Turkey: A Way To Avoid Unstable Electricity Market Prices In Turkey: Risk Sharing Contracts

Last Updated: 16 March 2015
Article by Safak Herdem

Following the privatization of energy market in Turkey, in last 10 years, many big investors have lined up to obtain energy generation, distribution, wholesale and retail-sale licenses in order to make investments in energy sector due to its high profit potential. Statically proven that according to Fortune magazine's top 500 companies in Turkey; 6 of top 10 companies are conducting operations in energy sector. It is surely a reasonable market to invest; however market privatization is still in maturity stage that leads very dynamic and surprising market prices causing low budget companies to go bankruptcy.

In order to minimize the risks of big losses; companies have started to sign financial contracts (or RISK SHARING CONTRACTS) in order to minimize the influence of unforeseen market prices.

Risks of energy trading contracts

Energy companies are binding themselves by making energy trading contracts and entering into obligation to provide the amount of energy in the date and time specified in signed contracts. Chancily, the market clearing price of electricity at that time may be much more than they estimated. In this scenario, companies must buy that high priced electricity in order to fulfill their contractual obligations at a loss. This is always risky for companies, unless they make true estimations over the price.

The key point of being successful on the market is to foresee the future energy price, which can be affected by climatic differences, meteorology, financial and political improvements of the State. Especially in Turkey, Energy market price fluctuations cause companies to suffer big losses.

Purposes and general features of the financial risk sharing contract

In order to avoid these losses, companies have commenced to sign risk sharing contracts over the unexpected tradeoff prices. Main idea behind the financial risk sharing contract is simply to estimate future market clearing price (hourly electricity tradeoff price announced by EPIAS) of electricityin daily basis and to make a simple bet over this price.

Companies signing a financial contract are setting down a reference price for the future. One of the contractual companies foresees the market clearing price above the reference price, while the other company claims the price will be lower than the reference price.

It works very simply, for example, if themarket clearingpriceis above the reference price, Company A shall pay the exceeded amount to the Company B; on contrary in case of the reference price being lower than the monthly tradeoff price, Company A shall pay the difference to Company B.

It should be pointed out that financial risk sharing contracts do not include a physical delivery of electricity. It is just an estimation of the future electricity price as is in the stock market.

How does it serve for financial stabilization?

In order to minimize the loss of a trading transaction, financial contract option is always there for service. It would be useful to explain it in an example.

Given that Company A signsa trading contractto sell 5MWh of electricity to Company B for 6 months and also signsa financial contract with Company C for 6 months over the reference price of 150,00TL.

When the market clearing price for the next 6 months islower than 150,00 TL (Turkish Lira)for each KWh, Company A will make a profit from the trading contact while it is selling 5MWh of total electricity to Company B during 6 months.

Let's assume that Company A would make a financial contract with Company C on this provision: ''Company A is entitled to obtain the difference amount if the tradeoff price (market clearing price) exceeds the limit of 150,00 TL''.

In the scenario, given that after 3 months energy price rise up to 160,00 TL and Company A inevitably makes a purchase from that price at a loss to deliver that amount of electricity to Company B. On the other hand, it makes a profit from the financial contract signed with Company C. Here we can see that Company A wins and losses at the same time either the price is above or below 150,00TL/KWh.

By any chance, if the tradeoff price of the Market is more than 150,00TL per KWh, Company A will get a loss from the trading contract but it makes profit according to financial contract.Simply saying that, Company A can compensate its far amount of loss arising from the trading contract with Company B. On the other hand, if the price is determined lower than 150,00TL; Company A would make a profit from the trading contract, but it would make a loss via financial contract.

These two transactions gently lower the profits and losses at the same time, and would serve as a financial stabilization in favor of Company A.

Financial contracts will have an essential role in the near future. Thus, even now, it is playing a big role for cover big losses arising from bilateral trading contracts.

As far as we know, in conjunction with the assignment of EPİAŞ board of management, establishment of a new energy exchange market has been hellaciously speed up. One of the main goals of the new market is to direct investors to make financial agreements in EPİAŞ system, instead of making bilateral energy trading contracts that include physical delivery and acceptance of electricity. These developments aim to provide a stabilization and reliability in the energy market just like the stock market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Safak Herdem
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