merrill lynch institutional investor workshop july 10,2001
TRANSCRIPT
Merrill Lynch Institutional Investor WorkshopJuly 10,2001
Managing risk in a competitive market
Karen MosesExecutive General Manager, Wholesale & Trading
Page 2
Managing risk in a competitive market
• The wholesale & trading function
• The nature of eastern Australian energy markets
• Market risks
• Origin’s approach to managing risk
• Summary
Page 3
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
Page 4
Managing risk in a competitive market
• The wholesale & trading function
• The nature of eastern Australian energy markets
• Market risks
• Origin’s approach to managing risk
• Summary
Page 5
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
Page 6
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
Page 7
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
Page 8
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
Page 9
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
Page 10
Managing risk in a competitive market
• The wholesale & trading function
• The nature of eastern Australian energy markets
• Market risks & risk management tools
• Origin’s approach to managing risk
• Summary
Page 11
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
Page 12
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
Page 13
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
Page 14
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
Page 15
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
Page 16
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
Page 17
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
Page 18
Managing risk in a competitive market
• The wholesale & trading function
• The nature of eastern Australian energy markets
• Market risks
• Origin’s approach to managing risk
• Summary
Page 19
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
Page 20
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
Page 21
Capturing spark spread requires access to gas assets and generation
GENERATION
PPPPOwned
PPPPPPTolling
NSWVICVIC, SA, QLDMarkets
PPPPPPContracts
PPPPStorage
PPProduction
AGLTXUORIGINGAS ACCESS
Page 22
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
Page 23
“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
Page 24
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
Page 25
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
Page 26
…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%
Page 27
Managing risk in a competitive market
• The wholesale & trading function
• The nature of eastern Australian energy markets
• Market risks
• Origin’s approach to managing risk
• Summary
Page 28
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