September enviro markets update - STCs and LGCs

The small-scale market saw remarkable stability through September while trade activity returned in the scheme's large-scale sibling as prospects improved for the future of the RET.

Small-scale Technology Certificates (STCs)

Graph for September enviro markets update - STCs and LGCs

While the political battle for the future of the STC market continued, spot STC prices have experienced one of the most stable periods in the market’s history, though volatility in the forwards has been more evident. Despite strong support in the Parliament from almost everyone accept the Abbott Government and strong public endorsement of the scheme, the STC market remains vulnerable to government imposed change.

The spot STC market had a relatively bumpy journey through August though activity remained concentrated within the $38.60-$38.90 range. Across September however, this stability was taken to a new level with the market trading within a $0.15 range ($38.60-$38.75) across the entire month.

With late spikes in the spot price having occurred towards the end of four or the last five quarters participants are eagerly watching the market to see whether one will again occur in the coming weeks as the Q3 compliance date (October 28) looms.

Overall spot market activity declined during August and September with a monthly average of circa 650,000 across both months.

STC submission numbers have remained very stable with a modest surplus above the regulator’s forecast being recorded. Given the extent of the under surrender in Q2 (560,000, or 12 per cent of the nominal target) participants will again be closely observing surrender this quarter.

In the forward market, an escalation has applied within the current quarter of in the order of 3.5-4 per cent. Yet beyond that the backwardation of the curve (which has been present for some time) remains; a reflection of both concerns of regulatory change as well as a recognition of the presence of the $40 price ceiling. While a relatively modest discount has applied to Q4 (which currently sits around the $38.50 mark) subsequent periods are yielding lower prices with Q1 2015 at $37.85 and Q2, Q3 and Q4 2015 all around the $37.65 mark.

For now the Small-scale Renewable Energy Scheme appears well supported with Labor, the Greens and the Palmer United Party all throwing their weight behind it and maintaining a position of ‘no change’. The Abbott Government has felt the full force of both industry lobbying efforts (with a marginal seat campaign) as well as strong public support for a scheme which underpins a labour intensive industry. Yet significant regulatory risks still exist for the STC market given the control in several key areas that the Minister/Government can exercise without requiring a majority in both houses (i.e. via changes to regulations). These include the power to reduce the Clearing House price, the ability to reduce the number of STCs created per installation (either by the introduction of a multiplier of less than one, or via a reduction in the deeming period) as well as the ability to change the definition the maximum system size eligibility.

Changes in each of these areas have the ability to significantly impact the industry, with any alteration to the Clearing House price destined to directly impact on STC prices and all of them likely to greatly affect installation levels and STC supply.

Despite the prospect of these changes, or perhaps directly because of them, the forward market beyond Q3 has been active with participants seeking to provide some certainty for the businesses moving forward. In exchange for this certainty buyers have asked for a discount to reflect the potential of a reduction in the Clearing House price. In many cases, creators of STCs have been prepared to take that discount to give themselves a foundation for Q4 and beyond.

Large-scale Generation Certificate (LGCs)

Graph for September enviro markets update - STCs and LGCs

With the fight for the future of the RET taking place in Canberra, the LGC market has endured some serious prove movements in recent months. The release of the much anticipated Warburton Review, a surprisingly broad-based, vocal and effective campaign against that review and a surprising political grouping of Labor, The Greens and Palmer United have provided for unpredictability in the political sphere. The path forward for the LGC market will now depend on the prospects of a bipartisan compromise on the RET’s future form.

Across 2014 the LGC market has been buffeted by the winds of political uncertainty, with the spot price reacting accordingly. From (what many believe was the predetermined) Warburton Review, to the surprise stance of the Palmer United Party, a strong community backlash and now a negotiation between the major parties to restore true bipartisanship, traders have had to weather an erratic storm.

The spot market has fallen, endured false rallies and subsequent short-lived declines before ultimately recovering endless media speculation and plenty of political surprises have impacted the market. August and September in the spot provided a good example of this with the market softening across most of August (to reach a low of $27.25 in early September) before then recovering in September to breach the $33.00 mark late in the month.

Trade activity in August was generally subdued, though it returned in September as the prospects for the scheme improved and along with it pricing.

In the forward market a healthy focus in the Cal 15 and Cal 16 vintages took place across September including a number of larger (50,000-plus) transactions; a signal that some interpret as reflective of positive for the future of the scheme. A rate of escalation above the spot in excess of 4 per cent frequently prevailed.

And now the market finds itself at a crossroads. The Coalition has botched its attempt to dramatically alter the scheme by setting up a review process that was clearly destined to deliver a fixed outcome irrespective of the evidence it received, headed by an individual that was all-too-easily depicted as lacking impartiality. Which, in turn, has proven the perfect stimulus for those groups intent on saving the RET to summons a landslide of public support which the Abbott Government clearly underestimated.

The Coalition now finds itself looking for a way out, it's own review having undermined the original case for change (the RET having a 'very significant impact' on electricity prices), yet still threatening to starve the industry with further uncertainty should Labor not come to the negotiating table.

And so it is again to come to politics. Labor says it wants the scheme to remain in its current form (i.e. a fixed target, outlined in legislation) and that it will not accept either of the positions outlined in the Warburton Review. It therefore appears the return to bipartisanship will depend on whether Labor will budge on 41,000GWh or whether the Coalition will accept that as the target but push the year in which it peaks out from 2020 to some later stage (be it 2022 or even 2025).

From a project development perspective, bipartisanship is essential. Yet more than that is needed. As recommended under the review conducted by the Climate Change Authority in 2012, the legislative requirement for further reviews must be eliminated; all road blocks to certainty need to eliminated.

Yet even if this were to happen, there is still a possibility that the scars left from the Coalition’s departure from bipartisanship and the pangs of sovereign risk it has given rise to will be enough to put buyers off committing to long-term power purchase agreements. Right up until the 2013 election the Coalition continued to reiterate its support for the RET, while certain backbenchers agitated for change. For those being asked to commit to a 10- to 15-year offtake, this form of flippancy, underpinned by a fundamental disregard for the science of climate change, becomes a major source of concern.

Indeed it is under such a scenario (where the buyers are simply not there for the required number of projects) that LGC prices could really get moving. Should an altered, yet nonetheless strong target be agreed and project commitments subsequently prove clearly inadequate, the prospect of an LGC shortfall toward the end of the decade looms and along with it plenty of talk of penalty pricing. But getting to that point will still take significant time and, in the short term, all eyes will remain on Canberra to see what the politicians can muster.

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.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles