On risk and reward
The two best headlines from energy 2024
As the end of the year approaches quickly (and I haven’t written anything in ages), I’d like to publish a double header of what may be my two favourite, completely unrelated, headlines from energy this year (TBM Florence excluded).
As always, the comments are wide open and we want to hear what your favourite energy headlines for 2024 were.
Risk and reward in ESG-deprived assets
Rule changes in the NEM are a curious thing. For the most part they’re exceedingly dry — a proponent, usually an existing market participant, writes up a proposal to change some aspect of the National Electricity Rules (or Retail or Gas Rules); the AEMC reviews the merit of the application, seeks stakeholder input and then drafts a rule change that’s typically roughly in line with the original proposal.
Occasionally these proposals generate controversy or face widespread opposition from the industry and the projects drag out for extended periods of time as various interest groups fight it out ** ahem **. Sometimes rule changes are considered unmerited, or so controversial that they fail to gather the support of the industry and die on the table, never realising their destiny as another arcane numbered clause in the legalese of the NER.
At the beginning of October, a rule change proposal slid across the desk of the AEMC with a Post-it note that said “Hey, can you guys look at this real quick? Should be an easy one.”
Delta Electricity, the owner of Vales Point power station, a two unit 1,320 MW coal-fired power station on Lake Macquarie south of Newcastle in NSW, was the proponent of the rule change. The proposal itself is short — just 4 pages long, and Delta sought an outcome within 6 weeks.1
What’s it about?
Under the current NER, market participants require an Australian bank guarantee to provide credit support. Delta is seeking to change the rules to allow cash to be posted as credit support. Sounds simple.
When the NEM was designed in the 1990s the bank guarantee was one of the protective measures chosen to ensure that a participant’s (typically a retailer’s) bad debt couldn’t bring the broader market down.
Delta’s argument is that it is a solvent and successful business which has enough cash on hand to ensure that it could meet prudential requirements without going through the process of a bank guarantee.
Why now, 25 years after the start of the market?
Because in 2023 Delta’s existing lender advised them that they would be revoking their line of credit. Delta went to market and sought a new credit facility, and, according to the rule change proposal, no less than 15 Australian banks refused to do business with them, 13 of those on ESG (environmental, sustainability and governance) grounds. Spicy.
The background around this decision is relevant — unlike the other coal-fired stations in the NEM, Vales Point is the only asset under Delta’s control. It has not diversified its portfolio to include any other types of generation.
Furthermore, in 2022 Delta was sold to Sev.en, a Czech private equity firm which specialises in “higher risk opportunities offering strong risk-adjusted returns”. Sev.en’s investment strategy has also been described as investing in “ESG-deprived assets”, which is a cute way of saying that Sev.en exclusively invests in the stuff no one else wants to touch — coal mines, coal- and gas-fired power plants. Yummy.
Sev.en’s entire gambit is that there is still fuckloads of money to be made in burning fossil fuels, world be damned. They can maximise the private benefits to their investors and socialise the costs of climate change and environmental damage to everyone else.
So, with this additional context, it’s not massively surprising that major banks, with their own shareholders and ESG objectives, would wrinkle their noses at continuing to support Delta with a line of credit. Unlike the rest of the coal-fired station owners in the NEM, the company doesn’t even so much as pretend to give a shit about climate change. Their entire environmental policy fits on one page and climate change gets a single, paltry bullet point.
Well, well, well if it isn’t the consequences of my own actions
You might say, so what? — Delta is playing within the market rules; operating a coal-fired station is hardly illegal and indeed neither the NEM and or NSW is in a position to lose 1.3 GW of coal-fired generation right before a hot summer.
But this rule change is funny to me because Sev.en specifically invests in “higher risk opportunities”. And this is the risk — people don’t want to lend you money.2 And if you fuck around enough, eventually you will find out.
An industry peer suggested that this is concerning precedent. For example a future market participant who wanted to exclusively operate a fleet of gas peakers or liquid fuel generators in the NEM, would be unlikely to get bank guarantees and thus unable to participate.
And sure I take the point, but part of the story here has to be just how egregious Delta’s commitment to not having any kind of ESG policy is. Like surely one outcome of a year’s worth of negotiations with over a dozen banks was “draft an ESG policy that doesn’t look like the intern wrote it on an RSL coaster and we’ll provide you a bank guarantee”.
Going forward, there seem a few potential outcomes:
The AEMC rolls over and allows Delta to use cash (with AEMO becoming the financial intermediary), agreeing that the prudential risk profile is low.
The AEMC removes the requirement that bank guarantees must come from Australian banks.
The AEMC makes an exemption, or short term variation, allowing Delta to survive the early part of 2025 with cash, but with the intention that they must continue to negotiate with lenders to get a bank guarantee in the longer term (and you know, maybe work on fleshing out that beer coaster).
The AEMC maintains the bank guarantee requirements for market customers (loads, where the credit risk sits), but allows generators (which have a materially less risky prudential profile) to post cash. This would likely force Delta to divest their load portfolio but continue to operate Vales Point.
The lefty pinko Labor-Greens alliance forces Delta to divest Vales Point and the NSW government (Labor, classic) takes ownership. While the exact legal mechanics of such a manoeuvre aren’t clear, I expect to see energy experts like Peta Credlin and Ralph Babet talking about this option.
