recommended CPT Settings ................................................................................... 41

6 NEXT STEPS ..................................................................................................43

7 Appendix A IMPACTS OF CPT SETTINGS ON RETAILERS .........................44

8 Appendix B IMPACTS OF CPT SETTINGS ON CUSTOMER MARGIN .........52

DWGM CPT REVIEW


Version Release History

VERSION DATE BY CHANGES

1.0 2 July 2013 Market Operations and Performance First draft

DWGM CPT REVIEW


LIST OF TABLES

Table 2-1: DWGM Current Market Settings..................................................................................................... 10 Table 3-1: CPT Event Scenarios ..................................................................................................................... 13 Table 3-2: LNG Cost Assumptions .................................................................................................................. 14 Table 3-3: Standard Retail Assumptions ......................................................................................................... 15 Table 3-4: Standard Customer Assumptions................................................................................................... 15 Table 3-5: Test Parameters ............................................................................................................................. 16 Table 4-1: STTM Base Scenario Results ........................................................................................................ 19 Table 4-2: Retailer impacts for a 2-day CPT Event Scenario .......................................................................... 23 Table 4-3: Customer impacts for a 2-day CPT Event Scenario ...................................................................... 24 Table 4-4: Retailer impacts for a 3-day CPT Event Scenario .......................................................................... 27 Table 4-5: Customer impacts for a 3-day CPT Event Scenario ...................................................................... 28 Table 4-6: Retailer impacts for a 4-day CPT Event Scenario .......................................................................... 31 Table 4-7: Customer impacts for a 4-day CPT Event Scenario ...................................................................... 32 Table 4-8: Retailer impacts for a 5-day CPT Event Scenario .......................................................................... 35 Table 4-9: Customer impacts for a 5-day CPT Event Scenario ...................................................................... 36 Table 5-1: Combinations of CPT settings that satisfy our test for acceptable risk .......................................... 41 Table B-1: Customer impacts for a 2-day CPT Event Scenario for R2 ........................................................... 52 Table B-2: Customer impacts for a 2-day CPT Event Scenario for R3 ........................................................... 52 Table B-3: Customer impacts for a 2-day CPT Event Scenario for R4 ........................................................... 53 Table B-4: Customer impacts for a 2-day CPT Event Scenario for R5 ........................................................... 53 Table B-5: Customer impacts for a 3-day CPT Event Scenario for R2 ........................................................... 54 Table B-6: Customer impacts for a 3-day CPT Event Scenario for R3 ........................................................... 54 Table B-7: Customer impacts for a 3-day CPT Event Scenario for R4 ........................................................... 55 Table B-8: Customer impacts for a 3-day CPT Event Scenario for R5 ........................................................... 55 Table B-9: Customer impacts for a 4-day CPT Event Scenario for R2 ........................................................... 56 Table B-10: Customer impacts for a 4-day CPT Event Scenario for R3 ......................................................... 56 Table B-11: Customer impacts for a 4-day CPT Event Scenario for R4 ......................................................... 57 Table B-12: Customer impacts for a 4-day CPT Event Scenario for R5 ......................................................... 57 Table B-13: Customer impacts for a 5-day CPT Event Scenario for R2 ......................................................... 58 Table B-14: Customer impacts for a 5-day CPT Event Scenario for R3 ......................................................... 58 Table B-15: Customer impacts for a 5-day CPT Event Scenario for R4 ......................................................... 59 Table B-16: Customer impacts for a 5-day CPT Event Scenario for R5 ......................................................... 59

DWGM CPT REVIEW


LIST OF FIGURES

Figure 4-1: Lower Constraint Value for CPT ................................................................................................... 18 Figure 4-2: Impact of CPT settings on Retailer profit for a 2-day CPT Event ................................................. 21 Figure 4-3: Impact of CPT settings on customer types for a 2-day CPT Event .............................................. 22 Figure 4-4: Impact of CPT settings on Retailer profit for a 3-day CPT Event ................................................. 25 Figure 4-5: Impact of CPT settings on customer types for a 3-day CPT Event .............................................. 26 Figure 4-6: Impact of CPT settings on Retailer profit for a 4-day CPT Event Scenario .................................. 29 Figure 4-7: Impact of CPT settings on customer types for a 4-day CPT Event .............................................. 30 Figure 4-8: Impact of CPT settings on Retailer profit for a 5-day CPT Event Scenario .................................. 33 Figure 4-9: Impact of CPT settings on customer types for a 4-day CPT Event .............................................. 34 Figure 4-10: Impact of CPT settings on Retailer profit for the Lumo Scenario ................................................ 37 Figure 5-1: Impact of CPT settings on Retailer profit ...................................................................................... 40 Figure A-1: Impact on Retailer profit for a 2 day CPT Event, when CPP = 15 ................................................ 44 Figure A-2: Impact on Retailer profit for a 2 day CPT Event, when CPP = 25 ................................................ 44 Figure A-3: Impact on Retailer profit for a 2 day CPT Event, when CPP = 50 ................................................ 45 Figure A-4: Impact on Retailer profit for a 2 day CPT Event, when CPP = 70 ................................................ 45 Figure A-5: Impact on Retailer profit for a 3 day CPT Event, when CPP = 15 ................................................ 46 Figure A-6: Impact on Retailer profit for a 3 day CPT Event, when CPP = 25 ................................................ 46 Figure A-7: Impact on Retailer profit for a 3 day CPT Event, when CPP = 50 ................................................ 47 Figure A-8: Impact on Retailer profit for a 3 day CPT Event, when CPP = 70 ................................................ 47 Figure A-9: Impact on Retailer profit for a 4 day CPT Event, when CPP = 15 ................................................ 48 Figure A-10: Impact on Retailer profit for a 4 day CPT Event, when CPP = 25 .............................................. 48 Figure A-11: Impact on Retailer profit for a 4 day CPT Event, when CPP = 50 .............................................. 49 Figure A-12: Impact on Retailer profit for a 4 day CPT Event, when CPP = 70 .............................................. 49 Figure A-13: Impact on Retailer profit for a 5 day CPT Event, when CPP = 15 .............................................. 50 Figure A-14: Impact on Retailer profit for a 5 day CPT Event, when CPP = 25 .............................................. 50 Figure A-15: Impact on Retailer profit for a 5 day CPT Event, when CPP = 50 .............................................. 51 Figure A-16: Impact on Retailer profit for a 5 day CPT Event, when CPP = 70 .............................................. 51

DWGM CPT REVIEW


ABBREVIATIONS

CPT Cumulative Price Threshold

DWGM Declared Wholesale Gas Market

VoLL Value of Lost Load

CP Cumulative Price

CPP Cumulative Price Period

APC Administered Price Cap

GWCF Gas Wholesale Consultative Forum

NGR National Gas Rules

MCP Market Clearing Price

LAOS Last Approved Operating Schedule

R1 Retailer 1

R2 Retailer 2

R3 Retailer 3

R4 Retailer 4

R5 Retailer 5

C_10 Customer 1

C_30 Customer 2

C_60 Customer 3

C_500 Customer 4

STTM Short Term Trading Market

NEM National Electricity Market

MPC Market Price Cap

DWGM CPT REVIEW


EXECUTIVE SUMMARY

This document reports the results and recommendations from AEMO’s review of the Cumulative Price

Threshold (CPT) Mechanism for the Declared Wholesale Gas Market (DWGM).

This review examined the market settings for CPT, specifically, the Cumulative Price Threshold, the

Cumulative Price Period, and the mechanism by which these apply.

The decision to review the CPT Mechanism was made following a decision to remove force majeure

provisions from the National Gas Rules. The Gas Wholesale Consultative Forum (GWCF) was concerned

that this left limited scope to offer protection to market participants when market prices were being set at a

very high level, and no further market response was possible, and asked for this issue to be examined.

The approach used in conducting this review reflected the methodology used in previous CPT and Market

Parameter studies.

