Q. What is the basis of the $100/MWh assumption used in the base case, and will this forecast be revised ahead of every quarter or remain constant for several quarters?

A. The base case is intended to be a price projection under 'normal' or 'average' market conditions, which can then be used a reference point for considering the stress test cases.

The base case should not be interpreted as a forecast for the coming quarter. If it were a forecast, it would (presumably) reflect stress conditions if the system was already experiencing very tight supply, in which case it would no longer provide a useful base line for comparison purposes.

As regards the $100/MWh figure, this was derived from futures contract prices for 2012 winter quarters quoted on the ASX before hydro conditions became dry (to avoid prices being unduly influenced by prevailing conditions). The figure is also rounded to avoid an impression of undue precision.

Q. What is the basis of the prices in the stress tests? They seem high when compared to experience in the past five years?

A. The figures are scenario assumptions rather than forecasts generated by a modelling technique. The scenarios are intended to reflect rare 'stress' events and hence the prices are deliberately higher than typical levels.

On the comparison with historic prices, the following points are relevant:

  • five years of history is a relatively short period against which to make comparisons. The stress test scenarios are intended to reflect events which would be expected to occur very infrequently - and therefore would not necessarily be observed within any five year period.
  • regulatory changes, such as the introduction of scarcity pricing, mean that historic prices are not necessarily a reliable guide to future conditions during a supply emergency.

Q. Why are the stress test prices above the expected cost of building new generation? If prices go to the stress test levels doesn't this indicate the electricity market is uncompetitive, and that the long term interests of consumers are not being served?

A. Spot prices are expected to oscillate above and below those required to justify an investment in new generation, depending on prevailing short term conditions. During a severe adverse event (as contemplated in the stress tests) spot prices would be expected to be high, reflecting short term expectations about the real costs of shortage. This would not, of itself, indicate any lack of competition.

Q. What assessment has been carried out on the likely impact on prudential requirements if the stress test scenarios were to occur? Would the financial system be able to manage the necessary requirements?

A. We haven’t undertaken a detailed analysis of this issue but recognise that an increase in spot prices will lead to a step-up in prudential security requirements under current arrangements.

Clearly, if an energy stress test scenario was to occur, the short term increase in prudential requirements would be substantial. However, it is important to note that the requirement to post cash security or equivalent guarantees is calculated on each participant's net purchase obligations with the clearing manager. This reduces the aggregate volume of security to be lodged, and in some cases can mean that a purchaser does not need to lodge any cash security or guarantee.

Also, purchasers can lodge some hedge contracts as a form of prudential security. This further reduces the need to provide cash security or guarantees. In light of these factors, we are not aware of any information to show that the prudential requirements would be unmanageable for the financial system.

Finally, the issue of prudential arrangements was reviewed by the Wholesale Advisory Group and the Board has approved new settlement and prudential arrangements for the wholesale electricity market which are scheduled to come into effect on the 24th of March 2015.

Settlement and prudential security review.