Risk, Discipline and the Evolution of Trading & Origination with Domenico De Luca of Axpo

Welcome to the PEPS part podcast. Every two weeks we'll be bringing you fresh updates and insights on the renewable energy market along with a guest who'll share unique perspectives on the critical trends shaping our industry. Welcome back to the PEPS part podcast episode 29. I'm your host Luca Pedrati. In this episode I'm joined by Domenico de Luca, the long-standing head of trading and sales at Oxbow and Member of the Oxbow Executive Board. We look back at how trading and origination have evolved, what has stayed the same and why the fundamentals of risk management still anchor the business today. Domenico reflects on Expo's global expansion, the rise of renewables and storage, the limit of today's markets and the structural questions facing Europe as conventional assets retire. But before we jump into the conversation, let's take a quick look at what's been moving the markets in deals, prices, regulation and the broader renewable energy space. As always, this is mostly me suggesting what the PEPS part team has been reporting over the past two weeks. Today we're going to talk about some regulatory developments in the world's most interesting power markets. That's for me personally, ERCAD in Texas and Germany. First, Texas. ERCAD is preparing to launch the most significant market reform since nodal pricing began more than a decade ago. On the 5th of December, I'm recording this by the way, on December 4th, on the 5th of December, the system will have been moved to real-time co-optimization with integrated storage participation. This has been like six years in the making and it marks a decisive step toward a more efficient and flexible grid. The principle behind the reform is fairly simple and familiar, so the idea is that the lowest cost resources are dispatched at every interval and assets are rewarded that can provide value precisely when the system needs it. With real-time co-optimization, ERCAD will schedule energy and auxiliary service together every five minutes. This replaces the older day ahead approach where ancillary needs were forecasted rather than observed, often leading to inflated prices and inefficient outcomes. The intention is hands to address those known long-standing issues. By reallocating ancillary service to more expensive generators and freeing efficient units to run for energy, the system should make better use of the existing fleet. ERCAD estimates that annual consumer savings should be between two and six billion dollars, of course, and the opposite question is, are these lower revenues for batteries and operators? We will see. It will also retire the old scarcity adder, the so-called ORDC, which in the past year was the driver of very short price spikes. For long-term contracts, this has also meaningful implications. A more efficient market will generally deliver fewer scarcity hours and more stable clearing prices, at least in theory. So, forward curfews may still be catching up. As of late November, our composite 10-year solar PPA in ERCAD price just on the $49, which is over 15% up year-on-year. That suggests that expected dampening effect of the RTC plus storage is not yet fully reflected in valuations. For storage, the reform is equally important. ERCAD will now treat storage as a single continuous resource rather than splitting it into a generator and the load as it used to previously. This unlocks the full flexibility of those best units and it will allow them to participate much more naturally across and silery products. Overall, this is a new discipline. ERCAD will incorporate the state of charge as well directly into its awards. So, batteries will need to prove they have enough charge to meet all obligations they commit to, which may limit more extensive stacking. Again, this is a return to fundamentals. Provide the service you promise and keep the system stable. Again, on the savings, ERCAD leadership expects over a billion dollars directly in annual wholesale market saving once the system is fully implemented. More importantly, it signals that the grid is now entering a new phase and where efficiency, flexibility, and asset participation shape the market in real time, going to be excited to see how this turns out. Now, a quick look at Germany and what is happening there noted one regulatory shift where it is all about how flexibility again is treated on the grid and the recent move from the regulator could reshape the economics of storage for years to come. So, the Bundesnet's organ tour, the regulator has published, I think, end of last month's its first conclusion on the overhaul of grid fees and also here, message very clear. The country wants to move toward more flexible, incentive driven framework that rewards assets which support the grid and charges those that intensify congestion. Now, for storage, this matters hugely as under today's rule. Storage projects can avoid grid fees if they come online before 2029. After that, this exemption disappears and in the new model, there will be a simple principle which comes straight out of the traditional system thinking, if an asset makes congestion worse it pays, if it helps, helps to relieve congestion in earn, it earns. In practice, this means symmetric dynamic grid fees that can swing either positive or negative, demanding on how the battery dispatches. So, the regulator has not yet decided whether net payments to asset owners will be permitted, but overall the direction seems clear. It wants to create real incentive to operate in a way that the system operates in a way that the network is stabilized. Deals and prices and today I have not set out to talk about specific deals or price developments as in the previous episodes, but as you're nearing soon the end of the year, I wanted to wrap up a bit and look at the bigger picture. Namely, as we see those shifts as they are unfolding in European's power markets and how they impact the renewable business. Now, for years, the story around renewables felt almost effortless. This is maybe a strong word, but it was a very clear business model, cost dropped, built out, increased, and the revenues you were able to contract helped strong, steady, and especially long-term enough to keep landers comfortable, and wind and solar overall behaved almost like classic infrastructure bond like. Now, since, let's say, May 2024, this chapter really looks like it has been closing or winding down, at least in Europe, we have moved from scarcity to abundance in terms of renewable supply. And with a done abundance, always the rules change, of course. We are seeing more negative hours, lower capture rates, higher imbalance cost, and the steady rise in curtailments, nothing new for your listeners of this podcast, almost an evergreen on our episodes. Now, what matters is that the off-take market actually sell this coming. So, for the subscribers of Paxel Park, when you look at our curves, they have been anticipating this because they're based on actual prices from operators on the bit and the ask side when we ask, "Hey, what would you pay today for this future production?" And as a risk taker, of course, you need to think about this. It's not just a scenario, but you need to think, "What would you commit to that?" And hence, you have a huge incentive as a huge incentive to think about those problems. So, when we look actually at so-called pay-as-produced curves, so what could be the capture value, those discounts widened long before realized revenues collapsed. So, the signal was there, long before the actual cash flows hit. We had the clearest examples in Spain, Germany, and the Nordics. In Spain, solar capture fell sharply this spring, and curtailment search in places like Extremadura, where grid protection protocols kick in. In Germany, we have a solar fleet which faced similar strain, whereas in the Nordics, it was all about wind and the associated wind PPAs. Now, all of those issues and strains are not really a failure of renewables. It is, in the end, a natural consequence of the scale of the overall renewable penetration in the system. But, it is exposing finite structures that were designed for a different market and different expectation, regardless of what the price signals at the closing were saying. So, that service, coverage ratios are compressing, far faster than expected, and this is creating a real covenant crunch all across Europe. A big part of the pressure comes from contracts that were not written for today's realities. So, many pre-2022 PPAs never defined what happens during negative price hours. What look bankable at signing is now creating cash flow gaps exactly at the wrong time. And, as a result, we are seeing more wafers, resets, and renegotiations happening across entire portfolios. How are owners responding with two moves? First, they are adjusting PPAs for negative prices. This includes partial payment structure, shared risk collars, and clauses that carve out negative hours from settlement. In Spain, PPAs that exclude payment during negative hours have seen price uplifts of almost 9%. Italy and France follow with lower, but still meaningful uplifts as well. Secondly, owners are reshaping exposure. So, the old mindset that base load hatches were always toxic is fading. I must say fading again. As in today's environment, selective unwinds and short-term hatches can actually stabilize depth service coverage ratios and preserve solvency while the system rebalance. The differentiator is no longer the forecast, which was made at the final investment decision two, three, four years ago. It is actually the ability to actively manage risk when the forecast proves wrong. In many cases, what we still see is that we first have to convince that a hatch or an unwind can be done even though the curve is different than it was at a final investment decision. And this is really holding back sensible risk management decisions. So, what is going to help flexibility in storage will help, but they will not solve the problem in time, let's say in the period from now to 2028. New storage capacity is still one, I have three years away from truly improving capture rates at scale. So, while the priority is right now to build this flexibility as an asset owner, you are still on the task to bridge the face until this capacity is online. And here's the good news. Demand will rise for power thanks to electrification. Storage is coming in and it's coming in force, contracting and revenue management will mature and eventually also cost will further adjust thanks to progress and scale as we have been seeing over the last years. We believe what we are living through now is really a temporary imbalance. So, we're seeing all those things negative prices, curtailments, lower capture rates, these are temporary things which are related of course to the penetration in mass of renewable energy in markets. And those markets I will find a new equilibrium and what is, we also look at the longer term or medium term in the end solar and wind together with storage, they remain the cheapest form of electricity production we have and also the fastest to realize. So, with that comes of course a responsibility as an asset owner a responsibility to manage these assets wisely so that this transition remains not only green but as well financially sound but I have no doubt that we're actually on the right track and no one expected the transition to be without those wobbles. The wider energy world and to close out today's episode a quick look at the wider energy world and today it is about Gesu IPPs, my favorite kids on the block, deals and investments have to be done by someone, revenues have to be managed by someone and we love what IPPs do in this field. We believe and we