Merrill Lynch Institutional Investor Workshop July 10,2001

Merrill Lynch Institutional Investor WorkshopJuly 10,2001

Managing risk in a competitive market

Karen MosesExecutive General Manager, Wholesale & Trading


• The wholesale & trading function

• The nature of eastern Australian energy markets

• Market risks

• Origin’s approach to managing risk

• Summary

Within Origin Energy the task of the wholesale & trading function is to…

• Manage short term price and volume risks

• Assess and manage long term structural risks

– changing patterns in supply and demand dynamics

– changing price dynamics

• Identify growth opportunities

…enabling Origin to minimise earnings risk and enhance predictability of cash flow




• Market risks


• Summary

Growth in energy demand is strongest for major industrial users, gas-fired generation, and renewables

Electricity Natural Gas

Retail Market

Source: ABARE

PJ

E

0

500

1000

1500

2000

2500

2000 2000 2015

ResidentialIndustrial & CommercialMajor IndustrialElectricity

This growth is likely to be supplied directly by producers rather than retailers

The structure of the competitive segment

Coal

Renewables

90% of Eastern Australian gas market

supplied by Cooper and Gippsland Basins

19 generation companies in Eastern Australia provide 90% of electricity output

Currently 11 major retailers in Eastern Australia

Oil

MajorIndustrial

Industrial &CommercialResidential

MajorIndustrial

Industrial &Commercial

Residential

Natural G

asElectricity

Natural gasProduction

Wholesaler(Contract)

Retailer

Pool(Spot)

MassMarket

Gas supply is dominated by the Cooper Basin and Gippsland Basin

Cooper

CSG

GippslandOtway Bass

PNGTimor• 90% of demand for eastern

Australia supplied by Cooper Basin or Gippsland Basin

• Coal Seam Gas (CSG), Otway and Bass are best positioned to satisfy next requirements

• CSG, Bass Basin (Yolla) and Minerva have secured new contracts

• Thylacene & Geographe discoveries will change the SE Australian dynamics

• Santos onshore Otway discoveries small but significant

The Electricity Market Structure

OtherProducers

Hydro Gen A Gen BLadbroke GrovePower Station

Network Owner Market Operator

PoolSystemControl

Franchise Customers Reform Process Competitive Market

•Choice of Retailer•Wholesale option

Dist A Dist B Dist C

Physical flow of electricity

Financial Risk

FinancialPlayers

Retailer A Origin Energy

80MW

RomaPower Station

80MW

Origin Energy Trading Group

Retailer in 4

States

0

10

20

30

40

50

60

70

80

90

100

May-96

May-97

May-98

May-99

May-00

May-01

Mo

nth

ly A

vera

ge

($/M

Wh

)

NSW VIC

Electricity and natural gas have different risks

• Electricity risk = price – Base load over capacity and

peak shortages– Large number of major players– Risk management – vertical

integration & stable wholesale pricing

– Volume volatility limits hedging options

• Gas risk = Access to gas supplies– Supply dominated by 3 players– Wholesale price certainty –

eliminates scope for discounting– Daily volume vs annual demand

requires capacity investment

Electricity Pool Price Volatility

Victorian Gas Demand Profile

0

200

400

600

800

1000

1 Year (Jan-Dec)

Daily

Dem

and

(TJ/

d)

Daily demand

Average contract quantity




• Market risks & risk management tools


• Summary

The introduction of a competitive energy market has increased risk…

• Historically the energy industry has faced a number of industry risks:

– Regulatory– Economic environment– Commodity (oil and LPG)– Weather

• The introduction of competition has added to these risks:

– Pool price volatility– Volume– Sustainable retail margins– Stranded assets

…requiring participants to anticipate and be more flexible and responsive to structural changes

Electricity risk is an interplay of demand volatility, price volatility, and time

Load and price forecastsOptions to respondInvestment opportunities

Time

Competitive hedges, pool pricePrice – Purchases

Regulation, CompetitionPrice - Retail

Weather, ChurnDemand

California is a good example of this – but specifics don’t apply to Australia

• Market structure: half hourly pool price with no hedging allowed. High cost generators faced stranding of assets.

• Knowing this, combined generators/retailers negotiated fixed price tariffs in exchange for upfront payments to compensate for stranded assets – and then divested their generation assets and spent the compensation payments investing overseas.

