The electricity market is on the verge of a profound and fast transformation, triggered by new technologies such as electric vehicle (EV), energy storage, virtual-power-plants, digital products based on artificial intelligence (AI) to mitigate risks and maximize returns for medium and big electricity consumers and even blockchain solutions specific designed for final consumers.
I acknowledge that, for those who are not entirely aware of the ongoing techs & trends, all these things sounds like pure science fiction. However, I can assure you that all is real and closer than you dream.
Making a long story short, the future for the utility industry around the globe is bright and prosperous, especially when we focus our analysis on renewable generation (Solar PV and Wind) and storage. That´s definitely good, but let´s leave this topic for another sunny day.
Let´s bring on a new subject for discussion.
A theme much less prominent, but essential for the success of the present “revolution”:
Electricity Trading: Physical Contracts vs. Cash Settlement Contracts
Unlike other countries, the Brazilian electricity trading market is still entirely based on physical contracts (PPA – Power Purchase Agreement), with Generators (70%) and Traders (30%) driving the whole trading business.
Electricity trading business in Brazil stands out by a (i) huge information asymmetry, especially in relation to the final free-consumer and (ii) limited trade liquidity, even though I acknowledge the turnover has increased over the past two years.
Needless to say that poor liquidity in the electricity free-market limits opportunities to trade, reducing the scope to identify optimal hedging strategies that provide customers with the best possible deal (Price).
This can make it difficult for firms to increase their market share. It could also encourage companies that have migrated to the free-market to re-think the real need to trade in the wholesale market, or even restrict the churn ratio in the case of “educated” free-consumers (very few).
Bearing this in mind, the key question is: “How to increase the number of players and boost electricity trade liquidity?”
A quick look at other developed countries – Germany, Scandinavia, UK, US, France, Australia, etc. – with quite similar regulatory framework, the answer just emerge: “It is vital to attract newcomers to the utility sector”.
I tend to believe that newcomers (like treasuries, hedge-funds, asset management, brokerage firms, etc) may reshape the competition landscape, boosting liquidity and enhancing the trading business risk profile, as soon as the financial institutions start digging deeper into the energy trading world.
It is important to recall that key players (consumers, generators and autoproducers) are also clients of the financial institutions, leaving room for cross-business opportunities, such as structured products.
How to achieve that goal?
This is not a one million dollar question, given that the recipe is already known and has been successfully tested and applied all over most of the developed countries:
“Cash settlement contracts, followed by the implementation of a clearinghouse are the key drivers to attract these newcomers (financial players) and pave the way for a liquid and healthy electricity market”. These are the two golden rules to attract the financial industry to the business.
The implementation of a clearinghouse would bring high standards trading conditions and also foster liquidity, paving the way for a rapid free-market change, eliminating losses for the final consumers with the ongoing information asymmetry (Is B3 ready or interested in embracing this opportunity?)
Moreover, a liquid free-market may result in a clear/reliable price indicator for mid/long term contracts and, consequently, unlock new financing alternatives for greenfield projects.
Last but not least, poor liquidity and lack of price signals can deter firms from trading in the free-market, curbing the availability of products and prices. Thus, the market gets locked in a low liquidity trap, boosting price volatility sharply and the risk of bankruptcy among the traders.
Open market yes, but first we need to address these issues to avoid a trap for consumers
I’m a liberal, hence I´m in favor of expanding the free-market up to the residential consumer (open market).
I share the view that the use of financial derivatives should strongly contribute for the sector’s development going forward, with the energy price formation becoming more transparent and efficient as occurred in other markets.
I also acknowledge that cash settlement contracts should work as a hedge instrument, allowing customers and even generators to soften its risks.
I have no doubt that consumers can benefit from a competitive energy markets through downward pressure on bills, better service and greater choice.
However, I believe by heart that information asymmetry, restrict or inadequate access to power prices and poor liquidity in the wholesale electricity market must be solved before any attempt to speed up the implementation of the open-access or even the expansion of the current free-market.
In other words, it’s time to take the electric sector and mainly the trading business into the 21st century.