see day to day that the next generation of IPPs will not win by simply building more megawatts, they will win by managing revenue with discipline, by understanding exposure, by being able to shape, firm and manage supply as requested by the grid and their prospective clients. This is at the heart of our new paper the next gen IPP playbook. It captures what owners need to navigate the years ahead when price volatility is accepted as normal and flexibility defines value. If you want a sense of where the IPP sector is heading this playbook shows how the most resilient and forward leaning IPPs will operate or are in actually operating already. Based on eight executive interviews we did but basically as well the distillation of all our experience and insights from our teams working with IPPs over the last years. It is Christmas time, holidays are coming up, have a look at the paper, have a look at the interviews, link is in the show notes, we hope you will enjoy it. Welcome back to the second part of the Pexa Park podcast where I'm very happy to have with me today Domenico de Luca. Domenico de Luca is a member of the executive board of the Augsburg Group and he's heading the business area trading and sales and full disclosure first on my side. I have been a long time employee of Oxpo eight years ago so I'm very happy to have my former boss boss here. Domenico, welcome to the show. Thank you very much Luca. Thank you for inviting me. Yeah and I wanted to discuss like the evolution of trading and origination. This is where I worked. You've been in this field for such a long time but first maybe for our audience, Elisabeth who is Oxpo and how big is Oxpo nowadays? Okay so Oxpo is the largest would say in utility in Switzerland and we have hydro power plants and nuclear power plants. We have about 50% of the nuclear power plants in the country in Switzerland and we have hydro power plants 30% of of the power generation but we are also investing quite a lot into renewals in Europe mainly and and also in Oxpo we have a big let's say trading and sales activity for which I am very honored to be to be responsible for and we have grown quite a lot in the last 20 years. The activities we are currently in 32 countries we have in our business area trading sales about 2000 employees so it's probably one of the largest trading and sales organization in Europe. We are not only present in Europe we have expanded across we have expanded we are also in the United States and we have also we are starting activity I mean we have activities in Singapore we are starting activities also in Japan and and therefore we try to to to basically copy what we have learned out of Europe also to other continent and just if you were to what are the Braggowats of Oxpo when you look at I don't know a number of Gigawats on their management if you can disclose like what are some key figures for Oxpo. Well difficult because all these stickers have been you know I can I mean we we have probably about we are managing about in terms of renewable for third parties in terms of original activities we have about would say 14,000 megawatts that we are managing on behalf of the customs and this is either PPAs or just simple balancing agreements so it's quite that that's one stream of business very important but we are also managing other more conventional power plants on behalf of others and that's one part of the business then we have still on the customer business we are we are also very active in the full supply to large accounts to large customers and we are very glad I mean all to have under our I mean under our customers most of the blue chip companies in Europe we we basically trying to leverage also this this this is this very good relationship also to for activities in the other in the other continents and we also have developed through the years maybe when you left you you you you you this is something probably a bit more new for you because all the rest you know already but we have developed also quite a lot our retailing business so small immediately the price but also business to consumer activities and we are now about we have about one million 700,000 PODs this is many Europe I would say Portugal Spain Italy Poland Poland I think you know very well and this has been a business growing actually quite a lot and this also a business in which we would like to grow further in the in the coming in the coming years and this is peculiar I think is not what other companies are doing so I think we like this kind of that little integration between our original activities all large accounts and all those small accounts and our training activities to in our opinion to fit this fits very well yeah so I just said so eight years ago I left origination desk at Oxford and it was eight ten years before if you were to look back and say hey what are the real big changes now really specifically trading origination what has really changed from the extra point of view I think we we have changes which are structural to the market of course the penetration of renewable has changed the market in a way so we we have moved definitely in the past I would say the most traded market was was in the forward right in the forward year I had or two years I had three years I had I think the balancing and the very short term markets were more the remit of the small the utilities which had flexible power plants to do that I think we see more and more competition in those markets those markets become more and more relevant because the volatility and the because of the stochastic nature of the power and the renewable penetration so we have more and more interest in this in this area so if you want a bit of the interest moved from the very long term to short term and in the short term you have a lot of also new actors coming you know demand management small aggregators so it makes them the market much more