AEMO has worked closely with the GWCF to gain feedback with respect to the proposed approach,

assumptions and input data, and initial results. GWCF members are now invited to review and provide

feedback on this draft report. The final report and recommendations will be published for consideration at the

GWCF meeting of August 13, 2013.

The CPT mechanism

The Cumulative Price Threshold was introduced to the Victorian gas market on 1 June 2008.

It provides a mechanism to address unmanageable or excessive risk arising from prolonged exposure to

very high prices. The CPT mechanism allows for a high Value of Lost Load (VoLL) that better meets the

objectives of ensuring voluntary market clearing, but at the same time more closely managing risk due to

high price.

The CPT mechanism includes:

A Cumulative Price measure (CP) that is defined as the sum of the published market prices over a

defined period of consecutive trading intervals;

A Cumulative Price Threshold (CPT) that defines a cap on the Cumulative Price measure that, once

exceeded, triggers the application of the Administered Price; and

A Cumulative Price Period (CPP) that defines a rolling data collection period, measured in trading

intervals, according to which the CP and CPT is measured.

Both the National Electricity Market and the Short Term Trading Market also feature a CPT mechanism,

sharing a similar purpose and function. In the case of all markets, the CPT mechanism caps market

participant exposure to consecutive periods of very high prices, and acts as a trigger for the application of the

Administered Price Cap (APC).

Our Review

In consultation with the GWCF, we developed a set of principles to guide the analysis and findings of the

review. We also sought approval for a modelling approach, and for associated assumptions and input data to

inform the analysis. We developed two models for the review:

1. An LNG revenue sufficiency model to determine a lower constraint value for the CPT. This sought to

ensure that CPT recommendations did not deny the reasonable recovery of the fixed and variable costs

of LNG capacity and use; and

2. A retailer impact model to assess the effectiveness of alternative test settings for the CPT mechanism in

mitigating wholesale market price risk from a range of agreed CPT Event scenarios. We used this model

to identify levels of residual risk that may be excessive or unmanageable, therefore guiding

recommendations for the CPT and CPP.

DWGM CPT REVIEW


We also compared the risk-mitigation power of current settings of the CPT mechanisms in each of the

DWGM, the Short Term Trading Market (STTM) and the National Electricity Market (NEM).

Summary of Results

Due to immature financial markets for risk products in the gas industry, market participants must physically

hedge wholesale market risk, achieved via contracts for diverse sources of supply and transportation

capacity. In the case of the Victorian gas market, the Dandenong LNG facility is perhaps the most important

supply of reserve capacity during events that may trigger the CPT Mechanism. AEMO understands that

LNG capacity is mostly contracted, thereby presenting new entrant and rapidly growing retailers with limited

access to a physical hedge against high wholesale market settlement outcomes.

Our analysis has found that current CPT settings may not provide sufficient risk mitigation for new entrant

and rapidly growing retailers1. Moreover, our analysis has found that the level of residual risk is out-of-step

with other markets and may therefore impose an excessive and onerous management cost. These factors

can create a barrier to entry, discouraging new retailers from entering the DWGM. This can reduce

competition to the detriment of the National Gas Objective, and to the long-run interests of gas consumers.

Due to these findings, we recommend a change to the CPT settings to enable a reduction in the level of risk

that is resultant from the CPT mechanism.

We recommend:

1. Cumulative Price Period (CPP): 35 Scheduling Intervals (7 days)

We recommend that current settings for the CPP are maintained at 35 scheduling intervals. This

would satisfy the needs of short-duration CPT events, while also providing sufficient time to

understand and coordinate the initial management of long-duration events. This also shares

symmetry with the NEM and STTM (CPP = 7 days).

2. Cumulative Price Threshold (CPT): $1800

We recommend that the CPT is lowered from $3700 to $1800. Based on our measure of

excessive and/or unmanageable risk, this reduces the level of residual wholesale market risk to a

level that better addresses the needs of new entrant and rapidly growing retailers. We

understand that in the case of the Declared Transmission System, access to injection capacity

from the Dandenong LNG facility will often be required to maintain the security of the system

during possible CPT events. AEMO understands that the bilateral market for LNG capacity is not

liquid, and is mostly contracted by the larger established retailers. It follows that new entrant and

rapidly growing retailers may therefore experience difficulty in procuring sufficient LNG capacity to

address optimal risk management needs. This could present a barrier to entry, affecting

competition and price outcomes, and may create a possible insolvency risk during major CPT

events. Our assessment has also shown that the risk mitigation power of the current settings is

weaker than those of the CPT mechanisms of the NEM and STTM.

A CPT setting of $1800 will not deny sufficient cost recovery for the fixed and variable costs of the

LNG facility, which is also the most expensive source of supply in the Victorian system on a total

average cost basis.

1 We note that small, rapidly growing retailers may frequently need to adjust the size of their physical

contracts in order to maintain a desired level of risk mitigation. In a market that has limited alternatives for contracted gas supply, and that is relatively illiquid and immature, a small rapidly growing retailer may find that it is unable to maintain a desired level of protection from wholesale market price risk.

DWGM CPT REVIEW


1 INTRODUCTION

This document reports the results and recommendations from AEMO’s review of the CPT Mechanism for the

DWGM.

This review examined the market settings for CPT, specifically, the Cumulative Price Threshold, the

Cumulative Price Period, and the mechanism by which these apply.

The approach reflected the methodology that has been used in previous CPT and Market Parameter studies

for the DWGM and the STTM.

1.1 Structure of this report

Section 2 of the report provides background to the study. It summarises the decision to review the CPT

mechanism and the guiding principles for the review.

Section 3 describes the approach, including the models that have been developed to inform the analysis.

Section 4 presents the results of the analysis.

Section 5 provides and explains AEMO’s recommendations.

Section 6 presents next steps, including feedback on this draft report, and our schedule for publishing a final

report.

Appendix A and B contains a full set of the modelling results.

DWGM CPT REVIEW


2 BACKGROUND

2.1 The CPT Mechanism

The Cumulative Price Threshold was introduced to the Victorian gas market on 1 June 2008.

It provides a mechanism to address unmanageable or excessive risk arising from prolonged exposure to

very high prices. The CPT mechanism allows for a high Value of Lost Load (VoLL) that better meets the

objectives of ensuring voluntary market clearing, but at the same time more closely managing risk due to

high price.

The CPT mechanism includes:

A Cumulative Price measure (CP) that is defined as the sum of the published market prices over a

defined period of consecutive trading intervals;

A Cumulative Price Threshold (CPT) that defines a cap on the Cumulative Price measure that, once

exceeded, triggers the application of the Administered Price; and

A Cumulative Price Period (CPP) that defines a rolling data collection period, measured in trading

intervals, according to which the CP and CPT is measured.

Both the National Electricity Market and the Short Term Trading Market also feature a CPT mechanism,

sharing a similar purpose and function. In the case of all markets, the CPT mechanism caps market

participant exposure to consecutive periods of very high prices, and acts as a trigger for the application of the

Administered Price Cap (APC).

The following table shows the current settings for the CPT mechanism, and for the associated market

parameters of VoLL and APC:

Table 2-1: DWGM Current Market Settings

Market Parameter Value

VoLL $800 per GJ

APC $40 per GJ

CPP 35 scheduling intervals (7

days)

CPT $3,700

2.2 Decision to review the CPT Mechanism

Current settings for the CPT Mechanism have remained unchanged since it was introduced to the Victorian

gas market in 2008.

In December 2012 AEMO published the conclusions of its DWGM and STTM Market Parameter Review2.

AEMO concluded that it would not at this time recommend changes to VoLL and APC in the DWGM.

As part of a separate process, in 2012 the Gas Wholesale Consultative Forum (GWCF) considered the

removal of National Gas Rules (NGR) covering force majeure, and recommended that AEMO lodge a rule

change proposal to affect this3. However, the GWCF was concerned that this left limited scope to offer

2 STTM and DWGM Parameter Review - Final Report dated 14 December 2012 (click here for report)

3 GWCF meeting 176, Action item 176.4

http://www.aemo.com.au/Consultations/Gas-Consultations/General/~/media/Files/Other/consultations/sttm/STTM_AND_DWGM_%20PARAMETER_%20REVIEW_Final_Report.ashx

DWGM CPT REVIEW


protection to market participants where market prices were being set at a very high level, and no further

market response was possible, and asked for this issue to be examined.

