Okay I have been digging in to how derivatives hedging works for...

Okay I have been digging in to how derivatives hedging works for electricity retailers.

A thread -> -> ->.

Lets start with futures. The futures are for electrical energy in NSW, QLD, VIC and SA. The energy is split upinto two profiles, the "base load profile" and the "peak load profile". Units of the contract are megawatt hours.

The base load profile is basically the entire week (from 00:00 Monday to 24:00 Sunday). And the peak load profileis from 7am to 10pm, monday to friday, excluding public holidays.

Prices for these can be found on the AEMO dashboard.https://aemo.com.au/en/energy-systems/electricity/national-electricity-market-nem/data-nem/data-dashboard-nemYou can look at the average prices etc. "The Average Price table shows average prices for each day in the current month. RRP refers to the average spot price ($/MWh) per region for each day, and PEAK RRP refers to the average peak price from 7:00am to 10:00pm EST (weekdays excluding NEM Holidays). Please note that under the historical data the annual year refers to the financial year, not calendar year."

Mostly utilities are gong to be using the standard base load futures, volume / Open interest on the peak load futuresare pretty low. And probably for more specialized uses where hedging peaktime usage during the week is important.

So what is aim of the futures / hedging? The main stated goal of LPE is to "preserve margin" on electricity sales.Given electricity prices only change every 1 or 2 years (even if uncontracted, you don't want to be changing the customerselectricity price every quarter), it makes sense to hedge about 2-3 years ahead for the electricity you have basically alreadysold. If you had a flat number of customers, it is pretty easy, you just estimate electricity usage based on past profiles, andbuy the electricity in advance. With a growing customer base, it is a bit harder but you could just buy more hedging every quarterfor the next 2 years, based on new customers added and assume their profile is similar to existing customers. You could also use options here if you were uncertain about how many new customers you might have, or some uncertainty about demand.

The reason that this preserves margin is that you are matching the supply to demand when the price it set. Otherwise, you wouldhave the demand, but then be unsure of what supply price will be in the future to supply your customers.

Now lets have a think about what impact this has on the financial numbers. Ideally, hedging should have a dampening affect on P&L. Ifelectricity prices go higher, you aren't worried because you bought at certain price already. If electricity prices go lower, wellyou have a hedging loss, BUT the price was still initially set at a level for you to retain your margin so you shouldn't be tooworried. Basically hedging is all about giving you time to increase prices (new contracts etc) if the underlying product rises in price in thefuture.

This is why I am basically not very fond of people crying out that these derivatives changes are only on paper and not material orjust lucky for the business. Yes there will be years of losses and years of gains, but what it really means is that they have ALREADYsold the electricity to customers and already bought their supply (through futures/options) at a profit!

As for why a lot of the hedging profits are realized in the next FY. My guess is it could be due to the settlement date of the futures.The futures cash settle on the fourth business day after the last trading day of the quarter. And basically the mark to market price can still change between the last trading day and the settlement day which is in the next quarter.