interesting you know because you have new players it was the same when the renewable came basically in Europe we had a lot of new players a lot of new customers a lot of new businesses coming into otherwise a very static industry and this is this is good for the market is also fun I would say not for everybody which is which is in the market and what is driving you mentioned like this vertical integration that you see opportunity moving to for example retail well it's not the idea that you know we have us and we need to match with the short term retailing I don't think is so much that the idea this is has been potentially the strategy of some utilities in the past that's not too much the point but the point is that we we think that certain synergies certain expertise that we have developed through the years I'm mainly referring to risk management this technique can be very well deployed also serving smaller customers at the end of the day you need to manage a portfolio and you you need to buy the best the best moment you need to manage a full portfolio so I think in this in this activity there is a value that can be captured and a service that you can do to to our to to your customers also the kind of product that you are that you are that you can offer to to to this is more customers I mean you can be innovative right I think because you can you know bring index product or index product with certain feature that are not usually done by by other by other retailers more classic retailers because I think the classic retailers are very good very strong in terms of you know having potentially economy of scale or very good in marketing but I think once we also had to learn a lot on this on this aspect on the aspects of marketing is something a bit new for us but the on the other side we bring so much value on the risk management side which which I think opens a bit for us for us for us a new opportunity and there is also a process of consolidation in certain markets about about this I mean for for also for many retailers after the crisis that we have witnessed two three years ago the cost of being in the market is rise so so the you have you know you the you know the guarantees to the the market access is more expensive and this all of course opens then the door to to to someone with a good balance sheet with a strong balance sheet like expo you know to to be able to to capture certain opportunities I would say like that maybe a very specific question on retailer or the retailing business is like diminishing liquidity on forward markets a driver potentially to be interested in acquiring retail portfolios I don't think so because I think that the I mean I think you know at the the there is some reduction of liquidity as we said on the forward market but usually the retailers needs to edge one year maximum two years ahead right because because the the because basically you you hardly find customers willing to lock in for four years five years the contract so basically basically remains he remains still a very short-term business so it's very difficult I would say you know to sell a ppa to to to you know to an independent retailer with a fixed price I mean because you know the the interest the ten or interest is different and so therefore I think I think that this is not I mean the lack of the the diminishing liquidity I don't think is is is the point I think it's the cost of doing businesses is becoming higher in my opinion and I mean after the liquidity crunch of the last two three years I think everybody has learned and the cost of being in the business is higher because most of the products that in the past were not collateralized today are collateralized by having much more collateralization that you need to post more more capital to do the same business that you were doing in the past this is a very special European topic I would say US has been always I would say super collateralized so it's a different is a different business different different different continent with a different aspect but in Europe definitely we have seen it in the past also very weak a lot of weak from financial perspective company being able to be in the business and being able to to I would say the entry barrier for certain businesses are a bit higher today maybe a different angle on the question Dominico what has not changed in trading and origination in all those years well I would say the technique to risk manage we use we use the same technique that you know so I don't I don't see I didn't see any revolution there is a bit like the kernel you know the kernel cycle you know the theory of kernel I mean there is means so there was not much improvement in the last two hundred years in terms of efficiency of the capital cycle this is for engineers but I think I think also we are refining refining but I think the major breakthrough I didn't see it I think even even the introduction of artificial artificial intelligence so machine learning is is boosting certain activities like optimization of you know better forecast of weather or the better forecast of balancing cost for certain optimization problem is is bringing something but the main the main concept of how the best way you have to manage a portfolio I don't think they have structurally changed maybe artificial intelligence can bring you to do certain things faster or is speeding up the calculation that you need to you know when you have to solve a difficult a difficult mathematical problem to optimize your portfolio then you you can have a less analytic and less precise solution with artificial intelligence but more quick and so and so we have deployed artificial intelligence in certain domain or we have deploying in certain domain not to be more precise but to be more fast in in really the way which in which you know in in some certain models that you use to to manage our to manage our portfolio I would say