GWCF paper 12-082-02 ‘CPT review’4 was presented to GWCF meeting 177 on 17 December 2012. The

GWCF concluded that a CPT of between $1,800 and $2,500 would be appropriate, but that a review of the

CPT should be undertaken to evaluate the risks of a lower CPT and to make recommendations for the CPT

to apply in the event that the force majeure rules were removed from the NGR.

AEMO has therefore conducted this review, with the aim to evaluate the risks to market participants posed

by the current CPT settings once the force majeure rules are removed, and to recommend an appropriate

value for the cumulative price threshold, and cumulative price period, for consideration by the DWGM.

The agreed value for the CPT and CPP will apply from winter 2014.

2.3 Guiding Principles

The following principles have guided the design and implementation of this review:

1. Settings for the CPT mechanism should not act as a barrier to the supply of gas from all available

sources, including in respect of the fixed and variable costs of LNG.

Assumption: Cost recovery for the use of LNG may be limited to those events that also trigger

administered pricing via the CPT mechanism. If this is the case, the CPT mechanism should not be set in

a way that does not allow the reasonable recovery of the fixed and variable costs of LNG capacity and

use.

2. The review of the CPT mechanism should recognise industry structure, and therefore the incidence of

wholesale market price risk on the range of retailers that do or could participate in the market.

Assumption: Market price risk should not be excessive or unmanageable for the range of retail business

that do, or could, participate in the market. This recognises that retailers may have varying portfolio

characteristics and levels of contract cover.

3. The review of the CPT mechanism should recognise links between markets, including the operations and

activities of market participants in the National Electricity Market and the Short Term Trading Market.

Assumption: Many retailers operate across multiple jurisdictions and markets and have established

business arrangements to manage current and anticipated levels of risk. Potential changes to the CPT

mechanism should therefore be mindful of the varying levels of price risk in each of our energy markets,

including as a result of the CPT mechanisms in each of these markets.

4 GWCF meeting 177, Agenda item 4.4 (GWCF 12-082-02)

http://www.aemo.com.au/Gas/Resources/Working-Groups/Gas-Wholesale-Consultative-Forum/~/media/Files/Other/vicwholesalegas/GWCF_177/GWCF_12-082-02_CPT_Review.ashx

DWGM CPT REVIEW


3 APPROACH

3.1 The operation of the CPT Mechanism

The CPT is the cap for the cumulative price over 35 scheduling intervals (equivalent to 7 days).

The actual value of the CP, for a given schedule, must account for the Market Clearing Price (MCP) from the

Last Approved Operating Schedule (LAOS) of all other scheduling intervals that form part of the CPP. The

CPP spans 35 scheduling intervals including the current scheduling interval for which the CP is calculated,

plus the 34 contiguous scheduling intervals that immediately precede this scheduling interval.

The measure CP is compared to the CPT in determining when an administered pricing period should be

triggered. Once triggered, the administered pricing period commences from the start of the next scheduling

interval.

3.2 The modelling tasks

Given that the CPT Mechanism seeks to protect market participants from exposure to sustained price

outcomes that could otherwise represent an excessive or unmanageable level of business risk, the modelling

task required the development and use of a business impact model that links the wholesale and retail

markets.

A retailer impact model was therefore developed to assist an understanding of the risk mitigation power of

alternative settings for the CPT Mechanism. For a range of CPT Event scenarios, and after allowance for

the operation of the CPT Mechanism, the model measured the impact of residual wholesale market price risk

on the assumed operating profits of a range of model retailers. The impact metric that was used was the

number of “days of average operating profit foregone”, representing the operating profit impact of the total

CPT Event cost on a selection of modelled retailers, having different customer portfolios and levels of

hedging cover. We also considered CPT Event cost in terms of the number of “days of retail margin impact”

for the residential and business customers of the modelled retailers. However this was a secondary metric

that was only used to present an alternative perspective on the measure of this residual risk.

Given a principle that the CPT Mechanism should not act as a barrier to the supply of gas from all available

sources, and assuming that CPT Events may provide the only prospect of recovery for the fixed and variable

costs of the LNG facility, a LNG Revenue Sufficiency Model was developed to test for a lower-bound

constraint on the range of CPT values that may be appropriate for the DWGM.

Limited comparative analysis was also completed to compare the risk mitigation power of CPT Mechanisms

in each of the DWGM, Short Term Trading Market (STTM) and the National Electricity Market (NEM). This

required an adaptation of the retailer impact model and of a subset of the model retailers.

The following provides a detailed description of the CPT Event Scenarios, and each of these modelling

tasks.

3.2.1 CPT Event scenarios

CPT Event scenarios were defined to reflect the incidence and character of extreme price events that, via the

CPT Mechanism, would likely trigger the commencement of administered prices in the wholesale market.

We anticipate that extreme price events would typically occur in circumstances of a significant and protracted

supply outage at Longford or Iona, and/or the failure of major assets that support the operation of the gas

DWGM CPT REVIEW


supply infrastructure5. Other circumstances may include unexpected commercial events that affect the gas

supply or transportation operations of significant market participants.

It is possible that less significant supply events could combine with high levels of gas-fired power generation

in a way that contributes to high market prices, however the heat rate of installed power generation assets,

combined with the potential of high spot prices for gas, would likely produce high price outcomes in the

electricity market that could not be sustained for periods sufficient to test the limits of the cumulative price

period in the gas market (very high prices in the electricity market typically have a short duration and would

not likely endure for the length of the seven-day duration of CPP in the DWGM; prices would therefore

moderate in the electricity market, which when price is VoLL in the DWGM, would make gas-fired generation

uneconomic).

AEMO does not retain infrastructure models that can support the analysis of forced outage rates affecting

physical assets. Further, the relative infrequency of past events that would qualify as a CPT event scenario

makes a statistical determination of likely CPT Event scenarios unreliable.

For this reason we used the following CPT Event scenarios with unspecified triggers as given by Table 3-1.

Table 3-1: CPT Event Scenarios

Assumptions

48 hour (2 consecutive days) event with prices at VoLL, occurring once every 10 years




In each case we assumed a sequence of “normal prices” leading up to the commencement of the CPT

Event, therefore informing the initial values of the Cumulative Price. The assumed “normal price” was

$4.50/GJ. During the CPT Event we assumed prices were either VoLL or the Administered Price Cap

($40/GJ), depending on whether administered pricing was triggered by the CPT Mechanism.

We also assumed a profile of imbalances during the five scheduling intervals of each CPT Event day. For

each intra-day schedule we deemed 1/5 of the total daily imbalance to occur, effectively deeming a flat

profile across the peak period of the day, and a lower hourly imbalance during the last (off-peak) scheduling

interval. The amount of the daily imbalance was determined by the level of assumed contract (hedge) cover

for each model retailer. For example, hedge cover of 90% means that for each CPT Event day, 10% of the

retailer’s customer withdrawals are effectively supplied from the DWGM, and not from the supply of an

upstream contract.

The assumed imbalance profile was considered reasonable given the anticipated circumstances and

potential risks of the CPT Event scenario. Given the prospect of exposure to VoLL pricing, with supply

constraints requiring LNG, some profile for imbalances (and deviations) is realistic. Our assumed approach

provided a simplification that could be shared across the range of model retailers.

Additional CPT Event scenarios

As part of the consultative process that accompanied this CPT Mechanism review, Lumo Energy proposed

additional analysis to test an alternative “worst case” profile of event costs and market imbalances. The

5 An extreme price event may be limited to only a partial loss of Longford supply capacity and up to a total

loss of supply capacity at Iona. Greater capacity loss at Longford would likely require significant load curtailment.

