Small-scale Technology Certificates (STCs)
The heavy cynicism toward the independence of the Abbott Government’s RET Review has failed to blunt the short term pricing outcomes in the STC market, which have reached highs not seen since the market’s early days in Q1 2011. Yet the surprisingly strong outcome so early in this quarter has left many wondering whether Q2’s high may have already been reached, with the curve having flattened out to July.
The month of May in the STC market bore witness to a number of interesting phenomena, including a reduction in spot trade volumes, an increase in the focus of trade in July forwards and surprisingly strong prices in both.
The major factor impacting the STC market at present is the relatively tight balance between supply and demand. As the chart below illustrates the modest, yet consistent surplus of STCs that has been the mainstay of 2014’s creation weeks were eroded by the Easter/ANZAC Day period in which submissions fell. The Q2 target of circa 4.66m STCs again appears highly likely to be met without the use of the Clearing House, with an STC surplus of circa 1.4m likely and circa 600k remaining in the Clearing House queue.
This relatively slender surplus has ensured that the spot pricing outcome across the quarter so far has been very strong; the sharp softening across the second half of April (Q1) which saw the market fall from the low $39s to the low $38s proving short lived, with the spot pushing to a 3 year high of $39.45 in late May.
Yet the buoyant spot have led many to believe that the recent profile of softer pricing earlier in the quarter, followed by increases to a high reached early in the final month may not play out in Q2. Indeed this was evidenced by the flattening of the forward curve out to July which emerged in late May with only a very modest premium being paid for July settlement over spot.
With quarterly compliance, buyers have the option of purchasing spot STCs to carry out to the time of compliance and hence the intra-quarter forward curve operates on a cost of carry basis (generally an escalation around the rate at which large, rated entities can borrow from financial institutions, currently circa 3.5%). However with the spot having climbed toward the mid $39s, such a scenario is no longer present with buyers unwilling to pay anything more than a very modest escalation for July settlement (the most recent transaction for July having occurred at $39.40 off a spot price of $39.35).
In what appears to be a reflection of a number of factors, spot STC volumes fell dramatically in May with a 65% reduction on the busy month of April. A range of explanations have been offered for this phenomenon including an increase in the amount of forward market activity (specifically for July focus, with close to half a million July STCs done in May) along with a shift of many creators away from self-creation toward the use of aggregators as their creation numbers fall. Many aggregators (who deal with larger numbers of STCs) employ a more sophisticated hedging approach including forward contracting, supporting the increase in July activity.
Beyond that there is also the simple reality that the rate of STC submission has been lower in recent months and the number of participants left carrying STCs from the past has also diminished with strong pricing outcomes in previous quarters leaving little reason not to sell. But it also seems that tax implications may be a factor for those left holding on, with many participants buoyed by the strong pricing outcomes already experienced, deciding to wait till the new financial year before recognising revenues.
The combination of the recent drop in spot STC activity, the increased focus on July and the lack of willingness among buyers to pay a ‘normalised’ cost of carry above the inflated spot price have only fostered speculation as to whether the spot STC market for Q2 may have already reached its peak.
On the subject of the RET Review, the supply/demand reality coupled with quarterly compliance has ensured that the Q2 market has not felt any impact of the potential regulatory risk that may emerge from the RET Review. There are very few who believe the Abbott Government’s Review is anything other than a tightly stage-managed affair aimed at delivering a hefty to blow to both large and small-scale schemes alike. The STC forward curve beyond Q2 reflects this with Q3 pricing (circa $38.50) and beyond (Q4 circa $38.25) clearly in backwardation.
Interestingly the market for Q1 2015 was relatively active across May with over a 150k changing hands at prices beginning at $38.00 and gradually decreasing across the month to end at $37.80, proving there are at least some with a healthy degree of confidence that the scheme will remain in place that long.
Large-scale Generation Certificate (LGCs)
May in the LGC market was a period of steady losses as confidence in the independence of the RET Review and hence the future of the market continued to suffer, sending the spot down almost 12% to a low not seen since a time before bipartisanship on the expanded RET existed.
In the spot LGC market May proved another negative month. For those trading LGCs it is hard to believe that the RET Review process has been designed to achieve anything other than a considerable reduction to the scheme, if not its effective abolition. As time goes by and this increasingly negative view of things pervades the market, so too the spot market softens.
The effects of this view in recent weeks were dramatic with the spot market softening progressively across the month to reach a low not seen in over 7 years, to a time before bipartisan consensus on an expanded RET existed. Some have poignantly acknowledged that far from a coincidence, this implies something about the current political landscape.
While the sentiment was overwhelmingly negative during May, the overall level of spot market activity recovered when compared to April’s relatively modest levels with circa 275k reported in the spot market in May.
In the forward market it was the Cal 14 vintage which dominated proceedings with activity recorded across the month, the most recent of which at $26.00. The Cal 15 vintage did enjoy a smattering of attention with a number of trades at various points across the month. The forward curve continues to trade on a 3.5-4% cost of carry above the spot.
Looking to the future, and it is hard to see from precisely where the game changer will come. Rumours suggest it unlikely the RET Review Panel’s final report – which is expected to be handed to Government by late July – will be immediately made public. Hence the waiting will likely need to continue for many months to come. A(nother) surprise announcement from the Palmer United Party indicating it would stand in the way of changes to the RET or indeed a pre-emptive commitment from the Abbott Government that it will not make hefty changes would likely have a significantly positive impact on the market, though the odds on either outcome remain small. What has been surprising – and only illustrates the sense of pessimism that many are feeling – has been the number of sellers that have been present in the $25-26 range.
Short of some significant political development which would impact the prospects of passing significant legislative changes through the Senate, a period of stability and subdued trade volumes seem to be the most positive outcome the optimists would hope for in the near term.
Marco Stella is Senior Broker, Environmental Markets at TFS Green Australia. The TFS Green Australia team provides project and transactional environmental market brokerage and data services across all domestic and international renewable energy, energy efficiency and carbon markets.