What started as a very particular problem for a company with a lot of coal and not a lot of ESG documentation, has opened up something of a sore point within the industry.
A significant number of respondents made submissions highlighting that bank guarantees are problematic for several reasons, not least of which they can only be provided by a small handful of large Australian financial institutes. This was particularly the line of arguing from some of the smaller retailers, which is obviously rooted in competition and bureaucratic concerns but is also ironic because they’re a core reason the bank guarantee exists.
Anyway, regardless of how amusing I find the circumstances of this rule change (or the fact that there are genuine reasons for allowing cash to be used by a broader range of market participants), the AEMC is pragmatic and will end up changing something in order to allow Delta to continue operating Vales Point, especially this close to summer.
Fake Demand Response
This story occurred back in February, but I completely missed it. It is however extremely. our. shit.3
Unlike the NEM, most liberalised electricity markets are capacity markets — generators can receive payments based on the generation capacity of plant, (largely) independent of the delivery of that energy. Capacity markets are designed around ensuring system reliability — the capacity is procured based on the expected peak demands during summer (or winter).
This capacity is usually procured via annual auctions several years in advance (allowing participants time to build new plant), and in many markets, particularly the North American ones, allows demand response to participate — instead of generating electricity to meet the system peaks, customers can curtail load to reduce the severity of these peaks.
Relevant to this story, a very common business model of aggregation has developed — an intermediary business bundles together potentially large numbers of customers, determines how much demand response capability there is, and bids large numbers of MW (or even GW) into the capacity auction.
Although the demand response is physically provided by hundreds or thousands of customers, the aggregator is on the hook for the whole mechanics of the deal — ensuring individual customers actually respond, negotiating the commercials on both sides and dealing with the piles of paperwork from the system operator. They of course clip the ticket for all this, something in the order of 30-70% of the value of the deal.
The last piece of the puzzle are the tests to demonstrate portfolio capacity – the implementation varies significantly, but generally aggregators must be able to demonstrate that they are able to provide the capacity that they’re getting paid for. Usually this is done via real tests of the portfolio, but apparently in some markets you can get away with ‘mock data’…
Ketchup Caddy LLC pivots
I’ve don’t know how or why, but I’ve seen this video previously, in what I’m sure was a context unrelated to this story. I might be a little too online.
So, it turns out that maybe you just don’t need to bother yourself with any of that?
A man called Philip Mango (real name), the CEO of Texan company Ketchup Caddy LLC (real company, see video above) had lunch with an employee of a demand response aggregator and learned some basics about the capacity auctions of the Midcontinent Independent System Operator (MISO).4
Trawling through his wife’s YouTube account, it’s clear he and his wife are willing to get involved in any pyramid scheme on that grindset, and so Mango spoke to a computer programmer buddy of his and asked him to write a script which would scrape an electricity retailer website for customer data (CDR eat your heart out).
He explained to his buddy that using this data, he was going to approach these customers and offer them a 100/0% split — he would take 100% of the capacity market profits for their demand response and they would receive “green credits” (lol).
Except, he didn’t even do that. Because of the short time required to meet the capacity auction deadline that year he never contacted a single customer.5
Instead he took of all those details, and just registered them as a demand response portfolio. How much demand response were these customers able to provide? Ketchup Caddy LLC cleared 886.6 MW in the 2019, 2020 and 2021 capacity auctions for a total revenue of $1,013,004!? Holy shit, that is some good value capacity!
This is obviously fraud, and after a whistleblower flagged it, the Federal Energy Regulatory Commission (FERC) issued a show cause notice in February 2024 seeking $26.5 million in civil penalties.
Other than this story being utterly insane, I have precisely three thoughts:
Whyyyyy did MISO not do real portfolio tests? How does one just casually register close to a gigawatt of DR across over three years of capacity auctions seemingly without any questions?
If “Ketchup Caddy LLC” is not a massive red flag, then the fact that they accidentally double registered a bunch of existing DR customers (of legitimate DR portfolios) should have been! MISO picked up these double counted customers, but just struck them from the portfolio and asked no further questions?
It’s honestly damning that the main concern of the civil action by the FERC is the $17.6 million of additional revenue Mango diddled from legitimate DR aggregators, rather than you know, actual system reliability concerns! Not only is this an ironic indictment on privatised electricity markets, but Ketchup Caddy LLC’s clearing prices probably also should have been a huge red flag to MISO.
Perhaps best of all, we know this story because Phil Mango was openly candid to investigators in a manner best described as “rural Amway-dealing Sam Bankman-Fried”.
Anyway, I wish him the best of luck in whatever money making scheme the Mangos embark on next, after the chapter 11.
Also, if Ketchup Caddy LLC survives, there’s might need to expand dipping sauces:
‘Expedited’ rule changes can be progressed much more rapidly than the standard process if they are considered non-controversial. The expedited request was knocked back, and the rule change is being progressed under a normal timeframe.
Also fucking over the earth, but that’s not technically your risk.
Matt Levine of course covered it, in an excellent and amusing post in is his superb newsletter.
It’s worth pointing out here that a small section of eastern Texas is not in ERCOT, and is instead covered by MISO.
Reading between the lines, it’s not even clear that the stolen scraped customer data included contact information.