DWGM CPT REVIEW


requested profile of event cost featured an assumed VoLL price for the first scheduling interval of each CPT

Event day, with subsequent (intra-day) prices equal to the assumed “normal price”. Further, the requested

imbalance profile featured the entire daily imbalance in the first scheduling interval of each CPT Event day.

Lumo Energy also requested additional (higher) test-settings for the CPT Mechanism.

AEMO does not consider that these additional CPT Event scenarios are realistic. Indeed, when faced with

the prospect of VoLL and a possible multi-day CPT Event that could feature major infrastructure outages and

lead to customer curtailment, some portfolio risk management activities would be prudent for a retail

business. Indeed, the very prospect of an exposure to VoLL pricing in the NEM requires many retailers to

have some form of load-shedding agreements in place.

This report presents the results from these additional CPT Event scenarios.

3.2.2 LNG Revenue Sufficiency Model

The assumption is that LNG represents the highest cost source of gas for which CPT settings should not

deny efficient cost recovery. We also assumed that opportunities for LNG cost recovery may be limited to

CPT Events. The reasonable recovery of LNG costs therefore becomes a lower financial constraint on the

setting of the CPT.

We determined an approximate annualised total cost for the required inventory of the Dandenong LNG

facility. We used the maximum possible supply during the assumed CPT event scenario as the required

inventory level, capping this by the size of the existing facility.

It was assumed that the total cost must be fully recoverable by the CPT event scenario. Moreover, as a

conservative assumption, a cost recovery factor was applied, such that total cost recovery was deemed to be

provided by the use of half of the potential inventory. The assumed logic for this is the prospect of

uncertainty over the duration and LNG requirements of the CPT Event. To assume the recovery of total cost

over the full potential inventory could otherwise result in the under-recovery of cost should less LNG be

required.

We use the following assumptions given by Table 3-2 to inform this analysis.

Table 3-2: LNG Cost Assumptions

Assumptions Input Data/Value Source Capital cost of the LNG facility $192,152/tonne

AEMO/APA GasNet

Derived from Major System Augmentation

Report for the Victorian Principal

Transmission System (2005), where

GasNet provided a cost estimate to

replicate the Dandenong LNG plant.

Adjusted to 2013 prices.

Fixed operations and maintenance cost

$0/GJ AEMO assumption

Variable operations and maintenance cost

$0.5/GJ AEMO assumption, inclusive of liquefaction and vaporisation costs.

Variable supply cost of gas $4.50/GJ AEMO assumption.

Weighted Average Cost of Capital (WACC)

7% (pre-tax, real) AEMO assumption

Expected life of LNG facility 30 years AEMO assumption

DWGM CPT REVIEW


3.2.3 Retailer Impact Model

This model measures the impact of price risk on a range of representative retailers. The assessment metric

for price impact is “days of average operating profit foregone”, based on a typical retail margin for

representative customers.

The model assumes five types of retailer, each supplying standard residential and/or business customers.

For the standard customer types, a CPT Event Load Factor is used, reflecting the multiple of average daily

consumption that the customer is deemed to consume on each CPT Event day. Each model retailer is

prescribed a level of contract cover for their retail portfolio, with the value applying to each CPT Event day.

This determines their extent of exposure to prices in the organised wholesale market.

Table 3-3 and Table 3-4 summarise the specification of the standard retailer and customer types that

informed the analysis.

Table 3-3: Standard Retail Assumptions

Portfolio Load Share Contract Cover CPT Event

Retailer Label Residential Business Assumed Cover

Load Factor

Retailer 1 R1 50% 50% 90% Residential: 2.5 Business: 1.0



Retailer 4 R4 100% 0% 0% Residential: 2.5

Retailer 5 R5 0% 100% 0% Business: 1.0

Table 3-4: Standard Customer Assumptions

Customer Types Label GJ/YR Retailer Portfolio Contribution

Customer 1 C_10 10 33.3% Residential Load



Customer 4 C_500 500 100% Business Load

Bill Component Unit C_10 C_30 C_60 C_500

Commodity Cost $/GJ 5.00 5.00 5.00 5.00

Transmission cost $/GJ 0.37 0.37 0.37 0.37

Distribution $/GJ 9.34 7.31 6.70 1.70

Retail Costs $/GJ 9.00 3.00 1.50 0.16

Retail Margin Ave Customer 7% 7% 7% 7%

Retail Margin $/GJ 1.66 1.1 0.95 0.51

DWGM CPT REVIEW


3.2.4 Comparative Market Analysis

We limited consideration to a comparison of CPT settings between markets. These were translated into

retailer impact measures that are consistent with those of the retailer impact model. The following

summarises the approach:

For STTM:

We used our retailer impact model and the same CPT Event scenarios to measure the residual wholesale

market risk on our model retailers (R1 to R3 only), after allowance for the current settings of the CPT

Mechanism in the STTM.

For NEM:

We used our retailer impact model with changed customer assumptions and an alternative CPT Event

scenario:

Only considered Retailer 1 (R1)

• 50% residential, 50% business, 90% hedged.

o Residential customer 5MWh/Year

o Business customer 50MWh/Year

• Adapted cost structure and used a 1.4 load factor for residential load during the CPT event

CPT event scenario (6 day event: adapted from March 11-17 in 2008 -SA)

• All VoLL prices updated to current settings

• All other prices scaled by a factor of 2.5 with a minimum price of $80/MWh imposed

• This CPT event has been used in advice to the AEMC in their market setting studies6.

• No analysis of CPT event to determine likelihood.

Current CPT Parameters

Market CPP (days) CPT

DWGM 7 $3,700

STTM 7 $440

NEM 7 $193,900

3.2.5 Test parameters for the CPT mechanism

Table 3-5 provides the CPT test parameters for the CPT mechanism:

Table 3-5: Test Parameters

Cumulative Price Period

15 consecutive scheduling intervals Equivalent to 3 trading days



6

http://www.aemc.gov.au/Media/docs/Risk%20assessment%20of%20raising%20VoLL%20and%20the%20CPT%20-%20Concept%20Economics-658f5848-6273-4c58-9113-8ba387014079-0.pdf



DWGM CPT REVIEW



Cumulative Price Threshold

$1800 Equivalent to 2.25*VoLL




3.3 Approach

AEMO’s approach in reviewing the CPT Mechanism has been guided by the methodologies that have been

used in previous CPT and Market Parameter studies for the DWGM and the STTM.

The following summarises the approach:

1. Develop a revenue sufficiency model for the efficient recovery of LNG costs.

The assumption is that LNG represents the highest cost source of gas for which CPT settings should not

deny efficient cost recovery. We developed a model of expected LNG use for both a median and 1:20

year, in each case determining a revenue sufficiency measure for both fixed and variable costs.

2. Develop a retailer impact model to measure the incidence of price risk on a range of representative

retailers

The analysis assumed a range of representative retailers that are consistent with the current industry

structure, and that assume a range of hedging strategies. We developed a retailer impact model that

measures the incidence of price risk in terms of a measure of annual operating profit forgone.

3. Determine a set of CPT event scenarios

The analysis considered the range of likely trigger scenarios for the CPT mechanism, defining each via a

temporal profile of high price outcomes. These were modelled as a set of multi-day CPT event scenarios

that were used as an input to the retailer impact analysis.

4. Determine a basis for reviewing interactions between related markets.

We did not assume coincident CPT events between markets, and limited consideration to a comparison

of CPT settings between markets. We have translated settings into appropriate retailer impact measures

that are consistent with those of the proposed retailer impact model.

5. Draft a methodology and assumptions paper for review by interested members of the GWCF.

6. Prepare models and conduct analysis

7. Prepare a draft report to summarise results and to suggest recommendations for the value of the CPT.

8. Respond to feedback on the draft report from interested members of the GWCF.

9. Prepare a final report with recommendations for the consideration of the GWCF.

It is proposed that this will be presented for information and discussion at the GWCF meeting on August

13, 2013.

