October enviro markets update - STCs and LGCs

The small-scale spot market peculiarly lost ground and never recovered in October while trade activity in the scheme's large-scale sibling was stable despite the political focus.

Small-scale Technology Certificates (STCs)

The third quarter in the 2014 annual STC compliance ended the way it had spent most of the quarter; in unpredictable fashion. Meanwhile the passage of the final compliance date has shown a hefty under surrender has also played out in Q3. In terms of the scheme’s future it appears a reduction in the maximum eligible system size has become the Coalition’s main target now.

Q3 2014 proved a most unusual time in the STC market, having bucked the trend of most quarters since early 2013. Having started the period in early August around the $38.75, the spot was remarkably stable until early October. Indeed across the month of September the market experienced an almost unprecedented $0.15 trading range ($38.60-$38.75).

However, in early October (with the market into the final weeks before the final compliance date, the 28th) with many sellers waiting for the familiar spike in pricing, the spot market instead began to lose ground. By mid month the spot was sitting just above the $38 mark, by month’s end it had fallen through the $37.50 mark.

As the chart below illustrates, in the lead up to each of the three proceeding compliance periods (Q4 2013 and Q1 and Q2 2014) the spot market experienced a healthy increase in prices in the final weeks of the quarter, before ultimately losing ground in its final days. In Q3 however, the rally simply never came leaving sellers who has been hoping for the dependable $39 level to either sell at lower levels or to dig in and hold in the hope that things improve in Q4.

The spot market ultimately plumbed a low of $37.40, not seen since the early part of Q4 2013 when the spot traded down to an (intra-day) low of $36.90.

The soft pricing outcome has been ascribed to a number of factors. Firstly, the introduction of a new registry for the creation of STCs which has dramatically reduced the time it takes to approve certificates. This has reduced the number of STCs sitting in the ‘pending registration’ category to levels not seen since the scheme began. Whilst a god-send for STC creators who have had to fund their businesses through the often 4 week period between form submission and approval, the change has effectively increased STC supply in the short term by close to 600k.

Secondly, as mentioned previously, the last time the spot fell to levels such as these was around the same time in 2013, a reflection of the fact that Q4 has the lowest proportional quarterly surrender for the year (at 15% or the annual target).

Yet Q4 is also the period in which liable entities’ are required to true-up the estimate of their annual electricity demand (used to determine their surrender across the first three quarters of the year) with their actual demand outcome. In recent years the forecast of electricity demand outlined by the Australian Energy Market Operator has consistently overestimated demand, resulting in fewer STCs being surrendered across the year than the number implied by the Regulator in the Small-scale Technology Percentage (STP). Something which appears very likely to occur again in 2014.

However it is also possible for liable parties whose demand has fallen to apply for an exemption at the beginning of the year to ensure that they do not need to over-surrender STCs across the first three quarters. In the instance where their demand has dropped because (for example) they lost customers to another retailer, the other retailer need only surrender the additional STCs in Q4, meaning it is also possible that an increase in surrender in Q4 is possible.

Having passed the final compliance date for Q3 it is clear that the under surrender of over 560k STCs that was witnessed in Q2 was almost completely repeated in Q3 with only 4.15m STCs surrendered against an expected target of 4.66m. The under surrender of over 510k STCs represents 11% of the quarter’s expected obligation. Combining the first three quarters’ under surrender, there has thus far been over 1.2m fewer STCs surrendered in 2014 when compared to the nominal target. The big question now is whether or not some of this will be made up in Q4.

Trade activity in the spot market increased in October with over 850k reported in the over-the-counter market.

The forward market was particularly busy across October with the shape of the curve changing as the spot price fell. Having previous traded at a discount to the spot market, with the spot falling prices in Q4 fell at a far slower rate and by the middle of the month Q4 had returned to a state of contango (cost of carry escalation about the spots). Beyond Q4 the market remained backwardated (forwards below the spots) across the entirety of 2015. The majority of activity across the month took place for Q4 forwards, with January currently sitting at $37.60. There were also healthy levels of activity in Q1 which now resides at circa $37.55 and Q2-circa $37.50.

In terms of the future of the scheme, a strong anti-change campaign run by the solar industry as well as a positive reaction from the community ore broadly appears to have scared the Coalition off any intentions it may have had for scrapping the Small-scale Renewable Energy Scheme (SRES). In a bid to pacify the industry and the electorate the Abbott Government announced it would not pursue any changes to what it dubbed ‘household solar’. This development has led almost all onlookers, who know what happens to environmental schemes when the Coalition uses vague language (see pre-election statements about support for the 20% target), to suspect that it is now intent on trying to reduce the maximum system size eligibility under the SRES from 100kW to something far lower. Whether Labor would agree to this will likely depend on what else is being put in front of them in terms of the large-scale target.

Large-scale Generation Certificate (LGCs)

Following a positive start to the month all eyes in the LGC market were firmly focused on Canberra as the major parties set about negotiating an outcome that would see a return to bipartisanship on the RET. Despite all the headlines, the concrete developments in the political negotiation were minimal.

The spot LGC market began October in the low $33s and following a slow start the spot at one stage surged to an intra-day high of $36.50 on the 8th as expectations of a compromise between the major parties surged, though the market eventually closed the same day at $35.00. From that point on, despite being relatively well frequented, the market was generally stable across the month trading between $34.75 and $35.60, whilst ultimately ending the month at $34.75.

Spot over-the-counter trade volumes were down on September but, at just shy of 400k, remained healthy.

The forward market was busy with Cal 14s and Cal 15s featuring consistently across the month.

To the politics, and despite a running commentary in the media on what was taking place behind closed doors, there were surprisingly few genuine developments across the month. The negotiations began with Labor requiring the Coalition (as a condition precedent) to abandon any prospect of enacting the Warburton Review’s recommendations. Oddly enough the demand was agreed to. Yet when negotiations actually began the Coalition appeared to forget its agreement as the Minister for Industry outlined at the Press Club that it would be taking the ‘real 20%’ option into the parley.

Labor, for its part, continued to proffer its concession of a reduction to 39,000 GWh to reflect the removal of aluminium from the scheme, yet beyond that, despite all the noise, there was very little else of value to emerge.

It is evident that the compromise remains the maximum level of the target and the year in which that target peaks. While the Coalition is talking tough on the ‘real 20%’ (which depending on how you calculate it relates to in the realm of 27-28,000 GWh) there is little likelihood Labor would agree to such an outcome as it would decimate the large scale industry, offering little by way of additional benefit to the status quo, with the guaranteed downside of a reduced target.

For the most part a peak around the 35,000GWh appears to be commonly held as compromise that could ultimately be agreed to by both sides; though there is little doubt those seeking a further reduction will be pushing hard for it. In reality only time will tell whether this expectation proves accurate or whether agreement is reached at all.

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.