Alternative Contract Design: Analysing the Bankability of Fungible Derivative Contracts in Energy‐Only Markets

ABSTRACT With the retirement of 21GW of legacy coal fleet looming, the task to replace Australia's thermal capacity with alternative firmed renewable ‘bulk energy’ solutions is non‐trivial. Indeed, calibrating necessary capital investment in new plant stock with efficient economic outcomes, vis‐à‐vis cost and reliability, represents a fundamental challenge to the ‘dynamic efficiency’ ideal for energy‐only markets. Recently, a major review of Australia's National Electricity Market (NEM) has proposed that underwriting of new energy generation utilise fungible derivative contracts instead of the canonical run‐of‐plant (RoP) revenue contract design. The proposition is based upon re‐linking medium‐ and long‐term energy markets, while mitigating some of the worst externalities attributed to off‐market underwriting policies when implemented at‐scale. However, sound economic theory can collide with applied corporate finance in practice. The very basis of the RoP design has been to address the needs of capital markets vis‐à‐vis revenue quality for new‐entrant plant, making bankability a threshold issue for contract viability. This article examines a set of proposed fungible contract designs, leveraging 100 years of synthetic, stochastic market data to draw conclusions on the compatibility of contract fungibility and bankability. Findings indicate that eliminating incentive incompatibilities between plant dispatch and market signals (which are inherent in the RoP design) appears adequate to counteract ‘shape’ risk—both idiosyncratic and systematic—within the confines of a typical project finance structure. In other words, bankability and fungibility do not appear to be mutually exclusive.