DWGM CPT REVIEW


4 RESULTS OF ANALYSIS

4.1 Lower constraint value for the CPT

An assumption was made that LNG represents the highest cost source of gas for which CPT settings should

not deny efficient cost recovery. We also assumed that opportunities for LNG cost recovery may be limited

to CPT Events. The reasonable recovery of LNG costs therefore becomes a lower financial constraint on the

setting of the CPT.

In calculating the fixed cost for the lower financial constraint, we determined an approximate annualised total

cost for the required inventory of the Dandenong LNG facility. We used the maximum possible supply during

the assumed CPT event scenario as the required inventory level, capping this by the size of the existing

facility.

It was assumed that the total cost must be fully recoverable by the CPT event scenario. Moreover, as a

conservative assumption, a cost recovery factor was applied, such that total cost recovery was deemed to be

provided by the use of half of the potential inventory. The assumed logic for this is the prospect of

uncertainty over the duration and LNG requirements of the CPT Event. To assume the recovery of total cost

over the full potential inventory could otherwise result in the under-recovery of cost should less LNG be

required.

The variable costs of the Dandenong LNG facility was incorporated in the calculation of the lower financial

constraint. These costs included the liquefaction and vaporisation costs per CPT event and the sum of

typical prices during the cumulative price period. Refer to Section 3.2.2 for the input data assumptions.

Figure 4-1 displays the lower constraint values required by the LNG plant to recover costs, for different

values of CPP. The results indicate that an increase in the CPP leads to a higher lower constraint value. All

of the lower constraint values fall below $800, which are below the lowest CPT test parameter of $1800. This

indicates that the CPT test parameters would not deny the recovery of LNG costs.

Figure 4-1: Lower Constraint Value for CPT

DWGM CPT REVIEW


4.2 CPT settings in the STTM and NEM –Retailer impact analysis

A comparative analysis was completed to compare the risk mitigation power of the CPT mechanisms of the

STTM and the NEM. This required an adaptation of the retailer impact model and of a subset of the model

retailers.

For the STTM calculation, only the results for R1, R2 and R3 were considered. The results for R4 and R5 are

not provided as these retailers assumed zero contract cover, which is an unrealistic portfolio management

strategy. The cost structure, load factors, and CPT Event scenarios assumed for these retailers are the same

as the DWGM case. Refer to Section 3.2.3 for these input assumptions.

Table 4-1 presents the full set of results of how the CPT Event settings impact on the retailers’ gross

operating profits. The results show that retailers with less contract cover forego more days of gross operating

profit. The least was incurred by R1, which has a contract cover of 90%. It is also observed that when the

CPP is fixed, an increase to the CPT Event duration leads to an increase in the number of days of gross

operating profit foregone. Longer duration CPT events increase the Event Cost, due to the assumption of a

longer period of VoLL prices. Consequently, this increases the portfolio weighted cost7 incurred by retailers,

which increases the number of days of gross operating profit foregone.

Table 4-1: STTM Base Scenario Results

The NEM calculation only considered the result for R1. The cost structure adapted utilised the framework of

the DWGM case. Further, a 1.40 load factor was used for the residential load factor during a CPT Event. The

CPT Event scenario utilised the current market setting parameters and the AEMC’s event scenario that was

used for advice in its market parameter study8.

The modelling indicates that the days of operating profit foregone for R1 in the NEM is 21 days. This value is

significantly lower in comparison to the retailers for the STTM base case scenarios.

7 The portfolio-weighted cost quantifies the impact of the CPT Event on a retailer’s business and residential

portfolio, represented by a defined mix between business and residential customers, and an assumed level of contract cover. 8http://www.aemc.gov.au/Media/docs/Risk%20assessment%20of%20raising%20VoLL%20and%20the%20C

PT%20-%20Concept%20Economics-658f5848-6273-4c58-9113-8ba387014079-0.pdf

R1 R2 R3

Event Description

86.6656 171.9293 435.4263 2 days of prices at VoLL, CPT = 440, CPP = 7




Days of gross operating profit foregone

Impact Assessment



DWGM CPT REVIEW


4.3 CPT settings in the DWGM -Retailer impact analysis

A retailer impact model was developed to understand the risk mitigation power of alternative settings for the

CPT Mechanism. The model measured the impact of residual wholesale market price risk on the assumed

operating profits of a range of model retailers. The impact metric that was used was the number of “days of

average operating profit foregone”, representing the operating profit impact of the total CPT Event cost on a

selection of modelled retailers, having different customer portfolios and levels of hedging cover. This section

presents the results of the impact metric on the modelled retailers for the four CPT Event scenarios.

We also considered CPT Event cost in terms of the number of “days of retail margin impact” for the

residential and business customers of the modelled retailers. However this was a secondary metric that was

only used to present an alternative perspective on the measure of this residual risk.

4.3.1 CPT Event: 2 consecutive days with prices at VoLL

This section gives the results for the CPT Event scenario when there are two days of potential prices at

VoLL. Figure 4-2 compares the impact of alternative CPT settings on model retailers when the CPP is set to

35 scheduling intervals (7-days). A set of charts, covering alternative CPP test parameters, can be found in

Appendix A. It also shows the comparative impacts of the current specification of CPT mechanisms of the

STTM and the NEM.

For simplification, Figure 4-2 only displays days of gross operating profit foregone for R1, R2, and R3. The

results for R4 and R5 are not provided as these retailers have an assumed zero contract cover, which is an

unrealistic portfolio management strategy. A full list of results is given by Table 4-2.

Note that the bar graphs on the left, which are enclosed by the rectangle, give the days of operating

foregone for the DWGM and the STTM. These values are calculated using current market settings.

In addition, the purple dashed line gives the result for R1 for the NEM, utilising current CPT settings.

DWGM CPT REVIEW


Figure 4-2: Impact of CPT settings on Retailer profit for a 2-day CPT Event

The following summarises the impact of CPT settings on the modelled retailers.

For the DWGM case, the number of days of gross operating profit foregone for R1 are, 75 when

CPT = $1800, 75 when CPT = $2500, 137 when CPT = $3700, and 167 when CPT = $4500;

An increase in the CPT results in the retailers being more exposed to sustained high price

outcomes. This implies a higher Event Cost incurred by the retailers, which causes their portfolio-

weighted9 cost to increase. This in turn, results in an increase in the number of days of gross

operating profit foregone as the CPT increases;

A similar upward trend is also observed for R2 and R3 of the DWGM, whereby, an increase in the

CPT leads to an increase in the number of days of gross operating profit foregone. This indicates

that retailers would forego more gross operating profit as the CPT increases;

For the current market setting scenario the number of days of gross operating profit foregone for R1

are, 137 for the DWGM, 87 for the STTM, and 21 for the NEM; and

At the current CPT settings, the results indicate that the level of residual risk in the DWGM is

greater than the STTM, and much higher in comparison to the NEM.

Note that it is possible to obtain the same values of operating profit foregone for the respective retailers when

the CPT value increases. This occurs when alternative CPT test parameters have the same mitigation

power, and therefore do not influence the CPT Event Cost, and usually arises when the CPT values range

between $1800 and $2500.

Figure 4-3 compares the impact of alternative CPT settings on representative customer types. Similar to the

previous set of results, the retailer impact model was used to measure how alternative CPT settings impact

on R1 customers. The full set of results can be found in Appendix B.

9 The portfolio-weighted cost quantifies the impact of the CPT Event on a retailer’s business and residential

portfolio, represented by a defined mix between business and residential customers, and an assumed level of contract cover.

DWGM CPT REVIEW


Figure 4-3: Impact of CPT settings on customer types for a 2-day CPT Event

The above chart summarises the impact of CPT settings on R1’s customer retail margin.

