Retailer reliability obligation
Cau Thai | 31st October 2022Retailer reliability obligation: independent audit of bespoke firmness methodologies for non-standard qualifying contracts
Dr. Cau Thai, independent auditor of the AER’s RRO auditor panel
In this note, Dr. Cau Thai shares some of his general observations about the independent audit of the bespoke firmness methodologies for non-standard qualifying contracts within the retailer reliability obligation mechanism.
The Retailer Reliability Obligation
The Retailer Reliability Obligation (RRO) is one of the capacity management mechanisms currently adopted in the National Electricity Market (NEM). It is built upon a set of national electricity rules in chapter 4A with the main purpose to support the reliability of the electricity supply system through incentivising liable entities (retailers and other relevant market customers) to forward contract or invest in capacity or resources to ensure long-term supply adequacy.
The process of RRO works as follows. In their forecast, usually within the Electricity Statement of Opportunities process, the Australian Energy Market Operator (AEMO) will assess if there is a reliability gap three years ahead. If a reliability gap is identified, AEMO will request the Australian Energy Regulator (AER) to make a T-3 reliability instrument. If an identified gap remains in AEMO’s forecasts one year ahead, AEMO will request AER to make a T-1 reliability instrument. A T-1 reliability instrument will introduce obligations on all liable entities in the relevant region to assess their likely share of system peak demand and secure sufficient qualifying contracts to cover this.
Recently triggered reliability instruments
On 24 October 2022, the AER has decided [1]
- a T-1 reliability instrument for South Australia for the forecast reliability gap period of 8 January 2024 to 29 February 2024, and
- a T-3 reliability instrument for New South Wales for the forecast reliability gap period of 1 December 2025 to 28 February 2026.
With this, for South Australia, the T-1 reliability instrument requires liable entities to report net contract position to the AER on 31 July 2023, reflecting their portfolio of contracts held on 6 January 2023.
According to RRO rules, in their reports to the AER, liable entities must adjust their contract position to reflect their firmness with regard to the contract price, volume and any other contract limitation risks. The firmness of standard qualifying contracts such as standard swaps, caps and others is to be adjusted using a default firmness methodology whereas that of other non-standard qualifying contracts is to be adjusted using bespoke firmness methodologies. Bespoke firmness methodologies developed by liable entities and the resultant firmness factors are to be approved by an Independent Auditor on the AER’s Auditors Panel.
Some general observations
Many non-standard qualifying contracts have complex linkages with physical assets such as generators, interconnectors and demand response. This requires that owners of these contracts develop a deep understanding and carefully consider the contract terms and related physical operations of those linked assets to meet the RRO rules and principles for developing bespoke firmness methodologies and calculating firmness factors. Other non-standard qualifying contracts such as option-like financial derivatives or insurance contracts require careful considerations of contract terms and the likelihood of related triggers.
Regarding the estimation of firmness factors of non-standard qualifying contracts, different stakeholders might take different views. Using a particular set of assumptions, models and inputs, a portfolio manager might think he/she has sufficient hedging contracts to cover a physical position that maximises value. On the other hand, a risk manager with a specific risk appetite (or current risk limits) might take a more conservative view from the financial risk perspective. From the system wide perspective, the reliability manager of the power systems (ie the overseer of RRO rules) has set rules and guidelines that may not necessarily align with the portfolio and risk managers of individual liable entities.
It is also well known that over hedging or too stringent risk limits might become costly for individual liable entities as well as power systems as a whole. The question is how to pragmatically strike the balance between return and risk, as well as applying defensible assumptions, models and inputs while meeting the set RRO rules and guidelines.
Dr. Cau Thai, with his Master by research thesis on power systems optimisation, PhD thesis on electricity markets, 17 years of employment with Snowy Hydro and more than 3 recent years of energy market consulting, has extensive experience in energy portfolio management, development of complex structured contracts and how to model them in a risk management simulation system. Cau also has a solid understanding of the physical operations of generating plants and other energy resources. He has applied this relevant experience into the independent audit process to ensure the bespoke firmness methodology of a nonstandard qualifying contract strictly complies with RRO rules and guidelines and is fairly and consistently assessed across different types of contracts.
Cau’s experience to date as an RRO independent auditor suggests that liable entities who have complex non-standard qualifying contracts should take early steps on preparing bespoke firmness methodologies and the way they will be applied to calculate the firmness factors. It would often take them more time and efforts to prepare than it was initially thought would take.
Please contact Cau (cthai@oakleygreenwood.com.au) for further information.