the the customers are always the same typology of customers the same requirement means very low price if you're selling to customers it remains always a very important element a good risk management good credit quality I would say there is a lot of things that have not that have not changed and I think also the enthusiasm of people in the organization are still I would say at good level maybe the same level as we had so many years ago so yeah maybe zooming back into renewables and storage I was just wondering okay that's I'm very biased I do only renewables so how central is this business to trading and origination at Oxford today is very important it's very important as I was mentioning we have we are honored to manage a very large portfolio and and it remains very important now there has been some changes in the last year and the changes are stemming from the the we see unfortunately a bit less merchant ppa in the market in Europe I also am referring rather for Europe and the reason is is that through the inflation through through the increased cost of components for renewable and in the last year reduced price because in the car is also in backwardation as the forward car is in backwardation and the cannibalization and then you know we can explain a bit what we understand by cannibalization the cannibalization risk is is also going up because we see basically that the market there is more penetration of renewable and then oh definitely you know you will not be able to capture the base load price but you will be able the capture price the difference between the base load price and the capture price which we call let's say simplistically cannibalization this is also going in the wrong direction right for merchant ppa so it makes this less appealing it makes the investment in renewable less interesting and and therefore we also have closed a bit we have closed less ppa in this moment but probably this is just a phase I mean because you have to go through these cycles I mean I think the word of commodity but also the word of renewable will be very cyclical we are waiting now hopefully there is a lot of projects on battery that are supposed to solve this problem right the cannibalization problem and the and the enable the once again to you know to grow once again the renewable the renewable investment the renewable investment so so I think potentially I see I see this is very difficult to say because we see a lot of projects of battery and then you don't know whether you know maybe maybe too much maybe some of these projects will be stranded will be will be not a good investment because just too much on the other side they will help the investment in renewable and therefore will allow much more ppa is to be closed on the other side this this increase on battery will allow tolling agreement for batteries I mean there is a lot of requests now for batteries to close sort of ppa I mean basically cash flow protection for for for batteries like like tolling in which in which basically to a certain level we assure the revenue the cash flow of the battery so that also the battery can be financed and can be that the equity owner can invest it's very similar actually to the renewable and for us it's perfect in a way because you know if we are not so much in the ppa business we will be on the battery business so there is complementarity and out the interplay of these two will will happen we don't know so it can be you know one will depress the other or vice versa or one will help the other so it is will be interesting but it opens opportunities which are not only ppa and and I am referring only and to the renewable space so so I think very good development we see a lot of interest in the market at the moment on batteries in many countries and and hopefully they will be able to reduce the cannibalization risk because cannibalization risk is really a tough thing right and nobody really wants to to take this risk even if banks are getting more familiar now and they accept certain certain you're remembering the past the banks didn't want to talk about you know cannibalization you know they mean they know this risk not not for us and this was no financing if if the cannibalization risk is not passed over to the off-taker right but I think now now now the market has changed banks have learned and they are willing to take a certain level but of course if this gets worse and worse in certain market you know like the very heavy penetration is it's actually usually the trend going down and down then then then basically makes it can be a problem but batteries are coming there to rescue to rescue the PPA and to rescue the renewables from this problem hopefully you know that that's the idea you know that that we are able in Europe I'm talking now mainly about Europe to really continue this energy transition successfully with the interplay between you know renewable and battery although although this will not be enough and that's that's unfortunately not enough for the energy transition to to continue that's an interesting point so what else is needed then but I think that the the the one problem that is not addressed today by batteries the battery today have only a storage of two hours four hours so they are good to shift energy from a very super peak hours in a day to lower low peak and they have very good also the ancillary services in the interday markets and in the ancillary services but I would say ancillary services in the interday markets they are very small markets they will be saturated very quickly as the experience in UK and Sweden is showing and then the raison d'être for a battery today will be to be able to move energy from the from the the the lowest price hours to the highest price hours and this is a very short term so two hours four hours as I said now the problem of Europe is that since we have less and less conventional energy