The first four set of bar charts to the left show the impact of CPT settings on the four respective

customer types, when the CPP is set to 35 scheduling intervals. The latter four set of bar charts to

the right shows a similar set of results, but setting the CPP to 70 scheduling intervals;

In the case of when CPP = 35, the number of days of customer retail margin foregone for C_10 are,

56 when CPT = $1800, 56 when CPP = $2500, 102 when CPP = $3700, and 125 when CPP =

$4500;

The trend observed by C_10 is also seen for the other three customer types. This indicates that

more days of customer retail margin are foregone as the CPT increases;

An increase in the CPT results in the retailers being more exposed to sustained high price outcomes.

This implies a higher Event Cost incurred by the retailers, which causes their load-weighted cost to

increase. This in turn, results in an increase in the number of days of customer margin foregone as

the CPT increases;

In the case of when CPP = 70, the number of days of customer retail margin foregone for each

respective customer type also increases when the CPT is revised upwards. However, the values are

always less than or equal to the previous scenario when the CPP = 35;

An increase in the CPP can limit the retailers’ exposure to sustained high prices, as it enables the

CP to breach the CPT earlier during the CPT Event. In doing so, it limits the cost incurred by

retailers, which reduces the load-weighted cost. Hence, this results in a reduction in the number of

days of customer margin foregone.

DWGM CPT REVIEW


Table 4-2 presents the full set of results of how the CPT settings impact on retailers’ profit for a 2-day CPT

Event scenario.

Table 4-2: Retailer impacts for a 2-day CPT Event Scenario

The following is observed:

The number of days of gross operating profit foregone is generally much greater for R4 and R5,

when compared to R1, R2 and R3. This is because R4 and R5 have no contract cover (unhedged);

When the CPT is fixed an increase in the CPP leads to a reduction in the number days of gross

operating profit foregone; and

Alternatively, when the CPP is fixed, an increase in the CPT, leads to an increase in the number of

days of gross operating profit foregone.

R1 R2 R3 R4 R5

Event Desciption

75.40514 149.5905 378.8512 759.4182 740.9603 2 days of prices at VoLL, CPT = 1800, CPP =15





















Impact Assessment

DWGM CPT REVIEW


Table 4-3 presents the full set of results of how the CPT settings impact on days of customer retail margin

foregone for a 2-day CPT Event scenario.

Table 4-3: Customer impacts for a 2-day CPT Event Scenario


The number of days of customer margin foregone generally increases as the customer size

increases;

When the CPT is fixed, an increase in the CPP leads to a reduction in the number of days of

customer margin foregone; and

Alternatively, when the CPP is fixed, an increase in the CPT leads to an increase in the number of


C_10 C_30 C_60 C_500

Event Description

56.48611 85.41363 98.6946 74.09603 2 days of prices at VoLL, CPT = 1800, CPP =15




















Days of customer margin foregone

Impact Assessment

DWGM CPT REVIEW



This section gives the results for the CPT Event scenario when there are three days of prices at VoLL. Figure

4-4 compares the impact of alternative CPT settings on model retailers when the CPP is set to 35 scheduling

intervals (7-days). A set of charts, covering alternative CPP test parameters, can be found in Appendix A. It

also shows the comparative impacts of the current specification of CPT mechanisms of the STTM and the

NEM.

Figure 4-4: Impact of CPT settings on Retailer profit for a 3-day CPT Event



CPT = $1800, 83 when CPT = $2500, 144 when CPT = $3700, and lastly, 174 when CPT = $4500.

In comparison to the 2-day CPT Event Scenario, these values are higher;

Upward revision in the CPT Event scenario, from 2 days to 3 days, leads to an increase in the Event

Cost, due to a longer duration of VoLL prices. Consequently, this increases the portfolio-weighted

cost incurred by retailers, which implies a higher gross operating profit foregone;

Increase in the CPT results in the retailers being more exposed to sustained high price outcomes.

This implies a higher Event Cost incurred by the retailers, which causes their portfolio-weighted cost

to increase. This in turn, results in an increase in the number of days of gross operating profit

foregone as the CPT increases;

A similar upward trend is also observed for R2 and R3 for the DWGM, whereby, an increase in the

CPT, leads to an increase in the number of days of gross operating profit foregone;

At the current market settings, the number of days of gross operating profit foregone for R1 are, 144

for the DWGM, 94 for the STTM, and 21 for the NEM; and

Once again, the results for the current market settings indicate that the level of residual risk in the

DWGM is greater than the STTM, and much higher in comparison to the NEM.

DWGM CPT REVIEW


Figure 4-5 compares the impact of alternative CPT settings on representative customer types for R1, when

there are three days of prices at VoLL. The full set of results can be found in Appendix B.



The first set of bar charts to the left show the impact of CPT settings on the four respective customer

types, when the CPP is set to 35 scheduling intervals. The latter set of bar charts to the right shows

a similar set of results, but setting the CPP to 70 scheduling intervals;



$4500. In comparison to the 2-day CPT Event scenario, these values are higher;


Cost, due to a longer duration of VoLL prices. Consequently, this increases the load-weighted cost

incurred by retailers, which implies a higher number of days of customer margin foregone;


more days customer retail margin are foregone as the CPT increases;




the CPT increases;


respective customer type also increases when the CPT is revised upwards. However, the values are


Increase in the CPP can limit the retailers’ exposure to sustained high prices, as it enables the CP to

breach the CPT earlier during the CPT event. In doing so, limits the cost incurred by retailers, which

reduces the load-weighted cost. Hence, this results in a reduction in the number of days of customer

margin foregone; and

The set of results show that the customer retail margin foregone is reduced when the CPP is revised

upwards.

0

50

100

150

200

250

C_10 C_30 C_60 C_500 C_10 C_30 C_60 C_500

Day

s o

f cu

sto

me

r re

tail

mar

gin

fo

rego

ne

Customer type

Impact of CPT settings on R1 customer retail margin3 days of prices at VoLL

CPT = 1800

CPT = 2500

CPT = 3700

CPT = 4500

CPP = 70CPP = 35

DWGM CPT REVIEW



Event scenario.



The number of days of gross operating foregone is generally much greater for R4 and R5, when

compared to R1, R2 and R3. This is due to R4 and R5 having no contract cover;

The number of days of operating foregone incurred by retailers is generally larger, when compared

to the 2-days of CPT Event duration. The higher Event Cost caused an increase to retailers’ gross

operating profit foregone;

When the CPT is fixed, an increase in the CPP leads to a reduction in the number days of gross




R1 R2 R3 R4 R5

Event Desciption





















Impact Assessment


DWGM CPT REVIEW


Table 4-5 presents the full set of results of how the CPT settings impact on customer retail margin foregone

for a 3-day CPT Event scenario.




increases;

The number of days of customer margin foregone incurred by R1 is generally larger, when compared

to the 2-days of CPT Event duration. The higher Event Cost caused an increase in the number of

days of customer margin foregone;



Alternatively, when the CPP is fixed, an increase in the CPT, leads to an increase in the number


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


DWGM CPT REVIEW



This section gives the results for the CPT Event scenario when there are four days of prices at VoLL. Figure



also shows the comparative impacts of the current specification of CPT mechanisms for the STTM and the

NEM.

Figure 4-6: Impact of CPT settings on Retailer profit for a 4-day CPT Event Scenario













CPT, leads to an increase in the number of days of gross operating profit foregone.

For the current market settings, the number of days of gross operating profit foregone for R1 are,

151 for the DWGM, 101 for the STTM, and 21 for the NEM; and


DWGM is greater than the STTM, and significantly higher in comparison to the NEM.

DWGM CPT REVIEW



there are four days of prices at VoLL. The equivalent results for R2 to R5 have been provided in this section.

The full set of results can be found in Appendix B.








$4500. In comparison to the 3-day CPT Event Scenario, these values are higher;





more days customer retail margin are foregone as the CPT increases;




the CPT increases;


respective type also increases when the CPT is revised upwards. However, the values are always

less than or equal to the previous scenario when the CPP = 35;


breach the CPT earlier during the CPT Event. In doing so, limits the cost incurred by the retailers,

which causes the load-weighted cost to decrease. Hence, this results in a reduction in the number of

days of customer margin foregone; and


upwards.

