Reviewing the STTM

The Short Term Trading Market (STTM) is being developed under the direction of the Gas Market Leaders’ Group to replace the existing balancing markets in New South Wales and South Australia from 1 July 2010. The process of designing the market has had considerable industry input, as well as expert assistance from international consultants, ICF. However, the implementation timeline is ambitious and allows for little or no refinement of the market design.

Perhaps reflecting the ambitious timetable, the Phase 1 design document leaves a number of important elements of the market unspecified and raises questions for shippers, market participants and pipeliners about the relationship of the proposed design to its objectives. Seed Advisory reviewed the Phase 1 Design Documentation. The Phase 2 Design Documentation, recently released, provides more detail but does not fundamentally alter the issues raised below.

Three issues illustrate the potential for the design to fall short of the designers’ intentions.

The design may discourage private trade

A regulatory arbitrage is introduced by the proposed penalty structure for the non-delivery of scheduled gas on the Gas Day. The penalty structure caps the price of gas in the private market that a market participant with a shortfall would be prepared to pay at 150 per cent of the published predicted price and, adding insult to injury, in the event that the gas required to meet the shortfall was provided by a large market participant, restricts the benefit to the supplier to 110 per cent of the predicted price.

The asymmetry apparently reflects the concern by small market participants that they will be held to ransom by large market participants. The risk, however, is that new entrants with more aggressive risk profiles than existing market participants and uncertain demand profiles might rationally choose the penalty process over the private market. This is because the cost structure of long term gas supply and transportation contracts can be more expensive and risky than opportunity gas and non-firm transportation, given the proposed market structure.

Costs for smaller market participants

The level and potential fluctuations in the costs of market participation could represent significant issues for smaller market participants’ profitability and cash flow management.

The costs and the month-to-month fluctuation in the costs to be incurred by market participants cannot be assessed from the design documents. The documents devote some space to the potential size of the proposed Deviation Charges, which are imposed to encourage improved forecasting and scheduling, but significantly less space to estimating the cost and level of variation in the Market Operator Service, the Contingency Gas service and the Market Fees, including the allocations of surpluses and shortfalls to participants.

As an example, design decisions exclude certain pipelines from providing Market Operator Services, and in the process, potentially reducing the number of possible providers and contributing to higher than expected costs when the services are tendered. As the initial market for ancillary services to the electricity market showed, the introduction of a market for these services does not guarantee a reduction in participant costs.

Risk mitigation

Finally, despite assertions that the design will introduce a market for pipeline capacity at the New South Wales and South Australian city gates, it is more likely that market participants’ incentives to contract for firm transportation will be reduced, in the short term.

For traditional market participants, with relatively low margins and predictable
loads, the designers’ view is that
uncertainty in the cost of gas at the hub will be sufficient to encourage those participants to continue their traditional risk mitigation practices, contracting for gas and transportation. For newer market participants, with different risk/reward tradeoffs, this is unlikely to be the case.

Accommodating a changing market

Embedding the market regulations and procedures in legislation, as is currently proposed, restricts the ability to refine the design post-implementation.

To date, testing of the design has been restricted to proving the underlying algorithms and re-running a limited selection of scheduled and actual behaviours from the existing balancing markets, on the assumption that the changed market structure results in no systematic behavioural changes.

With changing market participation and further participation from the gas-fired generation sector anticipated over time, market participants need to consider the robustness of the current proposals against the original design intentions.

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