Swaps, caps, futures and hedge accounting

In a simplified fixed-price buyer swap, the buyer receives the floating spot price and pays the fixed strike on the agreed hedge quantity. Its net receipt is hedge MWh × (spot − strike). A negative receipt means the buyer pays the swap counterparty.

For 100 MWh of load, an 80 MWh swap, spot $180/MWh and strike $70/MWh, the physical purchase costs $18,000. The swap pays the buyer $8,800. Net energy cost is $9,200, before other charges. Cross-check it as 80 × $70 plus 20 × $180.

Repeat at spot $40/MWh: the physical purchase is $4,000 and the swap receipt is −$2,400. The buyer pays $2,400, so net cost is $6,400. The hedge is not defective because it pays out when spot falls; fixing a price gives up some benefit from lower spot prices.

For a simplified cap buyer, the interval payoff is hedge MWh × max(spot − strike, 0). The buyer pays for this protection through the agreed premium or pricing arrangement. Unlike a swap, a cap's intrinsic interval payoff does not become negative when spot is below the strike.

At spot $500/MWh and strike $300/MWh, a 20 MWh cap has a $4,000 intrinsic payoff. At spot $100/MWh it has zero intrinsic payoff. Neither figure is the net economic profit: premium, timing, fees and physical exposure still matter.

A cap can protect against a specified high-price exposure while leaving ordinary spot variation uncovered. Compare instruments against the objective and exposure; there is no universally best hedge.

ASX electricity derivatives include cash-settled products with specified regions and time profiles. Read the exact product specification rather than assuming all electricity contracts cover every hour. Cash settlement is a financial outcome, not physical delivery of electricity to a site.

In a synthetic flat-quantity example, 1 MW across 24 hours corresponds to 24 MWh. Over a stated 90-day, 24-hour-per-day block it is 2,160 MWh. A business with 1 MW average consumption can still have a different interval shape from that block.

For any actual contract, verify region, profile, contract period, settlement convention and clearing obligations. The June 2025 fact sheet linked here is a dated learning reference; check the current specification before professional use.

• ASX — Australian electricity derivatives, June 2025

Volume risk remains when actual consumption differs from the hedge. Shape risk remains when load and contract profiles differ. Regional or other basis risk remains when the contract reference price differs from the economic price of the exposure. Credit and liquidity risks concern the counterparty and the cash needed to maintain the position.

Use a two-interval stress test. Keep total daily energy unchanged but move consumption from a low-price interval into a high-price interval. If the hedge quantity does not move with it, the net cost changes. This exposes a weakness that an annual-average spreadsheet can conceal.

Also test a plant outage, delayed customer demand, a negative-price interval and an increase in collateral needs. Report gross cash requirements as well as final net value; a position that reduces long-term price risk can still create short-term funding pressure.

Write a short hedge recommendation with the exposure, objective, alternatives, proposed limits, cash-flow stress and residual risks. Include who can approve, execute, independently confirm and reconcile the contract. Avoid placing all those responsibilities with the same individual.

Hedge accounting is a separate reporting question, not a label earned by having an economic hedge. Documentation, eligibility, designation and measurement need the applicable accounting standard and professional review. This workbook does not certify an accounting treatment.

Your final exercise is to reconcile the high-spot and low-spot examples, then explain why the remaining 20 MWh and any region or timing mismatch still matter. Continue to Topic 24 for portfolio risk and Topic 47 for an investment-committee decision paper.