• High demand/short supply pushed prices beyond tariffs with no structural options to mitigate

Outcome was predictable but not conventional wisdom

Discussion of risk management tools is best related to the electricity market

Pool(SMP)

Generator Retailer

Physical

CFD(Contract For Differences or Swap)

Financial Market

Similar tools will eventually evolve for natural gas but the current high level of wholesale contracting and lack of credible new entrants means this is unlikely for some years

Physical

Commonly used Derivatives in the Electricity Market

•Swaps (CfD’s) (swap fixed for floating spot)

• Inter-regional swaps (swap NSW price for Vic etc)

• Inter-regional options (one-way IR payoff)

•Options– Caps– Floors– Asian puts/calls

•Futures Contracts

These products provide price certainty against a specific position

Some thoughts

Gas Volume RiskStrategies for managing access to gas volumes include

• Development of pipeline grid and use of line-pack / park and loan

• Increasing recognition of value of deliverability

• Gas storage development

• Supply swap arrangements between producers

• Being vertically integrated helps manage these positions

Electricity Price Risk• Market has actively traded financial hedging products but market

remains immature and does not have great depth

• Physical assets, or wholesale arrangements that preserve retailer margin

• These risk management imperatives drive towards vertical integration

Risk capacity considerations and setting risk limits

• Trading limits for all commodities should be set with regard to the overall capacity of an organisation to absorb losses and still meet performance objectives

• Conventional approach is to measure Value at Risk– VAR typically tests a 95% event impact on Mark-to-

Market– Provides signal to lock in a position however ignores

competitive and corporate constraints

• Worst Case approach is more conservative– Tests blind spots and provides outside boundaries – Imposes time as a dynamic to be assessed– Competitive dynamics forced to be considered up front




• Market risks


• Summary

Identify risk management & growthopportunities

Effective risk management is an important element in successfully participating in a competitive market

• Integrated strategy

• Achieving competitive advantage by leveraging portfolio

Understanding the electricity and natural gas market through detailed modelling and analysis

Origin’s approach

Gas & Electricity Interplay

• Spark Spread– Use of gas resources to choose to sell direct to market or

to produce electricity

• Dual Fuel Retailers– Offer both gas & electricity to customers to increase

share of energy spend per customer

• Pull Through– Create a market for gas production through generation

development

• Environment– Increasing community and government focus on clean

alternatives for electricity generation.

• Flexibility– Gas fired generation can cost effectively fill base,

intermediate and peak niches

Capturing spark spread requires access to gas assets and generation

GENERATION

PPPPOwned

PPPPPPTolling

NSWVICVIC, SA, QLDMarkets

PPPPPPContracts

PPPPStorage

PPProduction

AGLTXUORIGINGAS ACCESS

Duel Fuel Capability provides defensive strategy and access to share of customer wallet • New players unlikely to enter market except via incumbent alliance

• Requires competitive cost of supply & cost to serve in each market

0

500

1000

1500

2000

AGL

Origin

Energy

Austra

lia

Energex

Pulse

Texas Util

ities

Inte

gral

Country E

nergy

Ergon

Aurora

Citipower

Net

ele

ctri

city

an

d n

atu

ral g

as c

ust

om

ers

TasNSWQldSAVict

Dual fuel enabled within the same state

Government owned entity

“Pull Through” is ability to create markets or use market position to support investment

Yolla development and NP alliance on pipeline

SEA Gas pipeline (Otway to SA)

Vic Power Market / Vic & SA Gas market

Thylacene & Geographe developments“in the

pipeline” Gas supply portfolio and generation expertice

Further generation projects

Under Development

Completed

Vic Gas Retail MarketOnshore Otway developments

Supported ByInvestment

SA Gas ContractsQuarantine SA Peakers

Vic Gas Retail MarketYolla Development

Katnook ProductionLadbroke Grove Generation

QLD Gas Production & Contracts

BP Bulwer Refinery Co-Gen / CSM Development

QLD Gas Production & Contracts

Roma Peakers / CSM Development

2002 2004

MW

Peak volumeGeneration & hedging cover

Origin has adequate cover for short term pool price volatility and minimal take or pay risk

Aggregate peak electricity cover Natural gas volume cover

NB: cover varies from state to state

2002 2005 2008

PJNG retail sales ACQTake or Pay

Origin will continue to actively pursue power generation to meet market growth and cover for its retail position

Integrated position allows Origin to grow its business while effectively managing risk…

• Exploration portfolio focused on south east Australia markets

• Flexible gas supply portfolio consisting of both physical and contractual resources

• Strong trading function and significant wholesale cover

• Investments in competitive natural gas fired peaking and intermediate power plants

• Leading retail position with ‘sticky’ volumes

…and achieves a balance between low-risk cash generative assets and growth assets

• Assets with secure earnings:

– Cooper Basin– Networks– Contracted power

generation/cogeneration

• Growth assets:– Gas and electricity

retailing– Merchant power

generation

Assets withsecure earnings

Otherprojects

Retail

% contribution to EBIT

0%

100%




• Market risks


• Summary

Origin is confident its strategic direction is correct

• Aware of risks and has a strong focus on risk management

• Ability to identify and deliver upon opportunities for growth

Merrill Lynch Institutional Investor Workshop July 10,2001

Documents

Transcript of Merrill Lynch Institutional Investor Workshop July 10,2001