conventional power plants so we have we don't have coal anymore we are very happy that we don't have coal anymore but we don't have them we have nuclear power plants have been reduced so so the the chunk of renewable is is determinant I mean the hours which are produced with renewable are very are very very important then we have some gas-fired power plants and now the the the problem is that if we have a prolonged period in which we have no wind or much less wind compared to the historical norm or less sun compared to the historical norm what the whatever reason in in in big geographic area so it's not I'm not talking about a small problem in a small area but in a big part of Europe then you know honestly the batteries are useless right because you know when you don't have the energy anymore there is nothing to store so basically and I think I I have very vivid in my mind what happened in in 21 2021 this was before the war in 2021 we had starting from from June the prices in the market in the ex the power prices in the market went from 50 to 100 euros in December 2021 there were 100 euros so they doubled and what was the reason I mean there was no war I mean the war if you remember this was in February 2022 in which there was the the mountain which Russia invaded Ukrainian but before the price went up and and the reason was that we had a very a very low wind spring in 2021 a very cold spring we had to use a lot of eating in gas from our reserve from from the storage in Europe and and we entered the autumn with very depleted storage gas storage which is actually today the only long term storage the seasonal storage I come to my point so we need and and and basically then then of course the price completely after the war and the situation it was also the concomitance of much less nuclear power power power production because the problem the TDF had at that moment so was a concomitance of several factors but definitely the weather played a very important role and and it considering the penetration of renewable that we will have in the future this problem can be can be magnified in the future so so it means that we need also some solution for a long-term storage today we have the gas the idea was to replace gas with hydrogen we know where it went hydrogen is just too expensive and just from a physical point of view too inefficient to to replace the gas so I am of the opinion that we should use all the existing infrastructure and not to you know not to impair not to let's say strand the the current infrastructure we have to use all the current infrastructure that we have and maybe potentially we will change fuel or we will find something else but but it's very important today that the gas continues to work to have this function of course gas as you know is not you know is not is not carbon free but but we should also aim at having first solving the problem of the 90% of the decarbonization and then we will take care of the last 10% because you know the first 90% is probably low-enging through it and the last 10% will cost 5 10 times to solve the problem so what I'm trying to say is that we should be not so much fundamentalist against you know any form of carbon within the system but being smart enough not to you know not to have a not to have a system which will cost a fortune at the end of the day will be the tax you know the tax payer that to take the bill so so that's that's my point but I think one point is we we miss long-term storage the gas is today filling the gap and therefore we should be less against gas that's that's my point and the gas it helps the energy transition and then we need to find a different if we want to get rid of the gas we need to solve the problem of long-term storage and this idea should come maybe from different from from other technologies to sum it up 90% renewables 10% gas very simplistic I don't know I don't know but it's just the idea it's just to put the idea and I will that yeah exactly baby the maker just to wrap up our conversation what where would you see where would you focus on in the next two three years you see any nuances in in where the business is developing well I am I'm talking more about my business area if you don't mind because there is what also I know better I think we will we will we want to continue to grow our customer-faced business as I said in several aspects or on the larger counts but also small we want to be part of continue to be a fundamental actor in the energy transition and support all the companies and the new investment which are to be made in the renewable space we want to grow in other in in other countries as I mentioned in US in Asia because I think we we have a good business model a very decentralized business model as you know as you remember which works very well and it's also very resilient if you want to to the current you know trade wars and trade geopolitical tensions you know because we really want to do the business in the countries where where we are present and we reduce to to the minimum level if you want a level of centralization this is kind of I would say makes us a bit resilient more resilient than other other companies with a different business model so that's that's definitely the plan to grow I think for instance United States is a great great opportunity for us to grow we have at the moment only a small small organization there we have about 30 people working 40 actually today but we really want to grow the business there because it's a huge market with with a lot of opportunities so this is part of part of our plan great Dominica thanks for coming to the show thanks for sharing your insights on trading and origination and to why the market thank you very much Luca thank you for listening to the Pexaport podcast if you're interested in more news data insights and analytics on the energy transition head to our website Pexaport.com to find out more