0

50

100

150

200

250

C_10 C_30 C_60 C_500 C_10 C_30 C_60 C_500

Day

s o

f cu

sto

me

r re

tail

mar

gin

fo

rego

ne

Customer type

Impact of CPT settings of R1 customer retail margin4 days of prices at VoLL

CPT = 1800

CPT = 2500

CPT = 3700

CPT = 4500

CPP = 70CPP = 35

DWGM CPT REVIEW



Event scenario.





The number of days of gross operating foregone incurred by retailers is generally larger, when

compared to the 3-days of CPT Event duration. The higher Event Cost caused an increase to

retailers’ gross operating profit foregone;

When the CPT is fixed, an increase in the CPP leads to a reduction in the number of days of gross




R1 R2 R3 R4 R5

Event Desciption





















Impact Assessment


DWGM CPT REVIEW







increases;








C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


DWGM CPT REVIEW



This section gives the results for the CPT Event scenario when there are five days of prices at VOLL. Figure



also shows the comparative impacts of the current specification of CPT mechanisms for the STTM and the

NEM.

Figure 4-8: Impact of CPT settings on Retailer profit for a 5-day CPT Event Scenario













CPT, leads to an increase in the number of days of gross operating profit foregone.

For the current market settings, the number of days of gross operating profit foregone for R1 are,

158 for the DWGM, 108 for the STTM, and 21 for the NEM; and


DWGM is greater than the STTM, and significantly higher in comparison to the NEM.

DWGM CPT REVIEW



there are five days of prices at VoLL. The full set of results can be found in Appendix B.








$4500. In comparison to the 4-day CPT Event Scenario, these values are higher;

Upward revision in the CPT event scenario, from 4 days to 5 days, leads to an increase in the Event




more days of customer retail margin are foregone as the CPT increases;




the CPT increases;


respective customer type also increases when CPT is revised upwards. However, the values are



breach the CPT earlier during the CPT event. In doing so, limits the cost incurred by retailers, which

causes the load-weighted cost to decrease. Hence, this results in a reduction in the number of days

of customer margin foregone; and

0

50

100

150

200

250

C_10 C_30 C_60 C_500 C_10 C_30 C_60 C_500

Day

s o

f cu

sto

me

r re

tail

mar

gin

fo

rego

ne

Customer type

Impact of CPT settings of R1 customer retail margin5 days of prices at VoLL

CPT = 1800

CPT = 2500

CPT = 3700

CPT = 4500

CPP = 70CPP = 35

DWGM CPT REVIEW



upwards.


Event scenario.





The number of days of gross operating foregone incurred by retailers is generally larger, when

compared to the 4-days of CPT Event duration. The higher Event Cost caused an increase to

retailers’ gross operating profit foregone;

When the CPT is fixed, an increase in the CPP leads to a reduction in the number of days of gross




R1 R2 R3 R4 R5

Event Desciption





















Impact Assessment


DWGM CPT REVIEW







increases;








C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


DWGM CPT REVIEW


4.3.5 Additional analysis requested by Lumo Energy

As part of the consultative process that accompanied this CPT Mechanism Review, Lumo Energy proposed

additional analysis to test an alternative “worst case” profile of event costs and market imbalances. The

requested profile of event cost featured an assumed VoLL price for the first scheduling interval of each CPT

Event day, with subsequent (intra-day) prices equal to the assumed “normal price”. Further, the requested

imbalance profile featured the entire daily imbalance in the first scheduling interval of each CPT Event day.

Lumo Energy also requested additional (higher) test-settings for the CPT Mechanism.

Figure 4-10 compares the impact of alternative CPT settings on model retailers when the CPP is set to 35

scheduling intervals (7-days) for the LUMO Energy scenario. It also shows the comparative impacts of the

current specification of CPT Mechanisms for the STTM and the NEM.

Figure 4-10: Impact of CPT settings on Retailer profit for the Lumo Scenario

The following summarises the impact of CPT settings on model retailers.



In comparison to the 5-day CPT Event Scenario, these values are approximately 4 times higher.

These results eventuated from letting the daily imbalance to occur only in the first scheduling

interval for each CPT Event day.

This caused the CPT Event cost to increase quite significantly, which consequently led to increases

in the number of days of gross operating profit foregone;

As seen previously, an increase in the CPT results in the retailers being more exposed to sustained

high price outcomes. This implies a higher Event Cost incurred by the retailers, which causes their

portfolio-weighted cost to increase. This in turn, results in an increase in the gross operating profit


A similar upward trend is also observed for R2 and R3 for DWGM, whereby, an increase in the

CPT, leads to an increase in the number of days of gross operating profit foregone; and

For the current market setting scenario, the number of days of gross operating profit foregone for

R1 is, 158 for the DWGM, and 21 for the NEM. This shows that the level of risk tolerated by retailers

DWGM CPT REVIEW


in the Lumo Energy scenario is significantly greater than the current market setting outcome for the

NEM.

DWGM CPT REVIEW


5 RECOMMENDATIONS

5.1 Summary of findings

The analysis has found that the current CPT settings may not sufficiently protect market participants from

sustained high prices, resulting in possible exposure to unmanageable and excessive price risk.

The analysis also found, for the modelled CPT Event scenarios and current CPT settings, that the DWGM

CPT mechanism provides significantly less protection than do the CPT mechanisms of the STTM and the

NEM.

5.2 Excessive or unmanageable Risk

Our test for wholesale market price risk measures the residual cost impact of a range of CPT Events on the

gross operating profits of a range of modelled retailers. In particular, we measured the cost impact of each

CPT Event scenario in terms of the number of days of gross operating profit foregone for each modelled

retailer. This measured cost took into account an assumed level of contract hedge cover for each modelled

retailer, thereby measuring the net cost, after hedging, of market prices for a retail portfolio featuring both

residential and/or business customers.

Unlike for the NEM, the financial markets do not offer a range of risk products to assist the management of

price risk in the wholesale gas markets. This means that in the case of the wholesale gas markets,

participants must physically hedge price risk; this requires a participant to hold a diverse gas portfolio,

including both supply and transportation capacity. In the case of the DWGM, price risk can be significant

because of the small amount of linepack within the Declared Transmission System. During a CPT Event,

this means that LNG and Iona gas inventories may be needed. Of these, the location of the Dandenong

LNG facility makes it an important facility from a security of supply perspective.

Our modelling assumption is that a CPT Event is likely to occur once every ten years. The actual prospect of

a CPT Event can vary by scenario however, with the shorter duration events perhaps more realistic. An

actual event that could otherwise cause five days of prices at VoLL may not be realistic, given that such a

scenario would likely require considerable curtailment, and possible market suspension. Indeed, for major

events we would expect that the limited linepack capacity of the Declared Transmission System would

require market suspension before the CPT event would otherwise end. For this reason we have given

greater weight to the two and three-day CPT event scenarios.

We determined that a CPT Event cost of more than 500 days of foregone gross operating profit could reflect

a level of risk that is unmanageable and excessive for a modelled retailer. This amounts to about 10% of the

annual operating costs of the Victorian retail portfolio of a typical retailer. For an established retailer with a

national dual-fuel business this would be manageable. However for a new entrant or small, rapidly growing

retailer, this could present an insolvency risk.

In the wholesale gas markets, the bilateral market for LNG supply and capacity is not liquid. AEMO

understands that most LNG capacity is subject to long-term contracts by the larger and more established

market participants. This may make it difficult for a new entrant retailer to establish and maintain a sufficient

physical hedge against CPT Events.

An inability to hedge against excessive levels of risk creates a barrier to entry to potential new retailers,

which can result in less competition in the long term. This outcome would not be in the long-run interests of

consumers, and does not assist the achievement of the National Gas Objective.

For this reason, we used our modelled retailer, R3, as the basis for determining whether CPT settings may

be insufficient. R3 is a proxy for a new entrant or small rapidly growing retailer, having a retail portfolio that

has an 80%:20% mix between residential and business customers, and having only 50% contract cover for

CPT Events.

