The fall in wholesale forward market prices is having a significant impact on the ‘big 3’ retailers, and no one is immune! Below are the recent announcements by each of them addressing the matter:
"We are assessing our business model and capital structure to maximise shareholder value" following a $2.686 m provision for onerous contracts and low forward energy prices
"Near-term outlook for Energy Markets is more challenging … wholesale electricity prices remain depressed, particularly as renewable supply continues to come online"
- Origin Energy
“The National Electricity Market experienced a significant decline in wholesale prices driven by increased renewable generation and changing energy consumption patterns due to the pandemic”. This was followed by “the ongoing impact of retail price regulation and intensified competition in the retail markets, including from newer retailers, put significant pressure on margins”
- CLP (Energy Australia's Owner)
Share Price & Wholesale Forward Price Link
We have reviewed the AGL share price to test the link between wholesale forward market prices and share price. AGL was selected given it is more directly related to the NEM than Origin Energy which has investments in LNG assets and gas field assets, while Energy Australia is owned by CLP which has many businesses operating in different countries.
Over the last 5-years, AGL share price has rallied from $18.22 in March 2016 peaking two-years later at $28.44 in April 2017 coinciding with record wholesale forward market prices. From this lofty height, the share price has been tracking downward closing at $10.07 at the time of writing this article.
We built a forecasting model for predicting AGL daily share prices based on wholesale forward market prices and previous share prices. Surprisingly, we found a remarkable fit as shown in the chart below.
This finding suggests that the big investment houses are watching wholesale forward prices closely in their trading decisions about AGL shares. We went further and found our trusty model has a better than even chance of predicting the direction of the daily AGL share price. Over the last 5-years, our model correctly predicted the direction of the daily price movement (i.e. up or down), 55% of the time and so far, this year has been 62%.
So, what does this mean?
Maybe we ought to move into forecasting share prices rather than electricity spot price forecasting? It looks easier, we have to say. But perhaps, not as much ‘fun’.
What it does mean is that as the transition to lower cost generation continues and is reflected in the wholesale forward market:
- the pain facing the big 3 vertically integrated retailers will create significant shareholder pressure
- such shareholder pressure will no doubt lead to change. AGL has already announced a strategic review with the findings expected at the end of March. Speculation suggests the review could lead to a split of the company into generation and retail? Origin Energy is now anticipating a ‘supply response’ to the low prices – which would likely involve the retirement of some power stations being brought forward. It is interesting to note that this summer, Origin is deploying Eraring Power Station differently, with a considerable increase of capacity only offered at extreme prices, which will help create volatility
- the prospect of AGL or Energy Australia building a gas-powered generator to notionally replace Liddell Power Station, is becoming less likely
- lower wholesale forward market prices will impact the pipeline of renewable projects. Delays can be expected as at these lower prices, the investment returns from these projects will be squeezed, perhaps to unacceptable levels
- the lower power prices will place pressure on proponents of large new interconnectors such as EnergyConnect between NSW and SA, as the cost benefits will get squeezed
- the change in deployment of base load assets will be accelerated from baseload to sculpted generation. Consequently, daytime spot prices will elevate and spot prices during the ‘dark hours’ will become more volatile and higher, as these hours become more critical in their contribution to earnings
The market has shown over history that as sustained structural changes are imposed, then those that have the muscle power, flex their muscle. The reality is they have no choice, as there is too much shareholder value at risk to sit by and watch the erosion in value.