Introduction and regulatory context
In setting tariffs Power NI must abide by various conditions of its licence, particularly those in relation to its Regulated customer base with regard to controlling its prices and preventing undue discrimination between customers or cross-subsidy.
Under its price control Power NI is permitted to recover an amount equal to its wholesale generation, transmission costs, distribution costs, renewable obligation costs, and any correction factor for amounts outstanding from previous years plus an allowed revenue for the supply business itself. Since it is able to recover expenditure on hedging contracts as part of its wholesale generation costs it is required to specify its policy for purchasing such hedges in advance in this hedging policy statement.
Power NI’s objectives in purchasing hedges against the risks of its wholesale electricity purchases are to acquire electricity at the best effective price reasonably obtainable having regard to the sources available.
Power NI interprets the best effective price to be that which best furthers its customers’ long term interests in respect of price, price stability and the security of supply. Power NI will use its judgement in balancing the price stability objective against the low price objective as it is almost always, in the long term, more expensive to hedge prices than to pass through market prices directly to customers.
In assessing its portfolio Power NI will use its best endeavours to be hedged to an optimal level in respect of the customers’ long term interest and customer demand associated with fixed price tariffs, subject to hedges being available, suitable and economic.
The assessment of hedging purchases will involve consideration of their impact on the likely level and variability of final prices to customers. It may also include longer term considerations relating to the future security, reliability and diversity of sources of electricity available for purchase.
In deciding whether a hedge should be purchased Power NI will need to consider the impact on both the likely price and its variability.
- If a hedge both lowers the expected price and reduces variability it is likely to be an efficient purchase unless there is an available alternative product that does so to a greater extent.
- Similarly, if a hedge reduces variability without affecting the expected price it is likely to be an efficient purchase unless there is a superior product available.
- If a hedge raises the expected price but reduces variability, Power NI will need to take a view on the relative values of those impacts. In doing so it will be guided by its view of its customers’ preferences.
In assessing the likely price level, Power NI will model the cost of wholesale purchases, hedge costs and other costs in the circumstances of one or more sets of customer demand and wholesale price projections. In assessing the variability of the price level, Power NI will consider the likely variability in customer demand, including in response to weather variation, and of generation purchase, hedging and other costs, including in response to variations in wholesale prices, fuel prices, exchange rates and customer demand. Its calculations will be based on its evaluation of projections of pool prices and on models of demand and of risk, both of which will be transparent to UR.
In assessing whether a hedge should be secured for its regulated customer base, Power NI will take into consideration an assessment of the extent to which the price level, economic conditions and competitive activity may potentially affect the level of forecast customer demand. In hedging costs related to a given tariff year, Power NI is conscious of both the current lack of sophistication of products and also the limited volumes of hedges available to do so. It will not be possible to hedge its generation purchases completely, even if it were otherwise sensible to do so.
Hedges may be obtained in a currency other than Sterling. This would result in a currency exposure between the currency denomination of the hedging instrument and that of the hedged item (Sterling wholesale cost). Where Power NI is exposed to currency risk it may hedge some or all of the associated exposure using an appropriate financial instrument.
Sources and governance
In order to obtain hedges Power NI will assess the directed contracts (DCs) available to it, participate in non-directed contract (NDC) and Public Service Obligation (PSO) seller led auctions arranged by ESBPG, PPB or other potential sellers, consider Moyle/ East West auction capacity and associated GB market purchases or sales and investigate purchases or sales resulting from other bilateral negotiation, competitive tenders or by participating in any bulletin board or over the counter (OTC) arrangements during the tariff year. In addition it will assess its contracted deminimis generation and will consider the possibility of obtaining: long term hedges to provide a degree of price stability over a period of more than a year if they become available; and also, any other product which may act as a hedge against price or volume risk.
With the exception of purchases through the DC and NDC processes, Power NI will not procure, on behalf of Regulated Customers, bilateral contracts from affiliates without the prior approval of UR.
Procurement activities and decisions taken will be auditable to provide assurance of compliance with economic purchasing obligations. They will be undertaken according to procedures notified to UR and supervised by Power NI’s Risk Committee. Power NI will manage risk by assessing the Value at Risk (VaR). VaR will be calculated using a model that compares purchase costs under a range of price scenarios. Total VaR will be monitored by the Risk Committee, who will receive reports showing the total value at risk and the contract levels supporting their objectives, and will direct hedging activities. Hedging will be procured to reduce the VaR and this will be kept under review as market conditions are revealed. A factor likely to affect the value of the target is that Power NI considers that in-year tariff adjustment is likely to be required if the forecast discrepancy between revenues and costs assigned to a tariff exceeds 2.5%.
Power NI will report to UR the hedging purchases and sales it has made on behalf of its regulated customer base (including those relating to currency) with respect to any time period both in advance, when tariffs are set, and after the event. If Power NI were to transfer any hedges between its regulated and deregulated market, the transfer would be made in accordance with the transfer procedure agreed with UR.