Snowy Hydro – The Business: Part 2, by Max Talbot

OVER the last few weeks I have posted information suggesting that Snowy Hydro has not managed the vast waters under its control appropriately and in particular that it has failed to store flood waters for subsequence seasons and even exacerbated flooding in the Riverina by making water releases from Lake Eucumbene – the system’s central reservoir.

Max Talbot was the Executive Officer Strategic Engineering at Snowy Hydro and Operations Engineer Snowy Mountains Council for many years, retiring in 2003.  He has written extensively on the Corporation and recently updated a document ‘Snowy Hydro – The Business’ penned in 2008.   Mr Talbot has generously given permission for me to publish this document as a four part series.  Following is Part 2 – explaining sources of revenue and more.

Snowy Hydro Ltd. – a Corporate Entity

Overview

The Snowy Scheme was corporatised and began operation as Snowy Hydro Ltd in 2002.  Snowy Hydro is incorporated under the Corporations Act 2001 and is a public company limited by shares.  Shares were issued gratis to the Commonwealth, NSW and Victorian governments in the percentages of their electricity entitlements, i.e., 13, 58 and 29% respectively.  The Snowy Mountains Authority’s outstanding debt of about $700m was transferred to Snowy Hydro who was required to refinance it and repay the Commonwealth.

Corporatisation was achieved via the negotiation and implementation of a series of “agreements” (46 in total) of which the 75 year water licence – that sets out Snowy Hydro’s rights and obligations with respect to management of the Snowy Schemes water resource – and the transfer of the Schemes infrastructure and assets are of critical importance to the viability of its business

Snowy Hydro is a successful member of the NEM where it occupies a unique position selling peak and shoulder energy and energy services to the market and risk management products to other market participants. Since corporatisation it has widened its activities beyond the Scheme into gas turbine generation and electricity retailing. It had an income of $781.9m in 2009-10 and a net profit of $266.9m after tax of $113.7m.

The Electricity Business

Snowy Hydro owns and operates the 3900 MW Snowy Scheme, 620 MW of open cycle gas fired generation in Victoria and Red Energy, an electricity retailer, also primarily in Victoria.

Snowy Hydro is the NEM’s third largest generator by capacity and its portfolio of hydro and gas peaking generation assets places it in a strong position to take advantage of high prices in the NEM spot market.

As Snowy Hydro is able to provide significant generation at short notice it is a leading supplier of electricity price risk hedging contracts to other market participants seeking protection against price fluctuations in the NEM spot market.

Snowy Hydro is also mainland Australia’s largest renewable generator (70%) and as such benefits from existing schemes to promote the use of renewable energy.

Snowy Hydro’s marginal cost of generating from its hydro-electric generating plant is virtually zero, however, whilst it has a guaranteed amount of water available – by virtue of the water licence – water is not unlimited, thus the decision to generate or not generate at a particular time is the opportunity cost of the water used.

Snowy Hydro’s competitive position in the NEM is provided by its unique portfolio of highly reliable generation assets enabling it to provide ‘firm’ electricity price risk hedging contracts to other NEM participants.

Sources of Revenue

Snowy Hydro earns revenue from a variety of sources, namely;

Electricity sales into the NEM spot market
Energy (ancillary) services to NEM
Electricity price risk hedging contracts
Inter-regional settlements
Renewable energy certificates
Retail electricity sales (Red Energy)
Water, timing of release or pre-release fees.

Looking at each of the above briefly:

(a) Spot market sales
Snowy Hydro bids its available generation into the Market for dispatch generally targeting peak or shoulder demand periods that attract higher prices.  However, to manage its water release obligations and to manage periods of high inflows a portion of generation is dispatched during off-peak periods.

(b) Ancillary services to the market
The nature of Snowy Hydro’s generating assets provide an opportunity for it to provide ancillary services that assist in maintaining the security of the inter-connected power system.

These include, voltage and frequency control, black or system restart and generation contingency reserve.

(c) Electricity price risk hedging contracts
Price risk hedging contracts entered into with other generators and retailers include a range of financial instruments such as caps, swaps, collars and options.

Snowy Hydro receives or pays difference payments under the contracts and aims to generate when exposed to paying difference payments so as to cover its exposure.

(d) Inter-regional settlements
Snowy Hydro participates in the Settlement Residue Auction (SRA) process to partially offset the risk it faces by entering into contracts across NEM regions – such as, transmission system load constraints or transmission system failures – and receives revenue from the SRA Units that it has purchased, which may or may not fully offset payments that it may need to make to counterparties.

(e) Renewable energy certificates
Snowy Hydro sells renewable energy certificates (REC’s) to other market participants.  REC’s are created whenever Snowy Hydro’s hydro generation exceeds its historical average generation.  This situation does not arise every year and thus income generated from REC’s is variable.
(f) Retail electricity sales
Snowy Hydro’s retail electricity income is a result of its purchase of Victorian retailer Red Energy.  Its customer base is relatively small at present.

(g) Water timing of release or pre-release fees.
Snowy Hydro has – with the approval of water agencies – entered into agreements with irrigators which effectively enabled them to “borrow” water from future years releases for a fee.  The Water must be “paid back” from future entitlements.
During the recent drought these ‘borrows’ contributed to the premature triggering of the water licence dry inflow sequence clauses, with resultant reduction in releases from the Scheme. Such releases also have the potential to benefit irrigators able to afford Snowy Hydro’s price; to the detriment of the wider irrigation community.

 Timing of release fees are dependent on a number of factors outside Snowy Hydro’s control and are not e reliable source of income.                
 
Summarising

Snowy Hydro’s total income is comprised of a number of income streams.  Whilst income details are not publically available, it is reasonable to conclude that predominant sources of income result from spot market sales and electricity price risk hedging contracts.

Snowy Hydro uses its physical generation capacity to manage its price risk hedging contracts and its fast-start and reliable generation assets allow it to structure a portfolio that provides, on average, more upside than downside from unpredictable market events.

Additionally, its business is underpinned by the rights bestowed on it by the Snowy Water Licence over the collection, storage, diversion and release of the Snowy Scheme’s water resource.  Without these ‘rights’, Snowy Hydro – the electricity business – is virtually worthless.