DWGM CPT REVIEW


By comparison, our modelled retailer, R1, resembles a major established retailer, having an assumed 90%

level of contract cover for CPT Events.

Our risk threshold for deeming a level of risk that is excessive and/or unmanageable is therefore 500 days of

average gross operating profit foregone for retailer R3

5.3 Combinations of CPT settings that satisfy the risk threshold

We have found that the current settings for the CPT mechanism may not provide sufficient risk mitigation for

retailers that have limited contract cover. R3, that only has 50% contract cover, would forego 686 days of

gross operating profit in the case of our 2-day CPT Event. Figure 1 below illustrates this finding.10

Figure 5-1: Impact of CPT settings on Retailer profit

CPT settings that do not breach the risk threshold of 500 days for retailer R3:

Table 5-1 identifies those combinations of CPT settings that do not breach the risk threshold of 500 days for

retailer R3 (highlighted in green).

The results show that for each of the respective CPT Event scenarios, adjustment to the CPP or the

CPT or both, will be required in order to protect the model retailer, R3, from a level of risk that is

deemed excessive and/or unmanageable. These combinations of CPT settings are highlighted in

green;

For the CPT Event scenario of two days duration, it was noted that an acceptable level of risk can be

achieved by revising the CPT from $3700 to $1800, and selecting any one of the CPP test values.

Similarly, an acceptable level of risk can be achieved by revising the CPT from $3700 to $2500, and

choosing a CPP setting between 25 to 70 scheduling intervals;

The same combinations of CPT settings can achieve an acceptable level of risk for the CPT Event

scenario that has a duration of three days; and

For CPT Event scenarios of four and five days, the acceptable level of risk can achieved by setting

the CPP parameter to between 25 and 70 scheduling intervals, and setting the CPT to $1800 or

$2500.

10

Note that it is possible to obtain the same values of operating foregone for the respective retailers when the CPT

values increase. This occurs when the change in CPT values does not influence the CPT Event Cost.

DWGM CPT REVIEW


Table 5-1: Combinations of CPT settings that satisfy our test for acceptable risk

5.4 Recommended CPT Settings

The current CPT setting may not provide sufficient risk mitigation for retailers that have limited contract

cover. Moreover, our analysis has found that this level of risk is out-of-step with other markets and may

therefore impose an excessive and onerous management cost. These factors can create a barrier to entry

and may discourage new retailers from entering into the DWGM.

Due to these findings, we recommend a change to the CPT settings to enable a reduction in the level of risk

that is resultant from the CPT mechanism.

Recommended CPT Settings

Cumulative Price Period (CPP) 35 Scheduling Intervals (7 days)

Cumulative Price Threshold (CPT) $1800

We recommend:

1. Cumulative Price Period (CPP): 35 Scheduling Intervals (7 days)

We recommend that current settings for the CPP are maintained at 35 scheduling intervals. This

would satisfy the needs of short-duration CPT events, while also providing sufficient time to

understand and coordinate the initial management of long-duration events. This also shares

symmetry with the NEM and STTM (CPP = 7 days).

2. Cumulative Price Threshold (CPT): $1800

We recommend that the CPT is lowered from $3700 to $1800. Based on our measure of

excessive and/or unmanageable risk, this reduces the level of residual wholesale market risk to a

CPT ($) 15 25 35 50 70

1800 378.8512 378.8512 378.8512 225.2902 225.2902

2500 532.4122 378.8512 378.8512 378.8512 378.8512

3700 685.9732 685.9732 685.9732 685.9732 685.9732

4500 839.5342 839.5342 839.5342 839.5342 839.5342

1800 414.7157 414.7157 414.7157 261.1547 261.1547

2500 568.2768 414.7157 414.7157 414.7157 414.7157

3700 721.8378 721.8378 721.8378 721.8378 721.8378

4500 875.3988 875.3988 875.3988 875.3988 875.3988

1800 604.1413 450.5803 450.5803 297.0193 297.0193

2500 911.2633 450.5803 450.5803 450.5803 450.5803

3700 1371.946 757.7023 757.7023 757.7023 757.7023

4500 1525.507 911.2633 911.2633 911.2633 911.2633

1800 640.0059 486.4449 486.4449 332.8839 332.8839

2500 947.1279 486.4449 486.4449 486.4449 486.4449

3700 1407.811 793.5669 793.5669 793.5669 793.5669

4500 1714.933 947.1279 947.1279 947.1279 947.1279

2 days

CPT EVENT

DURATION

CPP

5 days

3 days

4 days

DWGM CPT REVIEW


level that better addresses the needs of new entrant and rapidly growing retailers. We

understand that in the case of the Declared Transmission System, access to injection capacity

from the Dandenong LNG facility will often be required to maintain the security of the system

during possible CPT events. AEMO understands that the bilateral market for LNG capacity is not

liquid, and is mostly contracted by the larger established retailers. It follows that new entrant and

rapidly growing retailers may therefore experience difficulty in procuring sufficient LNG capacity to

address optimal risk management needs. This could present a barrier to entry, affecting

competition and price outcomes, and may create a possible insolvency risk during major CPT

events. Our assessment has also shown that the risk mitigation power of the current settings is

weaker than those of the CPT mechanisms of the NEM and STTM.

A CPT setting of $1800 will not deny sufficient cost recovery for the fixed and variable costs of the

LNG facility, which is also the most expensive source of supply in the Victorian system on a total

average cost basis.

DWGM CPT REVIEW


6 NEXT STEPS

AEMO is seeking comments on the findings and recommendations of this draft report. In particular, we are

seeking feedback on:

1. Our basis for determining the level of residual CPT risk that may be excessive or unmanageable,

and therefore the basis of our justification for recommending alternative CPP and CPT settings.

a. Our use of the model retailer, R3, representing a proxy for a new-entrant or rapidly growing

retailer.

b. Our choice of the risk threshold, 500 days of average operating profit foregone, for major

CPT events having an assumed likelihood of ~1 in 10 years.

2. Our recommended setting of 35 scheduling intervals (7 days) for the Cumulative Price Period (CPP).

3. Our recommended setting of $1800 for the Cumulative Price Threshold (CPT).

Comments are due by Monday July 22, 2013.

A final report and recommendations will be prepared for information and consideration at the GWCF meeting

on August 13, 2013.

DWGM CPT REVIEW


7 Appendix A IMPACTS OF CPT SETTINGS ON RETAILERS

The following graphs show the impact of CPT settings on retailer gross operating profit for different CPP test

values, when there are two days of high price outcomes.

Figure A-1: Impact on Retailer profit for a 2 day CPT Event, when CPP = 15


DWGM CPT REVIEW




DWGM CPT REVIEW



values, when there are three days of high price outcomes.



DWGM CPT REVIEW




DWGM CPT REVIEW



values, when there are four days of high price outcomes.



DWGM CPT REVIEW




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values, when there are five days of high price outcomes.



DWGM CPT REVIEW




DWGM CPT REVIEW


8 Appendix B IMPACTS OF CPT SETTINGS ON CUSTOMER

MARGIN

The following tables show the CPT settings impact on the retailers’ days of customer margin foregone, when

there are two days of high price outcomes.

Table B-1: Customer impacts for a 2-day CPT Event Scenario for R2


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


DWGM CPT REVIEW




C_10 C_30 C_60 C_500

Event Description

564.8611 854.1363 986.946 0 2 days of prices at VoLL, CPT = 1800, CPP =15




















Impact Assessment


C_10 C_30 C_60 C_500

Event Description

0 0 0 740.9603 2 days of prices at VoLL, CPT = 1800, CPP =15




















Impact Assessment


DWGM CPT REVIEW



there are three days of high price outcomes.



C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


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C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


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there are four days of high price outcomes.



C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


DWGM CPT REVIEW




C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


DWGM CPT REVIEW



there are five days of high price outcomes.



C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


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C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


C_10 C_30 C_60 C_500

Event Description





















Impact Assessment


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